UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2014

OR

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

Commission File Number 001-15799

Ladenburg Thalmann Financial Services Inc.
(Exact name of registrant as specified in its charter)
Florida
65-0701248
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
 
 
4400 Biscayne Boulevard, 12th Floor
 
Miami, Florida
33137
(Address of principal executive offices)
(Zip Code)
(305) 572-4100
(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.
Large accelerated filer
 [ ]
 
 
Accelerated filer
[x]
 
 
 
 
 
 
 
 
Non-accelerated filer
[ ]
(Do not check if a smaller reporting company)
 
Smaller reporting company
[ ]
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ___ No  X 
As of November 6, 2014 there were 185,332,414 shares of the registrant's common stock outstanding.





LADENBURG THALMANN FINANCIAL SERVICES INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014

TABLE OF CONTENTS

 
 
Page
PART I. FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Financial Condition as of September 30, 2014 and December 31, 2013
 
 
 
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013
 
 
 
 
Condensed Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2014
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART  II. OTHER INFORMATION
 
 
 
 
 
 
 
   Item 1A.
 
 
 
 
 
 
 
 
 



1



PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)


LADENBURG THALMANN FINANCIAL SERVICES INC.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except share and per share amounts)
 
September 30, 2014 
 (Unaudited)
 
December 31, 2013
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
94,952

 
$
50,329

Securities owned, at fair value
5,858

 
4,789

Receivables from clearing brokers
68,378

 
31,391

Receivables from other broker-dealers
1,840

 
2,126

Notes receivable from financial advisors, net
26,898

 
31,751

Other receivables, net
28,671

 
21,687

Fixed assets, net
19,245

 
15,866

Restricted assets
470

 
570

Intangible assets, net
104,936

 
76,251

Goodwill
106,926

 
90,501

Unamortized debt issue cost
755

 
1,069

Cash surrender value of life insurance
10,140

 
12,370

Other assets
24,263

 
22,120

 
 
 
 
      Total assets
$
493,332

 
$
360,820



 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Securities sold, but not yet purchased, at fair value
$
3,434

 
$
83

Accrued compensation
21,813

 
20,098

Commissions and fees payable
39,392

 
32,800

Accounts payable and accrued liabilities
22,328

 
19,846

Deferred rent
1,585

 
1,871

Deferred income taxes
9,040

 
7,499

Deferred compensation liability
16,704

 
19,056

Accrued interest
2,039

 
1,506

Notes payable, net of $951 and $1,618 unamortized discount in 2014 and 2013, respectively
62,131

 
64,648

      Total liabilities
178,466

 
167,407

 
 
 
 
Commitments and contingencies (Note 7)


 


Shareholders’ equity:
 
 
 
Preferred stock, $.0001 par value; authorized 25,000,000 shares in 2014 and 2013: 8% Series A cumulative redeemable preferred stock; 11,290,000 and 8,290,000 shares authorized in 2014 and 2013, respectively; 10,873,206 and 6,189,497 shares issued and outstanding in 2014 and 2013, respectively (liquidation preference $271,830 in 2014 and $154,737 in 2013)
1

 
1

Common stock, $.0001 par value; authorized 800,000,000 and 600,000,000 shares in 2014 and 2013, respectively; shares issued and outstanding, 183,346,168 in 2014 and 181,433,815 in 2013
18

 
18

   Additional paid-in capital
452,263

 
350,780

   Accumulated deficit
(137,406
)

(157,438
)
 
 
 
 
      Total shareholders’ equity of the Company
314,876

 
193,361

 
 
 
 
Noncontrolling interest
(10
)
 
52

 
 
 
 
      Total shareholders' equity
314,866

 
193,413

 
 
 
 
      Total liabilities and shareholders' equity
$
493,332

 
$
360,820

See accompanying notes.

2



LADENBURG THALMANN FINANCIAL SERVICES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
(Unaudited)

 
 
Three months ended
 
Nine months ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
 
Commissions
 
$
109,575

 
$
101,469

 
$
316,520

 
$
293,507

Advisory fees
 
86,333

 
69,893

 
245,265

 
200,893

Investment banking
 
10,916

 
10,090

 
38,306

 
31,271

Principal transactions
 
433

 
841

 
1,699

 
1,690

Interest and dividends
 
1,760

 
1,826

 
5,132

 
5,139

Service fees and other income
 
14,715

 
16,370

 
49,381

 
49,163

Total revenues
 
223,732

 
200,489

 
656,303

 
581,663

Expenses:
 
 
 
 
 
 
 
 
Commissions and fees
 
163,393

 
146,906

 
477,133

 
424,942

Compensation and benefits
 
28,410

 
23,860

 
81,391

 
69,316

Non-cash compensation
 
3,679

 
1,647

 
7,689

 
4,439

Brokerage, communication and clearance fees
 
4,349

 
2,761

 
13,003

 
8,085

Rent and occupancy, net of sublease revenue
 
1,905

 
1,631

 
4,955

 
4,601

Professional services
 
3,127

 
2,247

 
8,091

 
6,401

Interest
 
1,701

 
2,283

 
5,193

 
13,395

Depreciation and amortization
 
4,902

 
3,776

 
12,527

 
11,553

Acquisition-related expense
 
850

 

 
1,308

 

Loss on extinguishment of debt
 

 
446

 
314

 
4,200

Amortization of retention loans
 
1,538

 
1,690

 
5,108

 
5,339

Other
 
10,449

 
10,284

 
31,627

 
30,587

Total expenses
 
224,303

 
197,531

 
648,339

 
582,858

Income (loss) before item shown below
 
(571
)
 
2,958

 
7,964

 
(1,195)

Change in fair value of contingent consideration
 

 

 
12

 
(121)

Income (loss) before income taxes
 
(571
)
 
2,958

 
7,976

 
(1,316)

Income tax expense (benefit)
 
(13,354
)
 
579

 
(11,994
)
 
1,718

Net income (loss)
 
12,783

 
2,379

 
19,970

 
(3,034
)
Net loss attributable to noncontrolling interest
 
(20
)
 
(23
)
 
(62)

 
(49
)
Net income (loss) attributable to the Company
 
$
12,803

 
$
2,402

 
$
20,032

 
$
(2,985
)
Dividends declared on preferred stock
 
(4,848
)
 
(2,879
)
 
(11,783
)
 
(3,907
)
Net income (loss) available to common shareholders
 
$
7,955

 
$
(477
)
 
$
8,249

 
$
(6,892
)
 
 
 
 
 
 
 
 
 
Net income (loss) per share available to common shareholders (basic)
 
$
0.04

 
$
(0.00
)
 
$
0.05

 
$
(0.04
)
 
 
 
 
 
 
 
 
 
Net income (loss) per share available to common shareholders (diluted)
 
$
0.04

 
$
(0.00
)
 
$
0.04

 
$
(0.04
)
 
 
 
 
 
 
 
 
 
Weighted average common shares used in computation of per share data:
 
 
 
 
 
 
 
 
Basic
 
182,988,516

 
181,759,305

 
182,082,141

 
182,895,952

Diluted
 
210,535,372

 
181,759,305

 
205,243,355

 
182,895,952



See accompanying notes.

3



LADENBURG THALMANN FINANCIAL SERVICES INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS’ EQUITY
(in thousands, except share amounts)
(Unaudited)


 
 
Preferred Stock
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Deficit
 
Noncontrolling Interest
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2013
 
6,189,497

 
$
1

 
181,433,815

 
$
18

 
$
350,780

 
$
(157,438
)
 
$
52

 
$
193,413

Issuance of common stock under employee stock purchase plan
 

 

 
71,703

 

 
224

 

 

 
224

Exercise of stock options, net of 43,535 shares tendered in payment of exercise price
 

 

 
1,744,378

 

 
2,028

 

 

 
2,028

Stock-based compensation to consultants and independent financial advisors
 

 

 

 

 
4,731

 

 

 
4,731

Stock-based compensation to employees
 

 

 

 

 
2,958

 

 

 
2,958

Repurchase and retirement of common stock
 

 

 
(2,444,490)

 

 
(8,090
)
 

 

 
(8,090
)
Common stock issued in Highland acquisition
 
 
 
 
 
2,540,762

 
 
 
7,953

 
 
 
 
 
7,953

Preferred stock issued, net of expenses of $2,302
 
4,683,709

 

 

 

 
103,462

 

 

 
103,462

Preferred stock dividends declared and paid
 

 

 

 

 
(11,783)

 

 

 
(11,783
)
Net income (loss)
 

 

 

 

 

 
20,032

 
(62
)
 
19,970

Balance, September 30, 2014
 
10,873,206

 
$
1

 
183,346,168

 
$
18

 
$
452,263

 
$
(137,406
)
 
$
(10
)
 
$
314,866



See accompanying notes.

