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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 28, 2012

OR

 

¨

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 0-16633

 

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

(Exact name of registrant as specified in its Charter)

 

 

 

MISSOURI   43-1450818

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

12555 Manchester Road

Des Peres, Missouri 63131

(Address of principal executive office)

(Zip Code)

(314) 515-2000

(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  x    NO  ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x (do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 26, 2012, 652,716 units of limited partnership interest (“Units”) are outstanding, each representing $1,000 of limited partner capital. There is no public or private market for such units.

 

 

 


Table of Contents

THE JONES FINANCIAL COMPANIES, L.L.L.P.

INDEX

 

 

 

          Page  
Part I.   

FINANCIAL INFORMATION

  
Item 1.   

Financial Statements

  
  

Consolidated Statements of Financial Condition

     3   
  

Consolidated Statements of Income

     4   
  

Consolidated Statements of Changes in Partnership Capital Subject to Mandatory Redemption

     5   
  

Consolidated Statements of Cash Flows

     6   
  

Notes to Consolidated Financial Statements

     7   
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20   
Item 3.   

Quantitative and Qualitative Disclosures about Market Risk

     44   
Item 4.   

Controls and Procedures

     45   
Part II.   

OTHER INFORMATION

  
Item 1.   

Legal Proceedings

     46   
Item 1A.   

Risk Factors

     47   
Item 6.   

Exhibits

     48   
  

Signatures

     49   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

 

(Dollars in thousands)

   September 28,
2012
     December 31,
2011
 

ASSETS:

     

Cash and cash equivalents

   $ 219,952       $ 819,506   

Cash and investments segregated under federal regulations

     6,027,622         4,472,526   

Securities purchased under agreements to resell

     1,068,056         676,448   

Receivable from:

     

Clients

     2,312,494         2,353,308   

Brokers, dealers and clearing organizations

     125,206         103,805   

Mutual funds, insurance companies and other

     323,427         300,007   

Securities owned, at fair value:

     

Inventory securities

     91,358         74,666   

Investment securities

     112,424         104,502   

Equipment, property and improvements, at cost, net of accumulated depreciation and amortization

     544,332         579,439   

Other assets

     91,452         99,379   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 10,916,323       $ 9,583,586   
  

 

 

    

 

 

 

LIABILITIES:

     

Payable to:

     

Clients

   $ 7,984,069       $ 6,727,090   

Brokers, dealers and clearing organizations

     95,092         80,247   

Securities sold, not yet purchased, at fair value

     5,189         7,586   

Accrued compensation and employee benefits

     650,600         540,416   

Accounts payable and accrued expenses

     188,095         165,970   

Long-term debt

     5,759         6,500   
  

 

 

    

 

 

 
     8,928,804         7,527,809   
  

 

 

    

 

 

 

Liabilities subordinated to claims of general creditors

     100,000         150,000   

Contingencies (Note 8)

     

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals

     1,787,990         1,758,365   

Reserve for anticipated withdrawals

     99,529         147,412   
  

 

 

    

 

 

 

Total partnership capital subject to mandatory redemption

     1,887,519         1,905,777   
  

 

 

    

 

 

 

TOTAL LIABILITIES

   $ 10,916,323       $ 9,583,586   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

3


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

     Three Months Ended     Nine Months Ended  

(Dollars in thousands, except per unit information)

   September 28,
2012
     September 30,
2011
    September 28,
2012
     September 30,
2011
 

Revenue:

          

Trade revenue

          

Commissions

   $ 501,736       $ 441,234      $ 1,462,340       $ 1,301,077   

Principal transactions

     38,274         71,897        125,390         219,556   

Investment banking

     27,007         37,865        86,119         120,720   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total trade revenue

     567,017         550,996        1,673,849         1,641,353   

Fee revenue

          

Asset-based

     519,285         451,669        1,496,250         1,325,174   

Account and activity

     141,519         136,098        425,549         391,085   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total fee revenue

     660,804         587,767        1,921,799         1,716,259   

Interest and dividends

     33,467         34,625        99,119         97,655   

Other revenue (loss)

     8,147         (6,611     27,352         5,161   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue

     1,269,435         1,166,777        3,722,119         3,460,428   

Interest expense

     15,134         16,344        47,010         51,495   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net revenue

     1,254,301         1,150,433        3,675,109         3,408,933   
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating expenses:

          

Compensation and benefits

     845,562         764,581        2,423,417         2,225,343   

Occupancy and equipment

     89,032         90,188        266,185         268,163   

Communications and data processing

     66,854         70,384        208,771         217,186   

Payroll and other taxes

     43,827         42,556        142,813         133,879   

Advertising

     14,089         9,951        39,613         39,733   

Postage and shipping

     12,194         13,428        36,541         36,696   

Clearance fees

     3,109         2,949        9,581         9,530   

Other operating expenses

     48,773         40,776        139,800         120,748   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total operating expenses

     1,123,440         1,034,813        3,266,721         3,051,278   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income before allocations to partners

     130,861         115,620        408,388         357,655   

Allocations to partners:

          

Limited partners

     16,941         16,743        53,107         52,080   

Subordinated limited partners

     14,049         12,176        45,116         37,349   

General partners

     99,871         86,701        310,165         268,226   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net Income

   $ —         $ —        $ —         $ —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Income before allocations to partners per weighted average $1,000 equivalent limited partnership unit outstanding

   $ 25.90       $ 25.11      $ 80.82       $ 77.69   
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted average $1,000 equivalent limited partnership units outstanding

     654,093         666,786        657,102         670,357   
  

 

 

    

 

 

   

 

 

    

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

4


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERSHIP CAPITAL

SUBJECT TO MANDATORY REDEMPTION

NINE MONTHS ENDED SEPTEMBER 28, 2012 AND SEPTEMBER 30, 2011

(Unaudited)

 

(Dollars in thousands)

   Limited
Partnership

Capital
    Subordinated
Limited
Partnership

Capital
    General
Partnership

Capital
    Total  

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY
REDEMPTION, DECEMBER 31, 2010

   $ 479,554      $ 237,415      $ 888,004      $ 1,604,973   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (28,205     (15,447     (64,596     (108,248

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, December 31, 2010

   $ 451,349      $ 221,968      $ 823,408      $ 1,496,725   

Issuance of partnership interests

     223,560        34,162        12,897        270,619   

Issuance of partnership interests through partnership loans

     —          —          90,893        90,893   

Redemption of partnership interests

     (9,812     (1,386     (75,213     (86,411

Income allocated to partners

     52,080        37,349        268,226        357,655   

Withdrawals and distributions

     (3,096     (34,134     (169,557     (206,787
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans

     714,081        257,959        950,654        1,922,694   

Partnership loans outstanding

     —          —          (86,410     (86,410

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION, SEPTEMBER 30, 2011

   $ 714,081      $ 257,959      $ 864,244      $ 1,836,284   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (48,984     (3,215     (36,977     (89,176
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, September 30, 2011

   $ 665,097      $ 254,744      $ 827,267      $ 1,747,108   

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION, DECEMBER 31, 2011

   $ 705,704      $ 271,083      $ 928,990      $ 1,905,777   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (43,478     (15,669     (88,265     (147,412

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, December 31, 2011

   $ 662,226      $ 255,414      $ 840,725      $ 1,758,365   

Partnership loans outstanding, December 31, 2011

     —          —          86,853        86,853   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans, net of reserve for anticipated withdrawals, December 31, 2011

     662,226        255,414        927,578        1,845,218   

Issuance of partnership interests

     —          35,534        99,506        135,040   

Redemption of partnership interests

     (8,812     (7,839     (76,802     (93,453

Income allocated to partners

     53,107        45,116        310,165        408,388   

Withdrawals and distributions

     (4,185     (40,722     (192,615     (237,522
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans

     702,336        287,503        1,067,832        2,057,671   

Partnership loans outstanding, September 28, 2012

     —          —          (170,152     (170,152
  

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION, SEPTEMBER 28, 2012

   $ 702,336      $ 287,503      $ 897,680      $ 1,887,519   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (48,922     (4,394     (46,213     (99,529
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, September 28, 2012

   $ 653,414      $ 283,109      $ 851,467      $ 1,787,990   

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

5


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Nine Months Ended  

(Dollars in thousands)

   September 28,
2012
    September 30,
2011
 

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ —        $ —     

Adjustments to reconcile net income to net cash used in operating activities:

    

Income before allocations to partners

     408,388        357,655   

Depreciation and amortization

     60,490        68,313   

Changes in assets and liabilities:

    

Cash and investments segregated under federal regulations

     (1,555,096     (485,136

Securities purchased under agreements to resell

     (391,608     542,040   

Net payable to clients

     1,297,793        505,251   

Net receivable from brokers, dealers and clearing organizations

     (6,556     42,247   

Receivable from mutual funds, insurance companies and other

     (23,420     (9,649

Securities owned, net

     (27,011     (12,274

Other assets

     7,927        750   

Accrued compensation and employee benefits

     110,184        55,152   

Accounts payable and accrued expenses

     21,126        (34,030
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (97,783     1,030,319   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Purchase of equipment, property and improvements, net

     (24,384     (42,840
  

 

 

   

 

 

 

Net cash used in investing activities

     (24,384     (42,840
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Repayment of long-term debt

     (741     (40,965

Repayment of subordinated liabilities

     (50,000     (53,700

Issuance of partnership interests (net of partnership loans)

     41,907        270,619   

Redemption of partnership interests

     (93,453     (86,411

Withdrawals and distributions from partnership capital

     (384,934     (315,035

Repayment of general partnership loans

     9,834        4,483   
  

 

 

   

 

 

 

Net cash used in financing activities

     (477,387     (221,009
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (599,554     766,470   

CASH AND CASH EQUIVALENTS:

    

Beginning of period

     819,506        87,584   
  

 

 

   

 

 

 

End of period

   $ 219,952      $ 854,054   
  

 

 

   

 

 

 

Cash paid for interest

   $ 45,391      $ 48,930   
  

 

 

   

 

 

 

Cash paid for taxes

   $ 3,952      $ 4,403   
  

 

 

   

 

 

 

NON-CASH ACTIVITIES:

    

Additions of equipment, property and improvements in accounts payable and accrued expenses

   $ 372      $ 1,318   
  

 

 

   

 

 

 

Issuance of general partnership interests through partnership loans in current period

   $ 94,098      $ 90,893   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

6


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, except per unit information)

NOTE 1 – BASIS OF PRESENTATION

The Partnership’s Business and Basis of Accounting. The accompanying Consolidated Financial Statements include the accounts of The Jones Financial Companies, L.L.L.P. and all wholly-owned subsidiaries (collectively, the “Partnership”). All material intercompany balances and transactions have been eliminated in consolidation. Non-controlling minority interests are accounted for under the equity method. The results of the Partnership’s subsidiary in Canada are included in the Partnership’s Consolidated Financial Statements for the three and nine month periods ended August 31, 2012 and 2011 because of the timing of the Partnership’s financial reporting process.

The Partnership’s principal operating subsidiary, Edward D. Jones & Co., L.P. (“Edward Jones”), is comprised of two registered broker-dealers primarily serving individual investors in the United States of America (“U.S.”) and, through a subsidiary, Canada. Edward Jones primarily derives its revenues from the retail brokerage business through the sale of listed and unlisted securities and insurance products, investment banking, principal transactions, distribution of mutual fund shares, and through fees related to assets held by and account services provided to its clients. The Partnership conducts business in the U.S. and Canada with its clients, various brokers, dealers, clearing organizations, depositories and banks. For financial information related to the Partnership’s two operating segments for the three and nine month periods ended September 28, 2012 and September 30, 2011, see Note 9 to the Consolidated Financial Statements. Trust services are offered to Edward Jones’ U.S. clients through Edward Jones Trust Company (“EJTC”), a wholly-owned subsidiary of the Partnership.

The Consolidated Financial Statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the U.S. (“GAAP”) which require the use of certain estimates by management in determining the Partnership’s assets, liabilities, revenues and expenses. Actual results could differ from these estimates.

Under the terms of the Partnership’s Eighteenth Amended and Restated Partnership Agreement (the “Partnership Agreement”), a partner’s capital is required to be redeemed by the Partnership in the event of the partner’s death or withdrawal from the Partnership, subject to compliance with ongoing regulatory capital requirements. In the event of a partner’s death, the Partnership must generally redeem the partner’s capital within six months. The Partnership has withdrawal restrictions in place limiting the amount of capital that can be withdrawn at the discretion of the partner. Under the terms of the Partnership Agreement, limited partners withdrawing from the Partnership are to be repaid their capital in three equal annual installments beginning the month after their withdrawal. The capital of general partners withdrawing from the Partnership is converted to subordinated limited partnership capital or, at the discretion of the Managing Partner, redeemed by the Partnership. Subordinated limited partners are repaid their capital in six equal annual installments beginning the month after their request for withdrawal of contributed capital. The Partnership’s Managing Partner has discretion to waive or modify these withdrawal restrictions and to accelerate the return of capital. All current and future partnership capital is subordinate to all current and future liabilities of the Partnership.

