SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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 30, 2006

OR

o

 

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

 

For the transition period from                  to                 

Commission File Number 001-13459


Affiliated Managers Group, Inc.

(Exact name of registrant as specified in its charter)

Delaware

 

04-3218510

(State or other jurisdiction

 

(IRS Employer Identification Number)

of incorporation or organization)

 

 

 

600 Hale Street, Prides Crossing, Massachusetts 01965

(Address of principal executive offices)

(617) 747-3300

(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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer x

Accelerated Filer o

Non-accelerated Filer o

 

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

There were 30,174,824 shares of the registrant’s common stock outstanding as of November 3, 2006.

 




 

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

AFFILIATED MANAGERS GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
(unaudited)

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

234,126

 

$

280,440

 

$

643,995

 

$

841,590

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Compensation and related expenses

 

95,474

 

122,841

 

259,545

 

358,029

 

Selling, general and administrative

 

44,009

 

40,946

 

115,285

 

129,705

 

Amortization of intangible assets

 

6,525

 

6,839

 

17,998

 

20,533

 

Depreciation and other amortization

 

2,035

 

2,239

 

5,052

 

6,386

 

Other operating expenses

 

5,314

 

5,516

 

15,071

 

16,698

 

 

 

153,357

 

178,381

 

412,951

 

531,351

 

Operating income

 

80,769

 

102,059

 

231,044

 

310,239

 

Non-operating (income) and expenses:

 

 

 

 

 

 

 

 

 

Income from equity method investments

 

(4,244

)

(7,464

)

(10,249

)

(19,530

)

Investment and other income

 

(2,717

)

(3,623

)

(5,784

)

(8,994

)

Investment (income) loss from Affiliate investments in partnerships

 

(214

)

4,959

 

(166

)

3,451

 

Interest expense

 

10,071

 

16,250

 

26,682

 

42,834

 

 

 

2,896

 

10,122

 

10,483

 

17,761

 

 

 

 

 

 

 

 

 

 

 

Income before minority interest and taxes

 

77,873

 

91,937

 

220,561

 

292,478

 

Minority interest

 

(32,619

)

(43,658

)

(92,439

)

(135,626

)

Minority interest in Affiliate investments in  partnerships

 

 

4,334

 

 

3,330

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

45,254

 

52,613

 

128,122

 

160,182

 

 

 

 

 

 

 

 

 

 

 

Income taxes – current

 

8,762

 

12,168

 

23,900

 

37,412

 

Income taxes – intangible-related deferred

 

7,058

 

6,991

 

21,918

 

19,793

 

Income taxes – other deferred

 

924

 

308

 

1,999

 

654

 

Net Income

 

$

28,510

 

$

33,146

 

$

80,305

 

$

102,323

 

 

 

 

 

 

 

 

 

 

 

Earnings per share – basic

 

$

0.84

 

$

1.09

 

$

2.39

 

$

3.22

 

Earnings per share – diluted(1)

 

$

0.67

 

$

0.87

 

$

1.91

 

$

2.53

 

 

 

 

 

 

 

 

 

 

 

Average shares outstanding – basic

 

33,926,047

 

30,371,364

 

33,611,937

 

31,746,855

 

Average shares outstanding – diluted(1)

 

44,908,036

 

44,399,722

 

44,465,513

 

45,298,012

 

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of total comprehensive income:

 

 

 

 

 

 

 

 

 

Net Income

 

$

28,510

 

$

33,146

 

$

80,305

 

$

102,323

 

Other comprehensive income (loss)

 

15,003

 

(1,206

)

14,851

 

11,788

 

Total comprehensive income

 

$

43,513

 

$

31,940

 

$

95,156

 

$

114,111

 

 


(1)          See Note 7 for the calculation of diluted earnings per share.

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

2




 

AFFILIATED MANAGERS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

 

 

December 31,

 

September 30,

 

 

 

2005

 

2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

140,423

 

$

222,062

 

Investment advisory fees receivable

 

148,850

 

160,442

 

Affiliate investments in partnerships

 

5,079

 

107,989

 

Prepaid expenses and other current assets

 

48,529

 

40,039

 

Total current assets

 

342,881

 

530,532

 

Fixed assets, net

 

50,592

 

59,862

 

Equity investments in Affiliates

 

301,476

 

285,806

 

Acquired client relationships, net

 

483,692

 

470,322

 

Goodwill

 

1,093,249

 

1,113,286

 

Other assets

 

49,746

 

71,822

 

Total assets

 

$

2,321,636

 

$

2,531,630

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

176,711

 

$

241,026

 

Senior debt

 

65,750

 

65,750

 

Payables to related party

 

14,127

 

8,595

 

Total current liabilities

 

256,588

 

315,371

 

Senior debt

 

175,500

 

216,000

 

Senior convertible securities

 

424,232

 

413,246

 

Mandatory convertible securities

 

300,000

 

300,000

 

Junior convertible trust preferred securities

 

 

300,000

 

Deferred income taxes

 

182,623

 

208,351

 

Other long-term liabilities

 

20,149

 

14,244

 

Total liabilities

 

1,359,092

 

1,767,212

 

Commitments and contingencies (Note 8)

 

 

 

Minority interest

 

145,163

 

126,704

 

Minority interest in Affiliate investments in partnerships

 

 

102,530

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

390

 

390

 

Additional paid-in capital

 

593,090

 

605,879

 

Accumulated other comprehensive income

 

16,756

 

28,544

 

Retained earnings

 

503,188

 

605,511

 

 

 

1,113,424

 

1,240,324

 

Less: treasury stock, at cost

 

(296,043

)

(705,140

)

Total stockholders’ equity

 

817,381

 

535,184

 

Total liabilities and stockholders’ equity

 

$

2,321,636

 

$

2,531,630

 

 

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

3




AFFILIATED MANAGERS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Cash flow from operating activities:

 

 

 

 

 

 

 

 

 

Net Income

 

$

28,510

 

$

33,146

 

$

80,305

 

$

102,323

 

Adjustments to reconcile Net Income to net cash flow from operating activities:

 

 

 

 

 

 

 

 

 

Amortization of intangible assets

 

6,525

 

6,839

 

17,998

 

20,533

 

Amortization of issuance costs

 

765

 

732

 

2,275

 

2,122

 

Depreciation and other amortization

 

2,035

 

2,239

 

5,052

 

6,386

 

Deferred income tax provision

 

7,982

 

7,299

 

23,917

 

20,447

 

Accretion of interest

 

474

 

589

 

1,422

 

1,771

 

Income from equity method investments, net of amortization

 

(4,244

)

(7,464

)

(10,249

)

(19,530

)

Distributions received from equity method investments

 

4,251

 

8,501

 

10,476

 

37,215

 

Tax benefit from exercise of stock options

 

5,362

 

1,447

 

11,103

 

4,881

 

Other adjustments

 

(1,384

)

1,434

 

(2,253

)

3,304

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

Increase in investment advisory fees receivable

 

(11,622

)

(12,735

)

(31,972

)

(13,375

)

Decrease in Affiliate investments in partnerships

 

 

1,891

 

 

2,865

 

Decrease in prepaids and other current assets

 

4,195

 

2,428

 

4,058

 

7,846

 

(Increase) decrease in other assets

 

(2,144

)

231

 

(1,897

)

1,301

 

Increase in accounts payable, accrued liabilities and other long-term liabilities

 

21,873

 

42,495

 

25,699

 

62,851

 

Increase (decrease) in minority interest

 

12,701

 

13,773

 

648

 

(9,819

)

Cash flow from operating activities

 

75,279

 

102,845

 

136,582

 

231,121

 

Cash flow used in investing activities:

 

 

 

 

 

 

 

 

 

Cost of investments in Affiliates, net of cash acquired

 

(62,375

)

(3,524

)

(80,766

)

(20,551

)

Purchase of fixed assets

 

(4,112

)

(3,026

)

(9,101

)

(14,962

)

Purchase of investment securities

 

 

(7,521

)

(6,393

)

(23,101

)

Sale of investment securities

 

 

 

24,062

 

 

Cash flow used in investing activities

 

(66,487

)

(14,071

)

(72,198

)

(58,614

)

Cash flow used in financing activities:

 

 

 

 

 

 

 

 

 

Borrowings of senior bank debt

 

170,000

 

82,000

 

