PENSON WORLDWIDE INC - FORM 10-Q - August 14, 2012

Attached files

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EX-10.8 - FINRA LETTER - PENSON WORLDWIDE INCa108-finraletter.htm
EX-32.1 - SECTION 1350 CERTIFICATION BY OUR PRINCIPAL EXECUTIVE OFFICER - PENSON WORLDWIDE INCpnsn-6302012xexhibit321.htm
EX-31.2 - RULE 13A-14(A) CERTIFICATION BY OUR PRINCIPAL FINANCIAL OFFICER - PENSON WORLDWIDE INCpnsn-6302012xexhibit312.htm
EX-32.2 - SECTION 1350 CERTIFICATION BY OUR PRINCIPAL FINANCIAL OFFICER - PENSON WORLDWIDE INCpnsn-6302012xexhibit322.htm
EX-31.1 - RULE 13A-14(A) CERTIFICATION BY OUR PRINCIPAL EXECUTIVE OFFICER - PENSON WORLDWIDE INCpnsn-6302012xexhibit311.htm
EX-10.1 - AMENDMENT OF ENGEL EXECUTIVE EMPLOYMENT AGREEMENT - PENSON WORLDWIDE INCa101-amendmentengelemploym.htm
EX-10.9 - PENDERGRAFT SEPARATION AGREEMENT - PENSON WORLDWIDE INCa109-23247735_4xpensonxsep.htm
EX-10.6 - LETTER AMENDMENT TO THE ASSET PURCHASE AGREEMENT - PENSON WORLDWIDE INCa106-ltramendmenttotheasse.htm
EX-10.3 - MCCAIN EMPLOYMENT LETTER - PENSON WORLDWIDE INCa103-23426181_1xpenxmyvmcc.htm
EX-10.5 - FORM OF RETENTION LETTER - PENSON WORLDWIDE INCa105-templateretentionlett.htm
EX-10.7 - TRANSITION SERVICES AGREEMENT - PENSON WORLDWIDE INCa107-futurestransitionserv.htm
EX-10.2 - ENGEL INCENTIVE RETENTION LETTER - PENSON WORLDWIDE INCa102-engelretentionincenti.htm
EX-10.4 - MCCAIN AMENDMENT TO EMPLOYMENT LETTER - PENSON WORLDWIDE INCa104-mccainamendmentexhibit.htm

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________
Form 10-Q
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  
For the Quarterly Period Ended June 30, 2012
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  
For the transition period from                      to                     
Commission file number. 001-32878
______________________________________________
Penson Worldwide, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
75-2896356
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
1700 Pacific Avenue, Suite 1400
Dallas, Texas
 
75201
(Zip Code)
(Address of principal executive offices)
 
(214) 765-1100
(Registrant’s telephone number, including area code)
______________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  o
Indicate by check mark whether the registrant is 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).
Large accelerated filer  o    Accelerated  filer  o    Non-accelerated filer  o    Smaller Reporting Company  þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
As of August 10, 2012, there were 28,149,076 shares of the registrant’s $.01 par value common stock outstanding.

 



Penson Worldwide, Inc.
INDEX TO FORM 10-Q
 
Item
Number
 
Page
 
1
 
 
 
 
 
2
4
 
1
1A
2
3
4
5
6
 

1

PART I. FINANCIAL INFORMATION
Item 1.    Financial Statements
Penson Worldwide, Inc.
Condensed Consolidated Statements of Financial Condition
 
 
June 30,
2012
 
December 31,
2011
 
(Unaudited)
 
 
 
(In thousands, except par values)
ASSETS
Cash and cash equivalents
$
2,805

 
$
40,293

Cash and securities — segregated under federal and other regulations
—

 
2,150,040

Receivable from broker-dealers and clearing organizations
287

 
124,739

Receivable from customers, net
3,051

 
979,897

Receivable from correspondents
64

 
74,521

Securities borrowed
—

 
544,109

Securities owned, at fair value
25,383

 
34,019

Deposits with clearing organizations
13,780

 
33,164

Property and equipment, net
5,063

 
19,328

Investment in Apex Clearing Holdings
98,086

 
—

Other assets (including assets at fair value of $7,559 at June 30, 2012 and $0 at December 31, 2011)
52,962

 
66,215

Assets held-for-sale
968,799

 
2,131,081

Total assets
$
1,170,280

 
$
6,197,406

LIABILITIES AND STOCKHOLDERS’ EQUITY
Payable to broker-dealers and clearing organizations
$
—

 
$
132,996

Payable to customers
—

 
2,832,013

Payable to correspondents
604

 
124,863

Short-term bank loans
—

 
80,800

Notes payable
248,338

 
271,302

Securities loaned
—

 
549,166

Securities sold, not yet purchased, at fair value
—

 
499

Accounts payable, accrued and other liabilities (including liabilities at fair value of $14,418 at June 30, 2012 and $0 at December 31, 2011)
50,621

 
59,566

Liabilities associated with assets held-for-sale
927,518

 
2,070,616

Total liabilities
1,227,081

 
6,121,821

Commitments and contingencies
 
 
 
STOCKHOLDERS’ EQUITY
Preferred stock, $0.01 par value, 10,000 shares authorized; none issued and outstanding as of June 30, 2012 and December 31, 2011
—

 
—

Common stock, $0.01 par value, 100,000 shares authorized; 32,932 shares issued and 28,139 outstanding as of June 30, 2012; 32,388 shares issued and 27,733 outstanding as of December 31, 2011
329

 
324

Additional paid-in capital
283,248

 
281,922

Accumulated other comprehensive income
3,918

 
3,909

Accumulated deficit
(286,445
)
 
(152,875
)
Treasury stock, at cost; 4,793 and 4,655 shares of common stock at June 30, 2012 and December 31, 2011
(57,851
)
 
(57,695
)
Total stockholders’ equity (deficit)
(56,801
)
 
75,585

Total liabilities and stockholders’ equity
$
1,170,280

 
$
6,197,406

See accompanying notes to condensed consolidated financial statements.

2

Penson Worldwide, Inc.
Condensed Consolidated Statements of Comprehensive Loss
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
 
(Unaudited)
 
 
 
(Unaudited)
 
 
 
(In thousands, except per share data)
Revenues
 
 
 
 
 
 
 
Clearing and commission fees
$
7,861

 
$
22,059

 
$
22,321

 
$
46,496

Technology
5,098

 
5,274

 
10,350

 
11,294

Interest, gross
7,766

 
23,233

 
19,283

 
45,789

Other
(1,668
)
 
7,126

 
(6,292
)
 
15,182

Total revenues
19,057

 
57,692

 
45,662

 
118,761

Interest expense from securities operations
1,623

 
6,201

 
6,083

 
12,009

Net revenues
17,434

 
51,491

 
39,579

 
106,752

Expenses
 
 
 
 
 
 
 
Employee compensation and benefits
18,941

 
15,763

 
35,784

 
33,043

Floor brokerage, exchange and clearance fees
3,233

 
8,775

 
10,675

 
17,368

Communications and data processing
12,839

 
12,780

 
27,803

 
25,594

Occupancy and equipment
3,144

 
4,428

 
6,925

 
9,379

Loss on Apex Clearing Holdings transaction
35,826

 
—

 
35,826

 
—

Gain on extinguishment of debt
(22,514
)
 
—

 
(22,514
)
 
—

Contract cease use charge
14,183

 
—

 
14,183

 
—

Bad debt expense
720

 
43,144

 
3,365

 
43,338

Other expenses
13,011

 
5,198

 
23,075

 
11,380

Interest expense on long-term debt
9,292

 
9,787

 
18,830

 
19,498

 
88,675

 
99,875

 
153,952

 
159,600

Loss from continuing operations before equity in loss in unconsolidated affiliate
(71,241
)
 
(48,384
)
 
(114,373
)
 
(52,848
)
Equity in loss in unconsolidated affiliate
(5,844
)
 
—

 
(5,844
)
 
—

Loss from continuing operations before income taxes
(77,085
)
 
(48,384
)
 
(120,217
)
 
(52,848
)
Income tax expense (benefit)
70

 
(18,947
)
 
167

 
(21,218
)
Loss from continuing operations
(77,155
)
 
(29,437
)
 
(120,384
)
 
(31,630
)
Loss from discontinued operations, net of tax of $(510), $457, $(1,220) and $974, respectively
(7,941
)
 
(732
)
 
(13,186
)
 
(1,400
)
Net loss
$
(85,096
)
 
$
(30,169
)
 
$
(133,570
)
 
$
(33,030
)
Loss per share — basic and diluted:
 
 
 
 
 
 
 
Loss per share from continuing operations
$
(2.75
)
 
$
(1.03
)
 
$
(4.30
)
 
$
(1.11
)
Loss per share from discontinued operations
$
(0.29
)
 
$
(0.03
)
 
$
(0.47
)
 
$
(0.05
)
Loss per share
$
(3.04
)
 
$
(1.06
)
 
$
(4.77
)
 
$
(1.16
)
Weighted average common shares outstanding — basic and diluted
28,035

 
28,546

 
28,005

 
28,512

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
$
(1,116
)
 
$
1,053

 
$
15

 
$
2,727

Income tax expense (benefit) related to items of other comprehensive income (loss)
(437
)
 
413

 
6

 
1,069

Other comprehensive income (loss), net of tax
(679
)
 
640

 
9

 
1,658

Comprehensive loss
$
(85,775
)
 
$
(29,529
)
 
$
(133,561
)
 
$
(31,372
)





See accompanying notes to condensed consolidated financial statements.

3

Penson Worldwide, Inc.
Condensed Consolidated Statement of Stockholders’ Equity
 
 
Preferred
Stock
 
Common Stock
 
Additional
paid-in
Capital
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income
 
Accumulated
Deficit
 
Total
Stockholders’
Equity (Deficit)
 
Shares
 
Amount
 
 
(Unaudited)
(In thousands)
Balance, December 31, 2011
$
—

 
27,733

 
$
324

 
$
281,922

 
$
(57,695
)
 
$
3,909

 
$
(152,875
)
 
$
75,585

Net loss
—

 
—

 
—

 
—

 
—

 
—

 
(133,570
)
 
(133,570
)
Foreign currency translation adjustments, net of tax of $6
—

 
—

 
—

 
—

 
—

 
9

 
—

 
9

Purchase of treasury stock
—

 
(138
)
 
—

 
—

 
(156
)
 
—

 
—

 
(156
)
Stock-based compensation expense
—

 
513

 
5

 
1,314

 
—

 
—

 
—

 
1,319

Purchases of common stock under the employee stock purchase plan
—

 
31

 
—

 
12

 
—

 
—

 
—

 
12

Balance, June 30, 2012
$
—

 
28,139

 
$
329

 
$
283,248

 
$
(57,851
)
 
$
3,918

 
$
(286,445
)
 
$
(56,801
)
 
 
See accompanying notes to condensed consolidated financial statements.

4

Penson Worldwide, Inc.
Condensed Consolidated Statements of Cash Flows
 
Six Months Ended June 30,
 
2012
 
2011
 
(Unaudited)
(In thousands)
Cash flows from operating activities:
 
 
 
Net loss
$
(133,570
)
 
$
(33,030
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Loss from discontinued operations, net of tax
13,186

 
1,400

Loss on Apex Clearing Holdings transaction
35,826

 
—

Gain on extinguishment of debt
(22,514
)
 
—

Gain on Penson Futures transaction
(381
)
 
—

Equity in loss in unconsolidated affiliate
5,844

 
—

Depreciation and amortization
6,058

 
8,463

Stock-based compensation
1,319

 
1,821

Debt discount accretion
2,409

 
2,232

Debt issuance costs
478

 
536

Contract cease use charge
14,183

 
—

Contingent consideration accretion
—

 
203

Contract cease use charge accretion
236

 
—

Bad debt expense
3,365

 
43,338

Write-down to fair value of RDC related municipal bonds
15,099

 
—

Changes in operating assets and liabilities exclusive of effects of business combinations, divestitures and discontinued operations:
 
 
 
Cash and securities — segregated under federal and other regulations
774,327

 
(230,857
)
Net receivable/payable with customers
(597,393
)
 
394,103

Net receivable/payable with correspondents
(27,928
)
 
(5,985
)
Securities borrowed
430,523

 
(196,966
)
Securities owned
(5,796
)
 
(32
)
Deposits with clearing organizations
44,152

 
(76,438
)
Other assets
(8,932
)
 
24,201

Net receivable/payable with broker-dealers and clearing organizations
27,039

 
(50,984
)
Securities loaned
(502,319
)
 
37,493

Securities sold, not yet purchased
(499
)
 
(72
)
Accounts payable, accrued and other liabilities
(28,453
)
 
(47,822
)
Net cash provided by (used in) operating activities of continuing operations
46,259

 
(128,396
)
Cash flows from investing activities:
 
 
 
Business combinations, net of cash acquired
(500
)
 
—

Purchase of property and equipment
(675
)
 
(6,702
)
Net cash used in investing activities of continuing operations
(1,175
)
 
(6,702
)
Cash flows from financing activities:
 
 
 
Proceeds from revolving credit facility
—

 
40,000

Repayments of revolving credit facility
(7,000
)
 
(15,000
)
Net borrowings on short-term bank loans
(80,800
)
 
99,013

Purchase of treasury stock
(156
)
 
(158
)
Proceeds from Penson Futures transaction
5,000

 
—

Issuance of common stock
12

 
140

Net cash provided by (used in) financing activities of continuing operations
(82,944
)
 
123,995

Cash flows from discontinued operations:
 
 
 
Net cash used in operating activities of discontinued operations
(31,484
)
 
(25,208
)
Net cash used in investing activities of discontinued operations
(314
)
 
(2,324
)
Net cash provided by (used in) financing activities of discontinued operations
10,072

 
(16,125
)
Net cash flows used in discontinued operations
(21,726
)
 
(43,657
)
Effect of exchange rates on cash
273

 
1,360

Decrease in cash and cash equivalents
(59,313
)
 
(53,400
)
Cash and cash equivalents at beginning of period
72,226

 
138,614

Cash and cash equivalents at end of period
$
12,913

 
$
85,214

Supplemental cash flow disclosures:
 
 
 
Interest payments
$
16,881

 
$
20,858

Income tax payments
$
344

 
$
692

Supplemental disclosure of non-cash activities:
 
 
 
Contingent consideration receivable from Penson Futures transaction
$
7,499

 
$
—

Investment in Apex Clearing Holdings LLC
$
103,930

 
$
—

See accompanying notes to condensed consolidated financial statements.

5

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share data or where noted)
 
1.
Basis of Presentation
Organization and business — Penson Worldwide, Inc. (individually or collectively with its subsidiaries, “PWI” or the “Company”) is a holding company incorporated in Delaware. The Company conducts business through its wholly owned subsidiary SAI Holdings, Inc. (“SAI”). SAI currently conducts business through its principal direct and indirect operating subsidiaries, Penson Financial Services, Inc. (“PFSI”), Penson Financial Services Canada Inc. (“PFSC”), and Nexa Technologies, Inc. (“Nexa”). The Company previously conducted business through Penson Futures, formerly known as Penson GHCO (“Penson Futures”), Penson Financial Services Ltd. (“PFSL”), Penson Asia Limited (“Penson Asia”) and Penson Financial Services Australia Pty Ltd (“PFSA”). On August 31, 2011 Penson Futures was combined with PFSI and was operated as a division of PFSI (references to Penson Futures after August 31, 2011 are references to the futures division of PFSI). During the fourth quarter of 2011, the Company ceased operations of Penson Asia. On November 30, 2011, the Company announced that it had sold PFSA to BNY Mellon Company. On December 16, 2011, the Company announced that it would cease operations of its PFSL subsidiary in 2012, and completed this closure in the second quarter of 2012. The Company has engaged investment bankers to assist in the anticipated sale of PFSC expected to close in 2012. As a result of the Company's recent transactions with Knight Execution & Clearing Services LLC (“Knight”) and Apex Clearing Holdings LLC (“Apex Holdings”), as previously disclosed in the Company's filings and as discussed in Note 3, the Company has presented the futures division of PFSI, along with the operations of PFSA, PFSC and PFSL as discontinued operations and has reclassified its operations for all periods presented. Through PFSC, the Company is continuing to provide securities clearing services including margin lending and securities lending and borrowing transactions, primarily to facilitate clearing and financing activities. Through Nexa, the Company is continuing to provide technology services, including trade routing and market data.
PFSC is an investment dealer registered in all provinces and territories in Canada and is a dealer member of the Investment Industry Regulatory Organization of Canada (“IIROC”). On August 3, 2012, PFSI filed a Form BDW with the Securities and Exchange Commission ("SEC") and the Financial Industry Regulatory Authority ("FINRA"), voluntarily withdrawing its registration as a broker-dealer and resigning as a member of FINRA. SEC's and FINRA's acceptance of withdrawal and resignation are pending.
The accompanying unaudited interim condensed consolidated financial statements include the accounts of PWI and its wholly owned subsidiary SAI. SAI’s wholly owned subsidiaries include among others, PFSI, Nexa, Penson Execution Services, Inc., Penson Financial Futures, Inc. (“PFFI”), GHP1, Inc. (“GHP1”), which includes its subsidiaries GHP2, LLC (“GHP2”) and Penson Futures, and Penson Holdings, Inc. (“PHI”), which includes its subsidiaries PFSC, PFSL, Penson Asia and PFSA. All significant intercompany transactions and balances have been eliminated in consolidation. The accounts of PFSC have been presented as assets held-for-sale and liabilities associated with assets held-for-sale on the consolidated statements of financial condition as of June 30, 2011. The accounts of PFSC and PFSL and the Penson Futures division of PFSI have been presented as assets held-for-sale and liabilities associated with assets held-for-sale on the consolidated statement of financial condition as of December 31, 2011. The operations of PFSC, PFSA, PFSL and the U.S. futures division of PFSI have been reported in discontinued operations, net of income tax on the consolidated statements of comprehensive loss for all periods presented with the exception of PFSA which had no operations subsequent to its sale on November 30, 2011. See Note 20.
The unaudited interim condensed consolidated financial statements as of and for the three and six months ended June 30, 2012 and 2011 contained in this Quarterly Report (collectively, the “unaudited interim condensed consolidated financial statements”) were prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for all periods presented.
In the opinion of management, the accompanying unaudited interim condensed consolidated statements of financial condition and related statements of comprehensive loss, cash flows, and stockholders’ equity include all adjustments necessary for their fair presentation in conformity with U.S. GAAP. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted in accordance with rules and regulations of the SEC. These unaudited interim condensed consolidated financial statements should be read in conjunction with the Penson Worldwide, Inc. consolidated financial statements as of and for the year ended December 31, 2011, as filed with the SEC on Form 10-K and the Company's other public filings. Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the entire year.
In connection with the delivery of products and services to its correspondents, clients and customers, the Company manages its revenues and related expenses in the aggregate. As such, the Company evaluates the performance of its business activities, such as clearing and commission, technology, interest income along with the associated interest expense as one

6

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


integrated activity.
The Company’s cost infrastructure supporting its business activities varies by activity. In some instances, these costs are directly attributable to one business activity and sometimes to multiple activities. As such, in assessing the performance of its business activities, the Company does not consider these costs separately, but instead, evaluates performance in the aggregate along with the related revenues. Therefore, the Company’s pricing considers both the direct and indirect costs associated with transactions related to each business activity, the client relationship and the demand for the particular product or service in the marketplace. As a result, the Company does not manage or capture the costs associated with the products or services sold, or its general and administrative costs by revenue line.
Management’s estimates and assumptions — The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company reviews all significant estimates affecting the financial statements on a recurring basis and records the effect of any necessary adjustments prior to their issuance.
Discontinued Operations — Long-lived assets classified as held for-sale are measured and reported at the lower of their carrying amount or fair value less cost to sell.
Reclassifications — The Company has reclassified prior period amounts associated with discontinued operations to conform to the current year’s presentation. The reclassifications had no effect on the condensed consolidated statements of comprehensive loss, stockholders’ equity (deficit) or cash flows as previously reported.
Recent Accounting Pronouncements
In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. The adoption of this guidance may expand existing disclosure requirements, which the Company is currently evaluating.
2.
Debt and Liquidity and Capital Resources
Debt
As previously announced, the Company and certain of its subsidiaries entered into a Restructuring Support Agreement, dated March 13, 2012 (the “Restructuring Support Agreement”) with (i) the holders of a majority of the Company's 12.5% senior second lien secured notes due 2017 (the “Senior Secured Second Lien Notes”), (ii) the holders of over 70% of our unsecured 8% senior convertible notes due 2014 (the “Senior Convertible Notes”), and (iii) Broadridge (such holders collectively, the “Debt Holders”). Under the terms of the Restructuring Support Agreement, the Debt Holders agreed to support an exchange offer pursuant to which the Company would exchange an aggregate of $280,578 face value of outstanding indebtedness as of the date of the Restructuring for new debt and equity securities (the “Restructuring”). Despite the efforts of the Company's executives and advisors and at a substantial cost, the Company was not able to complete an exchange offer and the Restructuring Support Agreement lapsed on May 14, 2012. As previously announced, on June 5, 2012, the Company entered into a Termination and Mutual Release Agreement with Broadridge pursuant to which, among other things, Broadridge released the Company from all claims under the Master Services Agreement with Broadridge (other than those relating to PFSC) equal to an amount not less than $87,000 and Company's promissory note to Broadridge in the original amount of $20,578 was terminated and discharged without payment. The Company has recommenced negotiations with certain major holders of the Senior Secured Second Lien Notes and the Senior Convertible Notes with the goal of restructuring these obligations in light of the Company's reorganization. There can be no assurance that the Company and such holders will reach agreement on terms of any revised restructuring. While management continues to believe that such a restructuring is in the best interests of its various stakeholders, in the absence of a satisfactory restructuring management will consider alternative options, including a restructuring pursuant to Chapter 11 of the U.S. Bankruptcy Code.
Liquidity and Capital Resources
As a result of the Knight and Apex transactions described in Note 3, the Company's primary liquidity needs are in its Canadian clearing broker, PFSC, which is presented as a discontinued operation, as it is held for sale.