 

7


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

The interim financial information included herein is unaudited. However, in the opinion of management, such information includes all adjustments, consisting primarily of normal recurring accruals, which are necessary for a fair presentation of the results of interim operations. Certain prior period amounts have been reclassified to conform to the current period presentation.

The results of operations for the three and nine month periods ended September 28, 2012 are not necessarily indicative of the results to be expected for the year ended December 31, 2012. These Consolidated Financial Statements should be read in conjunction with the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2011.

Revenue Recognition. The Partnership’s commissions, principal transactions and investment banking revenues are recorded on a trade date basis. All other forms of revenue are recorded on an accrual basis. The Partnership classifies its revenue into the following categories:

Commissions revenue consists of charges to clients for the purchase or sale of listed and unlisted securities, insurance products and mutual fund shares.

Principal transactions revenue is the result of the Partnership’s participation in market-making activities in over-the-counter corporate securities, municipal obligations, government obligations, unit investment trusts, mortgage-backed securities and certificates of deposit.

Investment banking revenue is derived from the Partnership’s underwriting of corporate securities and municipal obligations and distribution of U.S. government obligations and unit investment trusts on behalf of issuers.

Asset-based fee revenue is derived from fees determined by the underlying value of client assets. Most asset-based fee revenue is generated from fees for investment advisory services within the Partnership’s advisory programs, including Edward Jones Advisory Solutions (“Advisory Solutions”), which consists of 60 different research models (including Unified Managed Accounts), Edward Jones Managed Account Program (“MAP”) and, in Canada, Edward Jones Portfolio Program.

The Partnership also earns asset-based fee revenue through service fees and other revenues received under agreements with mutual fund and insurance companies based on the underlying value of the Partnership’s clients’ assets invested in those companies’ products, including revenue related to the Partnership’s ownership interest in Passport Research Ltd., the investment adviser to the Edward Jones Money Market Funds.

Account and activity fee revenue includes fees received from mutual fund companies for sub-transfer agent accounting services performed by the Partnership and retirement account fees primarily consisting of self-directed IRA custodian account fees. This revenue category also includes other activity-based fee revenue from clients, mutual fund companies and insurance companies.

Interest and dividend revenue is earned on client margin (loan) account balances, cash and cash equivalents, cash and investments segregated under federal regulations, securities purchased under agreements to resell, interest on partnership loans for general partnership interests, inventory securities and investment securities.

 

8


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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

The Partnership derived from one mutual fund vendor 18% and 19% of its total revenue for the three and nine month periods ended September 28, 2012, respectively, and 18% and 20% of its total revenue for the three and nine month periods ended September 30, 2011, respectively. All of the revenue generated from this vendor related to business conducted with the Partnership’s U.S. segment. Significant reductions in the revenues from this mutual fund source due to regulatory reform or other changes to the Partnership’s relationship with this mutual fund vendor could have a material impact on the Partnership’s results of operations.

NOTE 2 – FAIR VALUE

Substantially all of the Partnership’s financial assets and liabilities covered under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No. 820, Fair Value Measurement and Disclosure (“ASC 820”), are carried at fair value or contracted amounts which approximate fair value. Upon the adoption of fair value guidance set forth in FASB ASC No. 825, Financial Instruments, the Partnership elected not to take the fair value option on all debt and liabilities subordinated to the claims of general creditors.

Fair value of a financial instrument is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, also known as the “exit price.” Financial assets are marked to bid prices and financial liabilities are marked to offer prices. The Partnership’s financial assets and financial liabilities recorded at fair value in the Consolidated Statements of Financial Condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by ASC 820 with the related amount of subjectivity associated with the inputs to value these assets and liabilities at fair value for each level, are as follows:

Level I – Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

The types of assets and liabilities categorized as Level I generally are government and agency securities, equities listed in active markets, unit investment trusts and investments in publicly traded mutual funds with quoted market prices.

Level II – Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with related market data at the measurement date and for the duration of the instrument’s anticipated life. The Partnership uses the market approach valuation technique (incorporates prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities) in valuing these types of investments.

The types of assets and liabilities categorized as Level II generally are certificates of deposit, municipal bonds, mortgage and asset backed securities and corporate debt.

Level III – Inputs are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

The Partnership did not have any assets or liabilities categorized as Level III during the periods ended September 28, 2012 and December 31, 2011. In addition, there were no transfers into or out of Levels I, II or III during these periods.

 

9


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

The following tables set forth the Partnership’s financial assets and liabilities measured at fair value:

 

     Financial Assets at Fair Value as of
September 28, 2012
 
     Level I      Level II      Level III      Total  

Investments segregated under federal regulations

           

U.S. treasuries

   $ 758,450       $ —         $ —         $ 758,450   

Certificates of deposit

     —           200,000         —           200,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments segregated under federal regulations

   $ 758,450       $ 200,000       $ —         $ 958,450   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities owned:

           

Inventory securities:

           

State and municipal obligations

   $ —         $ 56,154       $ —         $ 56,154   

Equities

     19,032         —           —           19,032   

Certificates of deposit

     —           8,807         —           8,807   

Corporate bonds and notes

     —           5,547         —           5,547   

Collateralized mortgage obligations

     —           966         —           966   

Government and agency obligations

     798         —           —           798   

Unit investment trusts

     54         —           —           54   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inventory securities

   $ 19,884       $ 71,474       $ —         $ 91,358   
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities:

           

Mutual funds

   $ 85,943       $ —         $ —         $ 85,943   

Government and agency obligations

     14,755         —           —           14,755   

Equities

     6,148         —           —           6,148   

State and municipal obligations

     —           4,722         —           4,722   

Corporate bonds and notes

     —           683         —           683   

Collateralized mortgage obligations

     —           173         —           173   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 106,846       $ 5,578       $ —         $ 112,424   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Financial Liabilities at Fair Value as of
September 28, 2012
 
     Level I      Level II      Level III      Total  

Securities sold, not yet purchased:

           

Corporate bonds and notes

   $ —         $ 2,382       $ —         $ 2,382   

Equities

     1,514         —           —           1,514   

State and municipal obligations

     —           673         —           673   

Certificates of deposit

     —           429         —           429   

Government and agency obligations

     163         —           —           163   

Collateralized mortgage obligations

     —           16         —           16   

Unit investment trusts

     12         —           —           12   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities sold, not yet purchased

   $ 1,689       $ 3,500       $ —         $ 5,189   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

10


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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

 

     Financial Assets at Fair Value as of
December 31, 2011
 
     Level I      Level II      Level III      Total  

Investments segregated under federal regulations

           

U.S. treasuries

   $ 708,624       $ —         $ —         $ 708,624   

Certificates of deposit

     —           250,000         —           250,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments segregated under federal regulations

   $ 708,624       $ 250,000       $ —         $ 958,624   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities owned:

           

Inventory securities:

           

State and municipal obligations

   $ —         $ 41,484       $ —         $ 41,484   

Equities

     20,285         —           —           20,285   

Certificates of deposit

     —           5,390         —           5,390   

Corporate bonds and notes

     —           6,647         —           6,647   

Collateralized mortgage obligations

     —           249         —           249   

Government and agency obligations

     398         —           —           398   

Unit investment trusts

     213         —           —           213   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inventory securities

   $ 20,896       $ 53,770       $ —         $ 74,666   
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities:

           

Mutual funds

   $ 77,266       $ —         $ —         $ 77,266   

Government and agency obligations

     14,507         —           —           14,507   

Equities

     6,932         —           —           6,932   

State and municipal obligations

     —           4,902         —           4,902   

Corporate bonds and notes

     —           653         —           653   

Collateralized mortgage obligations

     —           242         —           242   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 98,705       $ 5,797       $ —         $
104,502
  
  

 

 

    

 

 

    

 

 

    

 

 

 
     Financial Liabilities at Fair Value as of
December 31, 2011
 
     Level I      Level II      Level III      Total  

Securities sold, not yet purchased:

           

Corporate bonds and notes

   $ —         $ 3,336       $ —         $ 3,336   

Equities

     3,210         —           —           3,210   

State and municipal obligations

     —           303         —           303   

Certificates of deposit

     —           277         —           277   

Government and agency obligations

     260         —           —           260   

Collateralized mortgage obligations

     —           71         —           71   

Unit investment trusts

     129         —           —           129   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities sold, not yet purchased

   $ 3,599       $ 3,987       $ —         $ 7,586   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

11


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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

The Partnership attempts to reduce its exposure to market price fluctuations of its inventory securities through the sale of U.S. government securities and, to a limited extent, the sale of fixed income futures contracts. The amount of the securities purchased or sold will fluctuate on a daily basis due to changes in inventory securities owned, interest rates and market conditions. Futures contracts are settled daily, and any gain or loss is recognized in principal transactions revenue. The notional amount of futures contracts outstanding were $5,000 and $3,500 at September 28, 2012 and December 31, 2011, respectively. The average notional amount of futures contracts outstanding throughout the three and nine month periods ended September 28, 2012 and the year ended December 31, 2011, were approximately $4,900, $4,700 and $5,400, respectively. The underlying assets of these contracts are not reflected in the Partnership’s Consolidated Financial Statements; however, the related mark-to-market adjustments of a $4 gain and a $10 loss are included in the Consolidated Statements of Financial Condition as of September 28, 2012 and December 31, 2011, respectively. The total losses related to these assets, recorded within the Consolidated Statements of Income, were losses of $103 and $393 for the three and nine month periods ended September 28, 2012, respectively, and losses of $685 and $1,037 for the three and nine month periods ended September 30, 2011, respectively. These losses are reflected as a component of net inventory gains, which are included in principal transactions revenue on the Partnership’s Consolidated Statements of Income.

The Partnership estimates the fair value of long-term debt and the liabilities subordinated to claims of general creditors, based on the present value of future principal and interest payments associated with the debt, using current rates obtained from external lenders that are extended to organizations for debt of a similar nature as that of the Partnership (Level II input). The following table shows the estimated fair values of long-term debt and liabilities subordinated to claims of general creditors as of:

 

     September 28,
2012
     December 31,
2011
 

Long-term debt

   $ 6,310       $ 6,968   

Liabilities subordinated to claims of general creditors

     106,613         157,762   
  

 

 

    

 

 

 

Total

   $ 112,923       $ 164,730   
  

 

 

    

 

 

 

See Notes 4 and 5 for carrying values of long-term debt and liabilities subordinated to claims of general creditors, respectively.

 

12


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

NOTE 3 – LINES OF CREDIT

The following table shows the composition of the Partnership’s aggregate bank lines of credit in place as of:

 

     September 28,
2012
     December 31,
2011
 

2011 Credit Facility

   $ 395,000       $ 395,000   

Uncommitted secured credit facilities

     415,000         595,000   
  

 

 

    

 

 

 

Total lines of credit

   $ 810,000       $ 990,000   
  

 

 

    

 

 

 

In March 2011, the Partnership entered into an agreement with 10 banks for a three year $395,000 committed unsecured revolving line of credit (“2011 Credit Facility”), which has a maturity date of March 18, 2014. The 2011 Credit Facility is intended to provide short-term liquidity to the Partnership should the need arise. This credit facility has a tiered interest rate margin based on the Partnership’s leverage ratio (ratio of total debt to total capitalization). Borrowings made with a three-day-advance notice will have a rate of LIBOR plus a margin ranging from 1.50% to 2.25%. Same day borrowings, which are subject to certain borrowing notification cutoff times, will have a rate consisting of a margin ranging from 0.50% to 1.25% plus the greater of the prime rate, the federal funds effective rate plus 1.00% or the one-month LIBOR rate plus 1.00%. In accordance with the terms of the credit facility, the Partnership is required to maintain a leverage ratio of no more than 35% and minimum partnership capital, net of reserve for anticipated withdrawals, of at least $1,200,000 plus 50% of subsequent issuances of partnership capital. As of September 28, 2012, the Partnership is in compliance with all covenants related to the 2011 Credit Facility. As of the date of this filing, the Partnership has not borrowed against the 2011 Credit Facility.

The Partnership’s uncommitted lines of credit are subject to change at the discretion of the banks and, therefore, based on credit market conditions and the uncommitted nature of these credit facilities, it is possible that these lines of credit could decrease or not be available in the future. The Partnership’s uncommitted lines of credit were reduced by $180,000 during the first six months of 2012 from $595,000 to $415,000, with no changes in the current quarter.

Actual borrowing availability on the uncommitted lines of credit is based on client margin securities and partnership securities, which serve as collateral on loans. There were no amounts outstanding on the uncommitted lines of credit as of September 28, 2012 and December 31, 2011. In addition, the Partnership did not have any draws against these lines of credit during the nine month periods ended September 28, 2012 or September 30, 2011.