175,000

 

395,000

 

Repayments of senior bank debt

 

(30,000

)

(60,000

)

(35,000

)

(354,500

)

Issuance of junior convertible trust preferred securities

 

 

 

 

300,000

 

Repayment of debt assumed from new investment

 

(150,811

)

 

(150,811

)

 

Repurchase of senior debt

 

 

 

(10,000

)

 

Issuance of common stock

 

10,232

 

11,376

 

24,257

 

46,824

 

Repurchase of common stock

 

(39,521

)

(60,454

)

(39,521

)

(462,924

)

Settlement of forward equity sale agreement

 

 

 

(14,008

)

 

Issuance costs

 

(28

)

(510

)

(651

)

(9,406

)

Excess tax benefit from exercise of stock options

 

 

4,402

 

 

17,352

 

Cost of call spread option agreements

 

 

 

 

(13,290

)

Repayments of notes payable and other liabilities

 

(2,201

)

(2,084

)

(15,486

)

(7,687

)

Redemptions of minority interest – Affiliate investments in partnerships

 

 

(1,891

)

 

(2,865

)

Cash flow used in financing activities

 

(42,329

)

(27,161

)

(66,220

)

(91,496

)

Effect of foreign exchange rate changes on cash and cash equivalents

 

1,424

 

43

 

794

 

628

 

Net increase (decrease) in cash and cash equivalents

 

(32,113

)

61,656

 

(1,042

)

81,639

 

Cash and cash equivalents at beginning of period

 

171,348

 

160,406

 

140,277

 

140,423

 

Cash and cash equivalents at end of period

 

$

139,235

 

$

222,062

 

$

139,235

 

$

222,062

 

Supplemental disclosure of non-cash financing activities:

 

 

 

 

 

 

 

 

 

Notes received for Affiliate equity sales

 

$

2,589

 

$

2,008

 

$

5,627

 

$

3,143

 

Payables recorded for Affiliate equity purchases

 

767

 

1,651

 

4,243

 

3,153

 

Debt assumed from new investment

 

150,811

 

 

150,811

 

 

Stock issued in new investment

 

24,556

 

 

24,556

 

 

Stock issued for zero coupon senior convertible note conversions

 

1

 

558

 

6

 

11,425

 

Stock received for the exercise of stock options

 

200

 

 

800

 

300

 

 

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

4




 

AFFILIATED MANAGERS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The consolidated financial statements of Affiliated Managers Group, Inc. (“Company” or “AMG”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments considered necessary for a fair statement of the results have been included. All intercompany balances and transactions have been eliminated. All dollar amounts in these notes (except information that is presented on a per share, per security, per note or per contract basis) are stated in thousands, unless otherwise indicated.  Certain reclassifications have been made to the prior period’s financial statements to conform to the current period’s presentation.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year. The Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005 includes additional information about AMG, its operations and its financial position, and should be read in conjunction with this Quarterly Report on Form 10-Q.

2. Senior Debt

The components of senior debt are as follows:

 

December 31,
2005

 

September 30,
2006

 

Senior revolving credit facility

 

$

175,500

 

$

216,000

 

Senior notes due 2006

 

65,750

 

65,750

 

 

 

$

241,250

 

$

281,750

 

 

Senior Revolving Credit Facility

The Company has a senior revolving credit facility (the “Facility”) which allows for borrowings of up to $550,000 at rates of interest (based either on the Eurodollar rate or the prime rate as in effect from time to time) that vary depending on the Company’s credit ratings. Subject to the agreement of the lenders (or prospective lenders) to increase their commitments, the Company has the option to borrow up to an aggregate of $650,000 under this Facility. Following the successful remarketing of the Company’s 2004 PRIDES (as described in Note 4), the Facility will mature in December 2010.  The Facility contains financial covenants with respect to net worth, leverage and interest coverage.  The Facility also contains customary affirmative and negative covenants, including limitations on indebtedness, liens, cash dividends and fundamental corporate changes.  Borrowings under the Facility are collateralized by pledges of all capital stock or other equity interests owned by the Company.

Senior Notes due 2006

In December 2001, the Company issued $230,000 of mandatory convertible securities (“2001 PRIDES”).  Each unit of the 2001 PRIDES initially consisted of (i) a senior note due November 17, 2006 with a principal amount of $25 per note (“Senior Notes due 2006”), and (ii) a forward purchase contract pursuant to which the holder agreed to purchase shares of the Company’s common stock on November 17, 2004, with the number of shares determined based upon the average trading price of the Company’s common stock for a period preceding that date.

The Company repurchased $154,250 in aggregate principal amount of the Senior Notes due 2006 and settled the forward purchase contracts in 2004.  In 2005, the Company repurchased $10,000 of the Senior Notes due 2006; the remaining $65,750 matures in November 2006 and has an interest rate of 5.406%.

5




 

3. Senior Convertible Securities

The components of senior convertible securities are as follows:

 

December 31,
2005

 

September 30,
  2006

 

Zero coupon senior convertible notes

 

$

124,232

 

$

113,246

 

Floating rate senior convertible securities

 

300,000

 

300,000

 

 

 

$

424,232

 

$

413,246

 

 

Zero Coupon Senior Convertible Notes

In May 2001, the Company issued $251,000 of principal amount at maturity of zero coupon senior convertible notes due 2021 (“zero coupon convertible notes”), with each note issued at 90.50% of such principal amount and accreting at a rate of 0.50% per year. Following the repurchase and conversion of $129,196 principal amount of such notes, $121,804 principal amount at maturity of zero coupon convertible notes remains outstanding. Each security is convertible into 17.429 shares of the Company’s common stock (at a current base conversion price of $53.28) upon the occurrence of certain events, including the following: (i) if the closing price of a share of its common stock is more than a specified price over certain periods (initially $62.36 and increasing incrementally at the end of each calendar quarter to $63.08 in April 2021); (ii) if the credit rating assigned by Standard & Poor’s to the securities is below BB-; or (iii) if the Company calls the securities for redemption. The holders may require the Company to repurchase the securities at their accreted value in May 2011 and 2016. If the holders exercise this option in the future, the Company may elect to repurchase the securities with cash, shares of its common stock or some combination thereof.  The Company has the option to redeem the securities for cash at their accreted value.  Under the terms of the indenture governing the zero coupon convertible notes, a holder may convert such security into common stock by following the conversion procedures in the indenture.  Subject to changes in the price of the Company’s common stock, the zero coupon convertible notes may not be convertible in certain future periods.

In February 2006, the Company amended the zero coupon convertible notes.  Under the terms of this amendment, the Company will pay interest through May 7, 2008 at a rate of 0.375% per year on the principal amount at maturity of the notes, in addition to the accrual of the original issue discount.

Floating Rate Senior Convertible Securities

In February 2003, the Company issued $300,000 of floating rate senior convertible securities due 2033 (“floating rate convertible securities”). The floating rate convertible securities bear interest at a rate equal to 3-month LIBOR minus 0.50%, payable in cash quarterly. Each security is convertible into shares of the Company’s common stock (at a base conversion price of $54.17) upon the occurrence of certain events, including the following: (i) if the closing price of a share of the Company’s common stock exceeds $65.00 over certain periods; (ii) if the credit rating assigned by Standard & Poor’s to the securities is below BB-; or (iii) if the Company calls the securities for redemption. Upon conversion, holders of the securities will receive 18.462 shares of the Company’s common stock for each convertible security. In addition, if the market price of the Company’s common stock exceeds the base conversion price at the time of conversion, holders will receive additional shares of common stock based on the stock price at that time. Based on the trading price of the Company’s common stock as of September 30, 2006, upon conversion a holder of each security would receive an additional 5.163 shares. The holders of the floating rate convertible securities may require the Company to repurchase such securities in February 2008, 2013, 2018, 2023 and 2028, at their principal amount. The Company may choose to pay the purchase price for such repurchases with cash, shares of its common stock or some combination thereof. The Company may redeem the convertible securities for cash at any time on or after February 25, 2008, at their principal amount.  Under the terms of the indenture governing the floating rate convertible securities, a holder may convert such security into common stock by following the conversion procedures in the indenture.  Subject to changes in the price of the Company’s common stock, the floating rate convertible securities may not be convertible in certain future periods.