7

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


PFSC typically finances its operating liquidity needs through short term secured bank lines of credit and through secured borrowings from stock lending counterparties in the securities business, which referred to as “stock loans.” Most of the borrowings are driven by the activities of its clients or correspondents, primarily the purchase of securities on margin by those parties. PFSC had two uncommitted lines of credit with two financial institutions permitting PFSC to borrow up to an aggregate of approximately $184,879. There are no specific limitations on our borrowing capacities pursuant to its stock loan arrangements, though none of these facilities is committed. Further, since stock loan borrowings are secured, the ability to borrow is limited by the available collateral pool and advance rates offered by counterparties against that collateral.
Broker-dealer bank debt facilities are typically secured, uncommitted and on demand. Therefore, lenders can refuse to extend loans, limit the size of loans, increase the amount of collateral required to support loans, or require repayment of outstanding loans. This can severely impact liquidity resources. Furthermore, the type of business a correspondent or client transacts can create liquidity needs. For example, certain option trades may create collateral for the broker-dealer to utilize for settlement, but the trade does create operating liquidity needs at the clearing corporation. In such cases, as there is no underlying collateral to post, the broker-dealer must utilize other available collateral. Borrowings under stock loan arrangements bear interest at variable rates based on various factors including market conditions and the types of securities loaned, are secured primarily by our customers' margin account securities, and are repayable on demand.
Excluding the PFSC business, the Company's current liquidity needs are limited to its operating expenses and funding any receivables related to the provision of services to Knight and Apex under the transitional services agreements.
Capital Resources — In general, the Company's capital resources are the existing capital in its businesses and any operating income, if applicable. The Company's broker-dealer subsidiaries are subject to minimum net capital requirements established in each jurisdiction. PFSC is subject to early warning capital levels which are significantly higher than minimum requirements. At June 30, 2012, PFSI had a net capital deficit of $14,142. This amount was $14,392 below its minimum capital requirement of $250, which resulted in a net capital violation that was communicated to its regulators. At June 30, 2012, PFSC had risk adjusted capital of approximately $26,327 and had early warning excess of approximately $15,229. For the past three quarters both PFSI and PFSC have operated at a loss. This reduces the Company's capital resources.
In addition to these statutory requirements, the Company's regulators have the discretion to require higher capital or liquidity levels. If the Company's regulators require that it retain significant regulatory capital at these subsidiaries, its liquidity could be impaired, perhaps significantly.
On June 3, 2009, the Company issued $60,000 aggregate principal amount of 8.00% Senior Convertible Notes due 2014. The net proceeds from the sale of the convertible notes were approximately $56,200 after initial purchaser discounts and other expenses. On May 6, 2010, the Company issued $200,000 aggregate principal amount of 12.50% Senior Second Lien Secured Notes, due May 15, 2017. The net proceeds from the sale of the senior second lien secured notes were approximately $193,294 after initial purchaser discounts and other expenses. The Company used a part of the net proceeds of the sale to pay down approximately $110,000 outstanding on its then current senior revolving credit facility, enter into a $70,000 subordinated loan arrangement with the broker-dealer in the U.S., to provide working capital to support the correspondents acquired from Ridge and for other general corporate purposes. The Company's obligations under the senior second lien secured notes are supported by a guaranty from SAI and PHI and a pledge by the PWI, SAI and PHI of equity interests of certain of their subsidiaries. As is common with facilities of this type, the negative covenants in its various credit facilities limit its ability to incur additional debt outside of the ordinary course of business and its ability to incur additional working capital debt facilities at a parent company level is therefore significantly restricted.
The Company incurs a significant amount of interest on its outstanding debt obligations. In 2011, the Company paid approximately $1,800 in interest under its then senior revolving credit facility and predecessor facility, $4,800 in interest under its Senior Convertible Notes, $25,000 in interest under its Senior Second Lien Secured Notes and $600 in interest under the Ridge Seller Note. The Company is required to make an interest payment of $12,500 on the Senior Second Lien Secured Notes in mid-November 2012, and this obligation will continue semi-annually through 2017, when the principal amount of $200,000 is due. The Company is required to make an interest payment of $2,400 on the Senior Convertible Notes in early December 2012, and this obligation will continue semi-annually through June 1, 2014, when the principal amount of $60,000 is due. In the first quarter of 2012, the Company unsuccessfully attempted to launch an exchange offer for all of its outstanding funded debt. If the Company is unable to complete an exchange offer for or an alternative restructuring of its senior debt, management will consider pursuing alternative options, including potentially winding down or liquidation of the Company’s operations, or a restructuring pursuant to Chapter 11 of the U.S. Bankruptcy Code.
As a holding company, earnings and capital of the Company's operating subsidiaries are accessed from time to time through the receipt of dividends or intercompany advances from these subsidiaries. As discussed above, however, the Company's broker-dealer subsidiaries are subject to minimum and early warning net capital requirements established in each jurisdiction. Additionally, as with other regulated entities in the Company's industry, the making of distributions from its regulated operating

8

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


subsidiaries is generally subject to prior approval by the applicable regulators. The Company's regulators have considerable discretion when deciding whether to permit a distribution, though management understands that they place importance on factors such as liquidity, excess regulatory capital, profitability, changes in the business mix and expected growth in aggregate debits. There is no assurance that the Company will be able to get approval for a distribution in the future. Any such difficulty would have a material impact on the Company's ability to service its debt obligations at the parent company level.
Historically, the Company has not experienced significant difficulty obtaining approval for distributions by its regulated operating subsidiaries when it has had significant excess capital. Currently, only PFSC has adequate excess regulatory capital. On May 15, 2012, in order to assist the Company in making the $12,500 semiannual payment on its Senior Secured Second Lien Notes, its regulators, allowed it to borrow $5,500 from PFSI. In return for this assistance, management agreed to continue its efforts to execute a strategic transaction with respect to PFSI, which resulted in the Apex transaction described in Note 3. In June 2012, the Company's regulators allowed a $2,400 dividend from PFSI to assist the Company in making the $2,400 semiannual payment on its Senior Convertible Notes.

As a result of the transactions with Knight and Apex Holdings, the cash flow at our U.S. broker-subsidiary, PFSI, will primarily be limited to amounts payable under the transitional services agreements with Knight and Apex Holdings, as described in Note 3, and the recovery of deposits held by various exchanges and regulatory authorities. PFSI may also receive Earnout Amounts paid by Knight or distributions paid as a result of PFSI's investment in Apex Clearing.
3.
Acquisitions and Dispositions
Acquisition of Ridge
On November 2, 2009, the Company entered into an asset purchase agreement (“Ridge APA”) to acquire the clearing and execution business of Ridge Clearing & Outsourcing Solutions, Inc. (“Ridge”) from Ridge and Broadridge Financial Solutions, Inc. (“Broadridge”), Ridge’s parent company. The acquisition closed on June 25, 2010, and under the terms of the Ridge APA, as later amended, the Company paid $35,189. The acquisition date fair value of consideration transferred was $31,912, consisting of 2,456 shares of PWI common stock with a fair value of $14,611 (based on our closing share price of $5.95 on that date) and a $20,578 five-year subordinated note (the “Ridge Seller Note”) with an estimated fair value of $17,301 on that date (see Note 11 for a description of the Ridge Seller Note discount), payable by the Company bearing interest at an annual rate equal to 90-day LIBOR plus 5.5%. On October 11, 2011 the Company amended and restated the terms of the Ridge Seller Note to provide for payment of interest by the Company at maturity rather than on a quarterly basis.
The Company initially recorded a liability of $4,089 attributable to the estimated fair value of contingent consideration to be paid 19 months after closing (subject to extension in the event the dispute resolution procedures set forth in the Ridge APA are invoked). The contingent consideration was primarily composed of two categories. The first category includes a group of correspondents that had not generated at least six months of revenue as of May 31, 2010 (“Stub Period Correspondents”). Twelve months after closing a calculation was performed to adjust the estimated annualized revenues as of May 31, 2010 to the actual annualized revenues based on a six-month review period as defined in the Ridge APA (“Stub Period Revenues”). The Ridge Seller Note is subject to adjustment 19 months after closing based on .9 times the difference between the estimated and actual annualized revenues. As of December 31, 2010, all of the correspondents in this category had generated at least six months of revenues. The Company reduced its contingent consideration liability by $343, which was included in other expenses in the consolidated statements of operations for the year ended December 31, 2010. The second category includes a group of correspondents that had not yet begun generating revenues (“Non-revenue Correspondents”) as of May 31, 2010. As of December 31, 2011 a calculation was performed to determine the annualized revenues, based on a six-month review period, for each such Non-revenue Correspondent (“Non-revenue Correspondent Revenues”). This calculation resulted in a reduction in the contingent consideration liability of approximately $51. Additionally, the liability was reduced by approximately $1,313 for other items such as client concessions, departing correspondents and additional business as negotiated by both parties. On June 5, 2012, as a part of the Apex transaction, the Ridge Seller Note was forgiven in its entirety, including the accrued contingent consideration. As of June 30, 2012 and December 31, 2011, the total amount of contingent consideration totaled $0 and $2,999.
The Company initially recorded goodwill of $15,901, intangibles of $20,100 and a discount on the Ridge Seller Note of $3,277. The qualitative factors that made up the recorded goodwill included value associated with an assembled workforce, value attributable to enhanced revenues related to various products and services offered by the Company and synergies associated with cost reductions from the elimination of certain fixed costs as well as economies of scale resulting from the additional correspondents. The goodwill was included in the United States segment. A portion of the recorded goodwill associated with the contingent consideration will not be deductible for tax purposes as future payments are less than the $4,089 initially recorded. The tax goodwill will be deductible for tax purposes over a period of 15 years. The Company incurred acquisition related costs of approximately $5,251. As of December 31, 2011, based upon an impairment test performed by the Company, it was determined that the goodwill was impaired, which resulted in a goodwill impairment charge that reduced the

9

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


Ridge goodwill balance to zero. Additionally, in connection with the Apex transaction net intangibles of $16,231 associated with the Ridge transaction were written off.
Acquisition of the clearing business of Schonfeld Securities, LLC
In November 2006, the Company acquired the clearing business of Schonfeld Securities LLC (“Schonfeld”), a New York-based securities firm. The Company closed the transaction in November 2006 and in January 2007, the Company issued approximately 1,100 shares of common stock valued at approximately $28,300 to the previous owners of Schonfeld as partial consideration for the assets acquired of which approximately $14,800 was recorded as goodwill and approximately $13,500 as intangibles. In addition, the Company agreed to pay an annual earnout of stock and cash over a four-year period that commenced on June 1, 2007, based on net income, as defined in the asset purchase agreement (“Schonfeld Asset Purchase Agreement”), for the acquired business. On April 22, 2010, SAI and PFSI entered into a letter agreement (the “Letter Agreement”) with Schonfeld Group Holdings LLC (“SGH”), Schonfeld, and Opus Trading Fund LLC (“Opus”) that amends and clarifies certain terms of the Schonfeld Asset Purchase Agreement. The Letter Agreement, among other things, for purpose of determining the total payment due to Schonfeld under the earnout provision of the Schonfeld Asset Purchase Agreement: (i) removes the payment cap; (ii) clarifies that PFSI has no obligation to compress tickets across subaccounts (unless PFSI does so for other of its correspondents at a later date); and (iii) reduces the SunGard synergy credit from $2,900 to $1,450 in 2010 and $1,000 in 2011. The Letter Agreement also assigns all of Schonfeld’s responsibilities under the Schonfeld Asset Purchase Agreement to its parent company, SGH, and extends the initial term of Opus’s portfolio margining agreement with PFSI from April 30, 2017 to April 30, 2019.
In January, 2011, the Company and SGH entered into a letter agreement setting the amount due for the third year earnout at $6,000 due to the provisions in various agreements related to the Schonfeld transaction, including the termination/compensation agreement, which reduced the amount that the Company was required to pay under the Schonfeld Asset Purchase Agreement. This resulted in a reduction in goodwill and other liabilities of $9,184 in the first quarter of 2011. The letter agreement also stipulated that the third year earnout will be paid evenly over a 12 month period commencing on September 1, 2011. As of December 31, 2011, based upon an impairment test performed by the Company, it was determined that the goodwill was impaired, which resulted in a goodwill impairment charge that reduced the Schonfeld goodwill balance to zero.
A payment of approximately $26,600 was paid in connection with the first year earnout that ended May 31, 2008; approximately $25,500 was paid in connection with the second year of the earnout that ended May 31, 2009 and approximately $9,269 was paid in connection with the fourth year of the earnout that ended on May 31, 2011. Pursuant to the terms of a letter agreement with Schonfeld, at June 30, 2012, the Company had paid $2,500 as result of the third year of the earnout ended May 31, 2010. The remaining $3,500 liability as of June 30, 2012 was to be paid evenly over the seven month period commencing on February 1, 2012. The Company has not made any payments subsequent to the payment due January 1, 2012, due to a contractual dispute with one of the Schonfeld correspondents. We continue to seek to negotiate a resolution to this dispute. In connection with the Apex transaction, net intangibles of $8,966 associated with the Schonfeld transaction were written off.
Disposition of Penson Futures
On May 28, 2012, the Company entered into an Asset Purchase Agreement (the "APA") with Knight, pursuant to which (i) the Company sold certain assets of PFSI's futures clearing business (the "FCM Business"), including but not limited to, customer contracts, segregated customer account assets, assets relating to the foreign currency exchange business, certain membership seats and licenses for clearing exchanges, and other related assets to Knight; and (ii) Knight assumed, subject to specified exceptions, certain liabilities and obligations under customer contracts in the FCM Business (the "Sale"). On May 31, 2012, the Company and Knight closed the Sale. In consideration for the Sale, Knight agreed to make an initial payment of $5,000 in cash to PFSI. This payment was received in two $2,500 wires and was fully paid by June 7, 2012.
Knight also agreed to pay an earnout amount ("Earnout Amount") within 45 days of the first, second and third anniversary of the closing of the Sale. The Earnout Amount is to be calculated as follows: (i) if the revenue for the FCM Business for the then trailing 12 month period ending on the last day of the last full month of such 12 month period, (a) is less than $21,000, then the Earnout Amount shall be $0, or (ii) if such revenue is equal to or greater than $21,000, then the Earnout Amount will be 1.25% of the total revenue for every $1,000 of revenue in excess of $20,000 for such period.
As a result of the transaction the Company recorded consideration of $12,499, which was comprised of cash consideration of $5,000 and contingent consideration of $7,499. The contingent consideration recorded was the present value of the estimated payments to be received by Knight over the next three years. The estimated revenues were based primarily on

10

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


historical revenues of the PFSI's futures division. These estimated payments were discounted using a weighted average cost of capital ranging from 9.53% for the first year of the earnout to 9.80% in the third year of the earnout. The Company will evaluate, on a quarterly basis, the estimated contingent consideration expected to be received from Knight with any changes in the fair value of the expected amounts being recognized in discontinued operations. Additionally, the Company will record interest revenue as a result of applying the effective interest method. This revenue will be presented in discontinued operations. The estimated fair value of the contingent consideration receivable as of June 30, 2012 was $7,559. This is considered a Level 3 asset in the fair value hierarchy as some of the inputs used to estimate fair value are unobservable and can not be corroborated by observable market data.
The transaction resulted in a gain of approximately $381, included in discontinued operations, based on a carrying value of tangible assets of approximately $7,990 and intangible assets of $4,128.
In connection with the Sale, the Company also entered into a Transition Services Agreement with Knight (the "Knight Services Agreement"), pursuant to which the Company agreed to provide Knight with all services, functions, products, software and intellectual property primarily used to support the FCM Business following the Sale, including services relating to regulatory compliance and reporting requirements (the "Transition Services"). Knight agreed to pay certain fees to PFSI for the Transition Services, and management expects that such fees will cover the costs for providing the Transition Services. The term of the Transition Services will continue for a period of 6 months, but may be terminated early by Knight upon 30-day advance notice. As of June 30, 2012, the majority of our former futures division personnel, including management, were employees of Knight.
Formation of Apex Clearing
In May and June, PFSI entered into a number of agreements with Apex Holdings, the parent company of Apex Clearing Corporation ("Apex Clearing"). On May 31, 2012, PFSI entered into a Limited Liability Company Agreement and other definitive agreements with Apex Holdings. Pursuant to the Limited Liability Company Agreement (the "LLC Agreement"), PFSI and Apex Clearing Solutions LLC ("ACS") established Apex Holdings, which is managed by ACS, a subsidiary of PEAK6 Investments, L.P. In addition, Broadridge Financial Solutions, Inc. ("Broadridge") transferred to Apex Holdings the ownership of its broker-dealer subsidiary (excluding certain assets and liabilities relating to its on-going outsourcing business), Ridge Clearing & Outsourcing Solutions, Inc., which was renamed "Apex Clearing Corporation" , and became a wholly-owned subsidiary of Apex Holdings.
In connection with this transaction, PFSI entered into an Assignment and Assumption Agreement with Apex Holdings (the "AAA"), dated May 31, 2012, pursuant to which PFSI (i) sold and transferred to Apex Clearing the customer and correspondent accounts and related contractual rights of PFSI under its securities clearing contracts and other related assets, (ii) transfered to Apex Clearing certain related liabilities and (iii) contributed net tangible assets with a fair value of $103,930 towards $90,000 of regulatory capital of Apex Clearing (collectively, the "Acquired Assets") in consideration for the issuance of membership interests representing 93.75% of the equity interests in Apex Holdings. In addition, ACS contributed $5,000 in cash for membership interests representing 5.21% of the equity interests in Apex Holdings, and certain other investors contributed a total of $1,000 in cash for membership interests representing an aggregate of 1.04% of the equity interests in Apex Holdings. Furthermore, ACS and certain of its affiliates have provided $35,000 in subordinated loans to Apex Clearing (the "Subordinated Loans"). The Subordinated Loans qualify for treatment as regulatory capital of Apex Clearing. Accordingly, Apex Clearing had approximately $130,000 in regulatory capital at the closing of the transactions. As set forth in the LLC Agreement, ACS is the managing member and has all management powers over Apex Clearing's business and affairs. None of the other members, including PFSI have any voting, consent or approval rights under the LLC Agreement. As such ACS is deemed to have control of Apex Clearing. The Company will account for its equity interests in Apex Holdings under the equity method with its share of Apex Holdings' profit or loss recognized in earnings.
ACS has the option, from time to time, to purchase all or a portion of PFSI's membership interest in Apex Holdings at an amount equal to 120% of the then current value of PFSI's capital account. Furthermore, pursuant to the AAA, PFSI deposited $2,000 in an escrow account to support PFSI's obligations to indemnify Apex Holdings, ACS and their affiliates under the AAA for claims arising from, among other things, PFSI or Nexa's breach, violation or non-fulfillment of their obligations under the AAA or related transaction document. The escrow amount, less the amount of any successful claims thereon, will be released to PFSI five years  after Closing.
The Company and its subsidiary Nexa have entered into an Indemnity and Support Agreement, pursuant to which they have agreed to indemnify Apex Holdings, ACS and their affiliates against certain claims for its losses incurred under the AAA or other transaction documents.

11

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


In connection with the closing of the Apex Clearing transactions, on June 5, 2012:

•
PFSI and Nexa entered into a Transition Services Agreement with Apex Holdings and Apex Clearing (the "TSA"), pursuant to which PFSI and Nexa agree to provide various transitional support services to Apex Holdings and Apex Clearing, including the continued servicing of various customer contracts to be transferred to Apex Clearing and other services to ensure a smooth transition of the business and compliance with certain applicable reporting and regulatory requirements. The initial term of the TSA is 12 months, which may be extended by Apex Holdings for up to an additional 6 months. The amounts to be paid to PFSI under the TSA may not fully cover the expenses of providing the transition support services. In addition, Nexa and PFSI entered into license agreements, pursuant to which Nexa and PFSI will grant certain licenses to Apex Clearing to use certain intellectual property in order, among other things, to enable Apex Clearing to perform its obligations under the clearing and customer contracts assigned to Apex Clearing and to conduct its clearing, settlement and execution business. As services are transitioned to Apex Clearing, the Company anticipates that the services required from PFSI under the TSA, and the associated payments from Apex Clearing, will be reduced proportionately.

•
PFSI entered into a credit agreement with Apex Clearing whereby PFSI has agreed to provide a $12,000 line of credit to Apex Clearing for up to 12 months, and ACS entered into a credit agreement with Apex Clearing whereby ACS has agreed to provide a $10,000 line of credit to Apex Clearing for up to 12 months; and

•
The Company entered into a Termination and Mutual Release Agreement with Broadridge (the "Release Agreement"), pursuant to which the Company and Broadridge agreed to (i) terminate the Schedules under the Master Services Agreement by and between the Company and Broadridge, dated November 2, 2009 (collectively the "Master Services Agreement"), other than to the extent necessary to provide the transition services under the Services Agreement and to continue to service the Company's Canadian subsidiary, PFSC; and (ii) terminate, discharge and release in full the Company's obligations, including all obligations to make principal and interest payments, under the Ridge Seller Note due June 25, 2015 with an outstanding principal amount of approximately $20,578 issued to Broadridge. The Company and Broadridge also agreed to release all claims equal to an amount not less than $87,000, arising under the Master Services Agreement, provided that Broadridge will retain claims of up to $20,000 under the Master Services Agreement against PFSC while the Company will retain all of its rights under the Master Services Agreement to defend any such claims against PFSC.
In connection with the Apex transaction, the Company received consideration of $200 and recorded an investment in Apex Holdings of $103,930, which represented the fair value of the contributed tangible net assets.In connection with the transaction the Company recorded a loss of $35,826 primarily related to approximately $10,650 of certain technology assets of which the exclusive rights to use were contributed to Apex Clearing as well as intangible assets of $25,376 primarily related to customer contracts associated with prior acquisitions that were contributed to Apex Clearing. As of June 30, 2012, the Company's maximum exposure to loss as a result of its involvement with Apex Holdings is $98,086 which represents the Company's investment.
4.
Computation of loss per share
The following is a reconciliation of the numerators and denominators of the basic and diluted loss per share computation. Common stock equivalents related to stock options are excluded from the diluted earnings per share calculation if their effect would be anti-dilutive to loss per share.
 

12

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Basic and diluted:
 
 
 
 
 
 
 
Loss from continuing operations
$
(77,155
)
 
$
(29,437
)
 
$
(120,384
)
 
$
(31,630
)
Loss from discontinued operations, net of tax
(7,941
)
 
(732
)
 
(13,186
)
 
(1,400
)
Net loss
$
(85,096
)
 
$
(30,169
)
 
$
(133,570
)
 
$
(33,030
)
Weighted average common shares outstanding — basic and diluted
28,035

 
28,546

 
28,005

 
28,512

Loss per share from continuing operations
$
(2.75
)
 
$
(1.03
)
 
$
(4.30
)
 
$
(1.11
)
Loss per share from discontinued operations
(0.29
)
 
(0.03
)
 
(0.47
)
 
(0.05
)
Basic and diluted loss per share
$
(3.04
)
 
$
(1.06
)
 
$
(4.77
)
 
$
(1.16
)

 At June 30, 2012 and 2011 stock options and restricted stock units totaling 2,033 and 2,210 were excluded from the computation of diluted EPS as their effect would have been anti-dilutive. For periods with a net loss, basic weighted average shares are used for diluted calculations because all stock options and unvested restricted stock units outstanding are considered anti-dilutive.
5.
Fair value of financial instruments
Fair value is defined as the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation techniques, including market, income and/or cost approaches. The fair value model establishes a hierarchy which prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy increases the consistency and comparability of fair value measurements and related disclosures by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs reflect the assumptions market participants would use in pricing the assets or liabilities based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy prioritizes the inputs into three broad levels based on the reliability of the inputs as follows:
•
Level 1 — Inputs are quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Valuation of these instruments does not require a high degree of judgment as the valuations are based on quoted prices in active markets that are readily and regularly available.
•
Level 2 — Inputs other than quoted prices in active markets that are either directly or indirectly observable as of the measurement date, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. These financial instruments are valued by quoted prices that are less frequent than those in active markets or by models that use various assumptions that are derived from or supported by data that is generally observable in the marketplace. Valuations in this category are inherently less reliable than quoted market prices due to the degree of subjectivity involved in determining appropriate methodologies and the applicable underlying assumptions.
•
Level 3 — Valuations based on inputs that are unobservable and not corroborated by market data. These financial instruments have significant inputs that cannot be validated by readily determinable data and generally involve considerable judgment by management.
The following is a description of the valuation techniques applied to the Company’s major categories of assets and liabilities measured at fair value on a recurring basis:
U.S. government and agency securities
U.S. government securities are valued using quoted market prices in active markets. Accordingly, U.S. government securities are categorized in Level 1 of the fair value hierarchy.
U.S. agency securities consist of agency issued debt and are valued using quoted market prices in active markets. As such these securities are categorized in Level 1 of the fair value hierarchy.

13

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


 
Corporate equity
Corporate equity securities represent exchange-traded securities and are generally valued based on quoted prices in active markets. These securities are categorized in Level 1 of the fair value hierarchy.
Corporate debt
Corporate bonds are generally valued using quoted market prices. Corporate bonds are generally classified in Level 2 of the fair value hierarchy as prices are not always from active markets.
Listed option contracts
Listed options are exchange traded and are generally valued based on quoted prices in active markets and are categorized in Level 1 of the fair value hierarchy.
Certificates of deposit and term deposits
The fair value of certificates of deposits and term deposits is estimated using third-party quotations. These deposits are categorized in Level 2 of the fair value hierarchy.
Money market
Money market funds are generally valued based on quoted prices in active markets. These securities are categorized in Level 1 of the fair value hierarchy.
Municipal bonds
Municipal bonds are generally valued based on quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. These securities are categorized in Level 2 of the fair value hierarchy. The fair value of municipal bonds categorized as Level 2 is generally determined using standard observable inputs, including reported trades, quoted market prices and broker/dealer quotes. In some instances municipal bonds are valued based on inputs that are unobservable and not corroborated by market data. These securities are categorized in Level 3 of the fair value hierarchy.
Contingent consideration receivable
Continent consideration receivable is valued using a discounted cash flow approach based on the estimated payments expected to be received. The various inputs used to estimate fair value are both observable and unobservable and therefore may not be corroborated by market data. Therefore fair value of the contingent consideration receivable is categorized as Level 3.
Contract cease-use liability
The contract cease use liability is valued using a discounted cash flow approach based on the contractual minimum payments to be made. The inputs used to estimate fair value are observable or corroborated by observable market data. Therefore, the fair value of the contract cease use liability is categorized as Level 2.
 
The following table summarizes by level within the fair value hierarchy “Securities owned, at fair value,” "Other assets," “Securities sold, not yet purchased, at fair value” and "Accounts payable, accrued and other liabilities" as of June 30, 2012 and December 31, 2011.