 

13


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

NOTE 4 – LONG-TERM DEBT

The following table shows the Partnership’s long-term debt as of:

 

     September 28,
2012
     December 31,
2011
 

Note payable, collateralized by real estate, fixed rate of 7.28%, principal and interest due in fluctuating monthly installments, with a final installment on June 1, 2017

   $ 5,759       $ 6,500   
  

 

 

    

 

 

 
   $ 5,759       $ 6,500   
  

 

 

    

 

 

 

NOTE 5 – LIABILITIES SUBORDINATED TO CLAIMS OF GENERAL CREDITORS

The following table shows the Partnership’s liabilities subordinated to claims of general creditors as of:

 

     September 28,
2012
     December 31,
2011
 

Capital notes 7.33%, due in annual installments of $50,000 commencing on June 12, 2010 with a final installment on June 12, 2014

   $ 100,000       $ 150,000   
  

 

 

    

 

 

 
   $ 100,000       $ 150,000   
  

 

 

    

 

 

 

In June 2012, the Partnership paid the annual scheduled installment on the capital notes in the amount of $50,000.

 

14


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

NOTE 6 – PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION

The following table shows the Partnership’s capital subject to mandatory redemption as of:

 

     September 28,
2012
    December 31,
2011
 

Partner capital issued:

    

Limited partnership capital

   $ 653,414      $ 662,226   

Subordinated limited partnership capital

     283,109        255,414   

General partnership capital issued

     1,021,619        927,578   
  

 

 

   

 

 

 

Total partner capital issued

     1,958,142        1,845,218   

Partnership loans outstanding:

    

General partnership loans outstanding at beginning of period

     (86,853     —     

General partnership loans issued during the period

     (95,758     (91,693

Repayment of general partnership loans during the period

     12,459        4,840   
  

 

 

   

 

 

 

Total partnership loans outstanding

     (170,152     (86,853

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals

     1,787,990        1,758,365   

Reserve for anticipated withdrawals

     99,529        147,412   
  

 

 

   

 

 

 

Partnership capital subject to mandatory redemption

   $ 1,887,519      $ 1,905,777   
  

 

 

   

 

 

 

FASB ASC No. 480, Distinguishing Liabilities from Equity (“ASC 480”), established standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. Under the provisions of ASC 480, the obligation to redeem a partner’s capital in the event of a partner’s death is one of the criteria requiring capital to be classified as a liability.

Since the Partnership Agreement obligates the Partnership to redeem a partner’s capital after a partner’s death, ASC 480 requires all of the Partnership’s equity capital be classified as a liability. Income allocable to limited, subordinated limited and general partners are classified as a reduction of income before allocations to partners, which results in a presentation of $0 net income. The financial statement presentations required to comply with ASC 480 do not alter the Partnership’s treatment of income, income allocations or capital for any other purposes.

Net income, as defined in the Partnership Agreement, is equivalent to income before allocations to partners on the Consolidated Statements of Income. Such income, if any, for each calendar year is allocated to the Partnership’s three classes of capital in accordance with the formulas prescribed in the Partnership Agreement. Income allocations are based upon partner capital contributions including capital contributions financed with loans from the Partnership, as indicated in the previous table. First, limited partners are allocated net income (as defined in the Partnership Agreement) in accordance with the prescribed formula for their share of net income. Limited partners do not share in the net loss in any year in which there is a net loss and the Partnership is not dissolved or liquidated. Thereafter, subordinated limited partners and general partners are allocated any remaining net income or net loss based on formulas as defined in the Partnership Agreement.

 

15


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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

The Partnership makes loans available to those general partners (other than members of the Executive Committee, which consists of the Managing Partner and the executive officers of the Partnership) that require financing for some or all of their partnership capital contributions. Loans made by the Partnership to general partners are generally for a period of one year but are expected to be renewed and bear interest at the prime rate, as defined in the loan documents. The Partnership recognizes interest income for the interest paid by general partners in connection with such loans. The outstanding amount of general partner loans financed through the Partnership is reflected as a reduction to total general partnership capital in the Partnership’s Consolidated Statements of Changes in Partnership Capital Subject to Mandatory Redemption. As of September 28, 2012 and December 31, 2011, the outstanding amount of general partner loans financed through the Partnership amounted to $170,152 and $86,853, respectively. Interest income from these loans, which is included in interest and dividends in the Partnership’s Consolidated Statements of Income, was $1,420 and $4,267 for the three and nine month periods ended September 28, 2012, respectively, and $722 and $2,167 for the three and nine month periods ended September 30, 2011, respectively.

The limited partnership capital subject to mandatory redemption is held by current and former employees and general partners of the Partnership. Limited partners participate in the Partnership’s profits and are paid a minimum 7.5% annual return on the face amount of their capital, in accordance with the Partnership Agreement. The minimum 7.5% annual return totaled $12,265 and $36,962 for the three and nine month periods ended September 28, 2012, respectively, and $12,497 and $37,702 for the three and nine month periods ended September 30, 2011, respectively. These amounts are included as a component of interest expense in the Partnership’s Consolidated Statements of Income.

The subordinated limited partnership capital subject to mandatory redemption is held by current and former general partners of the Partnership. Subordinated limited partners receive a percentage of the net income of the Partnership determined in accordance with the Partnership Agreement. The subordinated limited partnership capital subject to mandatory redemption is subordinated to the limited partnership capital.

The general partnership capital subject to mandatory redemption is held by current general partners of the Partnership. General partners receive a percentage of the net income of the Partnership determined in accordance with the Partnership Agreement. The general partnership capital subject to mandatory redemption is subordinated to the limited partnership capital and the subordinated limited partnership capital.

NOTE 7 – NET CAPITAL REQUIREMENTS

As a result of its activities as a broker-dealer, Edward Jones is subject to the net capital provisions of Rule 15c3-1 of the Securities Exchange Act of 1934 (“Exchange Act”) and capital compliance rules of the Financial Industry Regulatory Authority (“FINRA”) Rule 4110. Under the alternative method permitted by the rules, Edward Jones must maintain minimum net capital equal to the greater of $250 or 2% of aggregate debit items arising from client transactions. The net capital rules also provide that Edward Jones’ partnership capital may not be withdrawn if resulting net capital would be less than minimum requirements. Additionally, certain withdrawals require the approval of the U.S. Securities and Exchange Commission (“SEC”) and FINRA to the extent they exceed defined levels, even though such withdrawals would not cause net capital to be less than minimum requirements.

 

16


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

At September 28, 2012, Edward Jones’ net capital of $757,176 was 35.2% of aggregate debit items and its net capital in excess of the minimum required was $714,093. Net capital after anticipated capital withdrawals, as a percentage of aggregate debit items, was 22.4%. Net capital and the related capital percentages may fluctuate on a daily basis.

At September 28, 2012, the Partnership’s Canadian broker-dealer’s regulatory risk adjusted capital of $42,551 was $30,488 in excess of the capital required to be held by the Investment Industry Regulatory Organization of Canada (“IIROC”). In addition, EJTC was in compliance, as of September 28, 2012, with its regulatory capital requirements.

NOTE 8 – CONTINGENCIES

In the normal course of business, the Partnership has been named as a defendant in various legal actions, including arbitrations, class actions and other litigation. Certain of these legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. The Partnership is also involved from time to time in investigations and proceedings by governmental and self-regulatory organizations, certain of which may result in adverse judgments, fines or penalties. In addition, the Partnership provides for potential losses that may arise related to other contingencies.

The Partnership assesses its liabilities and contingencies utilizing available information. For those matters where it is probable the Partnership will incur a potential loss and the amount of the loss is reasonably estimable, in accordance with FASB ASC No. 450, Contingencies (“ASC 450”), an accrued liability has been established. These reserves represent the Partnership’s aggregate estimate of the potential loss contingency and are believed to be sufficient at this time. Such liability may be adjusted from time to time to reflect any relevant developments.

For such matters where an accrued liability has not been established and the Partnership believes a loss is both reasonably possible and estimable, as well as for matters where an accrued liability has been recorded but for which an exposure to loss in excess of the amount accrued is both reasonably possible and estimable, the current estimated aggregated range of possible loss is $6,000 to $42,000. This range of reasonably possible loss does not necessarily represent the Partnership’s maximum loss exposure as the Partnership was not able to estimate a range of reasonably possible loss for all matters.

Further, the matters underlying any disclosed estimated range will change from time to time, and actual results may vary significantly. While the outcome of these matters is inherently uncertain, based on information currently available, the Partnership believes that its established reserves are adequate and the liabilities arising from such proceedings will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Partnership. However, based on future developments and the potential unfavorable resolution of these matters, the outcome could be material to the Partnership’s future consolidated operating results for a particular period or periods.

 

17


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

NOTE 9 – SEGMENT INFORMATION

An operating segment is defined as a component of an entity that has all of the following characteristics: it engages in business activities from which it may earn revenues and incur expenses; its operating results are regularly reviewed by the entity’s chief operating decision-maker (or decision-making group) for resource allocation and to assess performance; and discrete financial information is available. Operating segments may be combined in certain circumstances into reportable segments for financial reporting. The Partnership has determined it has two operating and reportable segments based upon geographic location, the U.S. and Canada.

Each segment, in its own geographic location, primarily derives its revenues from the retail brokerage business through the sale of listed and unlisted securities and insurance products, investment banking, principal transactions, as a distributor of mutual fund shares and through revenues related to assets held by and account services provided to its clients.

The accounting policies of the segments are the same as those described in the Notes to the Consolidated Financial Statements of the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2011. Financial information about the Partnership’s reportable segments is presented in the following table. For the computation of its segment information, the Partnership allocates costs incurred by the U.S. entity in support of Canadian operations to the Canadian segment.

The Partnership evaluates the performance of its segments based upon income from continuing operations as well as income before variable incentive compensation. Variable incentive compensation is determined at the Partnership level for profit sharing and home office and branch employee bonus amounts, and therefore is allocated to each geographic segment independent of that segment’s individual income before variable incentive compensation. The amount of financial advisor bonuses is determined in part by the overall Partnership profitability, as well as the performance of the individual financial advisors at the segment. As such, both income before allocation to partners and income before variable incentive compensation are considered in evaluating segment performance.

The Canada segment information as reported in the following table is based upon the Consolidated Financial Statements of the Partnership’s Canadian operations without eliminating any intercompany items, such as management fees that it pays to affiliated entities. The U.S. segment information is derived from the Partnership’s Consolidated Financial Statements less the Canada segment information as presented. This is consistent with how management reviews the segments in order to assess performance.

 

18


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements, continued

 

Financial information for the Partnership’s reportable segments is presented in the following table:

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
    September 30,
2011
    September 28,
2012
    September 30,
2011
 

Net revenue:

        

United States of America

   $ 1,213,841      $ 1,102,719      $ 3,545,087      $ 3,266,744   

Canada

     40,460        47,714        130,022        142,189   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

   $ 1,254,301      $ 1,150,433      $ 3,675,109      $ 3,408,933   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pre-variable income (loss):

        

United States of America

   $ 269,986      $ 220,344      $ 776,121      $ 646,736   

Canada

     (2,506     2,419        (2,733     3,848   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total pre-variable income

     267,480        222,763        773,388        650,584   

Variable compensation:

        

United States of America

     133,886        103,887        355,906        283,685   

Canada

     2,733        3,256        9,094        9,244   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total variable compensation

     136,619        107,143        365,000        292,929   

Income (loss) before allocation to partners:

        

United States of America

     136,100        116,457        420,215        363,051   

Canada

     (5,239     (837     (11,827     (5,396
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income before allocation to partners

   $ 130,861      $ 115,620      $ 408,388      $ 357,655   
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 10 – SUBSEQUENT EVENT

On October 29, 2012, Hurricane Sandy caused extensive damage across large portions of the Mid-Atlantic and Northeastern United States causing the New York Stock Exchange to close for two days. The Partnership does not expect this to have a material impact on its consolidated financial statements.

In accordance with the Dodd-Frank Act and effective July 21, 2011, authority for the supervision and regulation of EJTC was transferred from the Office of Thrift Supervision (“OTS”) to the Office of the Comptroller of the Currency (“OCC”). As of the same date, responsibility for the supervision and regulation of EJTC’s parent, the Partnership, was transferred from the OTS to the Board of Governors of the Federal Reserve System (“FRB”). The Partnership continued to be regarded as a savings and loan holding company (“SLHC”) and remained subject to the requirements of the Home Owners’ Loan Act. However, section 604 of the Dodd-Frank Act allows entities controlling a savings association that functions solely in a trust or fiduciary capacity (as described in section 2(c)(2)(D) of the Bank Holding Company Act of 1956 (12 U.S.C. 1841(c)(2)(D))) to cease to be a SLHC. Given the Partnership meets these and other criteria, it requested on July 25, 2011 that the FRB deregister the Partnership as a SLHC. On October 31, 2012, the Partnership received confirmation that its request to deregister as a SLHC had been approved. The Partnership does not expect this to have a material impact on its consolidated financial statements.