6




 

The Company has entered into interest rate swap contracts that effectively exchange the variable interest rate for a fixed interest rate on $150,000 of the floating rate convertible securities.  Through February 2008, the Company will pay a weighted average fixed rate of 3.28% on that notional amount.

4. Mandatory Convertible Securities

In February 2004, the Company issued $300,000 of mandatory convertible securities (“2004 PRIDES”). As described below, these securities are structured to provide $300,000 of additional proceeds to the Company following a successful remarketing and the exercise of forward purchase contracts in February 2008.

Each unit of the 2004 PRIDES consists of (i) a senior note due February 2010 with a principal amount of $1,000 per note, on which the Company pays interest quarterly at the annual rate of 4.125%, and (ii) a forward purchase contract pursuant to which the holder has agreed to purchase shares of the Company’s common stock in February 2008. Holders of the purchase contracts receive a quarterly contract adjustment payment at the annual rate of 2.525% per $1,000 purchase contract. The current portion of the contract adjustment payments, approximately $6,200, is recorded in current liabilities. The number of shares to be issued in February 2008 will be determined based upon the average trading price of the Company’s common stock for a period preceding that date. Depending on the average trading price in that period, the settlement rate will range from 11.785 to 18.031 shares per $1,000 purchase contract. Based on the trading price of the Company’s common stock as of September 30, 2006, the purchase contracts would have a settlement rate of 12.737.

Each of the senior notes is pledged to the Company to collateralize the holder’s obligations under the forward purchase contracts. Beginning in August 2007, under the terms of the 2004 PRIDES, the senior notes are expected to be remarketed to new investors. A successful remarketing will generate $300,000 of gross proceeds to be used by the original holders of the 2004 PRIDES to fulfill their obligations on the forward purchase contracts. In exchange for the additional $300,000 in payment on the forward purchase contracts, the Company will issue shares of its common stock to the original holders of the senior notes. As referenced above, the number of shares of common stock to be issued will be determined by the market price of the Company’s common stock at that time. Assuming a successful remarketing, the senior notes will remain outstanding until at least February 2010.

5. Junior Convertible Trust Preferred Securities

In April 2006, the Company issued $300,000 of junior subordinated convertible debentures due 2036 to a wholly-owned trust simultaneous with the issuance, by the trust, of $291,000 of convertible trust preferred securities to investors. Under FASB Interpretation No. 46 (revised), “Consolidation of Variable Interest Entities,” the trust is not consolidated in the Company’s financial statements.  The junior subordinated convertible debentures and convertible trust preferred securities (together, the “junior convertible trust preferred securities”) have substantially the same terms. 

The junior convertible trust preferred securities bear interest at 5.1% per annum, payable quarterly in cash.  Each $50 security is convertible, at any time, into 0.333 shares of the Company’s common stock, which represents a conversion price of $150 per share.  Upon conversion, investors will receive cash or shares of the Company’s common stock (or a combination of cash and common stock) at the election of the Company.  The junior convertible trust preferred securities may not be redeemed by the Company prior to April 15, 2011.  On or after April 15, 2011, the junior convertible trust preferred securities may be redeemed if the closing price of the Company’s common stock exceeds $195 for a specified period of time.

As the trust’s only assets are the junior convertible subordinated debentures, the Company is obligated to ensure that holders of the convertible trust preferred securities receive all payments due from the trust.

7




 

6. Income Taxes

A summary of the provision for income taxes is as follows:

 

For the Three Months

 

For the Nine Months

 

 

 

Ended September 30,

 

Ended September 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Current:

 

 

 

 

 

 

 

 

 

Federal

 

$

5,807

 

$

7,485

 

$

19,927

 

$

23,790

 

State

 

332

 

2,414

 

1,350

 

5,508

 

Foreign

 

2,623

 

2,269

 

2,623

 

8,114

 

Total Current

 

8,762

 

12,168

 

23,900

 

37,412

 

Deferred:

 

 

 

 

 

 

 

 

 

Federal

 

7,871

 

7,480

 

22,548

 

22,391

 

State

 

450

 

427

 

1,708

 

1,279

 

Foreign

 

(339

)

(608

)

(339

)

(3,223

)

Total Deferred

 

7,982

 

7,299

 

23,917

 

20,447

 

Provision for income taxes

 

$

16,744

 

$

19,467

 

$

47,817

 

$

57,859

 

 

The components of deferred tax assets and liabilities are as follows:

 

December 31,

 

September 30,

 

 

 

2005

 

2006

 

Deferred assets (liabilities):

 

 

 

 

 

State net operating loss carryforwards

 

$

12,097

 

$

13,795

 

Intangible asset amortization

 

(139,866

)

(160,832

)

Non-deductible intangible amortization

 

(27,727

)

(27,880

)

Deferred compensation

 

1,712

 

2,629

 

Convertible securities interest

 

(12,854

)

(17,919

)

Fixed asset depreciation

 

(1,806

)

(1,924

)

Deferred income

 

(2,271

)

(2,652

)

Accrued expenses

 

189

 

227

 

 

 

(170,526

)

(194,556

)

Valuation allowance

 

(12,097

)

(13,795

)

Net deferred income taxes

 

$

(182,623

)

$

(208,351

)

 

Deferred tax liabilities are primarily the result of tax deductions for the Company’s intangible assets and convertible securities. The Company amortizes most of its intangible assets for tax purposes only, reducing its tax basis below its carrying value for financial statement purposes and generating deferred taxes each reporting period. In contrast, the intangible assets associated with the Company’s investments in its Canadian Affiliates are not deductible for tax purposes, but certain of these assets are amortized for book purposes.  As such, the Company has recorded deferred tax liabilities that represent the tax effect of the future book amortization of these assets. The Company’s floating rate senior convertible securities, mandatory convertible securities and junior convertible trust preferred securities also generate tax deductions that are higher than the interest expense recorded for financial statement purposes.

At September 30, 2006, the Company had state net operating loss carryforwards that will expire over a 15 year period beginning in 2006. The valuation allowances at December 31, 2005 and September 30, 2006 are related to the uncertainty of the realization of these loss carryforwards, which realization depends upon the Company’s generation of sufficient taxable income prior to their expiration. The change in the valuation allowance for the quarter ended September 30, 2006 is principally attributable to state net operating losses during this period and a provision for loss carryforwards that the Company does not expect to realize.

8




 

In the second quarter, the Company reduced its deferred tax liabilities for non-deductible intangible amortization by $1,408 to reflect a reduction in Canadian federal income tax rates that was enacted in June 2006 and will become effective beginning in 2008.  The reduction of these deferred tax liabilities was recorded as a benefit in the income tax provision for the three months ended June 30, 2006.

7. Earnings Per Share

The calculation of basic earnings per share is based on the weighted average number of shares of the Company’s common stock outstanding during the period. Diluted earnings per share is similar to basic earnings per share, but adjusts for the effect of the potential issuance of incremental shares of the Company’s common stock. The following is a reconciliation of the numerator and denominator used in the calculation of basic and diluted earnings per share. Unlike all other dollar amounts in these Notes, the amounts in the numerator reconciliation are not presented in thousands.

 

For the Three Months

 

For the Nine Months

 

 

 

Ended September 30,

 

Ended September 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Numerator:

 

 

 

 

 

 

 

 

 

Net Income

 

$

28,510,000

 

$

33,146,000

 

$

80,305,000

 

$

102,323,000

 

Interest expense on convertible securities, net of taxes

 

1,791,000

 

5,285,000

 

4,638,000

 

12,501,000

 

Net Income, as adjusted

 

$

30,301,000

 

$

38,431,000

 

$

84,943,000

 

$

114,824,000

 

 

 

For the Three Months

 

For the Nine Months

 

 

 

Ended September 30,

 

Ended September 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Denominator:

 

 

 

 

 

 

 

 

 

Average shares outstanding – basic

 

33,926,047

 

30,371,364

 

33,611,937

 

31,746,855

 

Effect of dilutive instruments:

 

 

 

 

 

 

 

 

 

Stock options

 

2,281,999

 

2,360,285

 

2,180,591

 

2,511,024

 

Forward equity sale agreement

 

 

 

118,205

 

 

Senior convertible securities

 

8,699,990

 

9,225,963

 

8,554,780

 

9,213,876

 

Mandatory convertible securities

 

 

442,110

 

 

507,576

 

Junior convertible trust preferred securities

 

 

2,000,000

 

 

1,318,681

 

Average shares outstanding – diluted

 

44,908,036

 

44,399,722

 

44,465,513

 

45,298,012

 

 

The calculation of diluted earnings per share for the three and nine months ended September 30, 2006 excludes the effect of the potential exercise of options to purchase approximately 100,000 shares.  For the three and nine months ended September 30, 2005, this calculation excludes the effect of any potential exercise of the forward purchase contract component of the mandatory convertible securities.