4

LADENBURG THALMANN FINANCIAL SERVICES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

 
Nine months ended 
 September 30,
 
2014
 
2013
 
 
 
 
Cash flows from operating activities:
 
 
Net income (loss)
$
19,970

 
$
(3,034
)
      Adjustments to reconcile net income (loss) to
 
 
 
          net cash (used) provided by operating activities:
 
 
 
Change in fair value of contingent consideration
(12
)
 
121

Adjustment to deferred rent
(286
)
 
213

Amortization of intangible assets
9,360

 
8,760

Depreciation and other amortization
3,167

 
2,793

Loss on extinguishment of debt
314

 
4,200

Amortization of debt discount
371

 
1,068

Amortization of debt issue cost
296

 
334

Amortization of retention loans
5,108

 
5,339

Deferred income taxes
(13,381
)
 
695

Benefit attributable to reduction of goodwill
58

 
58

Non-cash interest expense on forgivable loan
762

 
797

Non-cash compensation expense
7,689

 
4,439

Loss on write-off of furniture, fixtures and leasehold improvements, net
6

 
55

 
 
 
 
(Increase) decrease in operating assets, net of effects of acquisition:
 
 
 
Securities owned, at fair value
(1,069
)
 
(1,756
)
Receivables from clearing brokers
(36,987
)
 
(13,910
)
Receivables from other broker-dealers
286

 
346

Other receivables, net
(914
)
 
(353
)
Notes receivable from financial advisors, net
(255
)
 
1,365

Cash surrender value of life insurance
2,230

 
(413
)
Other assets
(358
)
 
728

 
 
 
 
Increase (decrease) in operating liabilities, net of effects of acquisition:
 
 
 
Securities sold, but not yet purchased, at fair value
3,351

 
41

Accrued compensation
(1,647
)
 
5,756

Accrued interest
(491
)
 
(3,033
)
Commissions and fees payable
5,142

 
1,831

Deferred compensation liability
(2,352
)
 
396

Accounts payable and accrued liabilities
(418
)
 
(630
)
      Net cash (used) provided by operating activities   
(60
)
 
16,206

 
 
 
 
Cash flows from investing activities:
 
 
 
Purchases of fixed assets
(5,887
)
 
(4,606
)
Decrease (increase) in restricted assets
100

 
(250
)
Acquisition of Highland, net of cash received
(3,353
)
 

      Net cash used in investing activities   
(9,140
)
 
(4,856
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Issuance of Series A preferred stock
103,462

 
140,413

Issuance of common stock
2,252

 
424

Series A preferred stock dividends paid
(11,783
)
 
(3,907
)
Repurchases of common stock
(8,090
)
 
(5,935
)
Term loan additional borrowing
500

 

Principal repayments on notes payable, including, in 2014, $21,834 of Highland's assumed debt
(32,518
)
 
(101,525
)
Principal repayments under revolving credit facility, net

 
(25,500
)
Third party investment in subsidiary

 
120

      Net cash provided by financing activities   
53,823

 
4,090

Net increase in cash and cash equivalents
44,623

 
15,440

Cash and cash equivalents, beginning of period
50,329

 
35,434

      Cash and cash equivalents, end of period   
$
94,952

 
$
50,874

 
 
 
 
Supplemental cash flow information:
 
 
 
Interest paid
$
4,246

 
$
14,220

Taxes paid
2,222

 
426

 
 
 
 
Acquisition of Highland:
 
 
 
Assets acquired
$
63,308

 
$

Liabilities assumed
(51,742
)
 

Net assets acquired
11,566

 

Stock issued in acquisition
(7,953
)
 

Cash acquired in acquisition
(260
)
 

Net cash paid in acquisition
$
3,353

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See accompanying notes.

5


LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited; in thousands, except share and per share amounts)

1. Description of Business and Basis of Presentation

Ladenburg Thalmann Financial Services Inc. (the “Company”) is a holding company. Its principal operating subsidiaries are Securities America, Inc. (collectively with related companies, ‘‘Securities America’’), Triad Advisors, Inc. (‘‘Triad’’), Investacorp, Inc. (collectively with related companies, ‘‘Investacorp’’), Ladenburg Thalmann & Co. Inc. (‘‘Ladenburg’’), Ladenburg Thalmann Asset Management Inc. (‘‘LTAM’’), Premier Trust, Inc. (‘‘Premier Trust’’) and Highland Capital Brokerage, Inc. (“Highland”), which the Company acquired in July 2014 (see Note 2).

Securities America, Triad and Investacorp are registered broker-dealers and investment advisors that have been serving the independent financial advisor community since 1984, 1998 and 1978, respectively. The independent financial advisors of Securities America, Triad and Investacorp primarily serve retail clients. Securities America, Triad and Investacorp derive revenue from advisory fees and commissions, primarily from the sale of mutual funds, variable annuity products and other financial products and services.

Ladenburg is a full service registered broker-dealer that has been a member of the New York Stock Exchange since 1879. Broker-dealer activities include sales and trading and investment banking. Ladenburg provides its services principally to middle-market and emerging growth companies and high net worth individuals through a coordinated effort among corporate finance, capital markets, brokerage and trading professionals.

LTAM is a registered investment advisor. It offers various asset management products utilized by Ladenburg and Premier Trust’s clients, as well as clients of Securities America’s, Triad's and Investacorp’s financial advisors.

Premier Trust, a Nevada trust company, provides wealth management services, including administration of personal trusts and retirement accounts, estate and financial planning and custody services.

Highland is a leading independent insurance brokerage that delivers life insurance, fixed and equity indexed annuities and long-term care solutions to investment and insurance providers. Highland provides specialized point-of-sale support along with advanced marketing and estate and business planning techniques, delivering customized insurance solutions to both institutional clients and independent producers.

Securities America's, Triad's, Investacorp's and Ladenburg's customer transactions are cleared through clearing brokers on a fully-disclosed basis and such entities are subject to regulation by, among others, the Securities and Exchange Commission (“SEC”), the Financial Industry Regulatory Authority (“FINRA”) and the Municipal Securities Rulemaking Board. Each of Securities America, Triad, Investacorp and Ladenburg is a member of the Securities Investor Protection Corporation. Securities America is also subject to regulation by the Commodities Futures Trading Commission and the National Futures Association. Premier Trust is subject to regulation by the Nevada Department of Business and Industry Financial Institutions Division.

Basis of Presentation
The condensed consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the periods presented. Because of the nature of the Company’s business, interim period results may not be indicative of full year or future results.
The unaudited condensed consolidated financial statements do not include all information and notes required in annual audited financial statements in conformity with GAAP. The statement of financial condition at December 31, 2013 has been derived from the audited financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statement presentation. Please refer to the notes to the audited consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2013 for additional disclosures and a description of accounting policies (except as updated below for Highland).


6

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)





2. Highland Acquisition

On July 31, 2014, the Company acquired HCHC Holdings, Inc. (“HCHC”), which is the parent company of Highland. Highland is an independent insurance brokerage that delivers life insurance, annuities and long-term care solutions to investment and insurance providers. Highland provides specialized point-of-sale support along with advanced marketing and estate and business planning techniques, delivering customized insurance solutions to both institutional clients and independent producers. Under the Agreement and Plan of Merger, dated July 31, 2014, by and among the Company, HCHC, HCHC Acquisition Inc. ("HCHC Acquisition"), a wholly-owned subsidiary of the Company, and the stockholders of HCHC, HCHC merged with and into HCHC Acquisition, with HCHC Acquisition remaining as the surviving corporation and a wholly-owned subsidiary of the Company.

The Company paid $3,613 in cash and issued 2,540,762 shares of the Company's common stock, which are subject to certain transfer restrictions, valued at $7,953. Also, the Company caused all indebtedness owed by certain HCHC subsidiaries under a credit agreement (in the amount of $21,834) to be repaid. Approximately $7,000 of HCHC Acquisition's (as successor in interest to HCHC) 10% promissory notes due February 26, 2019 remain outstanding. Legal and other acquisition related costs of approximately $566 were incurred and charged to expense for the second and third quarters of the Company's year ending December 31, 2014.

The Company has not completed the valuation studies necessary to finalize the acquisition-date fair values of assets acquired and liabilities assumed and related allocation of purchase price for Highland. Accordingly, amounts set forth below are preliminary estimates only. Once the valuation process has been completed, there may be changes to the reported values of assets acquired and liabilities assumed, including goodwill and intangible assets, and those changes could differ materially from what is presented below. The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition:
 

Cash
$
260

Receivables...............................................................................
6,070

Identifiable intangible assets...................................................
38,045

Goodwill...................................................................................
16,483

Other assets..............................................................................
2,450

Total assets acquired................................................................
$
63,308

Commissions and fees payable................................................
(1,450
)
Notes payable-current..............................................................
(21,834
)
Notes payable-long term..........................................................
(7,000
)
Accounts payable and accrued liabilities.................................
(6,536
)
Deferred taxes payable, net.....................................................
(14,922
)
Total liabilities assumed..........................................................
$
(51,742
)
Total purchase price.................................................................
$
11,566


A deferred tax liability has been recorded for the excess of financial statement basis over tax basis of the acquired assets and assumed liabilities with a corresponding increase to goodwill. Goodwill, which is non-deductible for income tax purposes, was assigned to the insurance brokerage segment. Factors that contributed to a purchase price resulting in the recognition of goodwill include Highland's strategic fit with the Company’s existing businesses, including the resulting synergies and economies of scale expected from the acquisition.