14

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


 
June 30, 2012
Level 1
 
Level 2
 
Level 3
 
Total
Securities owned
 
 
 
 
 
 
 
Corporate equity
$
—

 
$
—

 
$
—

 
$
—

Listed option contracts
—

 
—

 
—

 
—

Municipal bonds
$
—

 
$
25,383

 
$
—

 
$
25,383

 
$
—

 
$
25,383

 
$
—

 
$
25,383

Other Assets
 
 
 
 
 
 
 
Contingent consideration receivable
$
—

 
$
—

 
$
7,559

 
$
7,559

 
$
—

 
$
—

 
$
7,559

 
$
7,559

Accounts payable, accrued and other liabilities
 
 
 
 
 
 
 
Contract cease-use liability
$
—

 
$
14,418

 
$
—

 
$
14,418

 
$
—

 
$
14,418

 
$
—

 
14,418

 
 
 
 
 
 
 
 
December 31, 2011
Level 1
 
Level 2
 
Level 3
 
Total
Securities owned
 
 
 
 
 
 
 
Corporate equity
$
463

 
$
—

 
$
—

 
$
463

Listed option contracts
88

 
—

 
—

 
88

Municipal bonds
—

 
26,335

 
7,133

 
33,468

 
$
551

 
$
26,335

 
$
7,133

 
$
34,019

Securities sold, not yet purchased
 
 
 
 
 
 
 
Corporate equity
$
378

 
$
—

 
$
—

 
$
378

Listed option contracts
121

 
—

 
—

 
121

 
$
499

 
$
—

 
$
—

 
$
499

 
Level 3 assets measured at fair value on a recurring basis
The following table presents a summary of changes in the fair value of the Company’s Level 3 assets for the six months ended June 30, 2012. The realized loss is included in other revenue in the unaudited interim condensed consolidated statement of comprehensive loss.
 
Balance, December 31, 2011
$
7,133

Purchases of municipal bonds
7,966

Contingent consideration receivable
7,499

Amortization of contingent consideration receivable discount
60

Realized loss on municipal bonds
(15,099
)
Balance, June 30, 2012
$
7,559


At December 31, 2011, the Company’s Level 3 assets were comprised entirely of Retama Development Corporation (“RDC”) related municipal bonds. On April 25, 2012 the Company sold the bonds and certain other RDC related secured loans. See Note 8 and 21 for further discussion. As of June 30, 2012, the Company's Level 3 assets are comprised solely of the contingent consideration receivable.
6.
Segregated assets
As a result of the Apex and Knight transactions (see Note 3) PFSI no longer carries customer balances. As such, as of June 30, 2012, PFSI did not have any requirements to segregate assets for the benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) or pursuant to Commodity Futures Trading Commission Rule 1.20. As of June 30, 2012, $194,241 was segregated under similar Canadian regulations and is included in assets held-for-sale in the unaudited interim condensed consolidated statement of financial condition. See Note 20. At December 31, 2011, $2,150,040 was segregated for the benefit of customers under applicable U.S. regulations. Additionally, $110,044 and $11,068 was segregated under similar Canadian and United Kingdom regulations, respectively and $379,261 was segregated for the benefit of customers of the Penson Futures division of PFSI pursuant to Commodity Futures Trading Commission Rule 1.20. These are included in assets held-for-sale in the consolidated statement of financial condition as of December 31, 2011.

15

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


7.
Receivable from and payable to broker-dealers and clearing organizations
Amounts receivable from and payable to broker-dealers and clearing organizations consists of the following:
 
 
June 30,
2012
 
December 31,
2011
Receivable:
 
 
 
Securities failed to deliver
$
—

 
$
80,357

Receivable from clearing organizations
287

 
44,382

 
$
287

 
$
124,739

Payable:
 
 
 
Securities failed to receive
$
—

 
$
64,092

Payable to clearing organizations
—

 
68,904

 
$
—

 
$
132,996


Receivables from broker-dealers and clearing organizations include amounts receivable for securities failed to deliver, amounts receivable from clearing organizations relating to open transactions, good-faith and margin deposits, and floor-brokerage receivables.
Payables to broker-dealers and clearing organizations include amounts payable for securities failed to receive, amounts payable to clearing organizations on open transactions, and floor-brokerage payables. In addition, the net receivable or payable arising from unsettled trades is reflected in these categories.
8.
Receivable from and payable to customers and correspondents
Receivable from and payable to customers and correspondents include amounts due on cash and margin transactions. Securities owned by customers and correspondents are held as collateral for receivables. This collateral includes financial instruments that are actively traded with valuations based on quoted prices and financial instruments in illiquid markets with valuations that involve considerable judgment. Such collateral is not reflected in the unaudited interim condensed consolidated financial statements. Payable to correspondents also includes commissions due on customer transactions. As a result of the Apex and Knight transactions (see Note 3) PFSI no longer carries customer balances.
Typically, the Company’s loans to customers or correspondents are made on a fully collateralized basis because they are generally margin loans and the amount advanced is less than the then current value of the margin collateral. When the value of that collateral declines, when the collateral decreases in liquidity, or margin calls are not met, the Company may consider a variety of credit enhancements such as, but not limited to, seeking additional collateral or guarantees. In certain circumstances it may be necessary to acquire third party valuation reports for illiquid financial instruments held as collateral. These reports are used to assist management in its assessment of the collectibility of its receivables. In valuing receivables that become less than fully collateralized, the Company compares the estimated fair value of the collateral, deposits and any additional credit enhancements to the balance of the loan outstanding and evaluates the collectibility based on various qualitative factors such as, but not limited to, the creditworthiness of the counterparty, the potential impact of any outstanding litigation or arbitration and the nature of the collateral and available realization methods. To the extent that the collateral, the guarantees and any other rights the Company has against the customer or the related introducing broker are not sufficient to cover potential losses, the Company records an appropriate allowance for doubtful accounts. In the ordinary course of business the Company carries less than fully collateralized balances for which no allowance has been recorded due to the Company’s judgment that the amounts are collectible. The Company monitors every account that is less than fully collateralized with liquid securities every trading day. The Company reviews these accounts on a monthly basis to determine if a change in the allowance for doubtful accounts is necessary. This specific, account-by-account review is supplemented by the risk management procedures that identify positions in illiquid securities and other market developments that could affect accounts that otherwise appear to be fully collateralized. The Company and PFSC risk management officers monitor market developments on a daily basis. The Company maintains an allowance for doubtful accounts that represents amounts, in the judgment of the Company, necessary to adequately reflect anticipated losses in outstanding receivables. Typically, when a receivable is deemed not to be fully collectible, it is generally reserved at an amount correlating with the amount of the balance that is considered under-secured. Provisions made to this allowance are charged to operations based on anticipated recoverability.
The Company generally nets receivables and payables related to its customers’ transactions on a counterparty basis

16

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


pursuant to master netting or customer agreements. It is the Company’s policy to settle these transactions on a net basis with its counterparties. The Company generally recognizes interest income on an accrual basis as it is earned. Interest on margin loans is typically accrued monthly and, therefore, increases the margin loan balance reflected on the Company’s financial statements. However, there may be cases when the Company believes that, while the outstanding amount of the receivable is collectible, amounts greater than the current carrying value of the loan may not be collectible. At that point the Company may elect, even though the outstanding amount of the receivable is considered collectible, to recognize interest income only when received rather than reflecting any additional accrued interest on the receivable (“Nonaccrual Receivables”).
Generally, when an account has been reserved, no additional interest is accrued. With regard to margin loans, payments are generally recorded against the outstanding loan balance which includes accrued interest. The Company’s policy with regard to loans with stated terms is to apply payments as set forth in the individual loan agreement. The accrual of interest does not resume until such time as the Company has determined that the amount is fully collectible. This would be evidenced by payments on margin loans resulting in the account becoming fully secured or loans with stated terms becoming current. Margin loans become delinquent at the point that margin calls are not met while loans with stated terms become delinquent in accordance with their stated terms. When either a margin loan or a loan with stated terms becomes delinquent, the Company undertakes a collectibility review and generally requires customers to deposit additional collateral or to reduce positions.
As discussed in the Company’s prior periodic filings, consistent with its policy for the evaluation of collateral securing receivables from customers and correspondents and following its review of the collateral securing the Nonaccrual Receivables, the Company determined that the carrying value of its Nonaccrual Receivables was not fully realizable and recorded a charge of $43,000 in the quarter ended June 30, 2011. An important factor that prompted the Company to reevaluate its Nonaccrual Receivables in the second quarter was the reduced likelihood for expanded gaming rights in Texas in the near term. With the adjournment of the Texas Legislature on June 29, 2011 without taking up the bills that had been proposed to permit such expansion, the Company determined that, since the prospects for further consideration of legislation before the next Texas legislative session in 2013 appeared unlikely, it would be appropriate to reevaluate the value of Nonaccrual Receivables collateralized by bonds issued by the RDC and certain other interests in the horse racing track and real estate project (“Project”) financed by the RDC’s bonds. Based upon the Company’s re-assessment of the value of collateral securing the Nonaccrual Receivables, including review of appraisals of underlying real estate and the Project, among other factors, the Company recorded the charge against its Nonaccrual Receivables for the quarter ended June 30, 2011.
The Company also determined that it was appropriate to commence enforcement actions with respect to certain of those Nonaccrual Receivables, and therefore began foreclosure against collateral securing certain of these Nonaccrual Receivables. On August 4, 2011, the Company foreclosed on 1,001 shares of its common stock, which it held as collateral, at a price of $2.61 per share, the then current market price. The value of these shares, totaling $2,612, was applied to reduce the applicable Nonaccrual Receivables. The purchased shares increased the total number of treasury shares as of that date. Further, on September 1, 2011, the Company foreclosed on certain municipal bonds, limited partnership interests, secured debts and other collateral pursuant to a public foreclosure auction. At this foreclosure the Company credit bid for and thereby acquired the collateral offered for sale. This resulted in a reduction of the applicable Nonaccrual Receivables of $40,220. Subsequently, in February 2012, the Company conducted a further foreclosure auction of certain additional municipal bonds. Again the Company acquired the collateral after entering a credit bid of $7,966, which reduced the Nonaccrual Receivables by an equivalent amount. The debtors subject to the various foreclosure sales remain liable for the Nonaccrual Receivables to the extent not secured by the proceeds of the collateral subject to foreclosure, including Nonaccrual Receivables previously reserved against. The Company continues to evaluate whether additional enforcement action is feasible or advisable at this stage with respect to outstanding Nonaccrual Receivables and deficiency claims that the Company retains. As of June 30, 2012 and December 31, 2011, the Company had approximately $0 and $8,500 in Nonaccrual Receivables, net of reserves. The acquired municipal bonds are included in securities owned, at fair value, while the secured debts are included in other assets. After further evaluation of options available to the Company to realize upon the foreclosed assets and in light of the financial condition of the RDC and the then current status of the Exchange Offer, the Company determined that the prospects for a successful restructuring by the Company of its RDC related assets had diminished. The Company therefore determined that an immediate sale of the assets represented the best means for the Company to realize upon these assets. On April 25, 2012 the Company sold substantially all of its RDC related assets, including municipal bonds and certain secured loans comprised of a secured loan of $6,700 and the advances to the RDC by the Company of $400 on September 2, 2011 and $400 on December 20, 2011. The purchase price for the RDC related assets was $6,955 payable in cash. In connection with that transaction, during the quarter ended March 31, 2012, the Company recorded bad debt expense of $545 which reduced the secured loans and advances to their net realizable value of $6,955. In the quarter ended June 30, 2012, the Company reserved approximately $371 related to Nonaccrual receivables that were previously secured by Retama related assets. As of June 30, 2012, the Company has no exposure to Retama related Nonaccrual Receivables and retains no direct Retama related assets.

17

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


When assessing collectibility of its remaining Nonaccrual Receivables, or other receivables, the Company considers a variety of factors relating to the collateral securing such receivables such as, but not limited to, the macroeconomic environment, the underlying, value of assets (often real estate) held by those projects and the liquidity of the collateral. In each case the collateral is owned by customers and pledged to the Company and/or its affiliates.
There can be no assurances that the Company’s collection efforts, including anticipated funding and/or other actions by third parties, will be effectuated as currently contemplated, or that the Company will be able to realize the full value on the assets acquired as a consequence of foreclosure on collateral that secured the Nonaccrual Receivables, as currently contemplated. Given the illiquid nature of the assets, the Company anticipates that ultimate realization upon these assets may require investment of significant time and resources, including active participation in the restructuring of the investments, in order to execute upon a plan of liquidation.
The changes in the allowance for doubtful accounts during 2012 were as follows:
 
Balance, December 31, 2011
$
65,746

Bad debt expense
4,055

Transfer to Apex
(16,853
)
Write-offs
$
(545
)
Balance, June 30, 2012
$
52,403

Bad debt expense of $690 was directly offset against interest income in connection with certain receivables in which the Company had previously ceased recognizing interest income for the six months ended June 30, 2012. In connection with the Apex transaction, allowance for doubtful accounts of $16,853 was transferred along with the corresponding customer receivables of the same amount.
9.
Securities owned and securities sold, not yet purchased
Securities owned and securities sold, not yet purchased consist of trading securities at fair value as follows: 
 
June 30,
2012
 
December 31,
2011
Securities Owned:
 
 
 
Corporate equity
$
—

 
$
463

Listed option contracts
—

 
88

Municipal bonds
25,383

 
33,468

 
$
25,383

 
$
34,019

Securities Sold, Not Yet Purchased:
 
 
 
Corporate equity
$
—

 
$
378

Listed option contracts
—

 
121

 
$
—

 
$
499

 
10.
Short-term bank loans
At June 30, 2012 and December 31, 2011, the Company had $0 and $80,800, respectively in short-term bank loans outstanding with weighted average interest rates of approximately 0.0% and .8%, respectively. As of June 30, 2012, the Company no longer has any uncommitted line of credit. As of June 30, 2012, the Company's PFSC subsidiary had two uncommitted lines of credit with two financial institutions permitting PFSC to borrow up to an aggregate of approximately $184,879. Outstanding balances of $19,045 and $9,302, respectively are included in liabilities associated with assets held-for-sale in the unaudited interim condensed consolidated statements of financial condition as of June 30, 2012 and December 31, 2011. See Note 20. The fair value of short-term bank loans approximates their carrying values. The short-term bank loans do not contain any financial covenants.
11.
Notes payable
Senior convertible notes
On June 3, 2009, the Company issued $60,000 aggregate principal amount of 8.0% Senior Convertible Notes due 2014 (the “Convertible Notes”). The $60,000 aggregate principal amount of Convertible Notes includes $10,000 issued in connection with the exercise in full by the initial purchasers of their over-allotment option. The net proceeds from the sale of the

18

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


convertible notes were approximately $56,200 after initial purchaser discounts and other expenses.
The Convertible Notes bear interest at a rate of 8.0% per year. Interest on the Convertible Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning December 1, 2009. The Convertible Notes will mature on June 1, 2014, subject to earlier repurchase or conversion.
Holders may convert their Convertible Notes at their option at any time prior to the close of business on the business day immediately preceding the maturity date for such Convertible Notes under the following circumstances: (1) during any fiscal quarter (and only during such fiscal quarter), if the last reported sale price of the Company’s common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is equal to or more than 120% of the conversion price of the Convertible Notes on the last day of such preceding fiscal quarter; (2) during the five business-day period after any five consecutive trading-day period in which the trading price per $1,000 (in whole dollars) principal amount of the Convertible Notes for each day of that period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate of the Convertible Notes on each such day; (3) upon the occurrence of specified corporate transactions, including upon certain distributions to holders of the Company’s common stock and certain fundamental changes, including changes of control and dispositions of substantially all of the Company’s assets; and (4) at any time beginning on March 1, 2014. Upon conversion, the Company will pay or deliver, at the Company’s option, cash, shares of the Company’s common stock or a combination thereof. The initial conversion rate for the Convertible Notes was 101.9420 shares of the Company’s common stock per $1,000 (in whole dollars) principal amount of Convertible Notes (6,117 shares), equivalent to an initial conversion price of approximately $9.81 per share of common stock. Such conversion rate will be subject to adjustment in certain events, but will not be adjusted for accrued or additional interest. The Company has received consent from its stockholders to issue up to 6,117 shares of its common stock to satisfy its payment obligations upon conversion of the Convertible Notes.
Following certain corporate transactions, the Company will increase the applicable conversion rate for a holder who elects to convert its Convertible Notes in connection with such corporate transactions by a number of additional shares of common stock. The Company may not redeem the Convertible Notes prior to their stated maturity date. If the Company undergoes a fundamental change, holders may require the Company to repurchase all or a portion of the holders’ Convertible Notes for cash at a price equal to 100% of the principal amount of the Convertible Notes to be purchased, plus any accrued and unpaid interest, including any additional interest, to, but excluding, the fundamental change purchase date.
The Convertible Notes are unsecured obligations of the Company and contain customary covenants, such as reporting of annual and quarterly financial results, and restrictions on certain mergers, consolidations and changes of control. The Convertible Notes also contain customary events of default, including failure to pay principal or interest, breach of covenants, cross-acceleration to other debt in excess of $20,000, unsatisfied judgments of $20,000 or more and bankruptcy events. At June 30, 2012 the Company was in compliance with all covenants.
The Company was required to separately account for the liability and equity components of the Convertible Notes in a manner that reflected the Company’s nonconvertible debt borrowing rate at the date of issuance. The Company allocated $8,822, net of tax of $5,593, of the $60,000 principal amount of the Convertible Notes to the equity component, which represents a discount to the debt and is being amortized into interest expense using the effective interest method through June 1, 2014. Accordingly, the Company’s effective interest rate on the Convertible Notes was 15.0%. The Company is recognizing interest expense during the twelve months ending May 2013 on the Convertible Notes in an amount that approximates 15.0% of $52,966, the liability component of the Convertible Notes at June 1, 2012. The Convertible Notes were further discounted by $2,850 for fees paid to the initial purchasers. These fees are being accreted and other debt issuance costs are being amortized into interest expense over the life of the Convertible Notes. The interest expense recognized for the Convertible Notes in the twelve months ending May 2013 and subsequent periods will be greater as the discount is accreted and the effective interest method is applied. The Company recognized interest expense of $1,200 and $1,200, related to the coupon, $817 and $648 related to the conversion feature and $178 and $178 related to various issuance costs for the three months ended June 30, 2012 and 2011, respectively. For the six months ended June 30, 2012 and 2011 the Company recognized interest expense of $2,400 and $2,400 related to the coupon, $1,481 and $1,282 related to the conversion feature and $357 and $357 related to various issuance costs.
The fair value of the Convertible Notes was estimated using a discounted cash flow analysis based on the current estimated effective yield for the Company’s senior second lien secured notes, which approximates the estimated current borrowing rate for an instrument with similar terms (estimated to be 69.0%). At June 30, 2012 and December 31, 2011, the estimated fair value of the Convertible Notes was $24,097 and $41,902 respectively, which are considered Level 2 liabilities in the fair value hierarchy as the inputs used to estimate fair value are observable or can be corroborated by observable market

19

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


data for substantially the full term of the liabilities.
Senior second lien secured notes
On May 6, 2010, the Company issued $200,000 aggregate principal amount of its 12.5% Senior Second Lien Secured Notes due 2017 (the “Notes”). The Notes bear interest at a rate of 12.5% per year and are guaranteed by SAI and PHI. The Notes are secured by a pledge by PWI, SAI and PHI of the equity interests of certain of PWI’s subsidiaries. With the repayment of the Company's senior bank credit facility these liens are effectively now first priority liens. The Notes were issued pursuant to an Indenture dated as of May 6, 2010 with U.S. Bank National Association as Trustee and Collateral Agent (the “Trustee”) and a Second Lien Pledge Agreement dated as of May 6, 2010 with the Trustee. The rights of the Trustee pursuant to the Second Lien Pledge Agreement are subject to an Intercreditor Agreement entered between PWI, the Trustee and the Administrative Agent for the Company’s senior secured credit facility. However, we repaid this senior secured credit facility during the first quarter and these intercreditor provisions, therefore, are now largely moot.
The Notes contain customary representations and covenants, such as reporting of annual and quarterly financial results, and restrictions, among other things, on indebtedness, liens, certain restricted payments and investments, asset sales, certain mergers, consolidations and changes of control. The Notes also contain customary events of default, including failure to pay principal or interest, breach of covenants, cross-acceleration to other debt in excess of $20,000, unsatisfied judgments of $20,000 or more and bankruptcy events. The Company is in compliance with all covenants.
The Company used a part of the proceeds of the sale to pay down approximately $110,000 outstanding on its then current revolving credit facility, and used the balance of the proceeds to provide working capital, among other things, to support the correspondents the Company acquired from Ridge and for other general corporate purposes.
The Company recorded a discount of $5,500 for the costs associated with the initial purchasers. These costs and other debt issuance costs are being amortized into interest expense over the life of the Notes. For the three months ended June 30, 2012 and 2011 the Company recognized interest expense of $6,250 and $6,250 related to the coupon and $239 and $239 related to various issuance costs. For the six months ended June 30, 2012 and 2011 the Company recognized interest expense of $12,500 and $12,500 related to the coupon and $479 and $479 related to various issuance costs. At June 30, 2012 and December 31, 2011, the estimated fair value of the Notes was approximately $45,000 and $126,124, respectively, which are considered Level 2 liabilities in the fair value hierarchy as fair value was based on quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Revolving credit facility
On May 6, 2010, the Company entered into a second amended and restated credit agreement, as amended (the “Amended and Restated Credit Facility”) with Regions Bank, as Administrative Agent, Swing Line Lender and Letter of Credit Issuer, the lenders party thereto and other parties thereto. At December 31, 2011, $7,000 was outstanding. This facility was paid in full as of March 31, 2012.
Ridge seller note
On June 25, 2010, in connection with the acquisition of the clearing and execution business of Ridge, the Company issued a $20,578 five-year subordinated note due June 25, 2015 (the “Ridge Seller Note”), payable by PWI bearing interest at an annual rate equal to 90-day LIBOR plus 5.5%.
The Company determined that the stated rate of interest of the note was below the rate the Company could have obtained in the open market. The Company estimated that the interest rate it could obtain in the open market was 90-day LIBOR plus 9.6% (10.14% at June 25, 2010). The Company recorded a discount of $3,277, which resulted in an estimated fair value of $17,301 at issuance. For the three months ended June 30, 2012 and 2011, respectively, the Company recognized interest expense of $215 and $303 associated with the coupon and $102 and $138 related to the discount. For the six months ended June 30, 2012 and 2011, respectively, the Company recognized interest expense of $531 and $601 associated with the coupon and $251 and $272 related to the discount. As described in Note 3, the Company and Broadridge entered into a termination and release agreement that resulted in the extinguishment of the Ridge Seller Note, all accrued and unpaid interest and any amounts due under contingent earnout arrangements under the Ridge APA. As a result of this the Company recorded a gain of $22,514, which was comprised of the carrying amount of the Ridge Seller Note of $18,372, accrued interest of $1,143 and contingent consideration of $2,999.
The estimated fair value of the Ridge Seller Note at December 31, 2011, was calculated using a discounted cash flow

20

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


analysis based on the estimated effective yield for the Company’s senior second lien secured notes at that time, which approximated the estimated current borrowing rate for an instrument with similar terms (25.5% at December 31, 2011). The estimated fair value of the Ridge Seller Note at December 31, 2011 was $11,485 which is considered a Level 2 liability in the fair value hierarchy as the inputs used to estimate fair value were observable or could be corroborated by observable market data for substantially the full term of the liability.
12.
Financial instruments with off-balance sheet risk

Through PFSC, the Company purchases and sells securities as both principal and agent. If another party to the transaction fails to fulfill its contractual obligation, the Company could incur a loss if the market value of the security is different from the contract amount of the transaction.The Company deposits customers' margin account securities with lending institutions as collateral for borrowings. If a lending institution did not return a security, the Company may be obligated to purchase the security in order to return it to the customer. In such circumstances, the Company may incur a loss equal to the amount by which the market value of the security on the date of nonperformance exceeds the value of the loan from the institution.
In the event a customer failed to satisfy its obligations, the Company may be required to purchase or sell financial instruments at prevailing market prices to fulfill the customer's obligations. The Company generally seeks to control the risks associated with its customer activities by requiring customers to maintain margin collateral in compliance with various regulatory and internal guidelines. The Company monitors required margin levels on an intra-day basis and, pursuant to such guidelines, generally requires customers to deposit additional collateral or to reduce positions when necessary. Although the Company monitors margin balances on an intra-day basis in order to control our risk exposure, the Company is not necessarily able to eliminate all risks associated with margin lending.
Securities purchased under agreements to resell are collateralized by Canadian government securities. Such transactions could expose the Company to off-balance-sheet risk in the event such borrowers do not repay the loans and the value of collateral held is less than that of the underlying contract amount. These agreements provide the Company with the right to maintain the relationship between market value of the collateral and the contract amount of the receivable.
The Company’s policy is to regularly monitor its market exposure and counterparty risk and maintains a policy of reviewing the credit exposure of all parties, including customers, with which it conducts business.
For customers introduced on a fully-disclosed basis by other broker-dealers, the Company has the contractual right of recovery from such introducing broker-dealers in the event of nonperformance by the customer.
In addition, the Company has sold securities that it does not currently own and will therefore be obligated to purchase such securities at a future date. The Company has recorded these obligations in the financial statements at June 30, 2012 at fair values of the related securities and may incur a loss if the fair value of the securities increases subsequent to June 30, 2012.
13.
Stock-based compensation
The Company grants awards of stock options and restricted stock units (“RSUs”) under the Amended and Restated 2000 Stock Incentive Plan, as amended in April 2011 (the “2000 Stock Incentive Plan”), under which 6,283 shares of common stock have been authorized for issuance. Of this amount, options and RSUs to purchase 3,565 shares of common stock, net of forfeitures and tax withholdings have been granted and 2,718 shares remain available for future grants at June 30, 2012. The Company suspended operating its employee stock purchase plan (“ESPP”).
The 2000 Stock Incentive Plan includes two separate programs: (1) the discretionary option grant program under which eligible individuals in the Company’s employ or service (including officers, non-employee board members and consultants) may be granted options to purchase shares of common stock of the Company; and (2) the stock issuance program under which such individuals may be issued shares of common stock directly or stock awards that vest over time, through the purchase of such shares or as a bonus tied to the performance of services. The Company discontinued the automatic grant program under which grants were automatically be made at periodic intervals to eligible non-employee board members. The Company’s Board of Directors or its Compensation Committee may amend or modify the 2000 Stock Incentive Plan at any time, subject to any required stockholder approval.
Stock options
During the three and six month periods ended June 30, 2012 and 2011, the Company did not grant any stock options to employees.