In April 2005, the Company net settled its forward equity sale agreement for approximately $14,000 in cash, which was recorded as a reduction to stockholders’ equity. Prior to the net settlement of the forward equity sale agreement, the Company was required to use the treasury stock method to measure potentially issuable shares.

As more fully discussed in Notes 3 and 5, the Company had convertible securities outstanding during the nine months ended September 30, 2005 and 2006.  These securities are convertible into shares of the Company’s common stock upon certain conditions.  The aggregate number of shares of common stock that could be issued in the future to settle these securities is deemed outstanding for the purposes of the calculation of diluted earnings per share.  This approach, referred to as the if-converted method, requires that such shares be deemed outstanding regardless of whether the notes are then contractually convertible into the Company’s common stock.  For this if-converted calculation, the interest expense (net of

9




 

tax) attributable to these securities is added back to Net Income, reflecting the assumption that the securities have been converted.

For the three and nine months ended September 30, 2006, the Company repurchased approximately 0.6 million and 4.7 million shares, respectively, of common stock under various stock repurchase programs.  The Company repurchased approximately 0.6 million shares of common stock during the three and nine months ended September 30, 2005.

In May 2006, the Company’s stockholders approved an amendment to the Company’s Amended and Restated Certificate of Incorporation to increase the authorized shares of voting common stock to 150 million.

8. Commitments and Contingencies

The Company and its Affiliates are subject to claims, legal proceedings and other contingencies in the ordinary course of their business activities. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be resolved in a manner unfavorable to the Company or its Affiliates. The Company and its Affiliates establish accruals for matters for which the outcome is probable and can be reasonably estimated. Management believes that any liability in excess of these accruals upon the ultimate resolution of these matters will not have a material adverse effect on the consolidated financial condition or results of operations of the Company.

Certain Affiliates operate under regulatory authorities which require that they maintain minimum financial or capital requirements.  Management is not aware of any violations of such financial requirements occurring during the period.

The Company’s operating agreements generally provide Affiliate management partners the conditional right to require the Company to purchase their retained equity interests at certain intervals. These agreements also provide the Company the conditional right to require Affiliate management partners to sell their retained equity interests upon their death, permanent incapacity or termination of employment and provide such partners the conditional right to require the Company to purchase such retained equity interests upon the occurrence of such events. The partners are also permitted to sell their equity interests to other individuals or entities in certain cases, subject to the Company’s approval or other restrictions.  These purchases are generally calculated based upon a multiple of the Affiliate’s cash flow distributions, which is intended to represent fair value. As one measure of the potential magnitude of such purchases, in the event that a triggering event and resulting purchase occurred with respect to all such retained equity interests as of September 30, 2006, the aggregate amount of these payments would have totaled approximately $1,289,000. In the event that all such transactions were closed, the Company would own the cash flow distributions attributable to the additional equity interests purchased from Affiliate management partners. As of September 30, 2006, this amount would represent approximately $163,600 on an annualized basis.

9.  Affiliate Investments in Partnerships

Effective January 1, 2006, the Company implemented Emerging Issues Task Force Issue 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-05”).  Under EITF 04-05, a general partner is required to consolidate any partnership that it controls, including those interests in the partnerships in which the Company does not have ownership rights.  A general partner is presumed to control a partnership unless the limited partners have certain rights to remove the general partner or other substantive rights to participate in partnership operations.

As of September 30, 2006, the Company has consolidated $107,989 of client assets held in partnerships controlled by its Affiliates.  These assets are reported as “Affiliate investments in partnerships” in the consolidated balance sheet.  Substantially all of these assets, $102,530, are held by investors that are unrelated to the Company, and reported as “Minority interest in Affiliate investments in partnerships.”  For the quarter ended September 30, 2006, these partnerships reported a loss of $4,959, which is presented as “Investment (income) loss from Affiliate investments in partnerships” in the consolidated statements of income.  The portion of this loss that is attributable to investors that are unrelated to the Company, $4,334, is reported as a “Minority interest in Affiliate investments in partnerships.”  Management fees earned by the Company on these assets were $269 and $863 for the three and nine months ended September 30, 2006, respectively, and are reported within “Investment and other income.” During the three and nine month periods ended September 30, 2006, the partnerships purchased investments (principally equity securities) totaling $31,034 and $89,813, and sold investments totaling $34,252 and $93,896, respectively.

10




 

10. Related Party Transactions

The Company periodically records amounts payable to Affiliate partners in connection with the purchase of additional Affiliate equity interests. The total amount due to Affiliate partners as of September 30, 2006 was $11,503, of which $8,595 is due within one year and reported as a current liability.

The Company records notes receivable from Affiliate partners in connection with the transfer of Affiliate equity interests.  The total amount due from Affiliate partners as of September 30, 2006 was $7,410.

In certain cases, Affiliate management owners and Company officers may serve as trustees or directors of certain mutual funds from which the Affiliate earns advisory fee revenue.

11. Equity-Based Compensation Plans

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised), “Share-Based Payment” (“FAS 123R”).  FAS 123R revises SFAS No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”).  FAS 123R requires as an expense the cost of all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values over the requisite service period.  In addition, FAS 123R requires unrecognized costs related to options vesting after the date of initial adoption to be recognized as an expense in the financial statements over the remaining requisite service period.

The Company adopted FAS 123R using the modified prospective transition method.  Under this method, compensation expense includes: (i) an expense for all unvested options outstanding on January 1, 2006, and (ii) an expense for all options granted subsequent to January 1, 2006. Compensation expense recognized under FAS 123R, net of tax, was $225 and $604 for the three and nine months ended September 30, 2006, respectively.  This additional compensation expense decreased basic earnings per share by $.01 and had no impact on diluted earnings per share for the three months ended September 30, 2006, and decreased basic and diluted earnings per share by $.02 for the nine months ended September 30, 2006.

The following table presents net income and earnings per share as if the Company had applied the fair value recognition provisions of FAS 123 to stock-based employee compensation in the three and nine months ended September 30, 2005.

 

For the Three
Months Ended
September 30,
2005

 

For the Nine
Months Ended
September 30,
2005

 

 

 

 

 

 

 

Net Income—as reported

 

$

28,510

 

$

80,305

 

Add: Total stock-based employee compensation expense included in reported net income, net of tax

 

 

 

Less: Total stock-based employee compensation expense determined under fair value, net of tax

 

138

 

372

 

Net Income—FAS 123 pro forma

 

$

28,372

 

$

79,933

 

 

 

 

 

 

 

Earnings per share—basic—as reported

 

$

0.84

 

$

2.39

 

Earnings per share—basic—FAS 123 pro forma

 

0.84

 

2.38

 

Earnings per share—diluted—as reported

 

0.67

 

1.91

 

Earnings per share—diluted—FAS 123 pro forma

 

0.67

 

1.90

 

 

11




 

FAS 123R also requires the Company to report any tax benefits realized upon the exercise of stock options that are in excess of the expense recognized for reporting purposes as a financing activity in the Company’s consolidated statement of cash flows.  Prior to the adoption of FAS 123R, these tax benefits were presented as operating cash flows in the consolidated statements of cash flows.

Stock Option and Incentive Plans

The Company established the 1997 Stock Option and Incentive Plan (as amended and restated, the “1997 Plan”), under which it is authorized to grant options to employees, directors and other key persons. In 2002, stockholders approved an amendment to increase the number of shares of common stock authorized for issuance under this plan to 7,875,000.

In 2002, the Company’s Board of Directors established the 2002 Stock Option and Incentive Plan (as amended and restated, the “2002 Plan”), under which the Company is authorized to grant non-qualified stock options and certain other awards to employees and directors. This plan requires that the majority of grants under the plan in any three-year period must be issued to employees of the Company who are not executive officers or directors of the Company. This plan has not been approved by the Company’s stockholders. There are 3,375,000 shares of the Company’s common stock authorized for issuance under this plan.