Identifiable intangible assets as of the acquisition date consist of:






7

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)






 
 
 
Useful Life
(years)
Technology
$
972

 
 
4
Relationships with customers
 
1,914

 
 
25 & 11
Renewals revenue
 
30,337

 
 
8
Trade names
 
1,711

 
 
9
Non-solicitation agreement
 
3,111

 
 
3
Total identifiable intangible assets
$
38,045

 
 
 
 
 
 
 
 
 


Fair value amounts (Level 3 inputs) were determined using an income approach for renewals revenue, relationships with customers and trade names and a cost approach for technology.

The accompanying condensed consolidated financial statements include the results of operations of Highland from the date of acquisition. The following unaudited pro forma information represents the Company’s consolidated results of operations as if the acquisition of Highland had occurred at the beginning of 2013. The pro forma net loss reflects amortization of the amounts ascribed to identifiable intangible assets acquired in the acquisition and elimination of Highland's interest expense related to notes repaid at the date of acquisition. In addition, the $14,125 non-recurring income tax benefit resulting from the acquisition has been eliminated from the pro forma results (see Note 5).

 
Three Months Ended
September 30, 2014
Nine Months Ended
September 30, 2014
Three Months Ended
September 30, 2013
Nine Months Ended September 30, 2013
Revenue
$
227,641

$
686,110

$
217,980

$
631,004

Net income (loss)
$
11,008

$
16,501

$
1,637

$
(1,858
)
Net loss available to common shareholders
$
(7,610
)
$
(9,436
)
$
(2,428
)
$
(9,775
)
Basic and diluted loss per share available to common shareholders
$
(0.04
)
$
(0.05
)
$
(0.01
)
$
(0.05
)
Weighted average common shares outstanding:
 
 
 
 
     Basic and diluted
183,816,643

184,045,751

184,300,067

185,436,714


The unaudited pro forma financial information is not intended to represent or be indicative of the Company’s consolidated results of operations that would have been reported had the acquisition of Highland been completed as of the beginning of 2013, nor should it be taken as indicative of the Company’s future consolidated results of operations.

Revenues and net loss for Highland for the period from August 1, 2014 to September 30, 2014 included in the accompanying statements of operations were $9,242 and $742, respectively.

3. Securities Owned and Securities Sold, But Not Yet Purchased
The components of securities owned and securities sold, but not yet purchased at September 30, 2014 and December 31, 2013 were as follows:


8

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



 
 
Securities Owned   
 
Securities Sold,
But Not Yet Purchased
September 30, 2014
 
 
 
 
Debt securities
 
$
1,896

 
$
(66
)
U.S. Treasury notes
 
1

 
(297
)
Common stock and warrants
 
1,805

 
(3,071
)
Restricted common stock and warrants
 
1,131

 

Other investments
 
1,025

 

Total
 
$
5,858

 
$
(3,434
)
 
 
 
 
 
December 31, 2013
 
 
 
 
Certificates of deposit
 
$
24

 
$

Debt securities
 
1,402

 
(46
)
U.S. Treasury notes
 
1

 

Common stock and warrants
 
689

 
(33
)
Restricted common stock and warrants
 
725

 
(4
)
Other investments
 
1,948

 

Total
 
$
4,789

 
$
(83
)

As of September 30, 2014 and December 31, 2013, approximately $5,233 and $4,014, respectively, of securities owned were deposited with clearing brokers and may be sold or hypothecated by the clearing brokers pursuant to clearing agreements with such clearing brokers. Securities sold, but not yet purchased, at fair value represents obligations of the Company’s subsidiaries to purchase the specified financial instrument at the then current market price. Accordingly, these transactions result in off-balance-sheet risk as the Company’s subsidiaries’ ultimate obligation to repurchase such securities may exceed the amount recognized in the consolidated statements of financial condition.
Authoritative accounting guidance defines fair value, establishes a framework for measuring fair value, and establishes a fair value hierarchy which prioritizes the inputs to valuation techniques. Fair value is 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. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market. Valuation techniques that are consistent with the market, income or cost approach are used to measure fair value.

The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

Level 1 — Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 — Inputs other than quoted market prices that are observable, either directly or indirectly, and reasonably available. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the Company.

Level 3 — Unobservable inputs which reflect the assumptions that the Company develops based on available information about what market participants would use in valuing the asset or liability.

Securities are carried at fair value and classified as follows:

As of September 30, 2014:


9

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



Securities owned, at fair value
 
   Level 1
 
   Level 2
 
   Level 3
 
   Total
Debt securities
 
$

 
$
1,896

 
$

 
$
1,896

U.S. Treasury notes
 

 
1

 

 
1

Common stock and warrants
 
1,805

 
1,131

 

 
2,936

Other investments
 

 
1,025

 

 
1,025

Total
 
$
1,805

 
$
4,053

 
$

 
$
5,858


Securities sold, but not yet purchased, at fair value
 
   Level 1
 
   Level 2
 
   Level 3
 
   Total
Certificates of deposit
 
$

 
$
(66
)
 
$

 
$
(66
)
U.S. Treasury notes
 

 
(297
)
 

 
(297
)
Common stock and warrants
 
(3,071
)
 

 

 
(3,071
)
Total
 
$
(3,071
)
 
$
(363
)
 
$

 
$
(3,434
)

As of December 31, 2013:
Securities owned, at fair value
 
   Level 1
 
   Level 2
 
   Level 3
 
   Total
Debt securities
 
$

 
$
1,402

 
$

 
$
1,402

Certificates of deposit
 
24

 

 

 
24

U.S. Treasury notes
 

 
1

 

 
1

Common stock and warrants
 
689

 
725

 

 
1,414

Other investments
 

 
1,948

 

 
1,948

Total
 
$
713

 
$
4,076

 
$

 
$
4,789


Securities sold, but not yet purchased, at fair value
 
   Level 1
 
   Level 2
 
   Level 3
 
   Total
Debt securities
 
$

 
$
(46
)
 
$

 
$
(46
)
Common stock and warrants
 
(33
)
 
(4
)
 

 
(37
)
Total
 
$
(33
)
 
$
(50
)
 
$

 
$
(83
)
    
Debt securities and U.S. Treasury notes are valued based on recently executed transactions, market price quotations, and pricing models that factor in, as applicable, interest rates and bond default risk spreads.

Warrants are carried at a discount to fair value as determined by using the Black-Scholes option pricing model due to illiquidity. This model takes into account the underlying securities' current market values, the underlying securities' market volatility, the terms of the warrants, exercise prices and risk-free return rate. As of September 30, 2014 and December 31, 2013, the fair values of the warrants were $505 and $534, respectively, and are included in common stock and warrants (level 2) above.

From time to time, Ladenburg receives common stock as compensation for investment banking services. These securities are restricted under applicable securities laws and may be freely traded only upon the effectiveness of a registration statement covering them or upon the satisfaction of the requirements of Rule 144, including the requisite holding period. Restricted common stock is classified as Level 2 securities.
Other investments consist principally of equity interests in real estate investment trusts, which are valued based on broker-dealer quotations and pricing available from buyers in the secondary market, and are classified as Level 2 securities.





4. Net Capital Requirements


10

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)




The Company’s broker-dealer subsidiaries are subject to the SEC’s Uniform Net Capital Rule 15c3-1, which requires the maintenance of minimum net capital. Each of Securities America, Triad, Investacorp and Ladenburg has elected to compute its net capital under the alternative method allowed by this rule, and, at September 30, 2014, each had a $250 minimum net capital requirement. At September 30, 2014, Securities America had regulatory net capital of $8,516, Triad had regulatory net capital of $3,558, Investacorp had regulatory net capital of $4,364 and Ladenburg had regulatory net capital of $46,928, which included the proceeds of a $25,000 temporary subordinated loan from the Company to Ladenburg.

Securities America, Triad, Investacorp and Ladenburg claim exemptions from the provisions of the SEC’s Rule 15c3-3 pursuant to paragraph (k)(2)(ii) as they clear their customer transactions through correspondent brokers on a fully disclosed basis.

Premier Trust, chartered by the state of Nevada, is subject to regulation by the Nevada Department of Business and Industry Financial Institutions Division. Under Nevada law, Premier Trust must maintain minimum stockholders’ equity of at least $1,000, including at least $250 in cash. At September 30, 2014, Premier Trust had stockholders’ equity of $1,301, including at least $250 in cash.

5. Income Taxes

The Company files a consolidated federal income tax return and certain combined state and local income tax returns together with its subsidiaries.

A net deferred tax liability of approximately $14,922 was recorded in connection with the acquisition of Highland for the excess financial statement basis over tax basis of the acquired assets and assumed liabilities (See Note 2). As Highland will be included in the Company’s consolidated federal and certain combined state and local income tax returns, deferred federal and a portion of deferred state and local tax liabilities assumed in the acquisition may be used to offset the reversal of the Company’s pre-existing deferred tax assets. Accordingly, the Company’s deferred tax valuation allowance has been reduced by $14,125 of the deferred tax liability recorded in the acquisition and recorded as a deferred tax benefit in the accompanying statements of operations for the three and nine-month periods ended September 30, 2014.
Income tax benefit and income tax expense includes the tax effect of goodwill, which is amortized for income tax purposes, of $294 and $298 for the three months ended September 30, 2014 and 2013, respectively, and $881 and $885 for the nine months ended September 30, 2014 and 2013, respectively.