21

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


The Company recorded compensation expense relating to options of $0 and $13, respectively, for the three months ended June 30, 2012 and 2011 and $0 and $38, respectively, for the six months ended June 30, 2012 and 2011.
A summary of the Company’s stock option activity is as follows:
 
 
Number of
Shares
 
Weighted
Average
Exercise Price
 
Weighted
Average
Contractual
Term
 
Aggregate
Intrinsic
Value of
In-the-Money
Options
 
 
 
(in whole dollars)
 
(in years)
 
 
Outstanding, December 31, 2011
701

 
$
17.24

 
2.11
 
$
—

Granted
—

 
—

 

 


Exercised
—

 
—

 

 


Forfeited, canceled or expired
(199
)
 
14.92

 

 


Outstanding, June 30, 2012
502

 
$
18.16

 
1.80
 
$
—

Options exercisable at June 30, 2012
502

 
$
18.16

 
1.80
 
$
—

No options were exercised during the three and six month periods ended June 30, 2012 and 2011. At June 30, 2012, the Company had no unrecognized compensation expense related to stock option plans.
 Restricted stock units
A summary of the Company’s RSU activity is as follows:
 
 
Number of
Units
 
Weighted
Average
Grant Date Fair
Value
 
Weighted
Average
Contractual
Term
 
Aggregate
Intrinsic
Value
 
 
 
(in whole dollars)
 
(in years)
 
 
Outstanding, December 31, 2011
1,285

 
$
5.35

 
1.80
 
$
1,491

Granted
1,080

 
0.93

 

 


Vested and issued
(513
)
 
4.61

 

 


Forfeited
(437
)
 
4.52

 

 


Outstanding, June 30, 2012
1,415

 
$
2.50

 
1.63
 
$
212

The Company recorded compensation expense relating to restricted stock units of $397 and $799, respectively, for the three months ended June 30, 2012 and 2011 and $1,267 and $1,720, respectively, for the six months ended June 30, 2012 and 2011.
As of June 30, 2012, there was approximately $2,675 of unamortized compensation expense, net of estimated forfeitures, related to unvested restricted stock units outstanding that will be recognized over the weighted average period of 1.62 years.
Employee stock purchase plan
In July 2005, the Company’s Board of Directors adopted the ESPP, designed to allow eligible employees of the Company to purchase shares of common stock, at semiannual intervals, through periodic payroll deductions. A total of 313 shares of common stock were initially reserved under the ESPP. The share reserve will automatically increase on the first trading day of January each calendar year, beginning in calendar year 2007, by an amount equal to 1% of the total number of outstanding shares of common stock on the last trading day in December in the prior calendar year. Under the current plan, no such annual increase may exceed 63 shares.
The ESPP may have a series of offering periods, each with a maximum duration of 24 months. Offering periods will begin at semi-annual intervals as determined by the plan administrator. Individuals regularly expected to work more than 20 hours per week for more than five calendar months per year may join an offering period on the start date of that period. However, employees may participate in only one offering period at a time. Participants may contribute 1% to 15% of their annual compensation through payroll deductions, and the accumulated deductions will be applied to the purchase of shares on

22

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


each semi-annual purchase date. The purchase price per share shall be determined by the plan administrator at the start of each offering period and shall not be less than 85% of the lower of the fair market value per share on the start date of the offering period in which the participant is enrolled or the fair market value per share on the semi-annual purchase date. The plan administrator has discretionary authority to establish the maximum number of shares of common stock purchasable per participant and in total by all participants for each offering period. The Company’s Board of Directors or its Compensation Committee may amend, suspend or terminate the ESPP at any time, and the ESPP will terminate no later than the last business day of June 2015. As of June 30, 2012, 688 shares of common stock had been reserved and 625 shares of common stock had been purchased by employees pursuant to the ESPP. The Company recognized expense of $17 and $33 for the three months ended June 30, 2012 and 2011, respectively and $52 and $63 for the six months ended June 30, 2012 and 2011, respectively.
The Company’s Compensation Committee suspended the ESPP after the May 15, 2012 purchase.
14.
Commitments and contingencies
From time to time, we are involved in other legal proceedings arising in the ordinary course of business. In some instances, but not all, where we are named in arbitration proceedings solely in our role as the clearing broker for our former correspondents, we are able to pass through expenses related to the arbitration to the correspondent involved in the arbitration.
Under its bylaws, the Company has agreed to indemnify its officers and directors for certain events or occurrences arising as a result of the officer or director’s serving in such capacity. The Company has entered into indemnification agreements with each of its directors and certain of our officers that require us to indemnify our directors and certain of our officers to the extent permitted under our bylaws and applicable law. Although management is not aware of any claims, other than the Purported Class Action and Derivative Litigation Matters (see Item 1. Legal Proceedings), the maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company has a directors and officer liability insurance policy that limits its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal and has no liabilities recorded for these agreements as of June 30, 2012.
In connection with the Assignment and Assumption Agreement with Apex Holdings, the Company agreed to indemnify certain parties for certain potential events or occurrences. As of June 30, 2012 the Company has no liabilities recorded related to these indemnifications.
In the course of its business the Company is subject to litigation which if adversely determined could result in claims against the Company.
In re Sentinel Management Group, Inc. is a Chapter 11 bankruptcy case filed on August 17, 2007 in the U.S. Bankruptcy Court for the Northern District of Illinois by Sentinel. Prior to the filing of this action, Penson Futures and PFFI held customer segregated accounts with Sentinel totaling approximately $36,000. In the days immediately preceding its bankruptcy filing, Sentinel sold certain securities to Citadel Equity Fund, Ltd. and Citadel Limited Partnership. On August 20, 2007, the Bankruptcy Court authorized distributions of 95% of the proceeds Sentinel received from that sale to certain FCM clients of Sentinel, including Penson Futures and PFFI. This distribution to the Penson Futures and PFFI customer segregated accounts along with a distribution received immediately prior to the bankruptcy filing totaled approximately $25,400.
On May 12, 2008, a committee of Sentinel creditors, consisting of a majority of non-FCM creditors, together with the trustee appointed to manage the affairs and liquidation of Sentinel (the “Sentinel Trustee”), filed with the Court their proposed Plan of Liquidation (the “Committee Plan”) and on May 13, 2008 filed a Disclosure Statement related thereto. The Committee Plan allows the Sentinel Trustee to seek the return from FCMs, including Penson Futures and PFFI, of a portion of the funds previously distributed to their customer segregated accounts. On June 19, 2008, the Court entered an order approving the Disclosure Statement over objections by Penson Futures, PFFI and others. On September 16, 2008, the Sentinel Trustee filed suit against Penson Futures and PFFI and several other FCMs that received distributions to their customer segregated accounts from Sentinel. The suit against Penson Futures and PFFI seeks the return of approximately $23,600 of post-bankruptcy petition transfers and approximately $14,400 of pre-bankruptcy petition transfers. The suit also seeks to declare that the funds distributed to the customer segregated accounts of Penson Futures and PFFI by Sentinel are the property of the Sentinel bankruptcy estate rather than the property of customers of Penson Futures and PFFI.
On December 15, 2008, over the objections of Penson Futures and PFFI, the court entered an order confirming the Committee Plan, and the Committee Plan became effective on December 17, 2008. On January 7, 2009 Penson Futures and PFFI filed their answer and affirmative defenses to the suit brought by the Sentinel Trustee. Also on January 7, 2009, Penson Futures, PFFI and a number of other FCMs that had placed customer funds with Sentinel filed motions with the federal district

23

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


court for the Northern District of Illinois, effectively asking the federal district court to remove the Sentinel suits against the FCMs from the bankruptcy court and consolidate them with other Sentinel related actions pending in the federal district court. On April 8, 2009, the Sentinel Trustee filed an amended complaint, which added a claim for unjust enrichment. Following an unsuccessful attempt to dismiss that claim on September 1, 2009, the Court denied the motion for reconsideration without prejudice. On September 11, 2009, Penson Futures and PFFI filed their amended answer and amended affirmative defenses to the Sentinel Trustee’s amended complaint. On October 28, 2009, the federal district court for the Northern District of Illinois granted the motions of Penson Futures, PFFI, and certain other FCMs requesting removal of the matters referenced above from the bankruptcy court, thereby removing these matters to the federal district court.
In one of the actions brought by the Sentinel Trustee against an FCM whose customer segregated accounts received distributions similar to those made to the customer segregated accounts of Penson Futures and PFFI, the Sentinel Trustee has brought a motion for summary judgment on certain counts asserted against such FCM that may implicate the claims brought by the Sentinel Trustee against the Company. The FCM filed its response in August, 2011 and the Sentinel Trustee filed his reply brief in November 2011. On December 15, 2011, the National Futures Association filed an amicus curie brief in opposition to the Sentinel Trustee’s summary motion and on January 11, 2012, the Commodities Futures Trading Commission filed an amicus curie brief in opposition to the Sentinel Trustee’s summary judgment motion. There is no date set for the resolution of that motion.
On January 13, 2012, four FCMs whose customer segregated accounts received distributions similar to those made to the customer segregated accounts of Penson Futures and PFFI filed motions for summary judgment with respect to the Sentinel Trustee’s claims seeking recovery of pre-bankruptcy petition transfers that may implicate the claims brought by the Sentinel Trustee by which the Trustee is seeking recovery from the Company of $14,400 of pre-bankruptcy transfers. The federal district court has set April 13, 2012 as the deadline for the Sentinel Trustee to respond to the FCMs summary judgment motions. There is no date set for the resolution of that motion.
On February 21, 2012, the Sentinel Trustee filed a motion to set a trial date with respect to its suit against one FCM whose customer segregated accounts received distributions similar to those made to the customer segregated accounts of Penson Futures and PFFI. The federal district court judge has set the trial for that case to commence on October 1, 2012.
On February 21, 2012, the Sentinel Trustee filed a Motion for Leave to Amend Complaint to amend claims against Penson Futures and PFFI. On February 28, 2012, the federal district court entered an order authorizing the Sentinel Trustee to file the amended complaint and on March 7, 2012, the Sentinel Trustee filed his Second Amended Complaint. On April 4, 2012, Penson Futures and PFFI filed a motion to dismiss one count of the Second Amended Complaint and its Answer and Affirmative Defenses to the remaining counts of the Second Amended Complaint. The Trustee has not yet responded to the motion to dismiss. No trial date has been set with respect to the Trustee’s suit against Penson Futures and PFFI.
Purported Class Action and Derivative Litigation Matters
On August 23, 2011, a class action complaint alleging violations of the federal securities laws was filed in the United States District Court for the Northern District of Texas against the Company and its Chief Executive Officer and Chief Financial Officer, Philip A. Pendergraft and Kevin W. McAleer, by Reid Friedman, on behalf of himself and all others similarly situated (the “Friedman Action”). Plaintiff contended, among other things, that “Penson concealed from investors that by at least the end of 2010, 1) that the Company had approximately $96 million to $97 million in receivables of which approximately $43 million were collateralized by illiquid securities and therefore unlikely to be collected; 2) the Company’s assets (Nonaccrual Receivables) were materially overstated and should have been written down at least by the end of 2010; 3) as a result, the Company’s reported income and EBITDA (earnings before interest, taxes, depreciation, amortization and stock-based compensation, and excluding certain non-operating expenses) were materially overstated; and 4) the Company’s financial statements were not prepared in accordance with generally accepted accounting principles. In March 2012, Plaintiff filed an Amended Complaint alleging a class period between March 30, 2007 and August 4, 2011, inclusive, adding allegations, among others, that certain transactions should have been disclosed as related party transactions, and adding Daniel P. Son, Roger Engemoen, Jr., Thomas R. Johnson, and BDO Seidman, LLP and BDO USA, LLP as additional parties. These events have led to increased regulatory scrutiny of our operations and margin lending. Plaintiff seeks to recover an unspecified amount of damages, including interest, attorneys’ fees, costs, and equitable/injunctive relief as the Court may deem proper. The Company filed a Motion to Dismiss and intends to vigorously defend itself against these claims.
On September 21, 2011, a verified shareholder derivative petition was filed in County Court at Law No. 3, Dallas, County, Texas by Chadwick McHugh, “individually and on behalf of nominal defendant Penson Worldwide, Inc.,” against the Company and current or former members of the Company’s board of directors, Roger J. Engemoen, Jr., David M. Kelly, James

24

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


S. Dyer, David Johnson, Philip A. Pendergraft, David A. Reed, Thomas R. Johnson, and Daniel P. Son (the McHugh Action”). A second verified shareholder derivative petition was filed against the same defendants on September 21, 2011, by Sanjay Israni, “individually and on behalf of nominal defendant Penson Worldwide, Inc.,” in County Court at Law No. 1, Dallas, County, Texas (the “Israni Action”). On November 4, 2011, another shareholder derivative suit was filed in the United States District Court for the Northern District of Texas, by Adam Leniartek, “derivatively on behalf of Penson Worldwide, Inc.,” against the same defendants (the “Leniartek Action”). Plaintiffs in both the McHugh Action and the Israni Action allege, among other things, causes of action for breaches of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets. Plaintiff in the Leniartek Action alleges those same causes of action as well as a claim for contribution and indemnification. The McHugh Action and the Israni Action have now been consolidated. The plaintiffs seek, among other things, unspecified monetary damages in favor of the Company, changes to corporate governance procedures, restitution and disgorgement, and costs, including attorneys’ fees, accountants’ and experts’ fees, costs, and expenses. The defendants have not yet filed an Answer or responsive motion.
In response to these actions, Penson has retained experienced securities litigation counsel to vigorously represent it and its officers and directors. Management cannot currently estimate a range of reasonably possible loss. As is not unusual in these situations, this litigation has encouraged increased regulatory scrutiny of our operations by our regulators, including FINRA and the SEC.
Realtime Data, LLC d/b/a IXO v. Thomson Reuters et al. In July and August 2009, Realtime Data, LLC (“Realtime”) filed lawsuits against the Company and Nexa (along with numerous other financial institutions, exchanges, and financial data providers) in the United States District Court for the Eastern District of Texas in consolidated cases styled Realtime Data, LLC d/b/a IXO v. Thomson Reuters et al. Realtime alleges, among other things, that the defendants’ activities infringe upon patents allegedly owned by Realtime, including our use of certain types of data compression to transmit or receive market data. Realtime is seeking both damages for the alleged infringement as well as a permanent injunction enjoining the defendants from continuing infringing activity. Discovery with respect to this matter is proceeding.
The United States Court of Appeals for the Federal Circuit issued an order mandating the transfer of the case to the Southern District of New York. The trial before the New York District Court is scheduled for November 26, 2012. Based on its investigation to date and advice from legal counsel, the Company believes that resolution of these claims will not result in any material adverse effect on its business, financial condition, or results of operation. Nevertheless, the Company has incurred and will likely continue to incur significant expense in defending against these claims, and there can be no assurance that future liability will be avoided. Management cannot currently estimate a range of reasonably possible loss. The Company has entered into a Standstill Agreement pursuant to which the claims against it will be stayed following the conclusion of expert discovery and the determination of summary judgment motions.  In exchange, the Company will be bound by the Court's determinations of liability as to certain other defendants, against whom the plaintiff's claims are proceeding to trial.   
Penson Financial Services, Inc. v. SAMCO Capital Markets, Inc., Roger J. Engemoen, et al. On July 24, 2012, PFSI filed a FINRA arbitration against SAMCO Capital Markets, Inc. (“SAMCO”) and its principal Roger J. Engemoen (“Engemoen”), a former director of the Company.  PFSI is seeking to recover unpaid interest advances that are owed to it by SAMCO and Engemoen, believed to total approximately $2.6 million.  The case is in its initial stage, so no discovery has yet been conducted and no hearing dates set. 
In the general course of business, the Company and certain of its officers have been named as defendants in other various pending lawsuits and arbitration and regulatory proceedings. These other claims allege violation of federal and state securities laws, among other matters. The Company believes that resolution of these claims will not result in any material adverse effect on its business, financial condition, or results of operation.
15.
Income taxes
The Company’s overall effective income tax rate was 0.5% and 0.8%, respectively for the three and six month periods ended June 30, 2012, and was 38.0% and 38.0%, respectively for the three and six month periods ended June 30, 2011. The primary factor contributing to the difference between the effective tax rates and the federal statutory income tax rate of 35% for the three and six month periods ended June 30, 2012 is a deferred tax asset valuation allowance. Additional factors contributing to the difference in both periods are lower tax rates applicable to non-U.S. earnings, state and local income taxes, net of federal benefit and stock-based compensation.
16.
Segment information
Prior to the third quarter of 2011, the Company was organized into operating segments based on geographic regions. Those operating segments were aggregated into three reportable segments; United States, Canada and Other. During 2011, the

25

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


Company disposed its PFSA subsidiary and shut down the operations of Penson Asia. As of June 30, 2012 the Company's PFSL subsidiary has ceased operations with all results reported as discontinued operations for all periods presented. Additionally, the Company has reported the results of PFSC as discontinued operations. As of June 30, 2012, the Company operates in only one operating segment.
17.
Regulatory requirements
PFSI is subject to the SEC Uniform Net Capital Rule (SEC Rule 15c3-1) which requires the maintenance of minimum net capital. PFSI elected to use the alternative method, permitted by Rule 15c3-1, which requires that PFSI maintain minimum net capital, as defined, equal to the greater of $250 or 2% of aggregate debit balances, as defined in the SEC’s Reserve Requirement Rule (Rule 15c3-3). As a result of the Apex transactions (see Note 3), PFSI had no debit balances as of June 30, 2012, therefore, its minimum requirement was $250. At June 30, 2012, PFSI had a net capital deficit of $14,142 and was $14,392 below its minimum requirement of $250, which resulted in a net capital violation that was communicated to its regulators. At December 31, 2011, PFSI had net capital of $142,735, and was $116,049 in excess of its 2% net capital requirement of $26,686. The Company's PFSC business is also subject to minimum financial and capital requirements. PFSC was in compliance with its statutory minimum financial and capital requirements as of June 30, 2012.
The regulatory rules referred to above may restrict the Company’s ability to withdraw capital from its regulated subsidiaries, which in turn could limit the subsidiaries’ ability to pay dividends and the Company’s ability to satisfy its debt obligations. PFSC is subject to Canadian regulatory requirements which also limits the amount of dividends that it may be able to pay to its parent, which may be significantly in excess of the minimum requirement depending upon the restrictions placed on it by its regulator.
18.
Stock repurchase program
On July 3, 2007, the Company’s Board of Directors authorized the Company to purchase up to $25,000 of its common stock in open market purchases and privately negotiated transactions. The repurchase program was completed in October 2007. On December 6, 2007, the Company’s Board of Directors authorized the Company to purchase an additional $12,500 of its common stock. From December, 2007 through 2008, the Company repurchased approximately 654 shares at an average price of $10.32 per share. No shares were repurchased during the six months ended June 30, 2012 and 2011. The Company had approximately $4,700 available under the current repurchase program as of June 30, 2012; however, various of the Company's debt instruments limit its ability to repurchase its stock.
19.
Restructuring charges
In June 2010, in connection with the Company’s outsourcing agreement with Broadridge, the Company announced a plan to reduce its headcount across several of its operating subsidiaries primarily over the following six to 21 months. The terms of the plan included both severance pay and bonus payments associated with continuing employment (“Stay Pay”) until the respective outsourcing was completed. These payments were to occur at the end of the respective severance periods. In connection with the severance pay portion of the plan the Company recorded a severance charge of $2,016 for the year ended December 31, 2010 of which $1,687 was associated with the Company’s U.S. operations and $140 and $189, respectively related to the Company’s Canadian and U.K. operations, which have been discontinued. This charge was included in employee compensation and benefits in the unaudited interim condensed consolidated statement of comprehensive loss. During 2011, the Company reduced its severance liability by approximately $1,390 due to reductions in the number of employees that were eligible to receive severance payments due to voluntary terminations or transfers to other areas and made severance payments of approximately $413. Payments of $26 and $213 were made during the three and six month periods ended June 30, 2012. The severance accrual was $0 and $213 as of June 30, 2012 and December 31, 2011.
The Company initially estimated that it would incur costs of $2,141 associated with Stay Pay of which $1,808 was related to its U.S. operations, and $333 related to its Canadian and U.K. operations. The Company recorded a charge of $864 in connection with the Stay Pay for the year ended December 31, 2010 of which $723 was associated with its U.S. operations, $60 associated with its Canadian operations and $81 was associated with its U.K. operations. For the year ended December 31, 2011 the Company recorded charge of $89 associated with Stay Pay. The Company made payments of approximately $604 during 2011. Payments of $56 and $349 were made were made during the three and six month periods ended June 30, 2012. The Company had an accrual of $0 and $349 as of June 30, 2012 and December 31, 2011 related to Stay Pay.
Retention and Severance Plans
In connection with the closing of the transaction with Apex Holdings, the Company reduced its headcount as a result no longer being a U.S. securities correspondent clearing broker-dealer and the refocusing of the Company's business as third-party

26

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


provider of clearing related operational and technology services, principally through Nexa. In addition to the severance costs related to such reductions, the Company will incur future costs related to the retention program previously discussed.
On June 2, 2012, the Board of Directors of the Company approved a retention program for the employees of the Company, PFSI and Nexa that provides incentive payments to such employees if they continue to remain employed with the Company, PFSI or Nexa, as applicable, following the closing of the transaction with Apex Holdings. Employees continue to be eligible to receive severance payments and benefits under the Penson Severance Pay Plan, as amended June 5, 2012. The Penson Severance Pay Plan was amended on June 5, 2012, to provide that employees are not eligible to receive payments under the Penson Severance Pay Plan if they receive a comparable offer of employment from Apex Holdings or an entity related to Apex Holdings.
SunGard Contract Liability
In connection with the Company's conversion to Broadridge's BPS platform, Broadridge agreed to reimburse the Company for any minimum costs owed to SunGard Data Systems under its contract to provide certain back office services. This contract with SunGard is in effect until February 2014. As a result of the Termination and Mutual Release Agreement with Broadridge, Broadridge was no longer required to reimburse these costs. As a result of the Apex transaction, PFSI is no longer a clearing broker-dealer and as such no longer receiving any benefits under the SunGard contract. As of June 30, 2012 the Company has not terminated the contract. The Company recorded a charge of $14,183 as a result which reflects the estimated fair value of the future cash outflows associated with the minimum payments due under the contract. The estimated fair value was calculated using a present value technique based discounted using the Company's estimated credit-adjusted risk-free rate of 20%. The Company recorded an interest charge of $236 for the three and six month periods ended June 30, 2012. The estimated fair value of the liability as of June 30, 2012 was $14,418 which is considered a Level 2 liability in the fair value hierarchy as the inputs used to estimate fair value were observable or could be corroborated by observable market data for substantially the full term of the liability.
The Company accounts for its restructuring charges in accordance with Accounting Standards Codification Topic 420, Exit or Disposal Cost Obligations.
20.
Discontinued operations
In August 2011, the Company committed to a plan to sell its PFSL subsidiary in the United Kingdom and its PFSA subsidiary in Australia and initiated an active program to locate buyers for each business. The Company announced the completion of its sale of PFSA on November 30, 2011, which resulted in a gain of approximately $11,500, net of tax. It also announced its plans to sell certain assets of PFSL and wind down its business on December 16, 2011. Additionally, in December 2011 the Company announced plans to sell its PFSC subsidiary. The Company had treated its securities clearing businesses in both Canada and the U.K as discontinued operations. In June 2012 the Company completed the shutdown of PFSL.
As previously discussed in Note 3, the Company sold certain assets of the Penson Futures division which resulted in a gain of $381. As result of the receivable associated with the contingent consideration associated with the transaction, the Company recorded interest income of $60 for the three and six month periods ended June 30, 2012 which is included in the results of discontinued operations.
The results of the PFSC operations previously included in the Canada segment, the Penson Futures division of PFSI, previously included in the United States segment and PFSL and PFSA operations, previously included in the Other segment, are included in loss from discontinued operations, net of tax, for all periods presented. The net assets associated with PFSC and the Penson Futures division of PFSI totaling $41,281 as of June 30, 2012 and the net assets associated with PFSC, the Penson Futures division of PFSI and PFSL of $60,465 as of December 31, 2011 have been reclassified to assets held-for-sale and liabilities associated with assets held-for-sale in the consolidated statements of financial condition.
For a period of time, the Company will continue to operate the PFSC business and report statement of operations activity in loss from discontinued operations, net of tax.
The following summarized financial information relates to the operations of PFSC, the Penson Futures division of PFSI and PFSL for the three and six months ended June 30, 2012 and PFSC, the Penson Futures division of PFSI, PFSL and PFSA for the three and six months ended June 30, 2011 that have been segregated from continuing operations and reported as discontinued operations.
 