In December 2003, the Board of Directors approved an amendment to each of the 1997 Plan and 2002 Plan to accelerate the vesting of the then-outstanding unvested options (other than options granted to directors).  The shares issuable upon the exercise of the accelerated options remain subject to restrictions on transfer which lapse according to specified schedules, for so long as the option holder remains employed by the Company.  In the event the option holder ceases to be employed by the Company, the transfer restrictions will remain outstanding until the later of December 2010, or seven years after the date of grant.  All shares received upon exercise remain the property of the holder under any circumstance subject to transfer restrictions.

In May 2006, the stockholders of the Company approved the 2006 Stock Option and Incentive Plan (the “2006 Plan”), under which the Company is authorized to grant stock options and stock appreciation rights to employees, directors, and other key persons.  There are 3,000,000 shares of the Company’s common stock authorized for issuance under this plan.

The plans are administered by a committee of the Board of Directors.  Under the plans, options generally expire seven to ten years after the grant date, and all options have been granted with exercise prices equal to the fair market value of the Company’s common stock on the date of grant.

The fair value of options granted is estimated using the Black-Scholes option pricing model. The weighted average fair value of options granted during the nine months ended September 30, 2005 and 2006 was $18.14 and $30.34, respectively, based on the assumptions stated below.

 

For the Nine Months Ended
September 30,

 

 

 

2005

 

2006

 

Dividend yield

 

0.0%

 

0.0%

 

Expected volatility(1)

 

18.0%

 

27.7%

 

Risk-free interest rate(2)

 

4.2%

 

4.9%

 

Expected life of options (in years)(3)

 

5.0

 

5.0

 

Forfeiture rate(3)

 

0.0%

 

0.0%

 


(1)              Based on the implied volatility of the Company’s common stock.

(2)              Based on the U.S. Treasury yield curve in effect at the date of grant.

(3)              Based on historical data.

12




 

The following table summarizes the transactions of the Company’s stock option and incentive plans for the nine months ended September 30, 2006:

 

 

Stock Options

 

Weighted
Average
Exercise Price

 

Weighted Avg.
Remaining
Contractual
Life (years)

 

Unexercised options outstanding—January 1, 2006

 

7,808,389

 

$

41.26

 

5.5

 

Options granted

 

56,250

 

86.74

 

9.6

 

Options exercised

 

(1,049,506

)

34.53

 

 

 

Options forfeited

 

(82,880

)

52.13

 

 

 

Unexercised options outstanding—September 30, 2006

 

6,732,253

 

42.55

 

5.0

 

Exercisable at September 30, 2006

 

6,574,744

 

41.81

 

4.9

 

Exercisable and free from restrictions on transfer at September 30, 2006

 

4,531,883

 

37.74

 

4.4

 

 

The Company generally issues treasury stock to settle stock option exercises.  The total intrinsic value of options exercised during the nine months ended September 30, 2006, was $60,183.  As of September 30, 2006, the intrinsic value of options that were vested and free from restrictions on transfer was $282,654.  As of that date, the total intrinsic value of all vested options (including those subject to restrictions on transfer) was $383,308, and the intrinsic value of unvested options was $4,200.

During the nine months ended September 30, 2006, the cash received and the actual tax benefit recognized for options exercised were $35,944 and $22,233, respectively. During the nine months ended September 30, 2006, the excess tax benefit classified as a financing cash flow was $17,352.

The Company’s Net Income for the three and nine months ended September 30, 2006 includes $357 and $959 of compensation expense, respectively, and $132 and $355 of income tax benefits, respectively, related to our equity-based compensation arrangements.  As of September 30, 2006, there was $2,929 of deferred compensation expense related to stock options, which is expected to be recognized over a weighted average period of three years.

12. Call Spread Option Agreements

In March 2006, the Company entered into a series of call spread option agreements with a major securities firm.  The agreements provide the Company the option, but not the obligation, to repurchase up to 917,000 shares of its common stock, beginning in June 2007 and ending in December 2007, at a weighted-average price of $99.59 per share.  If the Company’s prevailing share price exceeds $132.74, on a weighted-average basis during this period, the net number of shares available for repurchase under the agreements will be less than 917,000.

In the event the Company elects to exercise its option, the Company may elect to receive cash proceeds rather than shares of common stock.  In connection with these agreements, the Company made payments of $13,290, which were recorded as a reduction of stockholders’ equity.

13. Segment Information

Financial Accounting Standard No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“FAS 131”), establishes disclosure requirements relating to operating segments in annual and interim financial statements. Management has assessed the requirements of FAS 131 and determined that the Company operates in three business segments representing the Company’s three principal distribution channels: Mutual Fund, Institutional and High Net Worth, each of which has different client relationships.

Revenue in the Mutual Fund distribution channel is earned from advisory and sub-advisory relationships with all domestically-registered investment products as well as non-institutional investment products that are registered abroad.  Revenue in the Institutional distribution channel is earned from relationships with foundations and endowments, defined benefit and defined contribution plans and Taft-Hartley plans.  Revenue in the High Net Worth distribution channel is earned from relationships with wealthy individuals, family trusts and managed account programs.

13




 

During the third quarter of 2005, the Company amended its definition of the Mutual Fund distribution channel in conjunction with its acquisition of First Asset Management Inc. (“First Asset”), which increased the number of investment products managed by its Affiliates that are registered outside the United States.  Certain reclassifications have been made to prior period financial results of the Company’s operating segments to conform them to the amended definition, as well as to conform to the current period’s presentation.  These reclassifications were not material to the financial results of the Company’s operating segments.

Revenue earned from client relationships managed by Affiliates accounted for under the equity method is not consolidated with the Company’s reported revenue but instead is included (net of operating expenses, including amortization) in “Income from equity method investments,” and reported in the distribution channel in which the Affiliate operates.  Income tax attributable to the profits of the Company’s equity-method Affiliates is reported within the Company’s consolidated income tax provision.

In firms with revenue sharing arrangements, a certain percentage of revenue is allocated for use by management of an Affiliate in paying operating expenses of that Affiliate, including salaries and bonuses, and is called an “Operating Allocation.” In reporting segment operating expenses, Affiliate expenses are allocated to a particular segment on a pro rata basis with respect to the revenue generated by that Affiliate in such segment. Generally, as revenue increases, additional compensation is typically paid to Affiliate management partners from the Operating Allocation. As a result, the contractual expense allocation pursuant to a revenue sharing arrangement may result in the characterization of any growth in profit margin beyond the Company’s Owners’ Allocation as an operating expense. All other operating expenses (excluding intangible amortization) and interest expense have been allocated to segments based on the proportion of cash flow distributions reported by Affiliates in each segment.

Statements of Income

 

 

For the Three Months Ended September 30, 2005

 

 

 

Mutual Fund

 

Institutional

 

High Net
Worth

 

Total

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

108,570

 

$

92,708

 

$

32,848

 

$

234,126

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Depreciation and other amortization

 

1,366

 

4,615

 

2,579

 

8,560

 

Other operating expenses

 

65,589

 

58,258

 

20,950

 

144,797

 

 

 

66,955

 

62,873

 

23,529

 

153,357

 

Operating income

 

41,615

 

29,835

 

9,319

 

80,769

 

 

 

 

 

 

 

 

 

 

 

Non-operating (income) and expenses:

 

 

 

 

 

 

 

 

 

Income from equity method investments

 

(224

)

(3,710

)

(310

)

(4,244

)

Investment and other income

 

(1,469

)

(1,095

)

(153

)

(2,717

)

Investment (income) loss from Affiliate investments in partnerships

 

 

 

(214

)

(214

)

Interest expense

 

4,679

 

4,102

 

1,290

 

10,071

 

 

 

2,986

 

(703

)

613

 

2,896

 

Income before minority interest and income taxes

 

38,629

 

30,538

 

8,706

 

77,873

 

Minority interest

 

(14,104

)

(14,177

)

(4,338

)

(32,619

)

Income before income taxes

 

24,525

 

16,361

 

4,368

 

45,254

 

Income taxes

 

9,075

 

6,053

 

1,616

 

16,744

 

Net Income

 

$

15,450

 

$

10,308

 

$

2,752

 

$

28,510

 

 

14




 

 

 

For the Three Months Ended September 30, 2006

 