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis is intended to help the reader understand the results of operations and the financial condition of the Partnership. Management’s Discussion and Analysis should be read in conjunction with the Partnership’s Consolidated Financial Statements and accompanying notes included in Item 1, Financial Statements of this Quarterly Report on Form 10-Q and Item 8, Financial Statements and Supplementary Data of the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2011.

Basis of Presentation

The Partnership broadly categorizes its net revenues into four categories: trade revenue (revenue from client buy or sell transactions of securities), fee revenue, net interest and dividends (net of interest expense) and other revenue. In the Partnership’s Consolidated Statements of Income, trade revenue is composed of commissions, principal transactions and investment banking. Fee revenue is composed of asset-based fees and account and activity fees. These sources of revenue are affected by a number of factors. Trade revenue is impacted by the number of financial advisors, trading volume (client dollars invested), mix of the products in which clients invest, margins earned on the transactions and market volatility. Asset-based fees are generally a percentage of the total value of specific assets in client accounts. These fees are impacted by client dollars invested in and divested from the accounts which generate asset-based fees and change in market values of the assets. Account and activity fees and other revenue are impacted by the number of client accounts and the variety of services provided to those accounts, among other factors. Net interest and dividend revenue is impacted by the amount of cash and investments, receivables from clients and payables to clients, the variability of interest rates earned and paid on such balances, the number of limited partner interests, and the balances of general partner loans, long-term debt and liabilities subordinated to claims of general creditors.

 

20


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

OVERVIEW

The following table sets forth the change in major categories of the Consolidated Statements of Income as well as several key related metrics for the three and nine month periods ended September 28, 2012 and September 30, 2011. Management of the Partnership relies on this financial information and the related metrics to evaluate the Partnership’s operating performance and financial condition. All amounts are presented in millions, except the number of financial advisors and as otherwise noted.

 

    Three Months Ended     Nine Months Ended  
    September 28,
2012
    September 30,
2011
    % Change     September 28,
2012
    September 30,
2011
    % Change  

Revenue:

           

Trade revenue:

           

Commissions

  $ 501.7      $ 441.2        14   $ 1,462.3      $ 1,301.1        12

Principal transactions

    38.3        71.9        -47     125.4        219.6        -43

Investment banking

    27.0        37.9        -29     86.1        120.7        -29
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trade revenue

    567.0        551.0        3     1,673.8        1,641.4        2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of net revenue

    45     48       46     48  

Fee revenue:

           

Asset-based

    519.3        451.7        15     1,496.3        1,325.2        13

Account and activity

    141.5        136.1        4     425.5        391.1        9
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fee revenue

    660.8        587.8        12     1,921.8        1,716.3        12
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of net revenue

    53     51       52     50  

Net interest and dividends

    18.3        18.2        1     52.1        46.1        13

Other revenue (loss)

    8.2        (6.6     224     27.4        5.1        437
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net revenue

    1,254.3        1,150.4        9     3,675.1        3,408.9        8

Operating expenses

    1,123.4        1,034.8        9     3,266.7        3,051.2        7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before allocations to partners

  $ 130.9      $ 115.6        13   $ 408.4      $ 357.7        14
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Related metrics:

           

Client dollars invested(1):

           

Trade ($ billions)

  $ 24.6      $ 23.0        7   $ 72.0      $ 67.7        6

Advisory programs ($ billions)

  $ 2.9      $ 3.9        -26   $ 8.8      $ 15.3        -42

Client households at period end (millions)

    4.50        4.48        0     4.50        4.48        0

U.S. net new assets for the period end ($ billions)

  $ 7.0      $ 5.9        19   $ 21.5      $ 20.2        6

Client assets under care:

           

Total:

           

At period end ($ billions)

  $ 659.5      $ 557.3        18   $ 659.5      $ 557.3        18

Average ($ billions)

  $ 648.8      $ 575.4        13   $ 633.3      $ 588.3        8

Advisory programs:

           

At period end ($ billions)

  $ 83.3      $ 63.0        32   $ 83.3      $ 63.0        32

Average ($ billions)

  $ 80.3      $ 65.5        23   $ 76.7      $ 62.4        23

Financial advisors:

           

At period end

    12,301        12,314        0     12,301        12,314        0

Average

    12,258        12,317        0     12,225        12,383        -1

Attrition %

    10.6     13.2     n/a        11.0     14.2     n/a   

Dow Jones Industrial Average:

           

At period end

    13,437        10,913        23     13,437        10,913        23

Average for period

    13,114        11,682        12     12,907        12,011        7

S&P 500 Index:

           

At period end

    1,441        1,131        27     1,441        1,131        27

Average for period

    1,401        1,230        14     1,367        1,282        7

 

(1)

Client dollars invested, related to trade revenue, includes the principal amount of clients’ buy and sell transactions generating a commission. Client dollars invested related to advisory programs revenue represents the net inflows of client dollars into the programs.

 

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PART I. FINANCIAL INFORMATION

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Quarter to Date 2012 versus 2011

The Partnership experienced improved financial results during the third quarter of 2012 as compared to 2011, which was attributable to market appreciation of asset values as well as continued investment of client dollars into its advisory programs and the resulting increase in fee revenue. In addition, the Partnership benefited from improved market conditions, reflected in the 14% increase in the daily average S&P 500 Index and the 12% increase in the daily average Dow Jones Industrial Average.

The Partnership’s key performance measures were relatively strong during the third quarter of 2012. Average client assets under care grew 13% to $648.8 billion, which included a 23% increase in the average advisory program’s assets under care to $80.3 billion. In addition, client dollars invested relating to trade revenue were up 7% and U.S. net new assets increased 19%.

For the third quarter of 2012, net revenue increased 9% to $1.3 billion over the third quarter of 2011. This increase was driven by a 12% increase in fee revenue, primarily due to higher levels of asset values on which fees were earned, driven by the continued investment of client dollars into advisory programs and the overall rise in the equity market daily averages. These factors also contributed to a changing composition of net revenue, which was 45% trade and 53% fee revenue in the third quarter of 2012, compared to 48% trade and 51% fee revenue in the third quarter of 2011.

Operating expenses increased 9% primarily due to an increase in compensation and benefits driven by increased financial advisor productivity as well as higher variable incentive compensation due to the increase in the Partnership’s profitability. This increase is partially offset by the impact of lower expenses due to the fact that the third quarter of 2012 had 13 weeks versus 14 weeks in the third quarter of 2011.

The net impact of the increase in net revenues and operating expenses resulted in a 13% increase in income before allocations to Partners.

Year to Date 2012 versus 2011

The Partnership also experienced improved financial results during the first nine months of 2012 as compared to 2011, which was attributable to market appreciation of asset values as well as continued investment of client dollars into its advisory programs and the resulting increase in fee revenue. In addition, the Partnership benefited from improved market conditions, reflected in the 7% increase in both the daily average S&P 500 Index and the daily average Dow Jones Industrial Average.

The Partnership’s key performance measures continued to be strong during the first nine months of 2012. Average client assets under care grew 8% to $633.3 billion, which included a 23% increase in the average advisory program’s assets under care to $76.7 billion. U.S. net new assets increased 6% and client dollars invested relating to trade revenue were up 6%.

For the nine month period ended September 28, 2012, net revenue increased 8% to $3.7 billion over the nine month period ended September 30, 2011. This increase was driven by a 12% increase in fee revenue, primarily due to higher levels of asset values on which fees were earned, driven by the overall rise in the equity market daily averages and the continued investment of client dollars into advisory programs. These factors also contributed to a changing composition of net revenue, which was 46% trade and 52% fee revenue in the first nine months of 2012, compared to 48% trade and 50% fee revenue in the first nine months of 2011.

 

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PART I. FINANCIAL INFORMATION

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Operating expenses increased 7% primarily due to an increase in compensation and benefits driven by increased financial advisor productivity as well as higher variable incentive compensation due to the increase in the Partnership’s profitability.

The impact of the increase in net revenues and operating expenses resulted in a 14% increase in income before allocations to Partners.

RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 28, 2012 AND SEPTEMBER 30, 2011

The discussion below details the significant fluctuations and the drivers for each of the major categories of the Partnership’s Consolidated Statements of Income.

Trade Revenue

Trade revenue, which consists of commissions, principal transactions and investment banking revenue, increased 3% to $567.0 million and 2% to $1.7 billion in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively. The increase in trade revenue for the third quarter and first nine months of 2012 was primarily due to the impact of increased client dollars invested, partially offset by a decrease in the margin earned on client dollars invested. In addition, trade revenue increased in spite of the fact that there were five fewer U.S. business days in the third quarter of 2012 compared to the third quarter of 2011 and one less U.S. business day in the first nine months of 2012 compared to the first nine months of 2011. A discussion specific to each component of trade revenue follows.

Commissions

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
     September 30,
2011
     % Change     September 28,
2012
     September 30,
2011
     % Change  

Commissions revenue ($ millions):

                

Mutual funds

   $ 264.3       $ 210.4         26   $ 768.0       $ 672.0         14

Equities

     139.5         124.1         12     401.2         342.4         17

Insurance

     97.9         106.7         -8     293.1         286.7         2
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total commissions revenue

   $ 501.7       $ 441.2         14   $ 1,462.3       $ 1,301.1         12
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Related metrics:

                

Client dollars invested ($ billions)

   $ 20.2       $ 17.2         17   $ 58.1       $ 50.1         16

Margin per $1,000 invested

   $ 24.90       $ 25.70         -3   $ 25.20       $ 26.00         -3

U.S. business days

     63         68         -7     188         189         -1

For the three months ended September 28, 2012, commissions revenue increased 14% to $501.7 million compared to the three months ended September 30, 2011. The increase was primarily due to a 17% increase in client dollars invested in commission generating transactions resulting from improved market conditions and the fact that clients are generally reinvesting their dollars from maturing fixed income products into mutual fund and equity products. This increase was partially offset by a 3% decrease in the margin per $1,000 invested caused by a shift from investments in higher-margin equity mutual funds to lower-margin debt mutual funds.

 

23


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

For the nine months ended September 28, 2012, commissions revenue increased 12% to $1.5 billion compared to the nine months ended September 30, 2011. The increase was primarily due to a 16% increase in client dollars invested in commission generating transactions resulting from improved market conditions and the fact that clients are generally reinvesting their dollars from maturing fixed income products into mutual fund and equity products. This increase was partially offset by a 3% decrease in the margin per $1,000 invested caused by a shift from investments in higher-margin equity mutual funds to lower-margin debt mutual funds.

Principal Transactions

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
     September 30,
2011
     % Change     September 28,
2012
     September 30,
2011
     % Change  

Principal transactions revenue ($ millions):

                

State and municipal obligations

   $ 29.0       $ 51.1         -43   $ 92.9       $ 162.9         -43

Corporate bonds and notes

     3.4         11.0         -69     13.2         28.8         -54

Certificates of deposit

     3.5         3.4         3     10.3         9.7         6

Unit investment trusts

     0.4         3.5         -89     3.7         8.5         -56

Government and agency obligations

     0.6         1.3         -54     2.5         4.9         -49

Net inventory gains

     1.1         0.7         57     1.6         1.9         -16

Collateralized mortgage obligations

     0.3         0.9         -67     1.2         2.9         -59
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total principal transactions revenue

   $ 38.3       $ 71.9         -47   $ 125.4       $ 219.6         -43
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Related metrics:

                

Client dollars invested ($ billions)

   $ 3.4       $ 4.6         -26   $ 10.6       $ 13.6         -22

Margin per $1,000 invested

   $ 11.00       $ 15.50         -29   $ 11.70       $ 16.00         -27

U.S. business days

     63         68         -7     188         189         -1

For the three months ended September 28, 2012, principal transactions revenue decreased 47% to $38.3 million compared to the three months ended September 30, 2011. This decrease was primarily caused by the continued low interest rate environment and improved equity market conditions, which led clients to reinvest their dollars from maturing fixed income products into mutual fund and equity products. This resulted in a 26% decrease in client dollars invested in products that resulted in principal transactions revenue. In addition, margins per $1,000 invested decreased 29% as client investments shifted in the current period towards products with shorter maturities, which have lower margins.

For the nine months ended September 28, 2012, principal transactions revenue decreased 43% to $125.4 million compared to the nine months ended September 30, 2011. This decrease was primarily caused by the continued low interest rate environment and improved equity market conditions, which led clients to reinvest their dollars from maturing fixed income products into mutual fund and equity products. This resulted in a 22% decrease in client dollars invested in products that resulted in principal transactions revenue. In addition, margins per $1,000 invested decreased 27% as client investments shifted in the current period towards products with shorter maturities, which have lower margins.