The effective tax rates differ from the statutory income tax rates for the 2014 and 2013 periods, primarily due to the reduction of the deferred tax valuation allowance, a tax provision related to amortization of goodwill for tax purposes and utilization of net operating loss carryforwards for which valuation allowances had previously been provided.


6.
Notes Payable

Notes payable consisted of the following:

 
September 30,
2014
 
December 31,
2013
Notes payable to clearing firm under forgivable loans (see Note 13)
$
14,285

 
$
14,285

Note payable to a subsidiary of Premier Trust’s former shareholder
264

 
450

Notes payable to finance Securities America acquisition, net of $951 and $1,618 of unamortized discount in 2014 and 2013, respectively
38,899

 
48,232

Note payable under term loan with bank
1,683

 
1,681

Notes payable to Highland's former shareholders
7,000

 

Total
$
62,131

 
$
64,648




11

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



The Company estimates that the fair value of notes payable was $66,223 at September 30, 2014 and $68,908 at December 31, 2013 based on then current interest rates at which similar amounts of debt could then be borrowed (Level 2 inputs). As of September 30, 2014, the Company was in compliance with all covenants in its debt agreements.

The lenders under the notes payable to finance the Securities America acquisition (the “November 2011 Loan”) included Frost Nevada Investments Trust (“Frost Nevada”), an affiliate of the Company's Chairman of the Board and principal shareholder, Vector Group, Ltd. (“Vector Group”), a principal shareholder of the Company, and the Company's President and Chief Executive Officer and a director. At September 30, 2014, outstanding principal amounts loaned by Frost Nevada, Vector Group and the Company's President and Chief Executive Officer were $33,477, $3,720 and $43, respectively.

The Company used the net proceeds from the sale of Series A Preferred Stock during the nine months ended September 30, 2014 (see Note 9) and working capital to prepay $10,000 principal amount of the remaining aggregate principal amount of the November 2011 Loan. In connection with the prepayment, the Company recorded a loss on extinguishment of debt for the nine months ended September 30, 2014 of $314, which included unamortized discounts and the write-off of debt issuance costs.

As of the date of the Highland acquisition, Highland had $21,834 payable under a credit agreement that was repaid by the Company. As of September 30, 2014, HCHC Acquisition, as successor in interest to HCHC, had outstanding $7,000 of its 10% promissory notes due February 26, 2019. Accrued interest on the promissory notes is payable quarterly on the 15th of October, January, April and July. The promissory notes may be prepaid, except that if the promissory notes are prepaid in full prior to August 26, 2016, the holders of the promissory notes are entitled to receive the total amount of interest that would otherwise have been payable through August 26, 2016, less any interest already paid.

At September 30, 2014, the Company had $40,000 available under its $40,000 revolving credit agreement with an affiliate of its principal shareholder.

7. Commitments and Contingencies

Litigation and Regulatory Matters

In October 2011, a suit was filed in the U.S. District Court for the District of Delaware by James Zazzali, as Trustee for the DBSI Private Actions Trust, against 50 firms, including two of the Company’s subsidiaries, and their purported parent corporations, alleging liability for purported fraud in the marketing and sale of DBSI securities. The plaintiff alleges, among other things, that the defendants failed to conduct adequate due diligence and violated securities laws. The plaintiff seeks an unspecified amount of compensatory damages as well as other relief. On September 24, 2014, a Company subsidiary entered into a settlement agreement resolving all claims against it; the amount paid by such subsidiary in connection with the settlement was not material. Effective September 26, 2014, the case involving the remaining parties was transferred to the U.S. District Court for the District of Idaho. The remaining Company subsidiary’s motion to dismiss the complaint is currently pending. The Company believes the claims are without merit and intends to vigorously defend against them.

In December 2011, a purported class action suit was filed in the U.S. District Court for the Southern District of Florida (“District Court”) against FriendFinder Networks, Inc. (“FriendFinder”), various individuals, and Ladenburg and another broker-dealer as underwriters for the May 11, 2011 FriendFinder initial public offering. On June 20, 2013, the plaintiff filed its second amended complaint, alleging that the defendants, including Ladenburg, were liable for violations of federal securities laws. On March 18, 2014, the District Court dismissed the second amended complaint with prejudice. On October 24, 2014, the U.S. Court of Appeals for the Eleventh Circuit affirmed the dismissal of the second amended complaint.

In December 2012, a purported class action suit was filed in the Superior Court of California for San Mateo County against Worldwide Energy & Manufacturing, Inc. (“WEMU”), certain individuals, and Ladenburg as placement agent for a 2010 offering of WEMU securities. The complaint alleged that the defendants, including Ladenburg, are liable for violations of state securities laws, and does not specify the amount of damages sought. On August 11, 2014, the parties entered into a settlement agreement resolving all claims in the complaint, which is subject to court approval. The amount expected to be paid by Ladenburg in connection with the settlement was accrued at December 31, 2013.

In April 2013, a former client of Securities America filed an arbitration claim against Securities America concerning the suitability of investments in three tenant-in-common interests purchased through Section 1031 tax-deferred exchanges;


12

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



the claimant sought compensatory damages equal to the purported total investment loss of approximately $2,164 and other relief. On September 15, 2014, the parties entered into a settlement agreement resolving all claims; the amount paid in connection with the settlement was not material.

During the period from June to November 2013, and in September 2014, seven former clients of Triad filed arbitration claims concerning the suitability of investments in tenant-in-common interests purchased through Section 1031 tax-deferred exchanges. In June and October 2014, two of the claimants entered into settlement agreements with Triad that resolved all of such claimants' claims; the amounts paid by Triad in connection with the settlements were not material. The five remaining claims, which seek purported investment losses totaling $6,051, and other relief, are currently pending. The Company believes the claims are without merit and intends to vigorously defend against them.

Commencing in October 2013, certain states have requested that Securities America provide information concerning the suitability of purchases of non-traded REIT securities by their residents. Securities America is complying with the requests. The Company currently is unable to determine the scope of any potential liability or whether and to what extent any of the states may seek to discipline Securities America.

From April to September 2014, six arbitration claims were filed on behalf of 40 individuals against Securities America and another brokerage firm concerning purported unauthorized trading and unsuitability of investments made on their behalf by a registered representative. Securities America believes that all or virtually all of the transactions at issue occurred while the registered representative was affiliated with his prior brokerage firm. On October 17, 2014, the parties to one of the arbitration claims reached an agreement in principle to resolve all claims on behalf of 29 individuals; the amount to be paid in connection with that settlement is not material. The 11 claimants in the remaining five arbitration claims are seeking reimbursement of investment losses that may exceed $3,000, and other relief. The Company believes the claims are without merit and intends to vigorously defend against them.

In the ordinary course of business, in addition to the above disclosed matters, the Company's subsidiaries are defendants in other litigation and arbitration proceedings and may be subject to unasserted claims primarily in connection with their activities as securities broker-dealers or as a result of services provided in connection with securities offerings. Such litigation and claims may involve substantial or indeterminate amounts and are in varying stages of legal proceedings. When the Company believes that it is probable that a liability has been incurred and the amount of loss can be reasonably estimated (after giving effect to any expected insurance recovery), the Company accrues such amount. Upon final resolution, amounts payable may differ materially from amounts accrued. The Company had accrued liabilities in the amount of approximately $3,854 at September 30, 2014 and $3,291 at December 31, 2013 for certain pending matters. For other pending matters, the Company was unable to estimate a range of possible loss as of September 30, 2014 or December 31, 2013, as applicable; however, in the opinion of management, after consultation with counsel, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity.


8. Off-Balance-Sheet Risk and Concentration of Credit Risk

Securities America, Triad, Investacorp and Ladenburg do not carry accounts for customers or perform custodial functions related to customers’ securities. They introduce all of their customer transactions, which are not reflected in these financial statements, to clearing brokers, which maintain cash and the customers’ accounts and clear such transactions. Also, the clearing brokers provide the clearing and depository operations for proprietary securities transactions. These activities create exposure to off-balance-sheet risk in the event that customers do not fulfill their obligations to the clearing brokers, as each of Securities America, Triad, Investacorp and Ladenburg has agreed to indemnify such clearing brokers for any resulting losses. Each of Securities America, Triad, Investacorp and Ladenburg continually assesses risk associated with each customer who is on margin credit and records an estimated loss when management believes collection from the customer is unlikely.

The clearing operations for the Securities America, Triad, Investacorp and Ladenburg securities transactions are provided by two clearing brokers, which are large financial institutions.

At September 30, 2014, amounts due from these clearing brokers was $68,378, which represents a substantial concentration of credit risk should these clearing brokers be unable to fulfill their obligations.



13

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



In the normal course of business, Securities America, Triad, Investacorp and Ladenburg may enter into transactions in financial instruments with off-balance sheet risk. As of September 30, 2014, Securities America, Triad and Ladenburg sold securities that they do not own and will therefore be obligated to purchase such securities at a future date. These obligations have been recorded in the statements of financial condition at the market values of the related securities, and such entities will incur a loss if, at the time of purchase, the market value of the securities has increased since the applicable date of sale.