 

 

Mutual Fund

 

Institutional

 

High Net
Worth

 

Total

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

124,052

 

$

117,775

 

$

38,613

 

$

280,440

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

1,960

 

5,164

 

1,954

 

9,078

 

Other operating expenses

 

74,350

 

71,948

 

23,005

 

169,303

 

 

 

76,310

 

77,112

 

24,959

 

178,381

 

Operating income

 

47,742

 

40,663

 

13,654

 

102,059

 

 

 

 

 

 

 

 

 

 

 

Non-operating (income) and expenses:

 

 

 

 

 

 

 

 

 

Income from equity method investments

 

(203

)

(6,452

)

(809

)

(7,464

)

Investment and other income

 

(1,460

)

(895

)

(1,268

)

(3,623

)

Investment (income) loss from Affiliate investments in partnerships

 

 

 

4,959

 

4,959

 

Interest expense

 

6,980

 

7,081

 

2,189

 

16,250

 

 

 

5,317

 

(266

)

5,071

 

10,122

 

Income before minority interest and income taxes

 

42,425

 

40,929

 

8,583

 

91,937

 

Minority interest

 

(17,179

)

(20,176

)

(6,303

)

(43,658

)

Minority interest in Affiliate investments in partnerships

 

 

 

4,334

 

4,334

 

Income before income taxes

 

25,246

 

20,753

 

6,614

 

52,613

 

Income taxes

 

9,341

 

7,679

 

2,447

 

19,467

 

Net Income

 

$

15,905

 

$

13,074

 

$

4,167

 

$

33,146

 

 

 

 

For the Nine Months Ended September 30, 2005

 

 

 

Mutual Fund

 

Institutional

 

High Net
Worth

 

Total

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

287,120

 

$

263,653

 

$

93,222

 

$

643,995

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Depreciation and other amortization

 

2,635

 

13,066

 

7,349

 

23,050

 

Other operating expenses

 

172,609

 

158,459

 

58,833

 

389,901

 

 

 

175,244

 

171,525

 

66,182

 

412,951

 

Operating income

 

111,876

 

92,128

 

27,040

 

231,044

 

 

 

 

 

 

 

 

 

 

 

Non-operating (income) and expenses:

 

 

 

 

 

 

 

 

 

Income from equity method investments

 

(224

)

(9,714

)

(311

)

(10,249

)

Investment and other income

 

(3,246

)

(1,932

)

(606

)

(5,784

)

Investment (income) loss from Affiliate investments in partnerships

 

 

 

(166

)

(166

)

Interest expense

 

11,712

 

11,524

 

3,446

 

26,682

 

 

 

8,242

 

(122

)

2,363

 

10,483

 

Income before minority interest and income taxes

 

103,634

 

92,250

 

24,677

 

220,561

 

Minority interest

 

(37,698

)

(42,722

)

(12,019

)

(92,439

)

Income before income taxes

 

65,936

 

49,528

 

12,658

 

128,122

 

Income taxes

 

24,601

 

18,491

 

4,725

 

47,817

 

Net Income

 

$

41,335

 

$

31,037

 

$

7,933

 

$

80,305

 

 

15




 

 

 

For the Nine Months Ended September 30, 2006

 

 

 

Mutual Fund

 

Institutional

 

High Net
Worth

 

Total

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

370,716

 

$

356,271

 

$

114,603

 

$

841,590

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

5,319

 

15,583

 

6,017

 

26,919

 

Other operating expenses

 

225,329

 

209,189

 

69,914

 

504,432

 

 

 

230,648

 

224,772

 

75,931

 

531,351

 

Operating income

 

140,068

 

131,499

 

38,672

 

310,239

 

 

 

 

 

 

 

 

 

 

 

Non-operating (income) and expenses:

 

 

 

 

 

 

 

 

 

Income from equity method investments

 

(780

)

(16,710

)

(2,040

)

(19,530

)

Investment and other income

 

(4,361

)

(2,539

)

(2,094

)

(8,994

)

Investment (income) loss from Affiliate investments in partnerships

 

 

 

3,451

 

3,451

 

Interest expense

 

18,301

 

19,051

 

5,482

 

42,834

 

 

 

13,160

 

(198

)

4,799

 

17,761

 

Income before minority interest and income taxes

 

126,908

 

131,697

 

33,873

 

292,478

 

Minority interest

 

(50,578

)

(66,491

)

(18,557

)

(135,626

)

Minority interest in Affiliate investments in partnerships

 

 

 

3,330

 

3,330

 

Income before income taxes

 

76,330

 

65,206

 

18,646

 

160,182

 

Income taxes

 

27,553

 

23,561

 

6,745

 

57,859

 

Net Income

 

$

48,777

 

$

41,645

 

$

11,901

 

$

102,323

 

 

Balance Sheet Information

 

 

Mutual Fund

 

Institutional

 

High Net
Worth

 

Total

 

 

 

 

 

 

 

 

 

 

 

Total assets as of December 31, 2005

 

$

873,386

 

$

1,106,187

 

$

342,063

 

$

2,321,636

 

Total assets as of September 30, 2006

 

$

911,477

 

$

1,124,377

 

$

495,776

 

$

2,531,630

 

 

14. Goodwill and Acquired Client Relationships

During the nine months ended September 30, 2006, the Company acquired certain interests from Affiliate management, made payments under contingent purchase arrangements and issued Affiliate equity interests to certain Affiliate employees. Most of the goodwill acquired during the nine months ended September 30, 2006 is deductible for tax purposes. During the quarter ended September 30, 2006, the Company completed its purchase price allocation for its investment in First Asset.

The following table presents the change in goodwill during the nine months ended September 30, 2006.

 

 

Mutual Fund

 

Institutional

 

High Net
Worth

 

Total

 

Balance, as of December 31, 2005

 

$

437,309

 

$

445,609

 

$

210,331

 

$

1,093,249

 

Goodwill acquired, net

 

7,608

 

3,481

 

288

 

11,377

 

Foreign currency translation

 

3,724

 

3,637

 

1,299

 

8,660

 

Balance, as of September 30, 2006

 

$

448,641

 

$

452,727

 

$

211,918

 

$

1,113,286

 

 

The following table reflects the components of intangible assets of the Company’s Affiliates that are consolidated as of December 31, 2005 and September 30, 2006:

16




 

 

 

December 31, 2005

 

September 30, 2006

 

 

 

Carrying
Amount

 

Accumulated
Amortization

 

Carrying
Amount

 

Accumulated
Amortization

 

Amortized intangible assets:

 

 

 

 

 

 

 

 

 

Acquired client relationships

 

$

336,549

 

$

109,108

 

$

343,154

 

$

129,641

 

 

 

 

 

 

 

 

 

 

 

Non-amortized intangible assets:

 

 

 

 

 

 

 

 

 

Acquired client relationships—mutual fund management contracts

 

256,251

 

 

256,809

 

 

Goodwill

 

1,093,249

 

 

1,113,286

 

 

 

For the Company’s Affiliates that are consolidated, definite-lived acquired client relationships are amortized using the straight-line method over a weighted average life of approximately 11 years.  The Company estimates that its consolidated annual amortization expense will be approximately $27,400 for the next 5 years, assuming no additional investments in new or existing Affiliates.

The definite-lived acquired client relationships attributable to the Company’s equity method investments are amortized using the straight-line method over approximately 11 years.  Amortization expense for these relationships was $2,192 and $2,332 for the three months ended September 30, 2005 and 2006, and $6,187 and $6,964 for the nine months ended September 30, 2005 and 2006.  The Company estimates that the annual amortization expense attributable to its current equity-method Affiliates will be approximately $9,300 for the next five years.

During the nine months ended September 30, 2006, as a result of the issuance of Affiliate equity interests to certain Affiliate employees, the Company’s Affiliate ownership percentage in those Affiliates decreased.  Accordingly, in this period goodwill and acquired client relationships decreased by approximately $9,610.