27

Penson Worldwide, Inc.
Notes to the Unaudited Condensed Consolidated Financial Statements — (Continued)


 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Net revenues
$
11,425

 
$
26,933

 
$
29,906

 
$
54,069

Loss from discontinued operations before income taxes
(8,451
)
 
(275
)
 
(14,406
)
 
(426
)
Income tax expense (benefit)
(510
)
 
457

 
(1,220
)
 
974

Loss from discontinued operations, net of tax
$
(7,941
)
 
$
(732
)
 
$
(13,186
)
 
$
(1,400
)
 
The following assets and liabilities have been segregated and classified as assets held-for-sale and liabilities associated with assets held-for-sale in the unaudited interim condensed consolidated statements of financial condition for PFSC as of June 30, 2012 and PFSC, the Penson Futures division of PFSI and PFSL as of December 31, 2011, respectively. The amounts presented below were adjusted to exclude intercompany receivables and payables between the businesses held-for-sale and the Company, which are to be excluded from the ultimate sales of the businesses.
 
 
June 30,
2012
 
December 31,
2011
Assets
 
 
 
Cash and cash equivalents
$
10,108

 
$
31,933

Cash and securities — segregated under federal and other regulations
194,241

 
500,373

Receivable from broker-dealers and clearing organizations
52,409

 
175,469

Receivable from customers, net
308,523

 
411,052

Receivable from correspondents
92,015

 
5,949

Securities borrowed
65,931

 
114,161

Securities owned, at fair value
113,992

 
288,274

Deposits with clearing organizations
120,112

 
497,461

Property and equipment, net
5,233

 
10,807

Other assets
6,235

 
95,602

Assets held-for-sale
$
968,799

 
$
2,131,081

Liabilities
 
 
 
Payable to broker-dealers and clearing organizations
$
171,532

 
$
133,452

Payable to customers
524,067

 
1,542,100

Payable to correspondents
199,125

 
248,633

Short-term bank loans
19,045

 
9,302

Securities loaned
2,423

 
15,439

Securities sold, not yet purchased, at fair value
324

 
81,097

Accounts payable, accrued and other liabilities
11,002

 
40,593

Liabilities associated with assets held-for-sale
$
927,518

 
$
2,070,616

21.
Subsequent event
On August 3, 2012, PFSI filed a Form BDW with the SEC and the FINRA, voluntarily withdrawing its registration as a broker-dealer and resigning as a member of FINRA. The SEC's and FINRA's acceptance of withdrawal and resignation are pending.

28

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and the consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, as amended, filed with the SEC and with the unaudited interim condensed consolidated financial statements and related notes thereto presented in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors including the risks discussed in “Risk Factors”, “Cautionary Note Regarding Forward-Looking Statements” and elsewhere in this Quarterly Report.
Results of continuing operations
The following discussion and analysis of the Company’s results of continuing operations exclude the results of PFSC, PFSL and the U.S. futures division of PFSI. These businesses are segregated from continuing operations and included in discontinued operations for all periods presented. See section entitled “Results of discontinued operations” following this section and Note 20 to our unaudited interim condensed consolidated financial statements for a discussion of our discontinued operations.
Overview
In the second quarter of 2012 we made material changes to our business. These changes were made for a number of reasons, including concerns about our continuing operating losses, the lack of meaningful progress in restructuring our outstanding indebtedness, and growing correspondent and regulatory concerns. These changes have resulted in our exit from the securities and futures clearing businesses in the U.S. Combined with our previously announced intention to exit these businesses in Canada, we anticipate that our operating business in the future will consist largely of our Nexa operations and the licensing of our patent portfolio. A more detailed discussion of these transactions is found below.
In May, PFSI sold certain of the assets of our futures clearing business, including customer contracts, segregated customer account assets, assets relating to our foreign currency exchange business, certain membership seats and licenses for clearing exchanges, and other related assets to Knight Execution & Clearing Services LLC (“Knight”). As a part of this transaction, Knight also assumed certain liabilities and obligations under customer contracts of our futures business. This transaction closed on May 31, 2012.
In May and June, PFSI entered into a number of agreements with Apex Clearing Holdings LLC ("Apex Holdings"), the parent company of Apex Clearing Corporation ("Apex Clearing"). In connection with these agreements, PFSI sold and transferred its customer and correspondent accounts and related contractual rights, and other related assets to Apex Clearing, contributing net assets with a value of approximately $90.0 million in regulatory capital. As a part of the transaction, Apex Clearing assumed certain liabilities and obligations under customer and correspondent contracts. In consideration for these transactions, PFSI received membership interests representing 93.75% of the equity interests in Apex Holdings. This transaction closed on June 5, 2012.
As a part of these transactions, PFSI and Nexa entered into transition services agreements with both Knight and Apex Holdings. Under these agreements, PFSI and Nexa agreed to provide personnel and infrastructure support to the operations of Knight and Apex Clearing. It is anticipated that the provision of these services will provide revenues to PFSI and Nexa during 2012 on a declining basis, as personnel and infrastructure support are assumed by Knight and Apex Clearing. The amounts to be payments from Knight and Apex Clearing pursuant to the transition services agreements may or may not cover the expenses of providing the transition support services. Therefore, there can be no guarantee that such payments will be sufficient to meet our liquidity needs.
As a result of these transactions, our primary products are the provision of front end trading systems, routing and execution infrastructure, and market data, both real time and historical. These products are largely marketed under the brand of Nexa Technologies, and are generally sold on a white label basis. Nexa products are used primarily in the U.S. and Canadian securities and futures markets. We also provide global data services under the brand of TickData.
For most of the quarter, prior to the transactions described above, we continued our business as a provider of a broad range of critical securities and futures processing infrastructure products and services to the global financial services industry. Our products and services included securities and futures clearing and execution, financing and cash management technology, foreign exchange services and other related offerings, and we provided tools and services to support trading in multiple markets, asset classes and currencies.
Our net revenues were $17.4 million and $51.5 million for the three months ended June 30, 2012 and 2011, respectively

29

and $39.6 million and $106.8 million for the six months ended June 30, 2012 and 2011, respectively. Our revenues have historically consisted primarily of transaction processing fees earned from our clearing operations and net interest income earned from our margin lending activities, from investing customers’ cash and from stock lending activities. Our clearing and commission fees have been based principally on the number of trades we clear. We have received interest income from financing the securities purchased on margin by the customers of our correspondents. We have also earned licensing and development revenues from fees that we charge to our clients for their use of our technology solutions.
Fiscal 2012 focal points
•
In March, we announced our intent to begin an exchange offer for most of our parent company’s funded indebtedness through the signing of a Restructuring Support Agreement (the “Restructuring Support Agreement”). In May, the Restructuring Support Agreement expired without the completion of any exchange offer.
•
In May, we disposed of our Retama Development Corporation (“RDC”) related assets for cash of approximately $7.0 million. This resulted in bad debt expense of approximately $0.5 million recorded for the quarter ended March 31, 2012 and a realized loss on our RDC related municipal bonds of $6.3 million in the second quarter of 2012.
•
In May, we completed the sale of our U.S. futures business to Knight.
•
In June, we completed the transactions with Apex Holdings, through which we disposed certain assets of PFSI and exited our broker-dealer business in the U.S.
•
In June, we completed the closure of PFSL, transferring all correspondents to alternative providers and allowing us to cease operations in the UK. We continue negotiations towards the sale of PFSC.
•
We have initiated an effort to generate license revenues from our patent portfolio.
•
We continued to seek to resolve certain open comments with the SEC with respect, among other things, to the timing of certain impairment charges that we have taken.
Debt
As previously announced, we and certain of our subsidiaries entered into a Restructuring Support Agreement, dated March 13, 2012 (the “Restructuring Support Agreement”) with (i) the holders of a majority of our 12.5% senior second lien secured notes due 2017 (the “Senior Secured Second Lien Notes”), (ii) the holders of over 70% of our unsecured 8% senior convertible notes due 2014 (the “Senior Convertible Notes”), and (iii) Broadridge (such holders collectively, the “Debt Holders”). Under the terms of the Restructuring Support Agreement, the Debt Holders agreed to support an exchange offer pursuant to which we would exchange an aggregate of approximately $281.0 million face value of outstanding indebtedness as of the date of the Restructuring for new debt and equity securities (the “Restructuring”). Despite the efforts of our executives and advisors, at substantial cost to the Company, we were not able to complete an exchange offer, and the Restructuring Support Agreement lapsed on May 14, 2012. Subsequently, as a part of the transactions with Apex Holdings, as discussed under “Strategic Transactions”, we were able to negotiate the forgiveness of the outstanding principal and interest due on the Ridge Seller Note and other obligations to Broadridge.
We have recommenced negotiations with certain major holders of our Senior Secured Second Lien Notes and the Senior Convertible Notes with the goal of restructuring these obligations in light of the Company's reorganization. There can be no assurance that we and the holders of these notes will reach agreement on terms of a revised restructuring. While we continue to believe that such a restructuring is in the best interests of its various stakeholders, in the absence of a satisfactory restructuring we will consider alternative options, including a restructuring pursuant to Chapter 11 of the U.S. Bankruptcy Code.
Liquidation of certain Nonaccrual Receivables
As discussed in Note 8 to our consolidated unaudited interim condensed consolidated financial statements, we foreclosed on certain of the collateral securing certain of the Nonaccrual Receivables. After further evaluation of options available to us to realize upon the foreclosed assets and in light of the financial condition of the RDC and the then current status of the Restructuring, we determined that the prospects for a successful restructuring by the Company of its RDC related assets had diminished. We therefore determined that an immediate sale of the assets represented the best means for us to realize upon these assets. We recorded a write-down to fair value of $8.8 million as of March 31, 2012 in respect of the RDC municipal bonds. On April 25, 2012 we sold substantially all of our RDC related assets, including certain real estate secured loans that had been advanced to the RDC, for approximately $7.0 million payable in cash and recorded a write-down of our RDC related municipal bonds of $6.3 million that is reflected in the second quarter of 2012. In connection with that transaction, as of March 31, 2012, we recorded bad debt expense of approximately $0.5 million. As of June 30, 2012 we retain no direct RDC related assets.

30

The debtors subject to the various foreclosure sales remain liable for deficiency claims of approximately $51.5 million in respect of which the Company continues to hold certain collateral not subject to the foreclosure sales. The various foreclosure and enforcement actions undertaken by the Company and the sale of the RDC related assets did not have a negative impact on the regulatory capital or liquidity of the Company or any of its operating subsidiaries.
Knight Transaction
In the second quarter, as a result of concerns about our continuing operating losses, the lack of meaningful progress in restructuring our outstanding indebtedness, and growing correspondent and regulatory concerns, we engaged in strategic discussions with a number of parties, including Knight. The Knight discussions resulted in negotiations regarding their purchase of our futures business. As these negotiations neared their end, our primary futures regulator, the Chicago Mercantile Exchange (“CME”), informed us that unless we entered into a sales transaction, they would consider taking regulatory action against PFSI. On May 21, 2012, shortly after receiving this notice, we entered into a letter of intent with Knight which satisfied the CME concerns.
On May 28, 2012, we entered into an Asset Purchase Agreement (the "APA") with Knight, pursuant to which (i) we sold certain assets of PFSI's futures clearing business (the "FCM Business"), including but not limited to, customer contracts, segregated customer account assets, assets relating to the foreign currency exchange business, certain membership seats and licenses for clearing exchanges, and other related assets to Knight; and (ii) Knight assumed, subject to specified exceptions, certain liabilities and obligations under customer contracts in the FCM Business (the "Sale"). On May 31, 2012, the Company and Knight closed the Sale. In consideration for the Sale, Knight agreed to make an initial payment of $5.0 million in cash to PFSI. This payment was received in two $2.5 million wires and was fully paid by June 7, 2012.
Knight also agreed to pay an earnout amount ("Earnout Amount") within 45 days of the first, second and third anniversary of the closing of the Sale. The Earnout Amount is to be calculated as follows: (i) if the revenue for the FCM Business for the then trailing 12 month period ending on the last day of the last full month of such 12 month period, (a) is less than $21.0 million, then the Earnout Amount shall be $0, or (ii) if such revenue is equal to or greater than $21.0 million, then the Earnout Amount will be 1.25% of the total revenue for every $1.0 million of revenue in excess of $20.0 million for such period. In connection with the Sale, we also entered into a Transition Services Agreement with Knight (the "Knight Services Agreement"), pursuant to which we agreed to provide Knight with all services, functions, products, software and intellectual property primarily used to support the FCM Business following the Sale, including services relating to regulatory compliance and reporting requirements (the "Transition Services"). Knight agreed to pay certain fees to PFSI for the Transition Services, and we expect that such fees will cover the costs for providing the Transition Services.
The term of the Transition Services will continue for a period of six months, but may be terminated early by Knight upon 30-day advance notice. As of June 30, 2012, the majority of our former futures division employees, including management, were employees of Knight.
The Apex Transactions
As previously mentioned, in the second quarter, as a result of concerns about our continuing operating losses, the lack of meaningful progress in restructuring our outstanding indebtedness, and growing correspondent and regulatory concerns, we engaged in strategic discussions with a number of parties. The growing regulatory concerns were expressed in a series of letters from FINRA, which resulted in an agreement with FINRA that we would enter into a strategic transaction, or face significant regulatory action, which could have included a SIPC liquidation.
As a result of these strategic discussions, we entered into a number of agreements with Apex Holdings , the parent company of Apex Clearing , which are fully described below. The Apex transaction closed on June 5, 2012.On May 31, 2012, PFSI entered into a Limited Liability Company Agreement and other definitive agreements with Apex Holdings. Pursuant to the Limited Liability Company Agreement (the "LLC Agreement"), we and Apex Clearing Solutions LLC ("ACS") established Apex Holdings, which is managed by ACS, a subsidiary of PEAK6 Investments, L.P. In addition, Broadridge Financial Solutions, Inc. ("Broadridge") transferred to Apex Holdings the ownership of its broker-dealer subsidiary (excluding certain assets and liabilities relating to its on-going outsourcing business), Ridge Clearing & Outsourcing Solutions, Inc., which was renamed "Apex Clearing Corporation", and became a wholly-owned subsidiary of Apex Holdings.
In connection with this transaction, PFSI entered into an Assignment and Assumption Agreement with Apex Holdings (the "AAA"), dated May 31, 2012, pursuant to which PFSI (i) sold and transferred to Apex Clearing the customer and correspondent accounts and related contractual rights of PFSI under its securities clearing contracts and other related assets, (ii) transferred to Apex Clearing certain related liabilities and (iii) contributed net assets valued at a total of $90.0 million towards the regulatory capital of Apex Clearing (collectively, the "Acquired Assets") in consideration for the issuance of membership interests representing 93.75% of the equity interests in Apex Holdings. In addition, ACS contributed $5.0 million in cash for membership interests representing approximately 5% of the equity interests in Apex Holdings, and certain other

31

investors contributed a total of $1.0 million in cash for membership interests representing an aggregate of approximately 1.0% of the equity interests in Apex Holdings. Furthermore, ACS and certain of its affiliates have provided $35.0 million in subordinated loans to Apex Clearing (the "Subordinated Loans"). The Subordinated Loans qualify for treatment as regulatory capital of Apex Clearing. Accordingly, Apex Clearing had approximately $130.0 million in regulatory capital at the closing of the transactions.
ACS has the option, from time to time, to purchase all or a portion of PFSI's membership interest in Apex Holdings at an amount equal to 120% of the then current value of PFSI's capital account. Furthermore, PFSI also deposited $2.0 million in an escrow account to support PFSI's obligations to indemnify Apex Holdings, ACS and their affiliates under the AAA for claims arising from, among other things, PFSI or Nexa's breach, violation or non-fulfillment of their obligations under the AAA or related transaction document. The the escrow amount, less the amount of any successful claims thereon, will be released to PFSI five (5) years after the closing of the transaction.
The Company and its subsidiary, Nexa, entered into an Indemnity and Support Agreement, pursuant to which they have agreed to indemnify Apex Holdings, ACS and their affiliates against certain claims for its losses incurred under the AAA or other transaction documents.
In connection with the closing of the transactions with Apex Holdings on June 5, 2012:

•
PFSI and Nexa entered into a Transition Services Agreement with Apex Holdings and Apex Clearing (the "TSA"), pursuant to which PFSI and Nexa agree to provide various transitional support services to Apex Holdings and Apex Clearing, including the continued servicing of various customer contracts to be transferred to Apex Clearing and other services to ensure a smooth transition of the business and compliance with certain applicable reporting and regulatory requirements. The initial term of the TSA is twelve (12) months, which may be extended by Apex Holdings for up to an additional six months. In addition, Nexa and PFSI entered into license agreements, pursuant to which Nexa and PFSI will grant certain licenses to Apex Clearing to use certain intellectual property in order, among other things, to enable Apex Clearing to perform its obligations under the clearing and customer contracts assigned to Apex Clearing and to conduct its clearing, settlement and execution business. As services are transitioned to Apex Clearing, the Company anticipates that the services required from PFSI under the TSA, and the associated payments from Apex Clearing, will be reduced proportionately.

•
PFSI entered into a credit agreement with Apex Clearing whereby PFSI has agreed to provide a $12.0 million line of credit to Apex Clearing for up to twelve months, and ACS entered into a credit agreement with Apex Clearing whereby ACS has agreed to provide a $10.0 million line of credit to Apex Clearing for up to twelve months; and

•
The Company entered into a Termination and Mutual Release Agreement with Broadridge (the "Release Agreement"), pursuant to which the Company and Broadridge agreed to (i) terminate the Schedules under the Master Services Agreement by and between the Company and Broadridge, dated November 2, 2009 (collectively the "Master Services Agreement"), other than to the extent necessary to provide the transition services under the Services Agreement and to continue to service the Company's Canadian subsidiary, PFSC; and (ii) terminate, discharge and release in full the Company's obligations, including all obligations to make principal and interest payments, under the Ridge Seller Note due June 25, 2015 with an outstanding principal amount of approximately $20.6 million issued to Broadridge. The Company and Broadridge also agreed to release all claims totaling not less than $87.0 million, arising under the Master Services Agreement, provided that Broadridge will retain claims of up to $20.0 million under the Master Services Agreement against PFSC while the Company will retain all of its rights under the Master Services Agreement to defend any such claims against PFSC.