The Company and its subsidiaries maintain cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash.

9. Shareholders’ Equity

Repurchase Program

In March 2007, the Company’s board of directors authorized the repurchase of up to 2,500,000 shares of the Company’s common stock from time to time on the open market or in privately negotiated transactions, depending on market conditions. In October 2011, the board approved an amendment to the repurchase program to permit the purchase of up to an additional 5,000,000 shares. Since inception through September 30, 2014, 6,194,247 shares of common stock have been repurchased for $14,179 under the program, including the repurchase of 1,280,400 shares for $4,674 and 2,444,490 shares for $8,090 during the three and nine months ended September 30, 2014, respectively.

Stock Compensation Plans

Options granted during the nine months ended September 30, 2014 were as follows:

Grant Date
 
Expiration Date
Shares
Exercise Price
Fair Value(1)
January 17, 2014
(2)(3) 
January 17, 2024
30,000
$
3.25

$
66

January 17, 2014
(2) 
January 17, 2024
2,268,000
$
3.25

$
3,859

January 22, 2014
(2) 
January 22, 2024
10,000
$
2.89

$
18

March 31, 2014
(2) 
March 31, 2024
30,000
$
3.02

$
55

June 25, 2014
(4) 
June 25, 2024
450,000
$
3.01

$
832

July 1, 2014
(2) 
July 1, 2024
10,000
$
3.32

$
19

July 31, 2014
(2) 
July 31, 2024
500,000
$
3.13

$
927

 
 
 
3,298,000
 
 

(1)
Fair value is calculated using the Black-Scholes option pricing model.
(2)
Options vest in four equal annual installments beginning on the first anniversary of the respective grant dates.
(3)
Compensation expense recognized each period is based on the award's estimated value at the most recent reporting date.
(4)
Options vest on the first anniversary of the grant date.

Options to purchase 201,413 shares of common stock were forfeited during the nine months ended September 30, 2014.

As of September 30, 2014, there was $13,813 of unrecognized compensation cost for stock-based compensation, of which $4,698 related to the 2014 grants described above. This cost is expected to be recognized over the vesting periods of the options, which on a weighted-average basis are approximately 1.84 years for all grants and approximately 3.06 years for the 2014 grants.

Options were exercised to purchase 498,976 and 1,787,913 shares of the Company’s common stock during the three and nine months ended September 30, 2014, for which the intrinsic value on dates of exercise was $1,187 and $3,354, respectively.

Capital Stock



14

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



On June 25, 2014, the Company's shareholders approved an amendment to the Company's Articles of Incorporation to increase the number of shares of common stock authorized from 600,000,000 to 800,000,000. On June 13, 2014, the Company filed articles of amendment to the Company's Articles of Incorporation to designate an additional 3,000,000 shares of its Series A Preferred Stock.
On June 24, 2013, the Company entered into an Equity Distribution Agreement under which it may sell up to an aggregate of 3,000,000 shares of its Series A Preferred Stock from time to time in an “at the market” offering under Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”). On June 13, 2014, the Company entered into another Equity Distribution Agreement under which it may sell up to an aggregate of 3,000,000 shares of its Series A Preferred Stock from time to time in an “at the market” offering under Rule 415 under the Securities Act. During the three and nine months ended September 30, 2014, the Company sold 2,542,490 and 4,683,709 shares of Series A Preferred Stock, respectively, pursuant to the “at the market” offering, which provided total gross proceeds to the Company of $57,652 and $105,764, respectively, before deducting the commission paid to unaffiliated sales agents and offering expenses aggregating $1,201 and $2,302, respectively.

For the three and nine months ended September 30, 2014, the Company paid dividends of $4,848 and $11,783, respectively, on its outstanding Series A Preferred Stock based on a monthly dividend of approximately $0.1667 per share.

10. Per Share Data

Basic net income per share is computed by dividing net income attributable to the Company, decreased by dividends declared on preferred stock, by the weighted-average number of common shares outstanding. The dilutive effect of incremental common shares potentially issuable under outstanding options and warrants is included in diluted earnings per share utilizing the treasury stock method. A reconciliation of basic and diluted common shares used in the computation of per share data follows:
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Basic weighted-average shares
182,988,516

 
181,759,305

 
182,082,141

 
182,895,952

Effect of dilutive securities:
 
 
 
 

 
 
     Common stock options
18,424,579

 

 
15,289,845

 

     Warrants to purchase common stock
9,122,277

 

 
7,871,369

 

Dilutive potential common shares
27,546,856

 

 
23,161,214

 

Weighted average common shares outstanding and dilutive potential common shares
210,535,372

 
181,759,305

 
205,243,355

 
182,895,952


For the three and nine months ended September 30, 2014, options to purchase 3,358,000 shares of common stock and for the three and nine months ended September 30, 2013 options and warrants to purchase 57,007,593 shares of common stock, were not included in the computation of diluted loss per share as the effect would have been anti-dilutive.


11. Noncontrolling Interest

Arbor Point Advisors, LLC (“APA”), a registered investment advisor, which began operations in 2013, provides investment advisory services through APA's licensed investment advisor representatives. Securities America holds an 80% interest in APA and an unaffiliated entity owns a 20% interest. Because Securities America is the controlling managing member of APA, the results of operations of APA are included in the Company's consolidated financial statements, and amounts attributable to the 20% unaffiliated investor are recorded as a noncontrolling interest.
    


15

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



12. Segment Information

The Company has three operating segments. The independent brokerage and advisory services segment includes the broker-dealer and investment advisory services provided by Securities America, Triad and Investacorp to their independent contractor financial advisors and wealth management services provided by Premier Trust. The Ladenburg segment includes the investment banking, sales and trading and asset management services and investment activities conducted by Ladenburg and LTAM. The insurance brokerage segment includes the wholesale insurance brokerage activities provided by Highland, which delivers life insurance, fixed and equity indexed annuities, as well as long-term care solutions to investment and insurance providers.

Earnings before interest, taxes, depreciation and amortization, or EBITDA, adjusted for acquisition-related expense, amortization of retention loans, change in the fair value of contingent consideration related to acquisitions, loss on extinguishment of debt, interest income and non-cash compensation expense, is a key metric the Company's management uses in evaluating financial performance for its reportable segments. EBITDA, as adjusted, is considered a non-GAAP financial measure as defined by Regulation G promulgated by the SEC under the Securities Act of 1933, as amended. The Company considers EBITDA, as adjusted, important in evaluating its financial performance on a consistent basis across various periods. Due to the significance of non-cash and non-recurring items, EBITDA, as adjusted, enables the Company's Board of Directors and management to monitor and evaluate the business on a consistent basis. The Company uses EBITDA, as adjusted, as a primary measure, among others, to analyze and evaluate financial and strategic planning decisions regarding future operating investments and potential acquisitions. The Company believes that EBITDA, as adjusted, eliminates items that are not indicative of its core operating performance, such as amortization of retention loans for the Securities America acquisition and other acquisition-related expenses, or do not involve a cash outlay, such as stock-related compensation, which is expected to remain a key element in our long-term incentive compensation program. EBITDA, as adjusted, should be considered in addition to, rather than as a substitute for, pre-tax income, net income and cash flows from operating activities.

Segment information for the three months ended September 30, 2014 and 2013 was as follows:


 

Independent
Brokerage and
Advisory Services
 
Ladenburg
 
Insurance Brokerage
 
Corporate
 
Total
2014
 
 
 
 
 
 
 
 
 
Revenues
$
197,730

 
$
16,675

 
$
9,242

 
$
85

 
$
223,732

Pre-tax income (loss)
1,186

 
3,400

 
(742
)
 
(4,415
)
(2) 
(571
)
EBITDA, as adjusted(7)
10,369

 
3,734

 
386

 
(2,429
)
 
12,060

Identifiable assets
314,083

 
72,190

(6) 
62,812

 
44,247

 
493,332

Depreciation and amortization
3,771

 
176

 
952

 
3

 
4,902

Interest
1,267

 
11

 
118

 
305

 
1,701

Capital expenditures
1,114

 

 
48

 

 
1,162

Non-cash compensation
2,640

 
153

 
58

 
828

 
3,679

 
 
 
 
 
 
 
 
 
 
2013

 
 
 
 
 
 
 

Revenues
$
184,085

 
$
16,325

 
$

 
$
79

 
$
200,489

Pre-tax (loss) income(3)
4,199

 
2,284

 

 
(3,525
)
(2) 
2,958

EBITDA, as adjusted(3)(7)
12,592

 
2,654

 

 
(2,478
)
 
12,768

Identifiable assets
315,401

 
34,526

 

 
4,908

 
354,835

Depreciation and amortization
3,550

 
214

 

 
12

 
3,776

Interest
1,906

 
3

 

 
374

 
2,283

Capital expenditures
1,090

 
479

 

 

 
1,569

Non-cash compensation
851

 
163

 

 
633

 
1,647

 
 
 
 
 
 
 
 
 
 


Segment information for the nine months ended September 30, 2014 and 2013 was as follows:


16

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)





 