15. Recent Accounting Developments

In July 2006, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 provides a comprehensive model for the accounting and disclosure of uncertain income tax return positions.  The Company will adopt FIN 48 in the first quarter of 2007 and is in the process of evaluating the effect that FIN 48 will have on its financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“FAS 157”).  FAS 157 establishes a framework for measuring fair value that applies to other accounting standards that use fair value measurements.  The Company will adopt FAS 157 in the first quarter of 2008 and is in the process of evaluating the effect that FAS 157 will have on its financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Retirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“FAS 158”), which will become effective for the fiscal year ended December 31, 2006.  FAS 158 is not expected to have an impact on the Company’s financial statements because the Company does not utilize defined benefit plans.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when quantifying Misstatements in Current Year Financial Statements” (“SAB 108”) to provide guidance on how to assess the materiality of financial statement misstatements. SAB 108 is effective for the fiscal year ended December 31, 2006, and the Company is currently evaluating the impact SAB 108 will have on its financial statements.

16. Comprehensive Income

A summary of comprehensive income, net of applicable taxes, is as follows:

17




 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended Setpember 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Net Income

 

$

28,510

 

$

33,146

 

$

80,305

 

$

102,323

 

Foreign currency translation adjustment

 

14,278

 

(345

)

13,646

 

11,886

 

Change in net unrealized (loss) gain on investment securities

 

17

 

(10

)

14

 

58

 

Change in net unrealized gain (loss) on derivative securities

 

708

 

(851

)

1,801

 

(156

)

Reclassification of unrealized gain on investment securities to realized gain

 

 

 

(610

)

 

Comprehensive income

 

$

43,513

 

$

31,940

 

$

95,156

 

$

114,111

 

 

The components of accumulated other comprehensive income, net of applicable taxes, are as follows:

 

December 31,

 

September 30,

 

 

 

2005

 

2006

 

Foreign currency translation adjustment

 

$

14,913

 

$

26,799

 

Unrealized (loss) gain on investment securities

 

(23

)

35

 

Unrealized gain on derivative securities

 

1,866

 

1,710

 

Accumulated other comprehensive income

 

$

16,756

 

$

28,544

 

 

17. Subsequent Events

On October 25, 2006, the Company entered into a definitive agreement to acquire a majority equity interest in Chicago Equity Partners, LLC (“CEP”). CEP manages over $11.4 billion in a wide range of U.S. equity and fixed income products across multiple capitalization sectors and investment styles.  The firm’s client base includes over 120 institutional investors, including public funds, corporations, endowments and foundations, Taft-Hartley plan sponsors and mutual funds.  This transaction is expected to close in the fourth quarter of 2006, subject to customary transaction-related closing conditions.

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

Forward-Looking Statements

When used in this Quarterly Report on Form 10-Q, in our other filings with the United States Securities and Exchange Commission, in our press releases and in oral statements made with the approval of an executive officer, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “believes,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among others, the following:

·                                                  our performance is directly affected by changing conditions in global financial markets generally and in the equity markets particularly, and a decline or a lack of sustained growth in these markets may result in decreased advisory fees or performance fees and a corresponding decline (or lack of growth) in our operating results and in the cash flow distributable to us from our Affiliates;

·                                                  we cannot be certain that we will be successful in finding or investing in additional investment management firms on favorable terms, that we will be able to consummate any announced investments in new investment management firms, or that existing and new Affiliates will have favorable operating results;

·                                                  we may need to raise capital by making long-term or short-term borrowings or by selling shares of our common stock or other securities in order to finance investments in additional investment management firms or additional investments in our existing Affiliates, and we cannot be sure that such capital will be available to us on acceptable terms, if at all; and

18




 

·                                          those certain other factors discussed under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, and in any other filings we make with the Securities and Exchange Commission from time to time.

These factors (among others) could affect our financial performance and cause actual results to differ materially from historical earnings and those presently anticipated and projected. We will not undertake and we specifically disclaim any obligation to release publicly the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of events, whether or not anticipated. In that respect, we wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.

Overview

We are an asset management company with equity investments in a diverse group of mid-sized investment management firms (our “Affiliates”).  We pursue a growth strategy designed to generate shareholder value through the internal growth of our existing business, in addition to investments in mid-sized investment management firms and strategic transactions and relationships designed to enhance our Affiliates’ businesses and growth prospects.

Through our Affiliates, we manage approximately $211 billion in assets (as of September 30, 2006) in more than 300 investment products across a broad range of asset classes and investment styles in three principal distribution channels: Mutual Fund, Institutional and High Net Worth.  We believe that our diversification across asset classes, investment styles and distribution channels helps to mitigate our exposure to the risks created by changing market environments. The following summarizes our operations in our three principal distribution channels.

·                  Our Affiliates provide advisory or sub-advisory services to more than 100 mutual funds. These funds are distributed to retail and institutional clients directly and through intermediaries, including independent investment advisors, retirement plan sponsors, broker-dealers, major fund marketplaces and bank trust departments.

·                  In the Institutional distribution channel, through our Affiliates we offer more than 150 investment products across more than 35 different investment styles, including small, small/mid, mid and large capitalization value and growth equity and emerging markets. In addition, our Affiliates offer quantitative, alternative and fixed income products. Through this distribution channel, our Affiliates manage assets for foundations and endowments, defined benefit and defined contribution plans for corporations and municipalities, and Taft-Hartley plans, with disciplined and focused investment styles that address the specialized needs of institutional clients.

·                  The High Net Worth distribution channel is comprised broadly of two principal client groups.  The first group consists principally of direct relationships with high net worth individuals and families and charitable foundations. For these clients, our Affiliates provide investment management or customized investment counseling and fiduciary services.  The second group consists of individual managed account client relationships established through intermediaries, generally brokerage firms or other sponsors.  Our Affiliates provide investment management services through more than 100 managed account and wrap programs.

In July 2005, we acquired equity interests in a group of Canadian asset management firms through the acquisition of First Asset Management Inc. (“First Asset”), a privately-held Canadian asset management company.  In connection with this transaction, First Asset was renamed AMG Canada Corp. These firms manage approximately 100 investment products, including Canadian, U.S. and international value and growth equity products, as well as balanced, fixed income, venture capital, structured products and alternative strategies.

In October 2006, we announced an agreement to acquire a majority equity interest in Chicago Equity Partners, LLC (“CEP”). CEP manages over $11.4 billion in a wide range of U.S. equity and fixed income products across multiple capitalization sectors and investment styles.  The firm’s client base includes over 120 institutional investors, including public funds, corporations, endowments and foundations, Taft-Hartley plan sponsors and mutual funds.  This transaction is expected to close in the fourth quarter of 2006, subject to customary transaction-related closing conditions.

19




 

While we operate our business through our Affiliates in our three principal distribution channels, we strive to maintain each Affiliate’s distinct entrepreneurial culture and independence through our investment structure. In each case, our Affiliates are organized as separate firms, and their operating or shareholder agreements are tailored to provide appropriate incentives for our Affiliate management owners and to address the particular characteristics of that Affiliate while enabling us to protect our interests.

We have revenue sharing arrangements with most of our Affiliates. Under these arrangements, a percentage of revenue is generally allocated for use by management of that Affiliate in paying operating expenses of the Affiliate, including salaries and bonuses. We call this the “Operating Allocation.” The portion of the Affiliate’s revenue that is allocated to the owners of that Affiliate (including us) is called the “Owners’ Allocation.” Each Affiliate allocates its Owners’ Allocation to its managers and to us generally in proportion to their and our respective ownership interests in that Affiliate. Where we hold a minority equity interest, our revenue sharing arrangement generally allocates a percentage of the revenue to us, with the balance to be used to pay operating expenses and profit distributions to the Affiliate management owners.

One of the purposes of our revenue sharing arrangements is to provide ongoing incentives for Affiliate managers by allowing them to:

·                  participate in the growth of their firm’s revenue, which may increase their compensation from the Operating Allocation and their distributions from the Owners’ Allocation; and

·                  control operating expenses, thereby increasing the portion of the Operating Allocation that is available for growth initiatives and compensation.

An Affiliate’s managers therefore have incentives to increase revenue (thereby increasing the Operating Allocation and their share of the Owners’ Allocation) and to control expenses (thereby increasing the amount of Operating Allocation available for their compensation).