Subsequent to the closing of the Apex transaction, on August 3, 2012, PFSI filed a Form BDW (Uniform Request for Broker-Dealer Withdrawal) with the SEC and FINRA to voluntarily withdraw its registration with the SEC as a broker-dealer and to resign as a member of the FINRA. Such withdrawal request is subject to the approval and acceptance of the SEC and FINRA, which are pending.
Sale of certain of PFSL's assets and closure of operations; Potential Sale or LIquidation of PFSC
After exploring available alternatives for rationalizing the operations of our U.K. subsidiary, PFSL, we announced in December, 2011 that we had elected to pursue the sale of certain of the assets of PFSL to third parties and to commence the closure of the operations of PFSL. We completed these efforts in June. Over the past six months, the closure of this operation has released approximately $11.0 million in capital, and has resulted in $8.0 million in expenses.
We have pursued negotiations with several parties for a possible sale of PFSC. While these efforts have not resulted in

32

any definitive agreements we are continuing to aggressively seek to execute the sale of PFSC and are also exploring alternative initiatives, including a potential liquidation.
Patent Portfolio
We have been granted a number of patents associated with the automated purchase and sale of financial instruments. We have engaged a leading law firm specializing in intellectual property to assist us in developing license revenues from our patent portfolio. While it is too early to determine the amount of potential license revenue, if any, the law firm has agreed to partner with us on a full contingency basis. We intend to aggressively pursue license revenue opportunities from this intellectual property portfolio.
Outstanding SEC Comments
As previously noted in our Annual Report on Form 10-K for the year ended December 31, 2011, we have received letters from the staff of the Division of Corporation Finance (the “Staff”) of the Securities and Exchange Commission (the “Commission”) setting forth comments and questions with respect to our Annual Report on Form 10-K for the years ended December 31, 2010 and our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2011 and September 30, 2011 (the “2011 Comment Letters”) and the Company has submitted responses to such letters. In addition, the Company has received comments on its Annual Report on Form 10-K for the year ended December 31, 2011 (the “2012 Comment Letter; the 2011 Comment Letters and the 2012 Comment Letter are referred to jointly as the “Comment Letters”). Among other things, the Comment Letters have questioned the timing of the impairment charge taken by us with respect to certain of our nonaccrual receivables. We reported a $43.0 million impairment charge (the “Impairment Charge”) with respect to these receivables in the second quarter of fiscal 2011. More recently, the Staff, along with the Commission’s Office of the Chief Accountant, has questioned whether we should have reflected all or a portion of the Impairment Charge in earlier periods. We have been discussing this accounting treatment with the Staff and a resolution is pending.
If it is ultimately determined that our initial valuation of the underlying collateral did not support the margin debt during the times in question we may need to accelerate the Impairment Charge into earlier periods. We will then need to review our analysis of the relevant factors in existence at each earlier period and reach a conclusion as to the amount of the Impairment Charge that should properly be reflected in each relevant earlier period. In performing such review we will need to evaluate the materiality of the applicable charge for each such period to determine whether a restatement of our historical financial statements for such period is required. We intend to continue our discussion with the Commission to reach a resolution on the Comment Letters.
Financial overview
Net revenues
Revenues
The completion of the Knight and Apex transactions will affect our revenue makeup significantly. On a going forward basis, we anticipate that revenues will be primarily from the sale of market data, both historical and real-time, and from transaction and terminal fees associated with our Nexa business. We also hope to generate license fees from our patent portfolio. For an interim period of time, we anticipate that we will also receive revenues from our transitional service agreements with Knight and Apex. The amounts to be paid to PFSI the transitional service agreements may or may not cover the expenses of providing the transition support services.
The following revenue information describes our historical revenue breakdown, including that from most of the 2012 second quarter, and also describes our ongoing PFSC revenue breakdown, which is included in discontinued operations.
We have historically generated revenues from most clients in several different categories. Clients generating revenues for us from clearing transactions almost always also generate significant interest income from related balances. Revenues from clearing transactions are driven largely by the volume of trading activities of the customers of our correspondents and proprietary trading by our correspondents. Our average clearing revenue per trade is a function of numerous pricing elements that vary based on individual correspondent volumes, customer mix, and the level of margin debit balances and credit balances. Our clearing revenue fluctuates as a result of these factors as well as changes in trading volume. We focus on maintaining the profitability of our overall correspondent relationships, including the clearing revenue from trades and net interest from related customer margin balances, and by reducing associated variable costs. We collect the fees for our services directly from customer accounts when trades are processed. We typically only remit commissions charged by our correspondents to them after deducting our charges.
We often refer to our interest income as “Interest, gross” to distinguish this category of revenue from “Interest, net” that is generally used in our industry. Interest, gross is generated by charges to customers or correspondents on margin balances and

33

interest earned by investing customers’ cash, and therefore these revenues fluctuate based on the volume of our total margin loans outstanding, the volume of the cash balances we hold for our correspondents’ customers, the rates of interest we can competitively charge on margin loans and the rates at which we can invest such balances. We also earn interest from our stock borrowing and lending activities.
Technology revenues consist of transactional, development and licensing revenues generated by Nexa. A significant portion of these revenues are collected directly from clearing customers along with other charges for clearing services as described above. Most development revenues and some transaction revenues are collected directly from clients and are reflected as receivables until they are collected.
Other revenues include charges assessed directly to customers for certain transactions or types of accounts, trade aggregation and profits from proprietary trading activities, including foreign exchange transactions and fees charged to our correspondents’ customers. Subject to certain exceptions, our clearing brokers in the U.S. and Canada each generate these types of transactions.
Revenues from clearing and commission fees represented 45% and 42% of our total net revenues for the three months ended June 30, 2012 and 2011, respectively and 56% and 44% of our total net revenues for the six months ended June 30, 2012 and 2011, respectively.
Interest expense from securities operations
Interest expense is incurred in our daily operations in connection with interest we pay on credit balances we hold and on short-term borrowings we enter into to fund activities of our correspondents and their customers. We have two primary sources of borrowing: commercial banks and stock lending institutions. Regulations differ by country as to how operational needs can be funded, but we often find that stock loans that are secured with customer or correspondent securities as collateral can be obtained at a lower rate of interest than loans from commercial banks. Operationally, we review cash requirements each day and borrow the requirements from the most cost effective source.
Net interest income represented 35% and 33% of our total net revenues in each of the three months ended June 30, 2012 and 2011, respectively and 33% and 32% in each of the six months ended June 30, 2012 and 2011.
Expenses
The completion of the Knight and Apex transactions will affect our expense makeup significantly. On a going forward basis, our expenses will largely consist of personnel costs, and the infrastructure costs associated with the provision of technology services by Nexa Technologies. We will also continue to incur significant interest expense associated with our outstanding indebtedness.
The following expense information describes our historical breakdown, including that from most of the 2012 second quarter, and also describes our continuing PFSC expense breakdown, which is included in discontinued operations. It also largely describes our ongoing expenses associated with the provision of services to Knight and Apex under the transitional services agreements, which are expected to decline over time.
Employee compensation and benefits
Our largest category of expense is the compensation and benefits that we pay to our employees, which includes salaries, bonuses, group insurance, contributions to benefit programs, stock compensation and other related employee costs. These costs vary by country according to the local prevailing wage standards. We utilize technology whenever practical to limit the number of employees and thus keep costs competitive. In the U.S., a majority of our employees are located in cities where employee costs are lower than where our largest competitors primarily operate. A portion of total employee compensation is paid in the form of bonuses and performance-based compensation. As a result, depending on the performance of particular business units and the overall Company performance, total employee compensation and benefits could vary materially from period to period. As previously discussed, the Company has implemented a retention program for employees of the Company, PFSI and Nexa and will incur severance charges related to employees terminated in connection with the previously discussed strategic initiatives.
Other operating expenses
Expenses incurred to process trades include floor brokerage, exchange and clearance fees, and those expenses tend to vary significantly with the level of trading activity. The related data processing and communication costs vary less with the level of trading activity. Occupancy and equipment expenses include lease expenses for office space, computers and other equipment that we require to operate our businesses. Other expenses include legal, regulatory, professional consulting, accounting, travel and miscellaneous expenses. In addition, as a public company, we incur additional costs for external advisers

34

such as legal, accounting, auditing and investor relations services.
Profitability of services provided
In the past, we have has recorded revenue for the clearing operations and technology business separately. We have recorded expenses in the aggregate as many of these expenses have been attributable to multiple business activities. As such, income (loss) before income taxes has been determined in the aggregate. We have also separately recorded interest income and interest expense to determine the overall profitability of this activity.
On a going forward basis, we anticipate that our operations will primarily consist of the provision of services by Nexa , and so our profitability will largely be determined by the success of this business and any licensing revenues from our intellectual property portfolio.
Comparison of the three months ended June 30, 2012 and June 30, 2011
Overview
Results of operations declined for the three months ended June 30, 2012 compared to the three months ended June 30, 2011 primarily due to lower clearing and commission fees, lower net interest income, lower technology revenue, lower other revenues, higher employee compensation and benefits, the loss on the Apex Holdings transaction, contract cease use charge, higher other expenses and equity in loss of Apex Holdings, partially offset by lower floor brokerage, exchange and clearance fees, lower bad debt expense, lower occupancy and equipment, the forgiveness of the Ridge Seller Note and lower interest expense on long-term debt. The operating results were also impacted by the previously announced deconversion of thinkorswim. Our loss from continuing operations increased approximately $47.7 million during the second quarter of 2012 as compared to the second quarter of 2011.
The following is a summary of the increases (decreases) in the categories of revenues and expenses for the three months ended June 30, 2012 compared to the three months ended June 30, 2011.
 

35

 
Change
Amount
 
%
Change from
Previous Period
 
(In thousands)
Revenues:
 
 
 
Clearing and commission fees
$
(14,198
)
 
(64.4
)%
Technology
(176
)
 
(3.3
)%
Interest:
—

 
 
Interest on asset based balances
(14,116
)
 
(68.5
)%
Interest on conduit borrows
(1,289
)
 
(68.3
)%
Money market
(62
)
 
(8.5
)%
Interest, gross
(15,467
)
 
(66.6
)%
Other revenue
(8,794
)
 
(123.4
)%
Total revenues
(38,635
)
 
(67.0
)%
Interest expense:
 
 
 
Interest expense on liability based balances
(3,736
)
 
(74.4
)%
Interest on conduit loans
(842
)
 
(71.5
)%
Interest expense from securities operations
(4,578
)
 
(73.8
)%
Net revenues
(34,057
)
 
(66.1
)%
Expenses:
 
 
 
Employee compensation and benefits
3,178

 
20.2
 %
Floor brokerage, exchange and clearance fees
(5,542
)
 
(63.2
)%
Communications and data processing
59

 
0.5
 %
Occupancy and equipment
(1,284
)
 
(29.0
)%
Loss on Apex Clearing Holdings transaction
35,826

 


Gain on extinguishment of debt
(22,514
)
 


Contract cease use charge
14,183

 


Bad debt expense
(42,424
)
 
(98.3
)%
Other expenses
7,813

 
150.3
 %
Interest expense on long-term debt
(495
)
 
(5.1
)%
 
(11,200
)
 
(11.2
)%
Loss from continuing operations before equity in earnings in unconsolidated affiliate
22,857

 
47.2
 %
Equity in earnings in unconsolidated affiliate
5,844

 


Loss from continuing operations before income taxes
28,701

 
59.3
 %
Net Revenues
Net revenues decreased $38.6 million, or 67.0%, to $17.4 million in the quarter ended June 30, 2012 as compared to the quarter ended June 30, 2011. The decrease is primarily attributable to the following:
Clearing and commission fees in the second quarter decreased $14.2 million, or 64.4%, to $7.9 million from the same period in 2011. This decrease is due the Apex Clearing Holdings transaction that closed on June 5, 2012 as well as the deconversion of thinkorswim in August 2011 and lower equity and option volumes.
Technology revenue decreased $0.2 million, or 3.3% from the same period in 2011 to $5.1 million due to lower recurring revenues of $0.2 million.
Interest, gross decreased $15.5 million or 66.6% to $7.8 million in the quarter ended June 30, 2012 as compared to the quarter ended June 30, 2011. Interest revenues from customer balances decreased $14.2 million or 66.4% to $7.2 million due to a decrease in our interest income on asset balances of $14.1 million and a decrease in money market revenues of $0.1 million. The decrease in our interest income on assets balances is attributable to a decrease in our average daily interest rate from the second quarter of 2011 of 5 basis points or 4.4% to 1.08%, and a decrease in our average daily interest earning assets of $3.7 billion or 50.5% to $3.6 billion. The decrease in average daily interest earnings assets was largely due to the deconversion of thinkorswim in August 2011. Interest, gross was also lower as a result of the Apex Clearing Holdings transaction that closed on

36

June 5, 2012.
Interest from our stock conduit borrowing operations decreased $1.3 million or 68.3% from the second quarter of 2011 to $0.6 million, as a result of a decrease in our average daily assets of approximately $477.3 million, or 72.2% to $184.2 million offset by an increase in our average daily interest rate of 81 basis points or 71.1% to 1.95%. Interest from our stock conduit borrowing operations was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Other revenue decreased $8.8 million, or 123.4% from the second quarter of 2011 to $(1.7) million primarily due to a realized loss of $6.3 million taken on our RDC municipal bonds as a result of the sale of certain RDC assets (see Notes 5 and 8 to our interim unaudited condensed consolidated financial statements), decreases in municipal bond, equity and foreign exchange trading of $1.2 million, approximately $0.7 million in our trade aggregation business, $1.3 million in execution services offset by other fees of approximately $0.7 million.
Interest expense from securities operations decreased $4.6 million, or 73.8%, to $1.6 million from the quarter ended June 30, 2011 to the quarter ended June 30, 2012. Interest expense from clearing operations decreased approximately $3.7 million, or 74.4% to $1.3 million due to a decrease in our average daily balances on our short-term obligations of $3.4 billion, or 51.8%, to $3.1 billion and a 6 basis point or 19.4% increase in our average daily interest rate to 0.25%. The decrease in average daily balances was largely due to the deconversion of thinkorswim in August 2011. Interest expense from securities operations was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Interest expense from our stock conduit loans decreased $0.8 million, or 71.5% from the second quarter of 2011 to $0.3 million due to a $476.6 million, or 72.1% decrease in our average daily balances to $184.3 million offset by 38 basis point increase, or 53.5% in our average daily interest rate to 1.09%. Interest expense from our stock conduit loans was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Interest, net decreased from $17.0 million for the quarter ended June 30, 2011 to $6.1 million for the quarter ended June 30, 2012. This decrease was due to lower average paying customer balances, lower money market revenues, lower conduit balances and a lower interest rate spread of 1 basis points on customer balances offset slightly by a higher interest rate spread of 43 basis points on conduit balances. Interest, net was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Employee compensation and benefits
Total employee costs increased $3.2 million, or 20.2%, to $18.9 million from the quarter ended June 30, 2011 to the quarter ended June 30, 2012, higher severance costs of approximately $3.9 million due to severance costs associated with headcount reductions as a result of the Apex and Knight transactions offset by lower stock-based compensation of approximately $0.4 million and lower incentive compensation of approximately $0.3 million.
Floor brokerage, exchange and clearance fees
Floor brokerage, exchange and clearance fees decreased $5.5 million, or 63.2%, to $3.2 million for the quarter ended June 30, 2012 from the quarter ended June 30, 2011, related to lower clearing costs as a result of lower equity and option volumes as compared to 2011 as well as the Apex Clearing Holdings transaction that closed on June 5, 2012.
Communication and data processing
Total expenses for our communication and data processing requirements increased $0.1 million, or 0.5%, to $12.8 million from the quarter ended June 30, 2011 to the quarter ended June 30, 2012 primarily due to higher data processing costs associated with the Ridge BPS platform partially offset by lower costs as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Occupancy and equipment
Total expenses for occupancy and equipment decreased $1.3 million, or 29.0% to $3.1 million from the quarter ended June 30, 2011 to the quarter ended June 30, 2012 due to lower depreciation expense resulting from a reduction in capital leases as well as the write-off of certain technology assets associated with the Apex Clearing Holdings transaction that closed on June 5, 2012.
Loss on Apex Clearing Holdings transaction
In connection with the Apex transaction, the Company received consideration of $0.2 million and recorded an investment in Apex Holdings of approximately $104.0 million, which represented the Company's 93.75% equity interest in the tangible

37

contributed net assets of Apex Holdings. As of August 14, 2012, the initial accounting for the business combination is incomplete as ACS, the managing member of Apex Holdings is still in the process of identifying and valuing all of the assets acquired and liabilities assumed. As a result, the Company estimated its investment based on the fair value of the tangible consideration given. At such time that the accounting for the business combination becomes complete, the Company will retrospectively adjust the provisional amounts recognized as of the acquisition date.
In connection with the transaction the Company recorded a loss of $35.8 million primarily related to approximately $10.6 million of certain technology assets of which the exclusive rights to use were contributed to Apex Clearing as well as intangible assets of $25.4 million primarily related to customer contracts associated with prior acquisitions that were contributed to Apex Clearing.
Gain on extinguishment of debt
As described in Note 3 to our unaudited interim condensed consolidated financial statements, the Company and Broadridge entered into a termination and release agreement that resulted in the extinguishment of the Ridge Seller Note, all accrued and unpaid interest and any amounts due under contingent earnout arrangements under the Ridge APA. As a result of this the Company recorded a gain of approximately $22.5 million, which was comprised of the carrying amount of the Ridge Seller Note of approximately $18.4 million, accrued interest of approximately $1.1 million and contingent consideration of approximately $3.0 million.
Contract cease use charge
In connection with the Company's conversion to Broadridge's BPS platform, Broadridge agreed to reimburse the Company for any minimum costs owed to SunGard Data Systems under its contract to provide certain back office services. This contract with SunGard is in effect until February 2014. As a result of the Termination and Mutual Release Agreement with Broadridge, Broadridge was no longer required to reimburse these costs. As a result of the Apex transaction, PFSI is no longer a clearing broker-dealer and as such no longer receiving any benefits under the SunGard contract. As of June 30, 2012 the Company has not terminated the contract. The Company recorded a charge of approximately $14.2 million, which reflects the estimated fair value of the future cash outflows associated with the minimum payments due under the contract. The estimated fair value was calculated using a present value technique based discounted using the Company's estimated credit-adjusted risk-free rate of 20%. The Company recorded an interest charge of $0.2 million for the quarter ended June 30, 2012.
Bad debt expense
Bad debt expense decreased $42.4 million, or 98.3% to $0.7 million from the quarter ended June 30, 2011 to the quarter ended June 30, 2012 primarily due to the $43.0 million write-down to certain nonaccural receivables in the second quarter of 2011, offset by approximately $0.7 million of reserves for unsecured receivables that management determined during the quarter were uncollectible, including approximately $0.4 million of nonaccrual receivables associated with RDC related assets. These primarily related to ongoing litigation matters and are not related to any trend that is expected to continue or recur. During the second quarter we sold our RDC related assets and following this transaction we have no remaining direct exposure to RDC related assets other than representations and indemnities related to the sale of the assets. See Note 8 to our unaudited interim condensed consolidated financial statements.
Other expenses
Other expenses increased $7.8 million, or 150.3%, to $13.0 million from the quarter ended June 30, 2011 to the quarter ended June 30, 2012, due primarily to $5.6 million of expenses related to restructuring, higher legal, accounting and professional fees of approximately $2.5 million offset by lower intangible amortization expense of $0.3 million resulting from the Knight and Apex transactions.
Interest expense on long-term debt
Interest expense on long-term debt decreased $0.5 million from $9.8 million for the quarter ended June 30, 2011 to $9.3 million for the quarter ended June 30, 2012 resulting primarily from approximately $0.7 million in lower interest costs associated with our revolving credit facility which was paid in full during the first quarter of 2012 from a beginning balance of $7.0 million and the extinguishment of the Ridge Seller Note (see Notes 3 and 11 to our interim unaudited condensed consolidated financial statements) offset by slightly higher interest costs on our Convertible Notes associated with the conversion feature and approximately $0.2 million in interest costs associated with the SunGard contract costs (see Note 19 to our interim unaudited condensed consolidated financial statements).

38

Equity in loss in unconsolidated affiliate
In connection with our 93.75% economic interest in Apex Clearing Holdings we recorded a loss of $5.8 million for the quarter ended June 30, 2012. See Note 3 to our unaudited interim condensed consolidated financial statements for a discussion of the accounting for this investments.
Income tax expense (benefit)
Income tax expense, based on an overall effective income tax rate of .5%, was approximately $0.1 million for the quarter ended June 30, 2012 as compared to an overall effective income tax rate of 38.0% and an income tax benefit of approximately $18.9 million for the quarter ended June 30, 2011. This change is primarily attributed to recording an additional valuation allowance in the 2012 period.
Loss from continuing operations
As a result of the foregoing, the loss from continuing operations was approximately $77.2 million for the quarter ended June 30, 2012 compared to a loss from continuing operations of approximately $29.4 million for the quarter ended June 30, 2011.
Comparison of the six months ended June 30, 2012 and June 30, 2011
Overview
Results of operations declined for the six months ended June 30, 2012 compared to the six months ended June 30, 2011 primarily due to lower clearing and commission fees, lower net interest income, lower technology revenue, lower other revenues, higher employee compensation and benefits, higher communications and data processing, the loss on the Apex Clearing Holdings transaction, contract cease use charge, higher other expenses and equity in loss of Apex Clearing Holdings, partially offset by lower floor brokerage, exchange and clearance fees, lower bad debt expense, lower occupancy and equipment, the forgiveness of the Ridge Seller Note and lower interest expense on long-term debt. Our loss from continuing operations increased approximately $88.8 million during the first six months of 2012 as compared to the first six months of 2011.
The following is a summary of the increases (decreases) in the categories of revenues and expenses for the six months ended June 30, 2012 compared to the six months ended June 30, 2011.

 

39

 
Change
Amount
 
%
Change from
Previous Period
 
(In thousands)
Revenues:
 
 
 
Clearing and commission fees
$
(24,175
)
 
(52.0
)%
Technology
(944
)
 
(8.4
)%
Interest:
—

 
 
Interest on asset based balances
(24,721
)
 
(61.2
)%
Interest on conduit borrows
(1,487
)
 
(41.3
)%
Money market
(298
)
 
(16.6
)%
Interest, gross
(26,506
)
 
(57.9
)%
Other revenue
(21,474
)
 
(141.4
)%
Total revenues
(73,099
)
 
(61.6
)%
Interest expense:
 
 
 
Interest expense on liability based balances
(4,976
)
 
(51.3
)%
Interest on conduit loans
(950
)
 
(41.1
)%
Interest expense from securities operations
(5,926
)
 
(49.3
)%
Net revenues
(67,173
)
 
(62.9
)%
Expenses:
 
 
 
Employee compensation and benefits
2,741

 
8.3
 %
Floor brokerage, exchange and clearance fees
(6,693
)
 
(38.5
)%
Communications and data processing
2,209

 
8.6
 %
Occupancy and equipment
(2,454
)
 
(26.2
)%
Loss on Apex Clearing Holdings transaction
35,826

 


Gain on extinguishment of debt
(22,514
)
 


Contract cease use charge
14,183

 


Bad debt expense
(39,973
)
 
(92.2
)%
Other expenses
11,695

 
102.8
 %
Interest expense on long-term debt
(668
)
 
(3.4
)%
 
(5,648
)
 
(3.5
)%
Loss from continuing operations before equity in earnings in unconsolidated affiliate
61,525

 
116.4
 %
Equity in earnings in unconsolidated affiliate
5,844

 


Loss from continuing operations before income taxes
67,369

 
127.5
 %
Net Revenues
Net revenues decreased $67.2 million, or 61.6%, to $39.6 million for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011. The decrease is primarily attributable to the following:
Clearing and commission fees for the six months ended June 30, 2012 decreased $24.2 million, or 52.0%, to $22.3 million from the same period in 2011. This decrease is due the Apex Clearing Holdings transaction that closed on June 5, 2012 as well as the deconversion of thinkorswim in August 2011 and lower equity and option volumes.
Technology revenue decreased $0.9 million, or 8.4% for the six months ended June 30, 2012 as compared to the same period in 2011 to $10.4 million due to lower recurring revenues of $0.9 million.
Interest, gross decreased $26.5 million or 57.9% for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011 to $19.3 million. Interest revenues from customer balances decreased $25.0 million or 59.3% to $17.2 million due to a decrease in our interest income on asset balances of $24.7 million and a decrease in money market revenues of $0.3 million. The decrease in our interest income on assets balances is attributable to a decrease in our average daily interest rate for the six months ended June 30, 2012 of 26 basis points or 23.0% to 0.87%, and a decrease in our average daily interest earning assets of $3.6 billion or 49.8% to $3.6 billion. The decrease in average daily interest earnings assets was largely due to the deconversion of thinkorswim in August 2011. Interest, gross was also lower as a result of the Apex Clearing Holdings

40

transaction that closed on June 5, 2012.
Interest from our stock conduit borrowing operations decreased $1.5 million or 41.3% from the six month period ended June 30, 2011 to $2.1 million, as a result of a decrease in our average daily assets of approximately $461.2 million, or 66.4% to $233.6 million offset by an increase in our average daily interest rate of 77 basis points or 74.0% to 1.81%. Interest from our stock conduit borrowing operations was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Other revenue decreased $21.5 million, or 141.4% for the six months ended June 30, 2012 to $(6.3) million primarily due to the realized loss of $15.1 million taken on our RDC municipal bonds as a result of the sale of certain RDC assets (see Notes 5 and 8 to our interim unaudited condensed consolidated financial statements)included in securities owned, decreases in municipal bond, equity and foreign exchange trading of $2.4 million, approximately $1.4 million in our trade aggregation business, $2.4 million in execution services and other fees of approximately $0.2 million.
Interest expense from securities operations decreased $5.9 million, or 49.3%, to $6.1 million from the six months ended June 30, 2011 to the six months ended June 30, 2012. Interest expense from clearing operations decreased approximately $5.0 million, or 51.3% to $4.7 million due to a decrease in our average daily balances on our short-term obligations of $3.3 billion, or 51.8%, to $3.0 billion while our average daily interest rate stayed constant at 0.31%. The decrease in average daily balances was largely due to the deconversion of thinkorswim in August 2011. Interest expense from securities operations was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Interest expense from our stock conduit loans decreased $1.0 million, or 41.1% from the six months ended June 30, 2011 to $1.4 million due to a $460.9 million, or 66.4% decrease in our average daily balances to $233.3 million, offset by a 50 basis point increase, or 74.6% in our average daily interest rate to 1.17% . Interest expense from our stock conduit loans was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Interest, net decreased from $33.8 million for the six months ended June 30, 2011 to $13.2 million for the six months ended June 30, 2012. This decrease was due to lower average paying customer balances, lower money market revenues, lower conduit balances and a lower interest rate spread of 26 basis points on customer balances offset slightly by a higher interest rate spread of 27 basis points on conduit balances. Interest, net was also lower as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Employee compensation and benefits
Total employee costs increased $2.7 million, or 8.3%, to $35.8 million from the six months ended June 30, 2011 to the six months ended June 30, 2012, primarily due to higher severance costs of approximately $4.6 million due to severance costs associated with headcount reductions as a result of the Apex and Knight transactions offset by lower compensation costs of approximately $1.1 million as a result of lower head counts, lower stock-based compensation of approximately $0.5 million and lower incentive compensation of approximately $0.3 million.
Floor brokerage, exchange and clearance fees
Floor brokerage, exchange and clearance fees decreased $6.7 million, or 38.5%, to $10.7 million for the six months ended June 30, 2012 from the six months ended June 30, 2011, related to lower clearing costs as a result of lower equity and option volumes as compared to the 2011 as well as the Apex Clearing Holdings transaction that closed on June 5, 2012.
Communication and data processing
Total expenses for our communication and data processing requirements increased $2.2 million, or 8.6%, to $27.8 million from the six months ended June 30, 2011 to the six months ended June 30, 2012 primarily due to higher data processing costs associated with the Ridge BPS platform partially offset by lower costs as a result of the Apex Clearing Holdings transaction that closed on June 5, 2012.
Occupancy and equipment
Total expenses for occupancy and equipment decreased $2.5 million, or 26.2% to $6.9 million from the six months ended June 30, 2011 to the six months ended June 30, 2012 due to lower depreciation expense resulting from a reduction in capital leases as well as the write-off of certain technology assets associated with the Apex Clearing Holdings transaction that closed on June 5, 2012.
Loss on Apex Clearing Holdings transaction