Independent
Brokerage and
Advisory Services
 
Ladenburg
 
Insurance Brokerage
 
Corporate
 
Total
2014
 
 
 
 
 
 
 
 
 
Revenues
$
588,987

 
$
57,830

 
$
9,242

 
$
244

 
$
656,303

Pre-tax income (loss)
6,927

 
13,176

 
(742
)
 
(11,385
)
(2) 
7,976

EBITDA, as adjusted(7)
32,318

 
14,123

 
386

 
(6,857
)
 
39,970

Identifiable assets
314,083

 
72,190

(6) 
62,812

 
44,247

 
493,332

Depreciation and amortization
11,082

 
486

 
952

 
7

 
12,527

Interest
4,121

 
18

 
118

 
936

 
5,193

Capital expenditures
4,805

 
926

 
48

 
108

 
5,887

Non-cash compensation
4,913

 
458

 
58

 
2,260

 
7,689

 
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
 
Revenues
$
535,702

(4) 
$
50,890

(4) 
$

 
$
(4,929
)
(5) 
$
581,663

Pre-tax (loss) income(3)
3,726

 
8,962

 

 
(14,004
)
(1)(2) 
(1,316
)
EBITDA, as adjusted(3)(7)
36,874

 
10,135

(1) 

 
(9,374
)
(1) 
37,635

Identifiable assets
315,401

 
34,526

 

 
4,908

 
354,835

Depreciation and amortization
10,880

 
626

 

 
47

 
11,553

Interest
10,830

 
71

 

 
2,494

 
13,395

Capital expenditures
3,575

 
1,031

 

 

 
4,606

Non-cash compensation
2,109

 
486

 

 
1,844

 
4,439

 
 
 
 
 
 
 
 
 
 


(1) 
Includes the elimination of $2,545, consisting of $5,148 of revenue net of employee brokerage commission expenses of $2,603 related to sales of the Company's Series A Preferred Stock.

(2) 
Includes interest on revolving credit and forgivable loan notes, compensation, professional fees and other general and administrative expenses.

(3) 
Management fees paid by the Company's operating segments to the Company have been reclassified within segments to conform to the current period’s presentation.

(4)  
Includes brokerage commissions of $4,240 and $908 in the Ladenburg and Independent brokerage and advisory services segments, respectively, related to the sale of the Company's Series A Preferred Stock (eliminated in consolidation).

(5)  
Includes the elimination of $5,148 of revenue referred to in (1).

(6)  
Includes a temporary subordinated loan of $25,000 made to Ladenburg from Corporate and repaid on October 7, 2014.

(7)  
The following table reconciles EBITDA, as adjusted, to pre-tax income (loss) for the three and nine months ended September 30, 2014 and 2013:



17

LADENBURG THALMANN FINANCIAL SERVICES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited; in thousands, except share and per share amounts)



 
Three months ended September 30,
 
Nine months ended September 30,
EBITDA, as adjusted
2014
 
2013
 
2014
 
2013
Independent Brokerage and Advisory Services
$
10,369

 
$
12,592

 
$
32,318

 
$
36,874

Ladenburg
3,734

 
2,654

 
14,123

 
10,135

Insurance Brokerage
386

 

 
386

 

Corporate
(2,429
)
 
(2,478
)
 
(6,857
)
 
(9,374
)
Total Segments
12,060

 
12,768

 
39,970

 
37,635

 
 
 
 
 
 
 
 
Adjustments:
 
 
 
 
 
 
 
Interest income
59

 
55

 
195

 
145

Change in fair value of contingent consideration

 

 
12

 
(121
)
Loss on extinguishment of debt

 
(446
)
 
(314
)
 
(4,200
)
Interest expense
(1,701
)
 
(2,283
)
 
(5,193
)
 
(13,395
)
Depreciation and amortization
(4,902
)
 
(3,776
)
 
(12,527
)
 
(11,553
)
Non-cash compensation expense
(3,679
)
 
(1,647
)
 
(7,689
)
 
(4,439
)
Amortization of retention loans
(1,538
)
 
(1,690
)
 
(5,108
)
 
(5,339
)
Acquisition-related expenses
(850
)
 

 
(1,308
)
 

Net loss attributable to noncontrolling interest
(20
)
 
(23
)
 
(62
)
 
(49
)
Pre-tax income (loss)
$
(571
)
 
$
2,958

 
$
7,976

 
$
(1,316
)

13. Subsequent events

On October 15, 2014, the Company acquired 100% of the outstanding capital stock of KMS Financial Services, Inc. (“KMS”) for a purchase price of $24,000, consisting of $11,000 in cash, $8,000 in notes and 1,440,922 shares of the Company's common stock valued at $5,000. KMS is a Seattle-based independent broker-dealer and investment advisor with a strong presence in the Pacific Northwest.

On September 21, 2014, the Company entered into a stock purchase agreement with Securities Service Network, Inc. (“SSN”), Renaissance Capital Corporation (“RCC”) and the shareholders of SSN and RCC, pursuant to which the Company agreed to acquire all of the issued and outstanding capital stock of SSN and RCC. SSN is an independent broker-dealer, registered investment advisor and insurance agency based in Knoxville, TN. Under the terms of the purchase agreement, the Company has agreed to pay to SSN's and RCC's shareholders an aggregate of approximately $45,000, consisting of a $25,000 cash payment to be paid on the date following the closing of the transaction (which is anticipated to occur in the fourth quarter of 2014) and $20,000 aggregate principal amount of promissory notes secured by a pledge of the acquired shares of SSN and RCC.

In 2009 and 2011, the primary clearing firm of the Company’s subsidiaries, National Financial Services LLC (“NFS”), a
Fidelity Investments company, provided the Company with forgivable loans, the proceeds of which were used to help fund the Company’s growth strategy. Under the terms of the loans, on an annual basis commencing November 2012, based on the Company’s subsidiaries continuing to clear with NFS and, in the case of one of the loans, meeting certain annual clearing revenue targets, a portion of the principal amount of the loans and related interest are forgiven. In November 2014, approximately $3,929 aggregate principal amount of the loans was forgiven together with related interest, and the Company will recognize an increase in pre-tax income for the fourth quarter of 2014 of approximately $3,100, net of related compensation expense, resulting from the forgiveness.




18


Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(dollars in thousands, except per share data)

Overview

We are a diversified financial services company engaged in independent brokerage and advisory services, investment banking, equity research, institutional sales and trading, asset management services, wholesale life insurance brokerage and trust services through our principal subsidiaries, Securities America, Inc. (collectively with related companies, “Securities America”), Triad Advisors, Inc. (“Triad”), Investacorp, Inc. (collectively with related companies, “Investacorp”), Ladenburg Thalmann & Co. Inc. (“Ladenburg”), Ladenburg Thalmann Asset Management Inc. (“LTAM”), Highland Capital Brokerage, Inc. (“Highland”), KMS Financial Services, Inc. (“KMS”) and Premier Trust, Inc. (“Premier Trust”). We are committed to establishing a significant presence in the financial services industry by meeting the varying investment needs of our clients.

Through our acquisitions of Securities America, Triad, Investacorp and KMS, we have established a leadership position in the independent broker-dealer industry. During the past decade, this has been one of the fastest growing segments of the financial services industry. With approximately 3,200 financial advisors located in 50 states, we have become one of the five largest independent broker-dealer networks. We believe that we have the opportunity through acquisitions, recruiting and internal growth to continue expanding our market share in this segment over the next several years. Since 2007, our plan has been to marry the more stable and recurring revenue and cash flows of the independent broker-dealer business with Ladenburg’s traditional investment banking, capital markets, institutional, sales and trading and related businesses.
    
Ladenburg’s traditional businesses are generally more volatile and subject to the cycles of the capital markets than our independent broker-dealer subsidiaries, but historically have enjoyed strong operating margins in good market conditions. Our goal has been to build sufficient scale in our independent brokerage business, with the accompanying more steady cash flows it can produce, so regardless of capital market conditions, we as a firm can generate significant operating cash to create value for our shareholders.

The appealing growth profile of the independent brokerage and advisory business has been a key factor in setting our strategic path. The independent brokerage channel has expanded significantly over the past decade, driven in large part by demographic trends, including the graying of America, the retirement of the baby boomer generation and the expected transfer of retirement assets from 401(k) and group plans to individual retirement accounts. The increasing responsibility of individuals to plan for their own retirement has created demand for the financial advice provided by financial advisors in the independent channel, who are not tied to a particular firm’s proprietary products. These developments have been occurring against a backdrop of the steady migration of client assets and advisors from the wirehouse, insurance and bank channels to the independent channel.

We operate each of our independent broker-dealers separately under their own management teams in a network model, which reflects our recognition that each firm has its own unique culture and strengths. We believe this is an important part of the glue that helps bind the advisors to the firm. At the same time, we have taken advantage of the scale we have created across the multiple firms by spreading costs in areas that are not directly visible to the advisors and their clients, such as technology, accounting and other back office functions.

While we keep each firm separate, we seek to share intellectual capital and best practices among the firms. For instance, we offer Securities America’s industry best practice development tools to our other advisors. Similarly, the advisors in our independent brokerage and advisory segment have resources to enhance their practices, including access to Ladenburg’s proprietary research, investment banking and capital markets services, fixed income trading and syndicate products, Premier Trust’s trust services, Highland’s insurance solutions and LTAM’s wealth management solutions.