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Investment Banking

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
     September 30,
2011
     % Change     September 28,
2012
     September 30,
2011
     % Change  

Investment banking revenue ($ millions):

                

Distribution

   $ 21.7       $ 31.1         -30   $ 68.0       $ 100.3         -32

Underwriting

     5.3         6.8         -22     18.1         20.4         -11
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total investment banking revenue

   $ 27.0       $ 37.9         -29   $ 86.1       $ 120.7         -29
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Related metrics:

                

Client dollars invested ($ billions)

   $ 1.1       $ 1.3         -15   $ 3.3       $ 4.0         -18

Margin per $1,000 invested

   $ 25.40       $ 29.90         -15   $ 26.10       $ 30.40         -14

U.S. business days

     63         68         -7     188         189         -1

For the three months ended September 28, 2012, investment banking revenue decreased 29% to $27.0 million compared to the three months ended September 30, 2011. Due to the continued low interest rate environment, the demand for the types of investment banking products the Partnership engages in decreased by 15%. The decrease in investment banking revenue was further caused by a 15% decrease in the margin earned per $1,000 invested, resulting from a shift in client investments away from higher margin municipal and corporate unit investment trusts towards lower margin equity unit investment trusts.

For the nine months ended September 28, 2012, investment banking revenue decreased 29% to $86.1 million compared to the nine months ended September 30, 2011. Due to the continued low interest rate environment and lower supply of state and municipal obligations, the demand for the types of investment banking products the Partnership engages in decreased by 18%. The decrease in investment banking revenue was further caused by a 14% decrease in the margin earned per $1,000 invested, resulting from a shift in client investments away from higher margin municipal and corporate unit investment trusts towards lower margin equity unit investment trusts.

 

25


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Fee Revenue

Fee revenue increased 12% to $660.8 million and 12% to $1.9 billion in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively. A discussion specific to each component of fee revenue follows.

Asset-based

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
     September 30,
2011
     % Change     September 28,
2012
     September 30,
2011
     % Change  

Asset-based fee revenue ($ millions):

                

Advisory program fees

   $ 270.1       $ 220.3         23   $ 768.2       $ 623.7         23

Service fees

     205.1         190.5         8     595.8         578.9         3

Revenue sharing

     33.5         33.5         0     102.3         97.7         5

Trust fees

     7.3         5.9         24     20.7         17.7         17

Cash solutions

     3.3         1.5         120     9.3         7.2         29
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total asset-based fee revenue

   $ 519.3       $ 451.7         15   $ 1,496.3       $ 1,325.2         13
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Related metrics ($ billions):

                

Average U.S. client asset values(1):

                

Mutual fund assets held outside of advisory programs

   $ 335.7       $ 301.5         11   $ 325.2       $ 309.1         5

Advisory programs

     80.1         65.3         23     76.5         62.2         23

Insurance

     54.9         49.7         10     53.9         50.6         7

Cash solutions

     18.3         17.8         3     18.1         17.9         1
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total client asset values

   $ 489.0       $ 434.3         13   $ 473.7       $ 439.8         8
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

(1)

Assets on which the partnership earns asset-based fee revenue. U.S. asset-based fee revenue represents 97% of consolidated asset-based fee revenue for the three month and nine month periods ended September 28, 2012 and September 30, 2011.

For the three months ended September 28, 2012, asset-based fee revenue increased 15% to $519.3 million compared to the three months ended September 30, 2011. This increase is primarily due to a 23% increase in advisory program fees. Advisory program fees increased primarily due to market appreciation of asset values as well as continued investment of client dollars into the advisory programs. A majority of client assets held in the advisory programs were converted from other client investments previously held with the Partnership.

For the nine months ended September 28, 2012, asset-based fee revenue increased 13% to $1.5 billion compared to the nine months ended September 30, 2011. This increase is primarily due to a 23% increase in advisory program fees. Advisory program fees increased primarily due to market appreciation of asset values as well as continued investment of client dollars into the advisory programs. A majority of client assets held in the advisory programs were converted from other client investments previously held with the Partnership.

 

26


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Account and Activity

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
     September 30,
2011
     % Change     September 28,
2012
     September 30,
2011
     % Change  

Account and activity fee revenue ($ millions):

                

Sub-transfer agent services

   $ 80.5       $ 74.3         8   $ 240.9       $ 215.5         12

Retirement account fees

     34.4         35.6         -3     101.9         102.8         -1

Other account and activity fees

     26.6         26.2         2     82.7         72.8         14
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total account and activity fee revenue

   $ 141.5       $ 136.1         4   $ 425.5       $ 391.1         9
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Related metrics (millions):

                

Average client accounts:

                

Sub-transfer agent services(1)

     18.5         17.4         6     18.3         16.8         9

Retirement accounts

     3.7         3.5         6     3.7         3.5         6

 

(1)

Amount represents average number of individual mutual fund holdings serviced, on which the Partnership recognizes sub-transfer agent services revenue.

For the three months ended September 28, 2012, account and activity fee revenue increased 4% to $141.5 million compared to the three months ended September 30, 2011, primarily due to an increase in revenue from sub-transfer agent services, partially offset by a decrease in revenue from retirement account fees. Sub-transfer agent services increased primarily due to increases in the number of average client holdings serviced. Retirement account fees decreased due to more client accounts reaching the asset level at which fees are waived.

For the nine months ended September 28, 2012, account and activity fee revenue increased 9% to $425.5 million compared to the nine months ended September 30, 2011, primarily due to increases in revenue from sub-transfer agent services and other account and activity fees, partially offset by a decrease in revenue from retirement account fees. Sub-transfer agent services increased primarily due to increases in the number of average client holdings serviced. Other account and activity fees increased primarily due to increases in various other types of fees including mortgage revenue, credit card revenue and other transaction fees. Retirement account fees decreased due to more client accounts reaching the asset level at which fees are waived. The Partnership will further reduce the asset level on which retirement account fees are charged effective January 1, 2013, which will further reduce retirement account fees. This change is not expected to have a material impact on the Partnership’s financial results.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Net Interest and Dividends

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
    September 30,
2011
    % Change     September 28,
2012
    September 30,
2011
    % Change  

Net interest and dividends revenue ($ millions):

            

Client loan interest

   $ 28.2      $ 31.0        -9   $ 84.5      $ 86.0        -2

Short-term investing interest

     2.9        1.5        93     7.8        5.8        34

Other interest and dividends

     2.3        2.0        15     6.8        5.8        17

Interest expense

     (15.1     (16.3     -7     (47.0     (51.5     -9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest and dividends revenue

   $ 18.3      $ 18.2        1   $ 52.1      $ 46.1        13
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Related metrics ($ millions):

            

Average aggregate client loan balance

   $ 2,205.3      $ 2,224.4        -1   $ 2,198.4      $ 2,207.5        0

Average rate earned

     5.13     5.19     -1     5.16     5.21     -1

Average funds invested

   $ 6,697.3      $ 4,653.4        44   $ 6,179.6      $ 4,803.2        29

Average rate earned

     0.18     0.12     50     0.17     0.16     6

Weighted average $1,000 equivalent limited partnership units outstanding

     657,102        666,786        -1     654,093        670,357        -2

For the three months ended September 28, 2012, net interest and dividends revenue increased 1% to $18.3 million compared to the three months ended September 30, 2011, primarily due to a decrease in interest expense and an increase in short-term investing interest. These increases are partially offset by a decrease in client loan interest. Interest expense decreased primarily due to lower average debt balances during the current period related to debt repayments in 2011 and 2012. Interest income from client loans decreased primarily due to one less week in the third quarter of 2012 on which to earn interest as well as a slight decrease in average aggregate client loans and the average rate earned.

Interest income from cash and cash equivalents, cash and investments segregated under federal regulations and securities purchased under agreements to resell increased 93% compared to the three months ended September 30, 2011 primarily due to an increase in the average funds invested on these types of investments. The related average funds invested increased 44% and included $5.6 billion of funds that were segregated in special reserve bank accounts for the benefit of U.S. clients under SEC Rule 15c3-3, compared to $4.0 billion in 2011. The average rate earned on total funds invested increased 50% to 0.18% and the average rate earned on the segregated funds invested increased 45% to 0.16%. See the Liquidity and Capital Resources discussion below for additional information.

For the nine months ended September 28, 2012, net interest and dividends revenue increased 13% to $52.1 million compared to the nine months ended September 30, 2011, primarily due to a decrease in interest expense and increases in short-term investing interest and other interest and dividends. Interest expense decreased in the first nine months of 2012 primarily due to decreased average debt balances in the current period related to debt repayments in 2011 and 2012. Other interest and dividends revenue increased 17% primarily due to an increase in interest income recognized for interest in connection with general partner partnership loans. See further discussion of these loans in Note 6 to the Consolidated Financial Statements.

Interest income from cash and cash equivalents, cash and investments segregated under federal regulations and securities purchased under agreements to resell increased 34% compared to the nine months ended September 30, 2011 primarily due to an increase in the average funds invested on these types of investments. The related average funds invested increased 29% and included $5.2 billion of

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

funds that were segregated in special reserve bank accounts for the benefit of U.S. clients under SEC Rule 15c3-3, compared to $3.8 billion for the same period in 2011. The average rate earned on total funds invested increased 6% to 0.17% and the average rate earned on the segregated funds invested increased 7% to 0.16% in the nine month period ended September 28, 2012. See the Liquidity and Capital Resources discussion below for additional information.

Other Revenue

Other revenue increased $14.8 million and $22.3 million in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively. These increases are primarily attributable to increases in the value of the investments held related to the Partnership’s non-qualified deferred compensation plan. As the market value of these investments fluctuates, the gains or losses are reflected in other revenue with an offset in compensation and fringe benefits expense, which results in no net impact to the Partnership’s income before allocations to partners.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Operating Expenses

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
     September 30,
2011
     % Change     September 28,
2012
     September 30,
2011
     % Change  

Operating expenses ($ millions):

                

Compensation and benefits

   $ 845.6       $ 764.6         11   $ 2,423.4       $ 2,225.3         9

Occupancy and equipment

     89.0         90.2         -1     266.2         268.2         -1

Communications and data processing

     66.8         70.4         -5     208.8         217.2         -4

Payroll and other taxes

     43.8         42.6         3     142.8         133.9         7

Advertising

     14.1         10.0         41     39.6         39.7         0

Postage and shipping

     12.2         13.4         -9     36.5         36.7         -1

Clearance fees

     3.1         2.9         7     9.6         9.5         1

Other operating expenses

     48.8         40.7         20     139.8         120.7         16
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total operating expenses

   $ 1,123.4       $ 1,034.8         9   $ 3,266.7       $ 3,051.2         7
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Related metrics:

                

Number of branches

                

At period end

     11,396         11,416         0     11,396         11,416         0

Average

     11,378         11,399         0     11,390         11,386         0

Financial advisors:

                

At period end

     12,301         12,314         0     12,301         12,314         0

Average

     12,258         12,317         0     12,225         12,383         -1

Branch employees(1):

                

At period end

     13,351         13,314         0     13,351         13,314         0

Average

     13,488         13,354         1     13,364         13,119         2

Home office employees(1):

                

At period end

     5,046         4,916         3     5,046         4,916         3

Average

     5,046         4,941         2     4,992         4,917         2

Home office employees(1) per 100 financial advisors (average)

     41.2         40.1         3     40.8         39.7         3

Branch employees(1) per 100 financial advisors (average)

     110.0         108.4         2     109.3         105.9         3

Average operating expenses per financial advisor(2)

   $ 44,503       $ 42,877         4   $ 131,956       $ 125,405         5

 

(1)

Counted on a full-time equivalent (“FTEs”) basis.

(2)

Operating expenses used in calculation represents total operating expenses less financial advisor and variable compensation.

For the three months ended September 28, 2012, operating expenses increased 9% to $1.1 billion compared to the three months ended September 30, 2011 primarily due to an 11% increase in compensation and benefits resulting from increases in financial advisor compensation, salary and fringe benefit expense and variable incentive compensation described below. The remaining operating expenses increased 3% ($7.6 million) due to a 41% increase in advertising expenses, a 3% increase in payroll and other taxes caused by increases in compensation and a 20% increase in other operating expenses due to increases in various general expenses. These increases were partially offset by the impact of lower expenses due to the fact that the third quarter of 2012 has one less week of expense compared to the third quarter of 2011.

Financial advisor compensation (excluding financial advisor salary and subsidy and variable incentive compensation) increased 10% ($41.7 million) compared to the three months ended September 30, 2011 primarily due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Financial advisor salary and subsidy increased 34% ($9.4 million) primarily due to new financial advisor compensation initiatives implemented in July 2012, in addition to more financial advisors participating in the programs.