An Affiliate’s Operating Allocation is structured to cover its operating expenses. However, should actual operating expenses exceed the Operating Allocation, our contractual share of cash under the Owners’ Allocation generally has priority over the allocations and distributions to the Affiliate’s managers. As a result, the excess expenses first reduce the portion of the Owners’ Allocation allocated to the Affiliate’s managers until that portion is eliminated, before reducing the portion allocated to us. Any such reduction in our portion of the Owners’ Allocation is required to be paid back to us out of the portion of future Owners’ Allocation allocated to the Affiliate’s managers. Nevertheless, we may agree to adjustments to revenue sharing arrangements to accommodate our business needs or those of our Affiliates if we believe that doing so will maximize the long-term benefits to us. In addition, a revenue sharing arrangement may be modified to a profit-based arrangement (as described below) to better accommodate our business needs or those of our Affiliates.

Certain of our Affiliates operate under profit-based arrangements through which we receive a share of profits as cash flow. As a result, we participate fully in any increase or decrease in the revenue or expenses of such firms. In these cases, we participate in a budgeting process and generally provide incentives to management through compensation arrangements based on the performance of the Affiliate. In recent periods, approximately 15% of our earnings has been generated through our profit-based arrangements.

For the nine months ended September 30, 2006, approximately $195.9 million was reported as compensation to our Affiliate managers under these revenue sharing arrangements.  Additionally, during this period we allocated approximately $135.6 million of our Affiliates’ profits to their managers (referred to on our Consolidated Statements of Income as “Minority interest”).

Our Net Income reflects the revenue of our consolidated Affiliates and our share of income from Affiliates which we account for under the equity method, reduced by:

·                  the operating expenses of our consolidated Affiliates;

·                  our operating expenses (i.e., our holding company expenses, including interest, depreciation and amortization, income taxes and compensation for our employees); and

20




 

·                  the profits allocated to managers of our consolidated Affiliates (i.e., minority interest).

As discussed above, for consolidated Affiliates with revenue sharing arrangements, the operating expenses of the Affiliate as well as its managers’ minority interest generally increase (or decrease) as the Affiliate’s revenue increases (or decreases) because of the direct relationship established in many of our agreements between the Affiliate’s revenue and its Operating Allocation and Owners’ Allocation. At our consolidated profit-based Affiliates, expenses may or may not correspond to increases or decreases in the Affiliates’ revenues.

Our level of profitability will depend on a variety of factors, including:

·                  those affecting the global financial markets generally and the equity markets particularly, which could potentially result in considerable increases or decreases in the assets under management at our Affiliates;

·                  the level of Affiliate revenue, which is dependent on the ability of our existing and future Affiliates to maintain or increase assets under management by maintaining their existing investment advisory relationships and fee structures, marketing their services successfully to new clients and obtaining favorable investment results;

·                  our receipt of Owners’ Allocation from Affiliates with revenue sharing arrangements, which depends on the ability of our existing and future Affiliates to maintain certain levels of operating profit margins;

·                  the increases or decreases in the revenue and expenses of Affiliates that operate on a profit-based model;

·                  the availability and cost of the capital with which we finance our existing and new investments;

·                  our success in making new investments and the terms upon which such transactions are completed;

·                  the level of intangible assets and the associated amortization expense resulting from our investments;

·                  the level of expenses incurred for holding company operations, including compensation for our employees; and

·                  the level of taxation to which we are subject.

Through our affiliated investment management firms, we derive most of our revenue from the provision of investment management services. Investment management fees (“asset-based fees”) are usually determined as a percentage fee charged on periodic values of a client’s assets under management; most asset-based advisory fees are billed by our Affiliates quarterly. Certain clients are billed for all or a portion of their accounts based upon assets under management valued at the beginning of a billing period (“in advance”). Other clients are billed for all or a portion of their accounts based upon assets under management valued at the end of the billing period (“in arrears”). Most client accounts in the High Net Worth distribution channel are billed in advance and most client accounts in the Institutional distribution channel are billed in arrears. Clients in the Mutual Fund distribution channel are billed based upon average daily assets under management. Advisory fees billed in advance will not reflect subsequent changes in the market value of assets under management for that period but may reflect changes due to client withdrawals. Conversely, advisory fees billed in arrears will reflect changes in the market value of assets under management for that period. In addition to generating asset-based fees, over 30 Affiliate products, representing approximately $24 billion of assets under management, also bill on the basis of absolute or relative investment performance (“performance fees”). These products, which are primarily in the Institutional distribution channel, are generally structured to have returns that are not directly correlated to changes in broader equity indices and, if earned, the performance fee component is typically billed less frequently than an asset-based fee. Although performance fees inherently depend on investment results and will vary from period to period, we anticipate performance fees to be a recurring component of our revenue. We also anticipate that, within any calendar year, the majority of performance fees will typically be realized in the fourth quarter.

For certain of our Affiliates, generally where we own a minority interest, we are required to use the equity method of accounting. Consistent with this method, we have not consolidated the operating results of these firms (including their revenue) in our Consolidated Statements of Income. Our share of these firms’ profits (net of intangible amortization) is reported in “Income from equity method investments,” and is therefore reflected in our Net Income and EBITDA. As a consequence, increases or decreases in assets under management at these firms ($42 billion as of September 30, 2006) will not affect reported revenue in the same manner as changes in assets under management at our other Affiliates.

Results of Operations

The following tables present our Affiliates’ reported assets under management by operating segment, which are also referred to as distribution channels in this Quarterly Report on Form 10-Q.

21




 

Assets under Management (1)

Statement of Changes – Quarter to Date
(dollars in billions)

 

Mutual
Fund

 

Institutional

 

High Net
Worth

 

Total

 

 

 

 

 

 

 

 

 

 

 

June 30, 2006

 

$

54.2

 

$

121.4

 

$

26.7

 

$

202.3

 

Net client cash flows

 

(1.1

)

5.2

 

 

4.1

 

Investment performance

 

1.3

 

2.3

 

0.7

 

4.3

 

September 30, 2006

 

$

54.4

 

$

128.9

 

$

27.4

 

$

210.7

 

 

Statement of Changes – Year to Date
(dollars in billions)

 

Mutual
Fund

 

Institutional

 

High Net
Worth

 

Total

 

 

 

 

 

 

 

 

 

 

 

December 31, 2005

 

$

50.3

 

$

109.3

 

$

24.7

 

$

184.3

 

Net client cash flows

 

0.4

 

11.7

 

0.7

 

12.8

 

Investment performance

 

3.7

 

7.9

 

2.0

 

13.6

 

September 30, 2006

 

$

54.4

 

$

128.9

 

$

27.4

 

$

210.7

 

 


(1)          See Note 2 on page 23 for a discussion of the changes to our operating segments.

The operating segment analysis presented in the following table is based on average assets under management. For the Mutual Fund distribution channel, average assets under management represents an average of the daily net assets under management. For the Institutional and High Net Worth distribution channels, average assets under management represent an average of the assets at the beginning and end of each calendar quarter during the applicable period.   We believe that this analysis more closely correlates to the billing cycle of each distribution channel and, as such, provides a more meaningful relationship to revenue.

 

 

For the Three Months
Ended September 30,

 

 

 

For the Nine Months
Ended September 30,

 

 

 

(in millions, except as noted)

 

2005

 

2006

 

% Change

 

2005

 

2006

 

% Change

 

Average assets under management(1)(2)
(in billions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Mutual Fund

 

$

46.5

 

$

53.7

 

 

15

%

 

$

41.0

 

$

53.7

 

 

31

%

 

Institutional

 

93.1

 

125.2

 

 

34

%

 

82.9

 

120.2

 

 

45

%

 

High Net Worth

 

22.2

 

27.0

 

 

22

%

 

19.7

 

26.3

 

 

34

%

 

Total

 

$

161.8

 

$

205.9

 

 

27

%

 

$

143.6

 

$

200.2

 

 

39

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mutual Fund

 

$

108.6

 

$

124.0

 

 

14

%

 

$

287.1

 

$

370.7

 

 

29

%

 

Institutional

 

92.7

 

117.8

 

 

27

%

 

263.7

 

356.3

 

 

35

%

 

High Net Worth

 

32.8

 

38.6

 

 

18

%

 

93.2

 

114.6

 

 

23

%

 

Total

 

$

234.1

 

$

280.4

 

 

20

%

 

$

644.0

 

$

841.6

 

 

31

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mutual Fund

 

$

15.5

 

$

15.9

 

 

3

%

 

$

41.3

 

$

48.8

 

 

18

%

 

Institutional

 

10.3

 

13.1

 

 

27

%

 

31.1

 

41.6

 

 

34