Ladenburg is a full service broker-dealer that has been a member of the New York Stock Exchange (“NYSE”) since 1879. It provides its services principally for middle market and emerging growth companies and high net worth individuals through a coordinated effort among corporate finance, capital markets, asset management, brokerage and trading professionals.



19


LTAM is a registered investment advisor. LTAM offers various asset management products utilized by Ladenburg's and Premier Trust's clients, as well as clients of our independent financial advisors.

Highland is a leading independent insurance brokerage that delivers life insurance, fixed and equity indexed annuities and long-term care solutions to investment and insurance providers. Highland provides specialized point-of-sale support along with advanced marketing and estate and business planning techniques, delivering customized insurance solutions to both institutional clients and independent producers.

Premier Trust, a Nevada trust company, provides trust administration of personal and retirement accounts, estate and financial planning, wealth management and custody services. We acquired Premier Trust in September 2010 to provide our network of independent financial advisors with access to a broad array of trust services. This was another important strategic step in our efforts to meaningfully differentiate our independent broker-dealer platform by the breadth of the products and services we offer to our advisors.

Each of Securities America, Triad, Investacorp, Ladenburg and KMS is subject to regulation by, among others, the Securities and Exchange Commission (“SEC”), the Financial Industry Regulatory Authority (“FINRA”), and the Municipal Securities Rulemaking Board and is a member of the Securities Investor Protection Corporation. Securities America is also subject to regulation by the Commodities Futures Trading Commission and the National Futures Association. Premier Trust is subject to regulation by the Nevada Department of Business and Industry Financial Institutions Division.

Recent Developments

KMS Financial Services, Inc. Acquisition

On October 15, 2014, we acquired all of the issued and outstanding capital stock of KMS. KMS is a leading Seattle-based independent broker-dealer and registered investment advisor with a strong presence in the Pacific Northwest. At the closing of the acquisition, we paid approximately $24,000, consisting of $11,000 cash, $8,000 principal amount of our promissory notes, and 1,440,922 shares of our common stock, which are subject to certain transfer restrictions. The notes are unsecured and bear interest at 1.84% per annum and are payable in 16 equal quarterly installments. Mark Hamby, KMS’s Chairman and CEO, Eric Westberg, its President and COO, and the rest of the KMS management team continue to operate KMS as a stand-alone business from its headquarters in Seattle, Washington.

Securities Service Network, Inc. Acquisition

On September 21, 2014, we entered into a stock purchase agreement with Securities Service Network, Inc. (“SSN”), Renaissance Capital Corporation (“RCC”) and the shareholders of SSN and RCC, pursuant to which we agreed to acquire all of the issued and outstanding capital stock of SSN and RCC. SSN is a leading independent broker-dealer, registered investment advisor and insurance agency based in Knoxville, TN. Under the terms of the purchase agreement, we have agreed to pay to SSN's and RCC's shareholders an aggregate of approximately $45,000, consisting of a $25,000 cash payment to be paid on the date following the closing of the transaction (which is anticipated to occur in the fourth quarter of 2014) and $20,000 aggregate principal amount of promissory notes secured by a pledge of the acquired shares of SSN and RCC. Upon completion of the transaction, SSN's President and Chief Executive Officer Wade Wilkinson and the other members of the SSN management team will continue to operate SSN as a stand-alone business from its headquarters in Knoxville.

Acquisition Strategy

We continue to explore opportunities to grow our businesses, including through possible acquisitions of other financial services firms, both domestically and internationally. These acquisitions may involve payments of material amounts of cash, the incurrence of material amounts of debt, which would increase our leverage, or the issuance of significant amounts of our equity securities, which may be dilutive to our existing shareholders. We cannot assure you that we will be able to complete any such possible acquisitions on acceptable terms or at all or, if we do, that any acquired business will be profitable. We also may not be able to integrate successfully acquired businesses into our existing business and operations.

We were incorporated under the laws of the State of Florida in February 1996.
 
Critical Accounting Policies


20



There have been no material changes from the critical accounting policies set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our annual report on Form 10-K for the year ended December 31, 2013. Please refer to those sections for disclosures regarding the critical accounting policies related to our business.
                       
Results of Operations

The following discussion provides an assessment of our results of operations, capital resources and liquidity and should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report. The unaudited condensed consolidated financial statements include our accounts and the accounts of Securities America, Triad, Investacorp, Ladenburg, Highland, Premier Trust and our other subsidiaries, other than KMS, which we acquired on October 15, 2014.

The following table includes a reconciliation of EBITDA, as adjusted, to net income (loss) attributable to the Company as reported:

 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2014
 
2013
 
2014
 
2013
 
Total revenues
$
223,732

 
$
200,489

 
$
656,303

 
$
581,663

 
Total expenses
224,303

 
197,531

 
648,339

 
582,858

 
Pre-tax (loss) income
(571
)
 
2,958

 
7,976

 
(1,316
)
(1) 
Net income (loss) attributable to the Company
12,803

 
2,402

 
20,032

 
(2,985
)
 
 
 
 
 
 
 
 
 
 
Reconciliation of EBITDA, as adjusted, to net income (loss) attributable to the Company:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
EBITDA, as adjusted
$
12,060

 
$
12,768

 
$
39,970

 
$
37,635

(1) 
Add:
 
 
 
 
 
 
 
 
   Interest income
59

 
55

 
195

 
145

 
 Change in fair value of contingent consideration

 

 
12

 
(121
)
 
Less:
 
 
 
 
 
 
 
 
    Loss on extinguishment of debt

 
(446
)
 
(314
)
 
(4,200
)
 
Interest expense
(1,701
)
 
(2,283
)
 
(5,193
)
 
(13,395
)
 
Income tax benefit (expense)
13,354

 
(579
)
 
11,994

 
(1,718
)
 
Depreciation and amortization
(4,902
)
 
(3,776
)
 
(12,527
)
 
(11,553
)
 
Non-cash compensation
(3,679
)
 
(1,647
)
 
(7,689
)
 
(4,439
)
 
Acquisition-related expense
(850
)
 

 
(1,308
)
 

 
Amortization of retention loans
(1,538
)
 
(1,690
)
 
(5,108
)
 
(5,339
)
 
Net income (loss) attributable to the Company
$
12,803

 
$
2,402

 
$
20,032

 
$
(2,985
)
 

(1)  2013 results included the elimination of $2,545, consisting of $5,148 of revenue net of employee brokerage commission expenses
of $2,603 related to sales of the Company’s Series A Preferred Stock. 

Earnings before interest, taxes, depreciation and amortization, or EBITDA, adjusted for acquisition-related expense, amortization of retention loans, change in the fair value of contingent consideration related to acquisitions, loss on extinguishment of debt, interest income and non-cash compensation expense, is a key metric we use in evaluating our financial performance. EBITDA, as adjusted, is considered a non-GAAP financial measure as defined by Regulation G promulgated by the SEC under the Securities Act of 1933, as amended. We consider EBITDA, as adjusted, important in evaluating our financial performance on a consistent basis across various periods.


21


Due to the significance of non-cash and non-recurring items, EBITDA, as adjusted, enables the Company’s Board of Directors and management to monitor and evaluate the business on a consistent basis.

We use EBITDA, as adjusted, as a primary measure, among others, to analyze and evaluate financial and strategic planning decisions regarding future operating investments and potential acquisitions. We believe that EBITDA, as adjusted, eliminates items that are not indicative of our core operating performance, such as amortization of retention loans for the Securities America acquisition and other acquisition-related expenses, or do not involve a cash outlay, such as stock-related compensation. The presentation of EBITDA, as adjusted, should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items or by non-cash items, such as non-cash compensation, which is expected to remain a key element in our long-term incentive compensation program. EBITDA, as adjusted, should be considered in addition to, rather than as a substitute for, pre-tax income, net income and cash flows from operating activities.

EBITDA, as adjusted, was $12,060 and $39,970 for the three and nine months ended September 30, 2014, respectively, a decrease of $708 (6%) and an increase of $2,335 (6%), respectively, from EBITDA, as adjusted, of $12,768 and $37,635, respectively, for the three and nine months ended September 30, 2013. The decrease in EBITDA, as adjusted, in the 2014 third quarter as compared to the 2013 third quarter was driven by higher clearing expenses, while the year-to-date growth was primarily due to increased advisory and commission revenues, as well as increased investment banking activities during 2014. 

Segment Description

We have three operating segments. The independent brokerage and advisory services segment includes the broker-dealer and investment advisory services provided by Securities America, Triad and Investacorp to their independent contractor financial advisors and the wealth management services provided by Premier Trust. The Ladenburg segment includes the investment banking, sales and trading and asset management services and investment activities conducted by Ladenburg and LTAM. The insurance brokerage segment includes the wholesale insurance brokerage activities provided by Highland, which delivers life insurance, fixed and equity indexed annuities and long-term care solutions to investment and insurance producers.