 

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Salary and fringe benefit expense increased 1% ($1.2 million) compared to the three months ended September 30, 2011 primarily due to salary increases, increases in fringe benefits expense caused by increased healthcare costs and increases in personnel to support increased productivity of the Partnership’s financial advisor network. On a full-time equivalent basis, the average number of the Partnership’s home office and branch employees increased 2% and 1% for the three months ended September 28, 2012 and September 30, 2011, respectively.

Variable incentive compensation expands and contracts in relation to revenues, income before allocations to partners and the Partnership’s related profit margin. As the Partnership’s financial results and profit margin improve, a significant portion is allocated to variable incentive compensation and paid to employees in the form of increased profit sharing and bonuses. As a result, variable incentive compensation increased 28% ($29.5 million) in the three months ended September 28, 2012 as compared to the three months ended September 30, 2011.

The Partnership uses the ratios of both the number of home office and the number of branch employees per 100 financial advisors and the average operating expenses per financial advisor as key metrics in managing its costs. For the three months ended September 28, 2012, the average number of home office employees per 100 financial advisors increased 3% compared to the three months ended September 30, 2011. The increase was primarily the impact of the decrease in the average number of financial advisors, as well as the increase in the number of home office employees. This result is despite the Partnership’s longer term cost management strategy to grow its financial advisor network at a faster pace than its home office support staff. Lack of growth in the number of financial advisors during the rest of 2012 could result in growing home office compensation costs at a faster rate than financial advisors, which would cause the average operating expense per financial advisor to increase. The average number of branch employees per 100 financial advisors increased 2% primarily due to the impact of the decrease in the average number of financial advisors, as well as the 1% increase in the number of branch employees. This is the result of increased branch employee hours in support of increased financial advisor productivity. The average operating expense per financial advisor increased 4% primarily due to increases in home office employees’ salary and fringe benefit expenses and branch operating expenses to support the Partnership’s financial advisor network, in addition to a decrease in the number of financial advisors.

For the nine months ended September 28, 2012, operating expenses increased 7% to $3.3 billion compared to the nine months ended September 30, 2011 primarily due to a 9% increase in compensation and benefits resulting from increases in financial advisor compensation, salary and fringe benefit expense and variable incentive compensation described below. The remaining operating expenses increased 2% ($17.4 million), primarily the result of a 7% increase in payroll and other taxes related to the increases in compensation described below and a 16% increase in other operating expenses due to increases in various general expenses.

Financial advisor compensation (excluding financial advisor salary and subsidy and variable incentive compensation) increased 7% ($83.1 million) compared to the nine months ended September 30, 2011 primarily due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Financial advisor salary and subsidy increased 10% ($8.0 million) primarily due to new financial advisor compensation initiatives implemented in July 2012, in addition to more financial advisors participating in the programs.

 

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Salary and fringe benefit expense increased 6% ($36.3 million) compared to the nine months ended September 30, 2011 primarily due to salary increases, increases in fringe benefits expense caused by increased healthcare costs and increases in personnel to support increased productivity of the Partnership’s financial advisor network. On a full-time equivalent basis, the average number of both the Partnership’s home office and branch employees increased 2%.

Variable incentive compensation increased 25% ($72.1 million) in the nine months ended September 28, 2012 as compared to the nine months ended September 30, 2011 due to the Partnership’s improved financial results.

The average number of home office employees per 100 financial advisors increased 3% compared to the nine months ended September 30, 2011. The increase was primarily the impact of the 1% decrease in the average number of financial advisors, as well as the 2% increase in the number of home office employees. The average number of branch employees per 100 financial advisors increased 3%, primarily the impact of the 1% decrease in the average number of financial advisors, as well as the 2% increase in the number of branch employees. The average operating expense per financial advisor increased 5% primarily due to increases in home office employees’ salary and fringe benefit expenses and branch operating expenses to support the Partnership’s financial advisor network, in addition to a decrease in the number of financial advisors.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Segment Information

An operating segment is defined as a component of an entity that has all of the following characteristics: it engages in business activities from which it may earn revenues and incur expenses; the entity’s chief operating decision-maker (or decision-making group) regularly reviews its operating results for resource allocation and to assess performance; and discrete financial information is available. Operating segments may be combined in certain circumstances into reportable segments for financial reporting. The Partnership has determined it has two operating and reportable segments based upon geographic location, the U.S. and Canada.

Each segment, in its own geographic location, primarily derives its revenues from the retail brokerage business through the sale of listed and unlisted securities and insurance products, investment banking, principal transactions, as a distributor of mutual fund shares and through revenues related to assets held by and account services provided to its clients.

The Partnership evaluates the performance of its segments based upon income from continuing operations as well as income before variable incentive compensation. Variable incentive compensation is determined at the Partnership level for profit sharing and home office and branch employee bonus amounts, and therefore is allocated to each geographic segment independent of that segment’s individual income before variable incentive compensation. The amount of financial advisor bonuses is determined in part by the overall Partnership’s profitability as well as the performance of the individual financial advisors at the segment. As such, both income before allocation to partners and income before variable incentive compensation are considered in evaluating segment performance.

The Canada segment information as reported in the following table is based upon the Consolidated Financial Statements of the Partnership’s Canadian operations without eliminating any intercompany items, such as management fees that it pays to affiliated entities. The U.S. segment information is derived from the Partnership’s Consolidated Financial Statements less the Canada segment information as presented. This is consistent with how management reviews the segments in order to assess performance.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Financial information about the Partnership’s reportable segments is presented in the following table. All amounts are presented in millions, except the number of financial advisors and as otherwise noted.

 

     Three Months Ended     Nine Months Ended  
     September 28,
2012
    September 30,
2011
    % Change     September 28,
2012
    September 30,
2011
    % Change  

Net revenue:

            

United States of America

   $ 1,213.8      $ 1,102.7        10   $ 3,545.1      $ 3,266.7        9

Canada

     40.5        47.7        -15     130.0        142.2        -9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

     1,254.3        1,150.4        9     3,675.1        3,408.9        8

Operating expenses (excluding variable compensation):

            

United States of America

     943.8        882.4        7     2,769.0        2,620.0        6

Canada

     43.0        45.3        -5     132.7        138.3        -4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     986.8        927.7        6     2,901.7        2,758.3        5

Pre-variable income (loss):

            

United States of America

     270.0        220.3        23     776.1        646.7        20

Canada

     (2.5     2.4        -204     (2.7     3.9        -169
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total pre-variable income

     267.5        222.7        20     773.4        650.6        19

Variable compensation:

            

United States of America

     133.9        103.8        29     355.9        283.6        25

Canada

     2.7        3.3        -18     9.1        9.3        -2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total variable compensation

     136.6        107.1        28     365.0        292.9        25

Income (loss) before allocation to partners:

            

United States of America

     136.1        116.5        17     420.2        363.1        16

Canada

     (5.2     (0.9     478     (11.8     (5.4     119
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total income before allocation to partners

   $ 130.9      $ 115.6        13   $ 408.4      $ 357.7        14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Client assets under care ($ billions):

            

United States of America

            

At period end

   $ 643.0      $ 543.4        18   $ 643.0      $ 543.4        18

Average

   $ 632.8      $ 560.3        13   $ 617.5      $ 572.4        8

Canada

            

At period end

   $ 16.4      $ 14.0        17   $ 16.4      $ 14.0        17

Average

   $ 16.1      $ 15.2        6   $ 15.8      $ 15.9        -1

Financial advisors:

            

United States of America

            

At period end

     11,678        11,700        0     11,678        11,700        0

Average

     11,631        11,703        -1     11,608        11,765        -1

Canada

            

At period end

     623        614        1     623        614        1

Average

     627        614        2     617        619        0

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

United States of America

For the three months ended September 28, 2012, net revenue increased 10% compared to the three months ended September 30, 2011, primarily due to increases in asset-based fee revenue, trade revenue and other revenue. Asset-based fee revenue increased 16% ($67.8 million) primarily due to increases in advisory program fee revenue of 23% ($46.0 million) which is the result of continued growth of the client assets under care in advisory programs. The increase to trade revenue of 4% ($19.8 million) is primarily due to the impact of increased client dollars invested, partially offset by fewer U.S. business days in the third quarter of 2012 compared to the third quarter of 2011 and by a decrease in the margin earned on client dollars invested. The increase in other revenue of 212% ($17.4 million) is primarily attributable to increases in the value of the investments held related to the Partnership’s non-qualified deferred compensation plan. In addition, the Partnership benefitted from improved market conditions.

Operating expenses (excluding variable incentive compensation) increased 7% compared to the three months ended September 30, 2011 primarily due to increases in financial advisor compensation and salary and fringe benefits. The increases in financial advisor compensation were due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Salary and fringe benefits expense increased due to salary increases and increased personnel to support increased productivity of the Partnership’s financial advisor network. The increase to salary and fringe benefits expense was partially offset by the impact of lower expenses due to the fact that the third quarter of 2012 had one less week of expense compared to the third quarter of 2011.

For the nine months ended September 28, 2012, net revenue increased 9% compared to the nine months ended September 30, 2011 primarily due to increases in asset-based fee revenue, trade revenue and account and activity fees. Asset-based fee revenue increased 13% ($171.6 million) primarily due to increases in advisory program fee revenue of 23% ($133.3 million) which is the result of continued growth of the client assets under care in advisory programs. The increase to trade revenue of 3% ($44.5 million) is primarily due to the impact of increased client dollars invested, partially offset by a decrease in the margin earned on client dollars invested. The increase in account and activity fees of 9% ($35.0 million) is primarily the result of increases in revenue from sub-transfer agent services primarily caused by increases in the number of average client holdings serviced.

Operating expenses (excluding variable incentive compensation) increased 6% compared to the nine months ended September 30, 2011 primarily due to increases in financial advisor compensation and salary and fringe benefits. The increases in financial advisor compensation were due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Salary and fringe benefits expense increased due to salary increases and increased personnel to support increased productivity of the Partnership’s financial advisor network.

Canada

For the three months ended September 28, 2012, net revenue decreased 15% compared to the three months ended September 30, 2011 primarily due to decreases in trade revenue and other revenue. Trade revenue decreased 14% ($3.8 million) primarily due to a decrease in client dollars invested. This decrease is consistent with the lower levels of client activity and unfavorable market conditions, reflected in the 10% decrease in the daily average of the Toronto Stock Exchange. The decrease in other revenue of 169% ($3.0 million) was primarily caused by a decrease in foreign currency gains on U.S. dollar denominated net assets due to the weakening of the U.S. dollar exchange rate during the third quarter of 2012.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

For the nine months ended September 28, 2012, net revenue decreased 9% compared to the nine months ended September 30, 2011 primarily due to a decrease in trade revenue. Trade revenue decreased 14% ($12.0 million) primarily due to reduced client activity, reflective of the 11% decrease in the daily average of the Toronto Stock Exchange.

Operating expenses (excluding variable incentive compensation) decreased 5% and 4% in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively, primarily due to decreases in financial advisor compensation caused by a decrease in trade revenue on which financial advisor commissions are paid.

Despite the decrease in pre-variable income of 204% and 169% in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively, the Canadian business segment continues to focus on strategies to achieve profitability in Canada. This includes several strategic initiatives to increase revenue and reduce expenses. Revenue initiatives include the plan to grow the number of financial advisors, client assets under care and the depth of financial solutions provided to clients and the roll out of additional advisory programs as well as other new products or enhancements. Expense reduction efforts put into place over the past few years included a change to new financial advisor compensation, conversion of certain communication systems to lower-cost options and review and renegotiation of several vendor contracts.

The Partnership has experienced a slight increase in the number of financial advisors, however, if this trend does not continue, a decrease in the number of financial advisors could impact the Partnership’s ability to grow revenue in the future, and thus could impact the ability of the Partnership to reach profitability for the Canadian business segment.

LEGISLATIVE AND REGULATORY REFORM

Money Market Mutual Funds. U.S. regulators, including the SEC, continue to explore reforms to the regulation of money market funds. For the nine months ended September 28, 2012, the Partnership had average client asset values in money market funds of $17.4 billion. Rules related to any potential reform have not been proposed, but any such rules may impact the structure of the Partnership’s money market funds. The Partnership will monitor and respond to any proposed rules if they are issued. Accordingly, the Partnership is not yet able to determine the full potential financial impact, if any, on its operating results in future years.

U.S. Fiscal Policy. Financial markets have recently been affected by concerns over U.S. fiscal policy, including uncertainty regarding the “fiscal cliff” composed of tax increases and automatic spending cuts that will become effective at the end of 2012 unless steps are taken to delay or offset them, as well as the U.S. federal government’s debt ceiling and the federal deficit. These concerns, as well as actions taken by the U.S. federal government in response to these concerns, could significantly impact the global and U.S. economies and financial markets, which could have a material adverse effect on our business, financial condition, and results of operations.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

MUTUAL FUNDS AND ANNUITIES

The Partnership derived 74% and 73% of its total revenue from sales and services related to mutual fund and annuity products in the three and nine month periods ended September 28, 2012, respectively, and 70% in both the three and nine month periods ended September 30, 2011, respectively. In addition, the Partnership derived from one mutual fund vendor 18% and 19% of its total revenue for the three and nine month periods ended September 28, 2012, respectively, and 18% and 20% of its total revenue for the three and nine month periods ended September 30, 2011, respectively. All of the revenue generated from this vendor relates to business conducted with the Partnership’s U.S. segment.