41

In connection with the Apex transaction, the Company received consideration of $0.2 million and recorded an investment in Apex Holdings of $103.9 million, which represented the Company's 93.75% equity interest in the tangible contributed net assets of Apex Holdings. As of August 14, 2012, the initial accounting for the business combination is incomplete as ACS, the managing member of Apex Holdings is still in the process of identifying and valuing all of the assets acquired and liabilities assumed. As a result, the Company estimated its investment based on the fair value of the tangible consideration given. At such time that the accounting for the business combination becomes complete, the Company will retrospectively adjust the provisional amounts recognized as of the acquisition date.
In connection with the transaction the Company recorded a loss of $35.8 million primarily related to approximately $10.6 million of certain technology assets of which the exclusive rights to use were contributed to Apex Clearing as well as intangible assets of $25.4 million primarily related to customer contracts associated with prior acquisitions that were contributed to Apex Clearing.
Gain on extinguishment of debt
As described in Note 3 to our unaudited interim condensed consolidated financial statements, the Company and Broadridge entered into a termination and release agreement that resulted in the extinguishment of the Ridge Seller Note, all accrued and unpaid interest and any amounts due under contingent earnout arrangements under the Ridge APA. As a result of this the Company recorded a gain of approximately $22.5 million, which was comprised of the carrying amount of the Ridge Seller Note of approximately $18.4 million, accrued interest of approximately $1.1 million and contingent consideration of approximately $3.0 million.
Contract cease use charge
In connection with the Company's conversion to Broadridge's BPS platform, Broadridge agreed to reimburse the Company for any minimum costs owed to SunGard Data Systems under its contract to provide certain back office services. This contract with SunGard is in effect until February 2014. As a result of the Termination and Mutual Release Agreement with Broadridge, Broadridge was no longer required to reimburse these costs. As a result of the Apex transaction, PFSI is no longer a clearing broker-dealer and as such no longer receiving any benefits under the SunGard contract. As of June 30, 2012 the Company has not terminated the contract. The Company recorded a charge of approximately $14.2 million as a result which reflects the estimated fair value of the future cash outflows associated with the minimum payments due under the contract. The estimated fair value was calculated using a present value technique based discounted using the Company's estimated credit-adjusted risk-free rate of 20%. The Company recorded an interest charge of $0.2 million for the six months ended June 30, 2012.
Bad debt expense
Bad debt expense decreased $40.0 million, or 92.2% to $3.4 million for the six months ended June 30, 2011 to the six months ended June 30, 2012 primarily due to the $43.0 million write-down to certain nonaccural receivables in the second quarter of 2011, offset by approximately $3.4 million of reserves for unsecured receivables that management determined during the period were uncollectible, including approximately $0.9 million of nonaccrual receivables associated with RDC related assets. These primarily related to ongoing litigation matters and are not related to any trend that is expected to continue or recur. During the second quarter we sold our RDC related assets and following this transaction we have no remaining direct exposure to RDC related assets other than representations and indemnities related to the sale of the assets. See Note 8 to our unaudited interim condensed consolidated financial statements.
Other expenses
Other expenses increased $11.7 million, or 102.8%, to $23.1 million from the six months ended June 30, 2011 to the six months ended June 30, 2012, due primarily to $8.5 million of expenses related to restructuring and higher legal, accounting,professional fees of approximately $3.5million offset by lower intangible amortization expense of $0.3 million resulting from the Penson Futures and Apex transactions.
Interest expense on long-term debt
Interest expense on long-term debt decreased $0.7 million from $19.5 million for the six months ended June 30, 2011 to $18.8 million for the six months ended June 30, 2012 resulting primarily from approximately $0.9 million in lower interest costs associated with our revolving credit facility which was paid in full during the first quarter of 2012 from a beginning balance of $7.0 million and the extinguishment of the Ridge Seller Note (see Notes 3 and 11 to our interim unaudited condensed consolidated financial statements) offset by slightly higher interest costs on our Convertible Notes associated with the conversion feature and approximately $0.2 million in interest costs associated with the SunGard contract costs (see Note 19

42

to our interim unaudited condensed consolidated financial statements).
Equity in loss in unconsolidated affiliate
In connection with our 93.75% economic interest in Apex Clearing Holdings we recorded a loss of $5.8 million for the six months ended June 30, 2012. See Note 3 to our unaudited interim condensed consolidated financial statements.
Income tax expense (benefit)
Income tax expense, based on an overall effective income tax rate of .8%, was $0.2 million for the six months ended June 30, 2012 as compared to an overall effective income tax rate of 38.0% and an income tax benefit of approximately $21.2 million for the six months ended June 30, 2011. This change is primarily attributed to recording an additional valuation allowance in the 2012 period.
Loss from continuing operations
As a result of the foregoing, the loss from continuing operations was approximately $120.4 million for the six months ended June 30, 2012 compared to a loss from continuing operations of $31.6 million for the six months ended June 30, 2011.
Results of discontinued operations
Comparison of the three months ended June 30, 2012 to the three months ended June 30, 2011
Loss from discontinued operations was approximately $7.9 million for the quarter ended June 30, 2012 compared to a loss of approximately $0.7 million for the quarter ended June 30, 2011 which includes the operations of PFSC, the Penson Futures division of PFSI and PFSL for the quarter ended June 30, 2012 and PFSC, the Penson Futures division of PFSI, PFSL and PFSA for the quarter ended June 30, 2011. Both PFSC and PFSL incurred greater losses in 2012 as compared to 2011. The Penson Futures division had net income in 2011 compared to a net loss in 2012 while PFSA had net income in 2011.
Comparison of the six months ended June 30, 2012 to the six months ended June 30, 2011
Loss from discontinued operations was approximately $13.2 million for the six months ended June 30, 2012 compared to a loss of approximately $1.4 million for the six months ended June 30, 2011 which includes the operations of PFSC, the Penson Futures division of PFSI and PFSL for the six months ended June 30, 2012 and PFSC, the Penson Futures division of PFSI, PFSL and PFSA for the six months ended June 30, 2011. Both PFSC and PFSL incurred greater losses in 2012 as compared to 2011. The Penson Futures division had net income in 2011 compared to a net loss in 2012 while PFSA had net income in 2011.
Liquidity and capital resources
As a result of the Knight and Apex transactions, our primary liquidity needs are in our Canadian clearing broker, PFSC, which is accounted for as a discontinued operation, as it is held for sale.
PFSC typically finances its operating liquidity needs through short term secured bank lines of credit and through secured borrowings from stock lending counterparties in the securities business, which referred to as “stock loans.” Most of the borrowings are driven by the activities of its clients or correspondents, primarily the purchase of securities on margin by those parties. PFSC had two uncommitted lines of credit with two financial institutions permitting PFSC to borrow up to an aggregate of approximately $184.9 million. There are no specific limitations on our borrowing capacities pursuant to its stock loan arrangements, though none of these facilities is committed. Further, since stock loan borrowings are secured, the ability to borrow is limited by the available collateral pool and advance rates offered by counterparties against that collateral.
Broker-dealer bank debt facilities are typically secured, uncommitted and on demand. Therefore, lenders can refuse to extend loans, limit the size of loans, increase the amount of collateral required to support loans, or require repayment of outstanding loans. This can severely impact liquidity resources. Furthermore, the type of business a correspondent or client transacts can create liquidity needs. For example, certain option trades may not create collateral for the broker-dealer to utilize for settlement, but the trade does create operating liquidity needs at the clearing corporation. As there is no underlying collateral to post, the broker-dealer must utilize other available collateral. Borrowings under stock loan arrangements bear interest at variable rates based on various factors including market conditions and the types of securities loaned, are secured primarily by our customers' margin account securities, and are repayable on demand.
Excluding our PFSC business, our current liquidity needs are limited to our operating expenses and funding any receivables related to the provision of services to Knight and Apex under the transitional services agreements. As a result, we believe our current capital base and cash flow from the transitional services agreements are sufficient to meet these liquidity needs.
Capital Resources — In general, our capital resources are the existing capital in our businesses and any operating

43

income, if applicable. Our broker-dealer subsidiaries are subject to minimum net capital requirements established in each jurisdiction. PFSC also has early warning capital levels which are significantly higher than minimum requirements. At June 30, 2012, PFSI had a net capital deficit of $14.1 million. This amount was $14.4 million below its minimum capital requirement of $250 thousand, which resulted in a net capital violation that was communicated to its regulators. At June 30, 2012, PFSC had risk adjusted capital of approximately $26.3 million and had early warning excess of approximately $15.2 million. For the past three quarters both PFSI and PFSC have operated at a loss, which has reduced our capital resources.
In addition to these statutory requirements, our regulators have the discretion to require higher capital or liquidity levels. We regularly review our capital and liquidity positions with our regulators, and our expectations of future levels. If our regulators require that we retain significant regulatory capital at these subsidiaries, our liquidity could be impaired, perhaps significantly.
On June 3, 2009, we issued $60.0 million aggregate principal amount of 8.00% Senior Convertible Notes due 2014. The net proceeds from the sale of the convertible notes were approximately $56.2 million after initial purchaser discounts and other expenses. On May 6, 2010, we issued $200.0 million aggregate principal amount of 12.5% senior second lien secured notes, due May 15, 2017. The net proceeds from the sale of the senior second lien secured notes were approximately $193.3 million after initial purchaser discounts and other expenses. We used a part of the net proceeds of the sale to pay down approximately $110.0 million outstanding on our then current senior revolving credit facility, enter into a $70.0 million subordinated loan arrangement with the broker-dealer in the US, to provide working capital to support the correspondents acquired from Ridge and for other general corporate purposes. Our obligations under senior second lien secured notes are supported by a guaranty from SAI and PHI and a pledge by us, SAI and PHI of equity interests of certain of our subsidiaries. As is common with facilities of this type, the negative covenants in our various credit facilities limit our ability to incur additional debt outside of the ordinary course of business and our ability to incur additional working capital debt facilities at a parent company level is therefore significantly restricted.
We incur a significant amount of interest on our outstanding debt obligations. In 2011, we paid $1.8 million in interest under our then senior revolving credit facility and predecessor facility, $4.8 million in interest under our Senior Convertible Notes, $25.0 million in interest under our Senior Second Lien Secured Notes and $0.6 million in interest under the Ridge Seller Note. We are required to make an interest payment of $12.5 million on the Senior Second Lien Secured Notes in mid-November 2012, and this obligation will continue semi-annually through 2017, when the principal amount of $200.0 million is due. We are required to make an interest payment of $2.4 million on the Senior Convertible Notes in early December 2012, and this obligation will continue semi-annually through 2014, when the principal amount of $60.0 million is due. In the first quarter of 2012, we unsuccessfully attempted to launch an exchange offer for all of our outstanding funded debt. If we are unable to complete an exchange offer for or an alternative restructuring of our senior debt, we will consider alternative options, including potentially winding down or liquidation of the Company’s operations, or a restructuring pursuant to Chapter 11 of the U.S. Bankruptcy Code.
As a holding company, we access the earnings and capital of our operating subsidiaries from time to time through the receipt of dividends or intercompany advances from these subsidiaries. As discussed above, however, our broker-dealer subsidiaries are subject to minimum and early warning net capital requirements established in each jurisdiction. Additionally, as with other regulated entities in our industry, the making of distributions from our regulated operating subsidiaries is generally subject to prior approval by the applicable regulators. Our regulators have considerable discretion when deciding whether to permit a distribution, though we understand that they place importance on factors such as liquidity, excess regulatory capital, profitability, changes in the business mix and expected growth in aggregate debits. Our regulators are following our progress on the strategic initiatives and, due to the Knight and Apex transactions, we anticipate that our regulatory requirements will change and ultimately be substantially reduced. While we have not historically experienced significant difficulty in obtaining this approval, as discussed above, there is no assurance that we will not have difficulty in obtaining such approval in the future. Any such difficulty would have a material impact on our ability to service our debt obligations at the parent company level.
Historically, the Company has not experienced significant difficulty obtaining approval for distributions by our regulated operating subsidiaries when we have had significant excess capital. Currently, only PFSC has adequate excess regulatory capital. On May 15, 2012, in order to assist us in making the $12.5 million semiannual payment on our Senior Secured Second Lien Notes, our regulators, allowed us to borrow $5.5 million from PFSI. In return for this assistance, we agreed to continue our efforts to execute a strategic transaction with respect to PFSI, which resulted in the Apex transaction described earlier. In June 2012, our regulators allowed a $2.4 million dividend from PFSI to assist us in making the $2.4 million semiannual payment on our Senior Convertible Notes.

As a result of the transactions with Knight and Apex Holdings, the cash flow at our U.S. broker-subsidiary, PFSI, will be limited primarily to amounts payable under the transitional services agreements with Knight and Apex Holdings, as described in Note 3, and the recovery of deposits held by various exchanges and regulatory authorities.

44

Contractual obligations and commitments
We have contractual obligations to make future payments under long-term debt and long-term non-cancelable lease agreements and have contingent commitments under a variety of commercial arrangements. See Note 14 to our unaudited interim condensed consolidated financial statements for further information regarding our commitments and contingencies.
Off-balance sheet arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. See Note 12 to our unaudited interim condensed consolidated financial statements for information on off-balance sheet arrangements.
Critical accounting policies
Our discussion and analysis of our financial condition and results of operations are based on our unaudited interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these unaudited interim condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We review our estimates on an on-going basis. We base our estimates on our experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in the notes to our unaudited interim condensed consolidated financial statements, we believe the accounting policies that require management to make assumptions and estimates involving significant judgment are those relating to revenue recognition, fair value, software development goodwill, stock-based compensation and allowance for doubtful accounts.
Revenue recognition
Revenues from clearing transactions are recorded in our unaudited interim condensed consolidated financial statements on a trade date basis. Cash received in advance of revenue recognition is recorded as deferred revenue.
There are three major types of technology revenues: (1) completed products that are processing transactions every month generate revenues per transaction which are recognized on a trade date basis; (2) these same completed products may also generate monthly terminal charges for the delivery of data or processing capability that are recognized in the month to which the charges apply; (3) technology development services are recognized when the service is performed or under the terms of the technology development contract as described below. Interest and other revenues are recorded in the month that they are earned.
To date, the majority of our technology development contracts have not required significant production, modification or customization such that the service element of our overall relationship with the client generally does meet the criteria for separate accounting under the FASB Codification. All of our products are fully functional when initially delivered to our clients, and any additional technology development work that is contracted for is as outlined below. Technology development contracts generally cover only additional work that is performed to modify existing products to meet the specific needs of individual customers. This work can range from cosmetic modifications to the customer interface (private labeling) to custom development of additional features requested by the client. Technology revenues arising from development contracts are recorded on a percentage-of-completion basis based on outputs unless there are significant uncertainties preventing the use of this approach in which case a completed contract basis is used. Our revenue recognition policy is consistent with applicable revenue recognition guidance in the FASB Codification and Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”).
Fair value
Fair value is defined as the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Our financial assets and liabilities are primarily recorded at fair value.
In determining fair value, we use various valuation approaches, including market, income and/or cost approaches. The fair value model establishes a hierarchy which prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy increases the consistency and comparability of fair value measurements and related disclosures by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs reflect the assumptions market participants would use in pricing the assets or liabilities based on

45

market data obtained from sources independent of us. Unobservable inputs reflect the our own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy prioritizes the inputs into three broad levels based on the reliability of the inputs as follows:
•
Level 1 — Inputs are quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date. Assets and liabilities utilizing Level 1 inputs include corporate equity, U.S. Treasury and money market securities. Valuation of these instruments does not require a high degree of judgment as the valuations are based on quoted prices in active markets that are readily and regularly available.
•
Level 2 — Inputs other than quoted prices in active markets that are either directly or indirectly observable as of the measurement date, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Assets and liabilities utilizing Level 2 inputs include certificates of deposit, term deposits, corporate debt securities and Canadian government obligations. These financial instruments are valued by quoted prices that are less frequent than those in active markets or by models that use various assumptions that are derived from or supported by data that is generally observable in the marketplace. Valuations in this category are inherently less reliable than quoted market prices due to the degree of subjectivity involved in determining appropriate methodologies and the applicable underlying assumptions.
•
Level 3 — Valuations based on inputs that are unobservable and not corroborated by market data. These financial instruments have significant inputs that cannot be validated by readily determinable data and generally involve considerable judgment by management.
See Note 5 to our unaudited interim condensed consolidated financial statements for a description of the financial assets carried at fair value.
Software development
Costs associated with software developed for internal use are capitalized based on the applicable guidance in the FASB Codification. Capitalized costs include external direct costs of materials and services consumed in developing or obtaining internal-use software and payroll for employees directly associated with, and who devote time to, the development of the internal-use software. Costs incurred in development and enhancement of software that do not meet the capitalization criteria, such as costs of activities performed during the preliminary and post- implementation stages, are expensed as incurred. Costs incurred in development and enhancements that do not meet the criteria to capitalize are activities performed during the application development stage such as designing, coding, installing and testing. The critical estimate related to this process is the determination of the amount of time devoted by employees to specific stages of internal-use software development projects. We review any impairment of the capitalized costs on a periodic basis.
Income taxes
We account for income taxes in accordance with the applicable sections of the Accounting Standards Codification, which establishes financial accounting and reporting standards for the effect of income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in addressing the future tax consequences of events that have been recognized in our unaudited interim condensed consolidated financial statements or tax returns.
As of June 30, 2012, the Company had federal net operating losses as well as state net operating loss carryforwards and loss carryforwards in certain foreign jurisdictions. Management has determined that a valuation allowance of $121.9 million and $78.5 million, respectively, was necessary as of June 30, 2012 and December 31, 2011 as the realization of the deferred tax assets was not more likely than not.
Stock-based compensation
Our accounting for stock-based employee compensation plans focuses primarily on accounting for transactions in which an entity exchanges its equity instruments for employee services, and carries forward prior guidance for share-based payments for transactions with non-employees. Under the modified prospective transition method, we are required to recognize compensation cost, after the effective date, for the portion of all previously granted awards that were not vested, and the vested portion of all new stock option grants and restricted stock. The compensation cost is based upon the original grant-date fair market value of the grant. We recognize expense relating to stock-based compensation on a straight-line basis over the requisite service period which is generally the vesting period. Forfeitures of unvested stock grants are estimated and recognized as a reduction of expense.

46

Allowance for doubtful accounts
Typically, our loans to customers or correspondents are made on a fully collateralized basis because they are generally margin loans and the amount advanced is less than the then current value of the margin collateral. When the value of that collateral declines, when the collateral decreases in liquidity, or margin calls are not met, we may consider a variety of credit enhancements such as, but not limited to, seeking additional collateral or guarantees. In valuing receivables that become less than fully collateralized, we compare the estimated fair value of the collateral, deposits and any additional credit enhancements to the balance of the loan outstanding and evaluate the collectibility based on various qualitative factors such as, but not limited to, the creditworthiness of the counterparty, the potential impact of any outstanding litigation or arbitration and nature of the collateral and available realization methods. To the extent that the collateral, the guarantees and any other rights we have against the customer or the related introducing broker are not sufficient to cover potential losses, we record an appropriate allowance for doubtful accounts. We review these accounts on a monthly basis to determine if a change in the allowance for doubtful accounts is necessary. This specific, account-by-account review is supplemented by risk management procedures to identify positions in illiquid securities and other market developments that could affect accounts that otherwise appear to be fully collateralized. The parent company and local country risk management officers monitor market developments on a daily basis. We maintain an allowance for doubtful accounts that represents amounts, in our judgment, necessary to adequately reflect anticipated losses in outstanding receivables. Typically, when a receivable is deemed not to be fully collectible it is generally reserved at an amount correlating with the amount of the balance that is considered under secured. See Note 8 to our unaudited interim condensed consolidated financial statements for a description of certain nonaccrual receivables.
Forward-Looking Statements
This report contains forward-looking statements that may not be based on current or historical fact. Though we believe our expectations to be accurate, forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Factors that could cause or contribute to such differences include but are not limited to:
•
interest rate fluctuations;
•
general economic conditions and the effect of economic conditions on consumer confidence;
•
our ability to successfully implement new product offerings;
•
our ability to obtain future credit on favorable terms;
•
reductions in per transaction clearing fees;
•
legislative and regulatory changes;
•
monetary and fiscal policy changes and other actions by the Board of Governors of the Federal Reserve System;
•
our ability to attract and retain customers and key personnel; and
•
those risks detailed from time to time in our press releases and periodic filings with the Securities and Exchange Commission.
Additional important factors that may cause our actual results to differ from our projections are detailed later in this report under the section entitled “Risk Factors.” You should not place undue reliance on any forward-looking statements, which speak only as of the date hereof. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement.
Item 4.
Controls and Procedures
Management’s evaluation of disclosure controls and procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as that term is defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this quarterly report. Based on that evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were effective in recording, processing, summarizing and reporting information required to be disclosed by us in reports that we file or submit under the Exchange Act, within the time periods specified by the SEC’s rules and regulations.
Changes in internal control over financial reporting
There have been no changes in our internal controls or in other factors that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting during the quarter ended June 30, 2012.