 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
   Independent Brokerage and Advisory Services
$
197,730

 
$
184,085

 
$
588,987

 
$
535,702

   Ladenburg
16,675

 
16,325

 
57,830

 
50,890

   Insurance Brokerage
9,242

 

 
9,242

 

   Corporate
85

 
79

 
244

 
(4,929
)
      Total revenues
$
223,732

 
$
200,489

 
$
656,303

 
$
581,663

 
 
 
 
 
 
 
 
Pre-tax income (loss):
 
 
 
 
 
 
 
   Independent Brokerage and Advisory Services
$
1,186

 
$
4,199

 
$
6,927

 
$
3,726

   Ladenburg
3,400

 
2,284

 
13,176

 
8,962

   Insurance Brokerage
(742
)
 

 
(742
)
 

   Corporate(1)   
(4,415
)
 
(3,525
)
 
(11,385
)
 
(14,004
)
      Total pre-tax (loss) income
$
(571
)
 
$
2,958

 
$
7,976

 
$
(1,316
)

(1) Includes interest on revolving credit agreement and forgivable loan notes, compensation, professional fees and other general and administrative expenses.


Three months ended September 30, 2014 versus three months ended September 30, 2013

For the quarter ended September 30, 2014 we had net income attributable to the Company of $12,803 as compared to net income attributable to the Company of $2,402 for the quarter ended September 30, 2013.


22


The increase was attributable to a $14,125 income tax benefit resulting from the reversal of a valuation allowance previously provided to offset deferred tax assets as discussed below. Net income attributable to the Company for the third quarter of 2014 was impacted positively by a 12% increase in revenues, which was partially offset by a 14% increase in expenses. Highland, which we acquired in the third quarter of 2014, had a loss of $742 from the acquisition date (July 31, 2014) through September 30, 2014.

Our total revenues for the three months ended September 30, 2014 increased $23,243 (12%) from the 2013 period, in part due to the addition of $9,242 in revenues from Highland. Third quarter 2014 revenues included increases in commissions of $8,106, advisory fees of $16,440 and investment banking revenue of $826, partially offset by decreases in service fees and other income of $1,655, principal transactions of $408 and interest and dividends of $66. Revenues in the 2014 period increased in each of our operating segments from the 2013 period. Our independent brokerage and advisory services segment revenues increased $13,645 (7%) from the 2013 period, primarily due to improved market conditions, successful recruitment of additional advisors and increased advisory assets under management. Our Ladenburg segment revenues in the third quarter of 2014 increased $350 (2%) from the 2013 period also due to improved market conditions and an increase in institutional sales personnel.
       
Our total expenses for the three months ended September 30, 2014 increased by $26,772 (14%) as compared to the 2013 period, in part due to the addition of $9,984 from Highland. Third quarter 2014 expenses included increases in commissions and fees expense of $16,487, compensation and benefits expense of $4,550, brokerage, communication and clearance fee expense of $1,588, depreciation and amortization of $1,126, acquisition-related expenses of $850, professional services expense of $880 and other expense of $165, which were partially offset by decreases in interest expense of $582 due to the prepayment of indebtedness and loss on extinguishment of debt of $446.

The $8,106 (8%) increase in commissions revenue for the three months ended September 30, 2014 as compared to the 2013 period was primarily attributable to the acquisition of Highland in the third quarter of 2014, which added $9,104 in commissions revenue. Our independent brokerage and advisory services segment experienced a decrease of $1,011 (1%) in commissions revenue due to lower sales of alternative investment products in the three months ended September 30, 2014 as compared to the prior-year period. Ladenburg segment commissions revenue was flat for the third quarter 2014 as compared to the third quarter of 2013.

The $16,440 (24%) increase in advisory fee revenue for the three months ended September 30, 2014 as compared to the 2013 period was primarily attributable to a $15,764 (23%) increase in advisory fee revenue in our independent brokerage and advisory services segment. Advisory fee revenue for a particular period is primarily affected by the level of advisory assets and market conditions. For the three months ended September 30, 2014, we experienced an increase in advisory assets of 14% as compared to the 2013 period, resulting from strong new business development and improved market conditions. Assuming continued favorable market conditions, we expect advisory fee revenue to increase in the near term due to newly-added advisory assets and the continued shift by our advisors toward the advisory business.

The $826 (8%) increase in investment banking revenue for the three months ended September 30, 2014 as compared to the 2013 period was primarily due to a $505 increase in capital raising revenue and a $321 increase in strategic advisory services revenue during the 2014 third quarter. We derive investment banking revenue from Ladenburg’s capital raising activities, including underwritten public offerings and private placements, and strategic advisory services. Revenue from capital raising activities was $10,357 for the 2014 third quarter as compared to $9,851 for the 2013 period, primarily due to an increase in capital raising activities for financial and energy companies and favorable market conditions. Strategic advisory services revenue was $559 in the third quarter of 2014 as compared to $238 in the comparable 2013 quarter.

The $408 (49%) decrease in principal transactions revenue for the three months ended September 30, 2014 as compared to the 2013 period was primarily attributable to our Ladenburg segment, which had a decrease of $419, due to a decrease in the value of the firm's investments.

The $66 (4%) decrease in interest and dividends revenue for the three months ended September 30, 2014 as compared to the 2013 period was primarily due to a decrease of $29 related to interest earned on customers' margin accounts at our Ladenburg segment. Our current cash sweep program expires in December 2014. We expect that interest and dividends revenue will decrease in the fourth quarter of 2014 and the first quarter of 2015 due to the wind-down and expiration of such program. We intend to implement a new cash sweep program in 2015.



23


The $(1,655) (10%) decrease in service fees and other income for the three months ended September 30, 2014 as compared to the 2013 period was primarily attributable to decreases in sponsor revenues of $1,372, primarily
due to lower sales of alternative investment products. We expect service fees and other income to increase in the fourth quarter of 2014 as compared to the third quarter of 2014 due to forgiveness of principal and interest on the NFS forgivable loans.

The $16,487 (11%) increase in commissions and fees expense for the three months ended September 30, 2014 as compared to the 2013 period was directly correlated to the increase in advisory fees revenue in our independent brokerage and advisory services segment. Commissions and fees expense comprises compensation earned by the registered representatives who serve as independent contractors in our independent brokerage and advisory services segment. These payments to the independent contractor registered representatives are calculated based on a percentage of revenues generated by such persons and vary by product. Accordingly, when our independent contractor registered representatives increase their business, both our revenues and expenses increase because our representatives earn additional compensation based on the revenues produced. The addition of Highland in the third quarter of 2014 increased commissions and fees expense by $2,477.

The $4,550 (19%) increase in compensation and benefits expense for the three months ended September 30, 2014 as compared to the 2013 period was primarily attributable to the addition of $4,659 in compensation and
benefits expense from Highland and an increase of $908 in the independent brokerage and advisory services segment, partially offset by a decrease of $1,053 in the Ladenburg segment.

The $2,032 (123%) increase in non-cash compensation expense for the three months ended September 30, 2014 as compared to the 2013 period was primarily attributable to an increase of $1,798 from stock option grants made to Securities America financial advisors in connection with the 2011 acquisition. Compensation expense for share-based awards granted to independent financial advisors is measured at their vesting date fair value. The compensation expense recognized each period is based on the awards' estimated value at the most recent reporting date. We use a Black-Scholes model to estimate fair value, which uses volatility, price and interest inputs. Also, we estimate a forfeiture rate based on historical experience. The increase in the price of our common stock and the decrease in the expected forfeitures for these grants has contributed to the increase in our non-cash compensation expense.

The $1,588 (58%) increase in brokerage, communication and clearance fees expense for the three months ended September 30, 2014 as compared to the 2013 period was primarily due to an increase of $1,163 in our independent brokerage and advisory services segment. Clearance fee expense for the third quarter of 2014 increased as compared to the third quarter of 2013, during which period such expenses were reduced by clearance expense credits of $1,495 provided by our primary clearing firm. These clearance expense credits expired in the fourth quarter of 2013. As a result, we expect clearing expense to increase in future periods as compared to 2013 levels.
 
The $880 (39%) increase in professional services expense for the three months ended September 30, 2014 as compared to the 2013 period was attributable to increases at our independent brokerage and advisory services segment of $636 and the addition of Highland, which added $180 in professional services expense.

The $582 (25%) decrease in interest expense for the three months ended September 30, 2014 as compared to the 2013 period resulted from decreased average debt balances and decreased average interest rates. Our average outstanding debt balance was approximately $61,447 for the third quarter of 2014 as compared to $80,868 for the 2013 period. The average interest rate was 9.8% for the three months ended September 30, 2014 as compared to 10.6% for the 2013 period. Our outstanding debt balance for the 2014 period declined in comparison to the prior-year period as a result of the prepayment of indebtedness in fiscal 2013 and an additional $10,000 prepayment of indebtedness in the first quarter of 2014, partially offset by the assumption of $7,000 of indebtedness in connection with the Highland acquisition. We expect increased interest expense in future periods from current levels due to the indebtedness we incurred in connection with the acquisitions of Highland and KMS and the indebtedness expected to be incurred in connection with the planned acquisition of SSN. We may prepay indebtedness with cash flows from operations and future proceeds, if any, from our “at the market” offering of Series A Preferred Stock