Significant reductions in the revenues from this mutual fund source due to regulatory reform or other changes to the Partnership’s relationship with mutual fund vendors could have a material adverse effect on the Partnership’s results of operations.

LIQUIDITY AND CAPITAL RESOURCES

The Partnership requires liquidity to cover its operating expenses, net capital requirements, capital expenditures, debt repayment obligations and redemptions of partnership interests. The principal sources for meeting the Partnership’s liquidity requirements include existing liquidity and capital resources of the Partnership and funds generated from operations. The Partnership believes that the liquidity provided by these sources will be sufficient to meet its capital and liquidity requirements for the next twelve months. Depending on conditions in the capital markets and other factors, the Partnership will, from time to time, consider the issuance of debt and additional partnership capital, the proceeds of which could be used to meet growth needs or for other purposes.

Partnership Capital

The Partnership’s growth in capital has historically been through the sale of limited partnership interests to its employees and existing limited partners, the sale of subordinated limited partnership interests to its current or retiring general partners and retention of general partner earnings.

The Partnership’s capital subject to mandatory redemption at September 28, 2012, net of reserve for anticipated withdrawals, was $1.8 billion, an increase of $29.6 million from December 31, 2011. This increase in the Partnership’s capital subject to mandatory redemption was due to the retention of general partner earnings ($71.3 million) and the issuance of subordinated limited partner and general partner interests ($35.5 million and $99.5 million, respectively), offset by redemption of limited partner, subordinated limited partner and general partner interests ($8.8 million, $7.8 million and $76.8 million, respectively) and the increase of partnership loans outstanding during the nine months ended September 28, 2012 ($83.3 million). The Partnership Agreement provides, subject to the Managing Partner’s discretion, that it is the intention, but not requirement, of the Partnership to retain approximately 20% to 30% of income allocated to general partners. During the nine month periods ended September 28, 2012 and September 30, 2011, the Partnership retained 23% of income allocated to general partners.

Under the terms of the Partnership Agreement, a partner’s capital is required to be redeemed by the Partnership in the event of the partner’s death or withdrawal from the Partnership, subject to compliance with ongoing regulatory capital requirements. In the event of a partner’s death, the Partnership must generally redeem the partner’s capital within six months. The Partnership has withdrawal restrictions in place limiting the amount of capital that can be withdrawn at the discretion of the partner. Under the terms of the

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Partnership Agreement, limited partners withdrawing from the Partnership are to be repaid their capital in three equal annual installments beginning the month after their withdrawal. The capital of general partners withdrawing from the Partnership is converted to subordinated limited partnership capital or, at the discretion of the Managing Partner, redeemed by the Partnership. Subordinated limited partners are repaid their capital in six equal annual installments beginning the month after their request for withdrawal of contributed capital. The Partnership’s Managing Partner has discretion to waive or modify these withdrawal restrictions and to accelerate the return of capital.

General partners (other than Executive Committee members) may elect to finance a portion or all of their purchase of general partnership interests through loans made available from the Partnership. Loans made by the Partnership to general partners are generally for a period of one year but are expected to be renewed and bear interest at the prime rate, as defined in the loan documents. The Partnership will recognize interest income for the interest paid by general partners in connection with such loans. General partners borrowing from the Partnership will be required to repay such loans by applying the majority of earnings received from the Partnership to such loans, net of amounts retained by the Partnership and amounts distributed for income taxes. However, any bank loans held by a general partner will be repaid prior to any application of earnings towards that partner’s Partnership loan. The Partnership will have full recourse against any general partner that defaults on loan obligations to the Partnership. The Partnership does not anticipate that general partner loans will have an adverse impact on the Partnership’s short-term liquidity or capital resources.

In addition, the Partnership has not and will not provide loans to members of the Executive Committee. Executive Committee members who require financing for some or all of their partnership capital contributions will continue to borrow directly from banks willing to provide such financing on an individual basis.

Any purchases of partnership interests financed through banks are unsecured bank loan agreements and are between the individual and the bank. The bank loans of the individual general and subordinated limited partners, obtained for new general or subordinated limited partner capital purchases prior to 2011, were one year term loans due on February 24, 2012, which were subsequently renewed with one year term loans due on February 22, 2013. These loans are subject to annual renewal and have no required principal payments prior to maturity. The current bank loans of the individual limited partners are primarily due on January 2, 2014 and also have no required principal payments prior to that time. The Partnership does not guarantee these bank loans nor can the individual general, subordinated limited or limited partners pledge their partnership interest as collateral for the bank loan.

Additionally, the Partnership has performed certain administrative functions in connection with its partners who have elected to finance a portion of the purchase of partnership interests through individual unsecured bank loan agreements from banks with whom the Partnership has other banking relationships. For all individual purchases financed through such agreements, the partners provide an irrevocable letter of instruction instructing the Partnership to apply the proceeds from the liquidation of that individual’s capital account to the repayment of their bank loan prior to any funds being released to the partner. In addition, the partner is required to apply partnership earnings, net of any firm retention and any distributions to pay taxes, to service the interest and principal on the bank loan. Should a subordinated limited or limited partner’s individual bank loan not be renewed upon maturity for any reason, the Partnership could experience increased requests for capital liquidations, which could adversely impact the Partnership’s liquidity.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Partners who finance all or a portion of their partnership interest with bank financing may be more likely to request the withdrawal of capital to meet bank financing requirements should the partners experience a period of reduced earnings, including potential operating losses. As a partnership, any withdrawals by general partners, subordinated limited partners or limited partners would reduce the Partnership’s available liquidity and capital.

As mentioned above, many of the same banks that provide financing to partners also provide various forms of financing to the Partnership. To the extent these banks increase credit available to the partners, financing available to the Partnership may be reduced.

The Partnership, while not a party to any partner unsecured bank loan agreements, does facilitate making payments of allocated income to certain banks on behalf of the partner. The following table represents amounts related to partnership loans as well as bank loans (for which the Partnership facilitates certain administrative functions). Partners may have arranged their own bank loans to finance their partnership capital for which the Partnership does not facilitate certain administrative functions and therefore any such loans are not included in the table.

 

     As of September 28, 2012  

($ in thousands)

   Limited
Partnership
Interests
    Subordinated
Limited
Partnership
Interests
    General
Partnership
Interests
    Total
Partnership
Capital
 

Partnership capital(1):

        

Total partnership capital

   $ 653,414      $ 283,109      $ 1,021,619      $ 1,958,142   
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital owned by partners with individual loans

   $ 231,685      $ 425      $ 527,341      $ 759,451   
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital owned by partners with individual loans as a percent of total partnership capital

     35.5     0.2     51.6     38.8

Partner loans:

        

Bank loans

   $ 63,752      $ 147      $ 36,326      $ 100,225   

Partnership loans

     —          —          170,152        170,152   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 63,752      $ 147      $ 206,478      $ 270,377   
  

 

 

   

 

 

   

 

 

   

 

 

 

Partner loans as a percent of total partnership capital

     9.8     0.1     20.2     13.8

Partner loans as a percent of partnership capital owned by partners with loans

     27.5     34.6     39.2     35.6

 

(1) 

Partnership capital, as defined for this table, is before the reduction of partnership loans and is net of reserve for anticipated withdrawals.

Historically, neither the amount of partnership capital financed with individual loans as indicated in the table above, nor the amount of partner capital withdrawal requests has had a significant impact on the Partnership’s liquidity or capital resources.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Partnership Debt

The following table shows the composition of the Partnership’s aggregate bank lines of credit in place as of ($ in thousands):

 

     September 28,
2012
     December 31,
2011
 

2011 Credit Facility

   $ 395,000       $ 395,000   

Uncommitted secured credit facilities

     415,000         595,000   
  

 

 

    

 

 

 

Total bank lines of credit

   $ 810,000       $ 990,000   
  

 

 

    

 

 

 

In March 2011, the Partnership entered into the 2011 Credit Facility, which has a maturity date of March 18, 2014. The 2011 Credit Facility is intended to provide short-term liquidity to the Partnership should the need arise. In addition, the Partnership has uncommitted lines of credit that are subject to change at the discretion of the banks. Based on credit market conditions and the uncommitted nature of these credit facilities, it is possible that these lines of credit could decrease or not be available in the future. During the first quarter of 2012, the Partnership's uncommitted lines of credit were reduced by $150 million by a bank reducing its exposure in the U.S. market. In addition, during the second quarter of 2012, the Partnership's uncommitted lines of credit were further reduced by $30 million by another bank. This decision is unrelated to the Partnership's creditworthiness. These decreases reduced the aggregated uncommitted bank lines of credit from $595 million to $415 million.

Actual borrowing availability on the uncommitted secured lines is based on client margin securities and partnership securities, which serve as collateral on loans. There were no amounts outstanding on the uncommitted lines of credit as of September 28, 2012 and December 31, 2011. In addition, the Partnership did not have any draws against these lines of credit during the nine month periods ended September 28, 2012 and September 30, 2011.

The Partnership is in compliance with all covenants related to its outstanding debt agreements as of September 28, 2012. For further details on covenants, see discussion regarding debt covenants in the Notes to the Consolidated Financial Statements.

Cash Activity

As of September 28, 2012, the Partnership had $220.0 million in cash and cash equivalents and $1.1 billion in securities purchased under agreements to resell, which have maturities of less than one week. This totals $1.3 billion of Partnership liquidity as of September 28, 2012, a 13% ($0.2 billion) decrease from $1.5 billion at December 31, 2011. In addition, the Partnership also had $6.0 billion and $4.5 billion in cash and investments segregated under federal regulations as of September 28, 2012 and December 31, 2011, respectively, which was not available for general use.

During the first nine months of 2012, cash and cash equivalents of $220.0 million decreased $599.5 million from $819.5 million as of December 31, 2011. This is primarily a result of the timing of an increase in the amount of cash and investments required by Rule 15c3-3 of the Securities Exchange Act of 1934 ("Exchange Act") to be segregated under federal regulations. Despite this shift of higher cash and investments segregated under federal regulation and lower cash and cash equivalents as of September 28, 2012 as compared to December 31, 2011, the Partnership is continuing to elect to leave funds in cash and cash equivalents, that otherwise

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

would have been invested in securities purchased under agreements to resell, due to the unlimited deposit insurance coverage currently being offered (under the Dodd-Frank Act) for non-interest bearing accounts at Federal Deposit Insurance Corporation (“FDIC”) insured depository institutions through December 31, 2012. In some cases, the banks will offer a credit for these uninvested cash balances that can be used to offset other bank fees, which is reflected as a reduction to other operating expenses in the Partnership’s Consolidated Statements of Income. Cash used in operating activities was $97.8 million for the nine month period ended September 28, 2012. The primary sources of net cash provided by operating activities was income before allocations to partners ($408.4 million) adjusted for depreciation expense ($60.5 million) and a net increase in liabilities ($1.4 billion). These sources were more than offset by the net cash used in operating activities from the increase in assets ($2.0 billion). During the first nine months of 2012, cash used in investing activities was $24.3 million consisting of capital expenditures supporting the growth of the Partnership’s operations. During the first nine months of 2012, cash used in financing activities was $477.4 million, consisting primarily of partnership withdrawals and distributions ($384.9 million), repayment of debt ($50.7 million) and redemption of partnership interests ($93.5 million), partially offset by issuance of partnership interests ($41.9 million) and repayment of general partnership loans ($9.8 million).

Regulatory Requirements

As a result of its activities as a U.S. broker-dealer, Edward Jones is subject to the net capital provisions of Rule 15c3-1 of the Exchange Act and capital compliance rules of the FINRA Rule 4110. Under the alternative method permitted by the rules, Edward Jones must maintain minimum net capital, as defined, equal to the greater of $0.25 million or 2% of aggregate debit items arising from client transactions. The net capital rules also provide that Edward Jones’ partnership capital may not be withdrawn if the resulting net capital would be less than minimum requirements. Additionally, certain withdrawals require the approval of the SEC and FINRA to the extent they exceed defined levels, even though such withdrawals would not cause net capital to be less than minimum requirements.

As of September 28, 2012, Edward Jones’ net capital of $757.2 million was 35.2% of aggregate debit items and its net capital in excess of the minimum required was $714.1 million. Net capital after anticipated capital withdrawals, as a percentage of aggregate debit items was 22.4%. Net capital and the related capital percentage may fluctuate on a daily basis.

As of September 28, 2012, the Partnership’s Canadian broker-dealer’s regulatory risk adjusted capital of $42.6 million was $30.5 million in excess of the capital required to be held by IIROC. In addition, EJTC was in compliance with its regulatory capital requirements.