47

PART II. OTHER INFORMATION
 
Item 1.
Legal Proceedings
In re Sentinel Management Group, Inc. is a Chapter 11 bankruptcy case filed on August 17, 2007 in the U.S. Bankruptcy Court for the Northern District of Illinois by Sentinel. Prior to the filing of this action, Penson Futures and PFFI held customer segregated accounts with Sentinel totaling approximately $36.0 million. In the days immediately preceding its bankruptcy filing, Sentinel sold certain securities to Citadel Equity Fund, Ltd. and Citadel Limited Partnership. On August 20, 2007, the Bankruptcy Court authorized distributions of 95 percent of the proceeds Sentinel received from that sale to certain FCM clients of Sentinel, including Penson Futures and PFFI. This distribution to the Penson Futures and PFFI customer segregated accounts along with a distribution received immediately prior to the bankruptcy filing totaled approximately $25.4 million.
On May 12, 2008, a committee of Sentinel creditors, consisting of a majority of non-FCM creditors, together with the trustee appointed to manage the affairs and liquidation of Sentinel (the “Sentinel Trustee”), filed with the Court their proposed Plan of Liquidation (the “Committee Plan”) and on May 13, 2008 filed a Disclosure Statement related thereto. The Committee Plan allows the Sentinel Trustee to seek the return from FCMs, including Penson Futures and PFFI, of a portion of the funds previously distributed to their customer segregated accounts. On June 19, 2008, the Court entered an order approving the Disclosure Statement over objections by Penson Futures, PFFI and others. On September 16, 2008, the Sentinel Trustee filed suit against Penson Futures and PFFI and several other FCMs that received distributions to their customer segregated accounts from Sentinel. The suit against Penson Futures and PFFI seeks the return of approximately $23.6 million of post-bankruptcy petition transfers and approximately $14.4 million of pre-bankruptcy petition transfers. The suit also seeks to declare that the funds distributed to the customer segregated accounts of Penson Futures and PFFI by Sentinel are the property of the Sentinel bankruptcy estate rather than the property of customers of Penson Futures and PFFI.
On December 15, 2008, over the objections of Penson Futures and PFFI, the court entered an order confirming the Committee Plan, and the Committee Plan became effective on December 17, 2008. On January 7, 2009 Penson Futures and PFFI filed their answer and affirmative defenses to the suit brought by the Sentinel Trustee. Also on January 7, 2009, Penson Futures, PFFI and a number of other FCMs that had placed customer funds with Sentinel filed motions with the federal district court for the Northern District of Illinois, effectively asking the federal district court to remove the Sentinel suits against the FCMs from the bankruptcy court and consolidate them with other Sentinel related actions pending in the federal district court. On April 8, 2009, the Sentinel Trustee filed an amended complaint, which added a claim for unjust enrichment. Following an unsuccessful attempt to dismiss that claim on September 1, 2009, the Court denied the motion for reconsideration without prejudice. On September 11, 2009, Penson Futures and PFFI filed their amended answer and amended affirmative defenses to the Sentinel Trustee’s amended complaint. On October 28, 2009, the federal district court for the Northern District of Illinois granted the motions of Penson Futures, PFFI, and certain other FCMs requesting removal of the matters referenced above from the bankruptcy court, thereby removing these matters to the federal district court.
In one of the actions brought by the Sentinel Trustee against an FCM whose customer segregated accounts received distributions similar to those made to the customer segregated accounts of Penson Futures and PFFI, the Sentinel Trustee has brought a motion for summary judgment on certain counts asserted against such FCM that may implicate the claims brought by the Sentinel Trustee against the Company. The FCM filed its response in August, 2011 and the Sentinel Trustee filed his reply brief in November 2011. On December 15, 2011, the National Futures Association filed an amicus curie brief in opposition to the Sentinel Trustee’s summary motion and on January 11, 2012, the Commodities Futures Trading Commission filed an amicus curie brief in opposition to the Sentinel Trustee’s summary judgment motion. There is no date set for the resolution of that motion.
On January 13, 2012, four FCMs whose customer segregated accounts received distributions similar to those made to the customer segregated accounts of Penson Futures and PFFI filed motions for summary judgment with respect to the Sentinel Trustee’s claims seeking recovery of pre-bankruptcy petition transfers that may implicate the claims brought by the Sentinel Trustee by which the Trustee is seeking recovery from the Company of $14.4 million of pre-bankruptcy transfers. The federal district court has set April 13, 2012 as the deadline for the Sentinel Trustee to respond to the FCMs summary judgment motions. There is no date set for the resolution of that motion.
On February 21, 2012, the Sentinel Trustee filed a motion to set a trial date with respect to its suit against one FCM whose customer segregated accounts received distributions similar to those made to the customer segregated accounts of Penson Futures and PFFI. The federal district court judge has set the trial for that case to commence on October 1, 2012.
On February 21, 2012, the Sentinel Trustee filed a Motion for Leave to Amend Complaint to amend claims against Penson Futures and PFFI. On February 28, 2012, the federal district court entered an order authorizing the Sentinel

48

Trustee to file the amended complaint and on March 7, 2012, the Sentinel Trustee filed his Second Amended Complaint. On April 4, 2012, Penson Futures and PFFI filed a motion to dismiss one count of the Second Amended Complaint and its Answer and Affirmative Defenses to the remaining counts of the Second Amended Complaint. The Trustee has not yet responded to the motion to dismiss. No trial date has been set with respect to the Trustee’s suit against Penson Futures and PFFI.
Purported Class Action and Derivative Litigation Matters
On August 23, 2011, a class action complaint alleging violations of the federal securities laws was filed in the United States District Court for the Northern District of Texas against the Company and its Chief Executive Officer and Chief Financial Officer, Philip A. Pendergraft and Kevin W. McAleer, by Reid Friedman, on behalf of himself and all others similarly situated (the “Friedman Action”). Plaintiff contended, among other things, that “Penson concealed from investors that by at least the end of 2010, 1) that the Company had approximately $96-97 million in receivables of which approximately $43.0 million were collateralized by illiquid securities and therefore unlikely to be collected; 2) the Company’s assets (Nonaccrual Receivables) were materially overstated and should have been written down at least by the end of 2010; 3) as a result, the Company’s reported income and EBITDA (earnings before interest, taxes, depreciation, amortization and stock-based compensation, and excluding certain non-operating expenses) were materially overstated; and 4) the Company’s financial statements were not prepared in accordance with generally accepted accounting principles. In March 2012, Plaintiff filed an Amended Complaint alleging a class period between March 30, 2007 and August 4, 2011, inclusive, adding allegations, among others, that certain transactions should have been disclosed as related party transactions, and adding Daniel P. Son, Roger Engemoen, Jr., Thomas R. Johnson, and BDO Seidman, LLP and BDO USA, LLP as additional parties. These events have led to increased regulatory scrutiny of our operations and margin lending. Plaintiff seeks to recover an unspecified amount of damages, including interest, attorneys’ fees, costs, and equitable/injunctive relief as the Court may deem proper. The Company filed a Motion to Dismiss and intends to vigorously defend itself against these claims.
On September 21, 2011, a verified shareholder derivative petition was filed in County Court at Law No. 3, Dallas, County, Texas by Chadwick McHugh, “individually and on behalf of nominal defendant Penson Worldwide, Inc.,” against the Company and current or former members of the Company’s board of directors, Roger J. Engemoen, Jr., David M. Kelly, James S. Dyer, David Johnson, Philip A. Pendergraft, David A. Reed, Thomas R. Johnson, and Daniel P. Son (the McHugh Action”). A second verified shareholder derivative petition was filed against the same defendants on September 21, 2011, by Sanjay Israni, “individually and on behalf of nominal defendant Penson Worldwide, Inc.,” in County Court at Law No. 1, Dallas, County, Texas (the “Israni Action”). On November 4, 2011, another shareholder derivative suit was filed in the United States District Court for the Northern District of Texas, by Adam Leniartek, “derivatively on behalf of Penson Worldwide, Inc.,” against the same defendants (the “Leniartek Action”). Plaintiffs in both the McHugh Action and the Israni Action allege, among other things, causes of action for breaches of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets. Plaintiff in the Leniartek Action alleges those same causes of action as well as a claim for contribution and indemnification. The McHugh Action and the Israni Action have now been consolidated. The plaintiffs seek, among other things, unspecified monetary damages in favor of the Company, changes to corporate governance procedures, restitution and disgorgement, and costs, including attorneys’ fees, accountants’ and experts’ fees, costs, and expenses. The defendants have not yet filed an Answer or responsive motion.
In response to these actions, Penson has retained experienced securities litigation counsel to vigorously represent it and its officers and directors. Management cannot currently estimate a range of reasonably possible loss. As is not unusual in these situations, this litigation has encouraged increased regulatory scrutiny of our operations by our regulators, including FINRA and the SEC.
Realtime Data, LLC d/b/a IXO v. Thomson Reuters et al. In July and August 2009, Realtime Data, LLC (“Realtime”) filed lawsuits against the Company and Nexa (along with numerous other financial institutions, exchanges, and financial data providers) in the United States District Court for the Eastern District of Texas in consolidated cases styled Realtime Data, LLC d/b/a IXO v. Thomson Reuters et al. Realtime alleges, among other things, that the defendants’ activities infringe upon patents allegedly owned by Realtime, including our use of certain types of data compression to transmit or receive market data. Realtime is seeking both damages for the alleged infringement as well as a permanent injunction enjoining the defendants from continuing infringing activity. Discovery with respect to this matter is proceeding.
The United States Court of Appeals for the Federal Circuit issued an order mandating the transfer of the case to the Southern District of New York. The trial before the New York District Court is scheduled for November 26, 2012. Based on its investigation to date and advice from legal counsel, the Company believes that resolution of these claims will not result in any material adverse effect on its business, financial condition, or results of operation. Nevertheless, the Company has incurred and will likely continue to incur significant expense in defending against these claims, and there can be no assurance that future liability will be avoided. Management cannot currently estimate a range of reasonably possible loss. The Company has entered into a Standstill Agreement pursuant to which the claims against it will be stayed following the conclusion of expert discovery

49

and the determination of summary judgment motions.  In exchange, the Company will be bound by the Court's determinations of liability as to certain other defendants, against whom the plaintiff's claims are proceeding to trial.   
Penson Financial Services, Inc. v. SAMCO Capital Markets, Inc., Roger J. Engemoen, et al. On July 24, 2012, PFSI filed a FINRA arbitration against SAMCO Capital Markets, Inc. (“SAMCO”) and its principal Roger J. Engemoen (“Engemoen”), a former director of the Company.  PFSI is seeking to recover unpaid interest advances that are owed to it by SAMCO and Engemoen, believed to total approximately $2.6 million.  The case is in its initial stage, so no discovery has yet been conducted and no hearing dates set. 
In the general course of business, the Company and certain of its officers have been named as defendants in other various pending lawsuits and arbitration and regulatory proceedings. These other claims allege violation of federal and state securities laws, among other matters. The Company believes that resolution of these claims will not result in any material adverse effect on its business, financial condition, or results of operation.
Item 1A.
Risk Factors
The Company may be unable to restructure its outstanding debt or return to positive cash flow.
The Company currently has substantial indebtedness and interest payment obligations. At June 30, 2012, the Company had significant senior parent company indebtedness outstanding which included $200.0 million aggregate principal amount outstanding in respect of its 12.50% Senior Second Lien Secured Notes due 2017 (“Senior Secured Second Lien Noes”) and $60.0 million aggregate principal amount outstanding under the 8.0% Senior Convertible Notes due 2014 (the “Senior Convertible Notes”). The Company has significant principal and interest payments under its indebtedness coming due in the next several years. Unless the Company is able to restructure its senior debt, the Company will be required to make the following payments during the balance of 2012: a payment of $12.5 million on November 15, 2012 for the Senior Secured Second Lien Notes, and a payment of $2.4 million on December 1, 2012 for the Senior Convertible Notes. The principal amount of the Senior Convertible Notes, $60.0 million, is due in full on June 1, 2014 and the principal amount of the Senior Secured Second Lien Notes, $200.0 million, is due May 15, 2017. The Company believes, therefore, that the completion of a restructuring of the senior indebtedness is critical to its plans to return to profitability. If the Company is unable to restructure its outstanding debt, the Company will consider other restructuring alternatives available to it, including a restructuring pursuant to Chapter 11 of the Bankruptcy Code.
The Company believes that a Chapter 11 case would materially and adversely affect the relationships between the Company and its existing and potential customers, employees, vendors, suppliers, and other stakeholders and subject the Company to other direct and indirect adverse consequences. For example:

•
a Chapter 11 case would likely cause the Company to lose many of its key management employees, including the most senior members of management;
•
losses of key management employees would likely make it difficult for the Company to complete a financial restructuring and may make it less likely that the Company will be able to continue as a viable business;
•
the Company could be forced to operate in bankruptcy for an extended period of time;
•
the Company's trade creditors, counterparties and other partners could seek to terminate their relationships with the Company, require financial assurances or enhanced performance, or refuse to provide credit on the same terms as they provided prior to the Chapter 11 case; and
•
the Company may be forced to liquidate under Chapter 7 of the Bankruptcy Code.
In addition, any liquidation or reorganization case or cases under the Bankruptcy Code could be a protracted and non-orderly process. Any distributions that might be received under a liquidation or reorganization case or cases under the Bankruptcy Code would be substantially delayed, and the value of any potential recovery likely would be materially and adversely impacted by such delay and by the potential consequences described above. Furthermore, in the event of any foreclosure, dissolution, winding-up, liquidation or reorganization, or other insolvency proceeding, there can be no assurance as to the value, if any, that would be available to creditors and shareholders. Distributions to the Company's creditors under a liquidation would be substantially delayed and diminished and/or eliminated. A recovery to current or future equity holders is unlikely with respect to sale or liquidation scenarios.
The Company has limited ability to generate revenue and cash flow from its continuing operations and current assets following the completion of recent strategic transactions.

The recent completion of the Knight and Apex transactions in June 2012 (the “Transactions”) has resulted in a significant shift of the Company's business operations that will limit the Company's ability to generate revenue and positive cash flow. The Company is no longer a clearing broker dealer, and its current business model focuses primarily on providing certain clearing-related operational and technology services through its subsidiary Nexa. The Company's involvement in the clearing

50

broker dealer business is limited to the Company's equity ownership interest in Apex Clearing. In addition, pursuant to a transition services agreement (the “TSA”), Apex agrees to pay certain fees to the Company for providing transition support services to Apex with respect to the customer contracts and other assets of PFSI acquired by Apex. Furthermore, the Company continues to explore strategic alternatives for its Canadian broker-dealer subsidiary, PFSC, which is accounted for as a discontinued operation.

The Company does not expect that its current business operations and assets will generate sufficient amount of cash to meet its liquidity and debt-service requirements. The technology services operations of Nexa is limited to providing front end trading systems, routing and execution infrastructure and market data, and it generated $4.0 million of revenue for the quarter ended June 30, 2012. While the Company has a 93.75% equity interest in Apex Clearing, this investment is not expected to yield any positive cash flow in the near future and it may never yield positive cash flow. The weakened global economy, prolonged market volatility, lower trading volumes and continued low short-term interest rates may have a negative effect on Apex Clearing's ability to generate a positive cash flow. In addition, the Company receives a minimum of amount of payment under the TSA, which is used primarily to recoup costs incurred in providing transition support services, and such payment is available only for a limited period of time under the TSA. The Company's failure to generate sufficient liquidity to meet its on-going obligations will have a material adverse impact on its business and its abilities to meet its payment obligations and will force the Company to seek other restructuring alternative such as a Chapter 11 bankruptcy proceeding. The lack of any significant source of revenue or liquidity may also adversely affect the creditors' ability to recover any value from the assets of the Company in a Chapter 11 proceeding.
The Company's ability to settle transactions often depends on the availability of credit from its short term credit facilities
As of June 30, the Company's PFSC subsidiary had available uncommitted lines of credit with two financial institutions for the purpose of facilitating its clearing business as well as the activities of its customers and correspondents permitting PFSC to borrow up to an aggregate of approximately $184.9 million. While the Company believes it has sufficient resources to address its short term borrowing needs, if the Company is not able to obtain sufficient credit or on favorable terms, its ability to settle its customer transactions could be impaired, or the costs of its business could be increased, such impacts could materially adversely affect the Company's business operations. Further these uncommitted lines may be terminated or restricted upon notice from the lender and outstanding loans are due on demand.
The loss of a significant number of key employees and personnel due to the completion of our recent strategic transactions or a long and protracted restructuring process will adversely affect the Company's business and operations.
Following the completion of the Knight and Apex transactions in June 2012 (the “Transactions”), a significant number of employees and personnel of the Company, including certain members of the management, have been transferred or assumed by Knight and Apex. While certain key employees and management members remain at the Company following the Transactions, many were retained to provide temporary transition support services to Knight and Apex in accordance with the applicable transition services agreements. There is no guarantee that these personnel will continue to be employed with the Company following the termination of transitions services, and many employees may decide to move to Knight, Apex or seek other opportunities. As a result, the Company may not have sufficient workforce to operate its business. The lack of qualified technical, financial and legal personnel may also adversely affect the Company's ability to comply with various regulatory requirements, including its obligations to provide timely and accurate disclosures about the Company pursuant to applicable SEC regulations.
In addition, a protracted financial restructuring could disrupt the Company’s business and would divert the attention of its management from operating its business and implementation of the Company’s business plan. It is likely that such a prolonged financial restructuring, especially if in a Chapter 11 proceeding, would cause the Company to lose many of its key management employees, including the most senior members of management. Such losses of key management employees would likely make it difficult for the Company to complete a financial restructuring and may make it less likely that the Company will be able to continue as a viable business.
The uncertainty surrounding a prolonged financial restructuring could also have other adverse effects on the Company. For example, it could also adversely affect:
•
the Company’s ability to capitalize on business opportunities and react to competitive pressure;
•
the Company’s ability to attract and retain employees;
•
the Company’s liquidity;
•
how the Company’s business is viewed by investors, lenders, strategic partners, correspondents, or customers; and
•
the Company’s enterprise value.

51

We could be required to a restate certain of our historical financial statements to appropriately reflect an acceleration of all or a portion of certain impairment charges into prior reporting periods.
We have received letters from the staff of the Division of Corporation Finance (the “Staff”) of the SEC setting forth comments and questions with respect to our Annual Report on Form 10-K for the year ended December 31, 2010 and our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2011 and September 30, 2011 (the “2011 Comment Letters”) and the Company has submitted responses to such letters. In addition, the Company has received comments on its Annual Report on Form 10-K for the year ended December 31, 2011 (the “2012 Comment Letter; the 2011 Comment Letters and the 2012 Comment Letter are referred to jointly as the “Comment Letters”). Among other things, the Comment Letters have questioned the timing of the impairment charge taken by the Company with respect to certain of its nonaccrual receivables. The Company reported a $43.0 million bad debt charge (the “Impairment Charge”) with respect to these receivables in the second quarter of fiscal 2011. More recently, the Staff, along with the Commission’s Office of the Chief Accountant, has questioned whether the Company should have reflected all or a portion of the Impairment Charge in earlier periods. The Company has been discussing this accounting treatment with the Staff and a resolution remains pending.
If it is ultimately determined that the Company’s valuation of the underlying collateral for the nonaccrual receivables did not support the margin debt prior to the timing of the Impairment Charge, the Company may need to accelerate the Impairment Charge into earlier periods. The Company will then need to review its analysis of the relevant factors in existence at each earlier period and reach a conclusion as to the amount of the Impairment Charge that should properly be reflected in each relevant earlier period. In performing such review, the Company will need to evaluate the materiality of the applicable charge for each such period to determine whether a restatement of our historical financial statements for such period is required. While the Company intends to continue its discussion with the Commission to resolve the Comment Letter, there is no guarantee that the Company will be successful.  In the event that the Company is required to conduct further analysis of this issue, or if it is determined that the Company is required to restate its financial statement in prior periods, the Company may not have sufficient financial and human resources to meet these requirements timely, or at all. 
In addition to the other information set forth in this report and the risk factors discussed in this report, you should carefully consider the factors discussed under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the SEC on March 15, 2012, which could materially affect our business operations, financial condition or future results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business operations and/or financial condition.

The common stock of the Company may be delisted from The NASDAQ Stock Market if the Company does not regain compliance with applicable NASDAQ continuing listing requirements

 As previously reported in an 8-K filed on July 27, 2012,  the Company received a letter from The NASDAQ Stock Market LLC (“NASDAQ”) stating that the Company is not in compliance with the NASDAQ listing rules requiring securities listed on the NASDAQ Global Select Market to maintain a minimum market value of publicly held shares (“MVPHS”) of $5,000,000.  The Company is provided a grace period of 180 calendar days, or until January 22, 2013, in which to regain compliance with the MVPHS rule.  If at any time during the grace period, the Company's MVPHS closes at $5,000,000 or more for a minimum of ten (10) consecutive business days, the Company will have complied with the MVPHS rule and the matter will be closed.  If compliance with the MVPHS rule cannot be demonstrated by January 22, 2013, NASDAQ will provide the Company written notification that the Company's common stock is subject to delisting. 

In addition, as previously reported in an 8-K filed on May 7, 2012, the Company is not in compliance with the NASDAQ listing rules requiring the Company to maintain a minimum bid price of $1.00 per share for its common stock.  The Company is provided a grace period of 180 calendar days, or until October 29, 2012, in which to regain compliance with the minimum bid price rule. If at any time during the grace period, the Company's minimum bid price of the Company's common stock closes at $1.00 or more for a minimum of ten (10) consecutive business days, the Company will have complied with the rule and the matter will be closed. If compliance with the rule cannot be demonstrated by October 29, 2012, NASDAQ will provide the Company written notification that the Company's common stock is subject to delisting.

The Company may be eligible to receive an additional 180 day grace period to regain compliance with each of the MVPHS and minimum bid price requirements, if it meets certain conditions, including satisfying certain initial and continuing listing standards for The NASDAQ Capital Market and submitting a timely application to NASDAQ to transfer the listing of its common stock to The NASDAQ Capital Market. However, the Company may not be able to satisfy these conditions to obtain the additional grace periods, and even if it does, there is no guarantee that the Company will ultimately regain compliance with the MVPHS and minimum bid price requirements. Failure to do so will result in the delisting of the common stock of the Company.


52

The delisting of common stock from trading on NASDAQ will have a material adverse effect on the market for, and the liquidity and price of, our common stock, and stockholders of the Company may not be able to sell their shares at a reasonable price, or at all. Delisting from NASDAQ could also have other negative results, including the potential loss of confidence by customers, employees, debt holders and other investors, and the loss of ability to negotiate and restructure the Company's convertible notes with certain debt holders.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth the repurchases we made during the six months ended June 30, 2012 for shares withheld to cover tax-withholding requirements relating to the vesting of restricted stock units issued to employees pursuant to the Company’s shareholder-approved stock incentive plan:
 
Period
 
Total Number of
Shares Repurchased
 
Average Price
Paid
per Share
April
 
2,763

 
$
0.68

May
 
1,785

 
0.58

June
 
206

 
0.20

Total
 
4,754

 
$
0.62

On December 6, 2007, our Board of Directors authorized us to purchase up to $12.5 million of our common stock in open market purchases and privately negotiated transactions. The plan is set to expire after $12.5 million of our common stock is purchased. No shares were repurchased under this plan in the first quarter of 2012. The maximum number of shares that could have been purchased under this plan for the months of April, May and June 2012 was 6,895,074, 8,083,879 and 23,443,250 respectively based on the remaining dollar amount authorized divided by the average purchase price in the month.
Item 3.
Defaults Upon Senior Securities
None reportable
Item 4.
Mine Safety Disclosures
Not applicable
Item 5.
Other Information
None reportable

53

Item 6.
Exhibits
The following exhibits are filed as a part of this report:
 
Exhibit
Numbers
Description
Method of
Filing
10.1
Amendment of Executive Employment Agreement between the Company and Bryce B. Engel, dated July 24, 2012
(1)
10.2
Retention Letter for Bryce B. Engel, dated July 24, 2012
(1)
10.3
Employment Letter between Penson Financial Services, Inc. and Bart McCain, dated June 12, 2006
(1)
10.4
Amendment to Employment Letter between Penson Financial Services, Inc. and Bart McCain, dated July 31, 2012
(1)
10.5
Form of Executive Retention Letter
(1)
10.6
Amendment to the Asset Purchase Agreement between Penson Financial Services, Inc. and Knight Execution & Clearing Services LLC, dated as of May 29, 2012
(1)
10.7
Transition Services Agreement between Penson Financial Services, Inc. and Knight Execution & Clearing Services LLC, effective as of May 31, 2012
(1)
10.8
Letter from the Financial Industry Regulatory Authority to Penson Financial Services, Inc., dated May 15, 2012
(1)
10.9
Separation Agreement between the Company and Philip A. Pendergraft, dated July 2, 2012
(1)
31.1
Rule 13a-14(a) Certification by our principal executive officer
(1)
31.2
Rule 13a-14(a) Certification by our principal financial officer
(1)
32.1
Section 1350 Certification by our principal executive officer
(1)
32.2
Section 1350 Certification by our principal financial officer
(1)
________________________ 
(1)
Filed herewith.


54

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
PENSON WORLDWIDE, INC.
 
 
 
 
 
/s/     Daniel P. Son       
 
 
Daniel P. Son
 
 
Chief Executive Officer
and principal executive officer
Date:
August 14, 2012
 

 
 
/s/ R. Bart McCain
 
 
R. Bart McCain
 
 
Executive Vice President, Chief Financial Officer and principal financial and accounting officer
Date:
August 14, 2012
 


55


INDEX TO EXHIBITS
 
The following exhibits are filed as a part of this report:
 
Exhibit
Numbers
Description
Method of
Filing
10.1
Amendment of Executive Employment Agreement between the Company and Bryce B. Engel, dated July 24, 2012
(1)
10.2
Retention Letter for Bryce B. Engel, dated July 24, 2012
(1)
10.3
Employment Letter between Penson Financial Services, Inc. and Bart McCain, dated June 12, 2006
(1)
10.4
Amendment to Employment Letter between Penson Financial Services, Inc. and Bart McCain, dated July 31, 2012
(1)
10.5
Form of Executive Retention Letter
(1)
10.6
Amendment to the Asset Purchase Agreement between Penson Financial Services, Inc. and Knight Execution & Clearing Services LLC, dated as of May 29, 2012
(1)
10.7
Transition Services Agreement between Penson Financial Services, Inc. and Knight Execution & Clearing Services LLC, effective as of May 31, 2012
(1)
10.8
Letter from the Financial Industry Regulatory Authority to Penson Financial Services, Inc., dated May 15, 2012
(1)
10.9
Separation Agreement between the Company and Philip A. Pendergraft, dated July 2, 2012
(1)
31.1
Rule 13a-14(a) Certification by our principal executive officer
(1)
31.2
Rule 13a-14(a) Certification by our principal financial officer
(1)
32.1
Section 1350 Certification by our principal executive officer
(1)
32.2
Section 1350 Certification by our principal financial officer
(1)
________________________ 
(1)
Filed herewith.



56

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