The Partnership and its subsidiaries are subject to examination by the Internal Revenue Service ("IRS") and by various state and foreign taxing authorities in the jurisdictions in which the Partnership and its subsidiaries conduct business. During the quarter ended June 29, 2012, the IRS began an examination of Edward Jones’ income tax returns for the years ended 2009 and 2010. At this time, this event does not have a material impact to the Partnership and the Partnership is not aware of any anticipated adjustments to the 2009 or 2010 income tax returns of Edward Jones that would result in a material change to the Partnership’s financial position.

OFF BALANCE SHEET ARRANGEMENTS

The Partnership does not have any significant off-balance-sheet arrangements.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

CRITICAL ACCOUNTING POLICIES

The Partnership’s financial statements are prepared in accordance with GAAP, which may require judgment and involve estimation processes to determine its assets, liabilities, revenues and expenses which affect its results of operations.

The Partnership believes that of its significant accounting policies, the following critical policies require estimates that involve a higher degree of judgment and complexity.

Asset-Based Fees. Due to the timing of receipt of information, the Partnership must use estimates in recording the accruals related to certain asset-based fees. These accruals are based on historical trends and are adjusted to reflect market conditions for the period covered. Additional adjustments, if needed, are recorded in subsequent periods.

Legal Reserves. The Partnership provides for potential losses that may arise out of litigation, regulatory proceedings and other contingencies to the extent that such losses can be estimated, in accordance with ASC 450. See Note 8 to the Consolidated Financial Statements and Part II, Item 1 – Legal Proceedings for further discussion of these items. The Partnership regularly monitors its exposures for potential losses. The Partnership’s total liability with respect to litigation and regulatory proceedings represents the best estimate of probable losses after considering, among other factors, the progress of each case, the Partnership’s experience and discussions with legal counsel.

Included in Item 3 – Quantitative and Qualitative Disclosures about Market Risk and in the notes to the financial statements (see Note 1 to the Consolidated Financial Statements), are additional discussions of the Partnership’s accounting policies.

THE EFFECTS OF INFLATION

The Partnership’s net assets are primarily monetary, consisting of cash and cash equivalents, cash and investments segregated under federal regulations, securities inventories and receivables less liabilities. Monetary net assets are primarily liquid in nature and would not be significantly affected by inflation. Inflation and future expectations of inflation influence securities prices, as well as activity levels in the securities markets. As a result, profitability and capital may be impacted by inflation and inflationary expectations. Additionally, inflation’s impact on the Partnership’s operating expenses may affect profitability to the extent that additional costs are not recoverable through increased prices of services offered by the Partnership.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, and in particular Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of the federal securities laws. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “will,” “should,” and other expressions which predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Partnership. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Partnership to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.

Some of the factors that might cause differences between forward-looking statements and actual events include, but are not limited to, the following: (1) general economic conditions; (2) regulatory actions; (3) changes in legislation or regulation, including new regulations under the Dodd-Frank Act; (4) actions of competitors; (5) litigation; (6) the ability of clients, other broker-dealers, banks, depositories and clearing organizations to fulfill contractual obligations; (7) changes in interest rates; (8) changes in technology; (9) a fluctuation or decline in the fair value of securities; and (10) the risks discussed under the caption "Risk Factors" in our most recently filed Annual Report on Form 10-K and subsequent Quarterly Reports on Form 10-Q. These forward-looking statements were based on information, plans, and estimates at the date of this report, and the Partnership does not undertake to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The SEC requires market risk disclosures of accounting policies for derivatives and other financial instruments and to provide quantitative and qualitative disclosures about market risk inherent in derivatives and other financial instruments. Various levels of management within the Partnership manage the Partnership’s risk exposure. Position limits in trading and inventory accounts are established and monitored on an ongoing basis. Credit risk related to various financing activities is reduced by the industry practice of obtaining and maintaining collateral. The Partnership monitors its exposure to counterparty risk through the use of credit exposure information, the monitoring of collateral values and the establishment of credit limits. For further discussion of monitoring, see the Risk Management discussion in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Partnership’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

The Partnership is exposed to market risk from changes in interest rates. Such changes in interest rates impact the income from interest earning assets, primarily receivables from clients on margin balances and short-term investments, which averaged $2.2 billion and $6.2 billion for the nine months ended September 28, 2012, respectively. The changes in interest rates may also have an impact on the expense related to liabilities that finance these assets, such as amounts payable to clients and other interest and non-interest bearing liabilities.

The Partnership performed an analysis of its financial instruments and assessed the related interest rate risk and materiality in accordance with the SEC rules. Under current market conditions and based on current levels of interest earning assets and the liabilities that finance these assets, the Partnership estimates that a 100 basis point (1.00%) increase in short-term interest rates could increase its annual net interest income by approximately $68 million. Conversely, the Partnership estimates that a 100 basis point (1.00%) decrease in short-term interest rates could decrease the Partnership’s annual net interest income by approximately $13 million. A decrease in short-term interest rates currently has a less significant impact on net interest income due to the current low interest rate environment. The Partnership has two distinct types of interest bearing assets: client receivables from margin accounts and short-term, primarily overnight, investments, which are primarily comprised of cash and investments segregated under federal regulations and securities purchased under agreements to resell. These investments have earned interest at an average rate of approximately 17 basis points (0.17%) in the first nine months of 2012, and therefore the financial dollar impact of further decline in rates is minimal. The Partnership has put in place an interest rate floor for the interest charged related to its client margin loans, which helps to limit the negative impact of declining interest rates.

In addition to the interest earning assets and liabilities noted above, the Partnership’s revenue earned related to its minority ownership interest in the investment adviser to the Edward Jones money market funds is also impacted by changes in interest rates. As noted in Note 1 to the Consolidated Financial Statements, as a 49.5% limited partner of Passport Research Ltd., the investment adviser to some of the money market funds made available to Edward Jones clients, the Partnership receives a portion of the income of the investment adviser. Due to the current historically low interest rate environment, the investment adviser voluntarily chose (beginning in March 2009) to reduce certain fees charged to the funds to a level that will maintain a positive client yield on the funds. This reduction of fees reduced the Partnership’s cash solutions revenue by $65 million for the nine months ended September 28, 2012 and September 30, 2011, or approximately $90 million annually, and is expected to continue at that level in future periods, based upon the current interest rate environment. Alternatively, if the interest rate environment improved such that this reduction in fees was no longer necessary to maintain a positive client yield, the Partnership’s revenue could increase annually by approximately $90 million.

 

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PART I. FINANCIAL INFORMATION

 

ITEM 4.

CONTROLS AND PROCEDURES

The Partnership maintains a system of disclosure controls and procedures which are designed to ensure that information required to be disclosed by the Partnership in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to management, including the Partnership’s certifying officers, as appropriate to allow timely decisions regarding required disclosure.

Based upon an evaluation performed as of the end of the period covered by this report, the Partnership’s certifying officers, the Chief Executive Officer and the Chief Financial Officer, have concluded that the Partnership’s disclosure controls and procedures were effective as of September 28, 2012.

There have been no changes in the Partnership’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Partnership’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

The following information supplements the discussion in Part I, Item 3 “Legal Proceedings” in the Partnership’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and Part II, Item 1 “Legal Proceedings” in the Partnership’s Quarterly Reports on Form 10-Q for the periods ended March 30, 2012 and June 29, 2012:

Countrywide. As has been previously reported, there have been cases filed against Edward Jones (in addition to numerous other issuers and underwriters) asserting claims under the Securities Act of 1933 in connection with registration statements and prospectus supplements issued for certain mortgage-backed certificates issued between 2005 and 2007. Three are purported class actions (David H. Luther, et al. v. Countrywide Financial Corporation, et al., filed in 2007; Maine State Retirement System, et al. v. Countrywide Financial Corporation, et al., filed in 2010; and Western Conference of Teamsters Pension Trust Fund v. Countrywide Financial Corporation, et al., filed in 2010). All three cases remain pending in the U.S. District Court for the Central District of California. Plaintiffs seek unspecified compensatory damages, attorneys’ fees, costs, expenses and rescission. In November 2010, the court in the Maine State case dismissed all of plaintiffs’ claims to the extent they related to any certificates for which Edward Jones acted as dealer and directed plaintiffs to amend their complaint. The Western Conference of Teamsters case has been stayed by agreement of the parties. On August 10, 2012, the Federal Deposit Insurance Corporation, in its capacity as receiver for Colonial Bank, filed a separate lawsuit (FDIC v. Countrywide Securities Corporation, Inc., et al.) in the U.S. District Court for the Central District of California against numerous issuers and underwriters including Edward JonesHowever, Plaintiff does not allege that it purchased any tranche of any offering for which Edward Jones acted as dealer. The parties have agreed to a briefing schedule on Defendants’ Motion to Dismiss.

Nebraska Public Power District. On April 27, 2012, the SEC requested documentation from Edward Jones, a co-manager, with respect to the Taxable Build America Bonds Nebraska Public Power District issued in 2009, which formed part of their 2009 General Revenue Bonds (“Bonds”) offering. On October 23, 2012, the SEC’s Division of Enforcement informed Edward Jones it had initiated an investigation into the Bonds and requested documentation and testimony from individuals involved in the Bonds transaction.

 

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PART II. OTHER INFORMATION

 

ITEM 1A.

RISK FACTORS

There have been no material changes from the risk factors disclosed in the Partnership’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 except as supplemented in the Partnership’s Quarterly Report on Form 10-Q for the periods ended March 30, 2012 and June 29, 2012 and the updates below:

LEGISLATIVE AND REGULATORY INITIATIVESNewly adopted federal legislation and pending regulatory proposals intended to reform the financial services industry could significantly impact the regulation and operation of the Partnership and its subsidiaries, its revenue and its profitability. In addition, such laws and regulations may significantly alter or restrict the Partnership's historic business practices, which could negatively affect its operating results.

Money Market Mutual Funds. U.S. regulators, including the SEC, continue to explore reforms to the regulation of money market funds. For the nine months ended September 28, 2012, the Partnership had average client asset values in money market funds of $17.4 billion. Rules related to any potential reform have not been proposed, but any such rules may impact the structure of the Partnership’s money market funds. The Partnership will monitor and respond to any proposed rules if they are issued. Accordingly, the Partnership is not yet able to determine the full potential financial impact, if any, on its operating results in future years.

U.S. Fiscal Policy. Financial markets have recently been affected by concerns over U.S. fiscal policy, including uncertainty regarding the “fiscal cliff” composed of tax increases and automatic spending cuts that will become effective at the end of 2012 unless steps are taken to delay or offset them, as well as the U.S. federal government’s debt ceiling and the federal deficit. These concerns, as well as actions taken by the U.S. federal government in response to these concerns, could significantly impact the global and U.S. economies and financial markets, which could have a material adverse effect on our business, financial condition, and results of operations.

 

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PART II. OTHER INFORMATION

 

ITEM 6. EXHIBITS

 

Exhibit

Number

   Description
3.1    *   

Eighteenth Amended and Restated Agreement of Registered Limited Liability Limited Partnership of the Registrant, dated as of November 26, 2010, incorporated by reference to Exhibit 3.1 to the Registrant's Form 8-K dated November 26, 2010.

3.2    **   

Fourth Amendment of Eighteenth Restated Certificate of Limited Partnership of The Jones Financial Companies, L.L.L.P., dated October 15, 2012.

31.1    **   

Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Act of 1934, as amended, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

31.2    **   

Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Act of 1934, as amended, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

32.1    **   

Certification of Chief Executive Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

32.2    **   

Certification of Chief Financial Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

101.INS    ***    XBRL Instance Document
101.SCH    ***    XBRL Taxonomy Extension Schema
101.CAL    ***    XBRL Taxonomy Extension Calculation
101.DEF    ***    XBRL Extension Definition
101.LAB    ***    XBRL Taxonomy Extension Label
101.PRE    ***    XBRL Taxonomy Extension Presentation

 

*

Incorporated by reference to previously filed exhibits.

**

Filed herewith.

***

Attached as Exhibit 101 to this Quarterly Report on Form 10-Q for the quarterly period ended September 28, 2012 are the following materials formatted in XBRL (Extensible Business Reporting Language) (i) Consolidated Statements of Financial Condition, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements, tagged as blocks of text. As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Exchange Act.

 

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PART II. OTHER INFORMATION

 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.
By:  

/s/ James D. Weddle

  James D. Weddle
  Managing Partner (Principal Executive Officer)
  November 13, 2012

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated:

 

Signatures

  

Title

 

Date

/s/ James D. Weddle

   Managing Partner   November 13, 2012
James D. Weddle    (Principal Executive Officer)  

/s/ Kevin D. Bastien

   Chief Financial Officer   November 13, 2012
Kevin D. Bastien   

(Principal Financial and

Accounting Officer)

 

 

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