SEI Investments Company 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2008
For the transition period from to
Commission file number 0 - 10200
SEI INVESTMENTS COMPANY
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code 610-676-1000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
(Cover page 1 of 2 pages)
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 definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the voting common stock held by non-affiliates of the registrant was approximately $3.2 billion based on the closing price of $23.52 as reported by NASDAQ on June 30, 2008 (the last business day of the registrants most recently completed second fiscal quarter). For purposes of making this calculation only, the registrant has defined affiliates as including all executive officers, directors and beneficial owners of more than ten percent of the common stock of the registrant.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes ¨ No ¨
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Number of shares outstanding of each of the registrants classes of common stock, as of the close of business on February 20, 2009:
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference herein:
(Cover page 2 of 2 pages)
SEI Investments Company
Fiscal Year Ended December 31, 2008
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Forward Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve certain known and unknown risks, uncertainties and other factors, many of which are beyond our control, and are not limited to those discussed in Item 1A, Risk Factors. All statements that do not relate to historical or current facts are forward-looking statements. These statements may include words such as anticipate, estimate, expect, project, intend, plan, believe, and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. In particular, these include statements relating to present or anticipated products and markets, future revenues, capital expenditures, expansion plans, future financing and liquidity, personnel, and other statements regarding matters that are not historical facts or statements of current condition.
Any or all forward-looking statements contained within this Annual Report on Form 10-K may turn out to be wrong. They can be affected by inaccurate assumptions we might make, or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below will be important in determining future results. Consequently, we cannot guarantee any forward-looking statements. Actual future results may vary materially.
We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in our filings with the U.S. Securities and Exchange Commission (SEC).
Item 1. Business.
SEI (NASDAQ: SEIC) is a leading global provider of investment processing, fund processing, and investment management business outsourcing solutions that help corporations, financial institutions, financial advisors, and ultra-high-net-worth families create and manage wealth. As of December 31, 2008, through its subsidiaries and partnerships in which the company has a significant interest, SEI administers $379.6 billion in mutual fund and pooled assets, manages $134.3 billion in assets, and operates from numerous offices worldwide.
Our wealth management business solutions include:
General Development of the Business
For over 35 years, SEI has been a leading provider of wealth management business solutions for the financial services industry.
We began doing business in 1968 by providing computer-based training simulations to train bank loan officers in credit lending practices.
We developed an investment accounting system for bank trust departments in 1972, and became a leading provider of investment processing outsourcing services to banks and trust institutions.
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SEI became a public company in 1981. We entered the asset management business in 1982 and launched a series of money market mutual funds for bank clients. Later in the decade, we expanded our services to bank clients by offering mutual fund accounting services, and investment operations outsourcing services.
We introduced our Manager-of-Managers investment process, and offered these programs to investment advisors who manage wealth for their high-net-worth clients. We entered the institutional investor market and began offering asset management programs to retirement plan sponsors and institutional investors in selected global markets, including the United States, Canada, the United Kingdom, continental Europe, South Africa and East Asia.
We delivered broader, more strategic solutions for clients and markets, including a complete life and wealth platform for operating an investment advisory business, a total operational outsourcing solution for investment managers, a fully-integrated pension management system for retirement plan sponsors and a complete life and wealth solution for ultra-high-net-worth families. We introduced Global Wealth Services, a next generation business solution integrating investment processing technology, operating processes and investment management programs.
We seek to achieve growth in earnings and shareholder value by strengthening our position as a provider of global wealth management solutions. To achieve this objective, we have implemented these strategies:
Create broader solutions for wealth service firms. Banks, investment managers and financial advisors seek to enter new markets, expand their service offerings, provide a differentiated experience to their clients, improve efficiencies, reduce risks, and better manage their businesses. We are developing next generation business solutions integrating technology, operating processes, and financial products designed to help these institutions better serve their clients and provide opportunities to improve their business success.
Help institutional investors manage retirement plans and operating capital. Retirement plan sponsors, not-for-profit organizations and other institutional investors strive to meet their financial objectives while reducing business risk. We deliver customized investment management solutions that enable investors to make better decisions about their investments and to manage their assets more effectively.
Help affluent individual investors manage their life and wealth goals. These investors demand a holistic wealth management experience that focuses on their life goals and provides them with an integrated array of financial services that includes substantially more than traditional wealth management offerings. We help these investors identify their goals and offer comprehensive life and wealth advisory services including life planning, investments and other financial services.
Expand into global markets. Global markets are large and present significant opportunities for growth. We are evolving U.S. business models for the global wealth management marketplace, focusing on the needs of institutional investors, private banks, investment advisors and affluent individual investors.
We are guided by these fundamental principles in managing the business and adopting these growth strategies:
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Products and Services
Investment processing solutions include computer processing services, software services, business process outsourcing services, securities valuation and trade execution services. We offer these outsourcing solutions to banks and trust institutions that provide wealth management services to their private and institutional investors. Investment advisors also use these investment processing solutions, together with our investment management programs, to provide wealth management services to their investors.
These solutions include TRUST 3000®, a comprehensive trust accounting and investment system that provides securities processing and investment accounting for all types of domestic and global securities, and support for multiple account types, including personal trust, corporate trust, institutional trust, and non-trust investment accounts.
In 2007, we introduced Global Wealth Services, a next generation business solution that integrates investment processing technology, operating processes and investment management programs. Global Wealth Services provides the strategic infrastructure to help private banks grow and keep pace with a rapidly changing wealth management industry.
Enhancing the Global Wealth Services solution is the Global Wealth Platform, an investment accounting and securities processing system with capabilities that include global securities processing, trade-date and multi-currency accounting and reporting. The Global Wealth Platform offers enhanced client experience capabilities and improved operating efficiencies, and enables us to enter new markets in the United Kingdom, continental Europe and the United States. The platform is designed around the client and portfolio management processes. This enables banks to institutionalize their client processes around an investors investment objectives, facilitating a transition to model-based portfolio management, providing an improved client experience, while minimizing the expense associated with investment operations and reducing risk.
Revenues from investment processing services are earned as monthly fees from contracted services including software licenses, information processing, and investment operations. Revenues are primarily earned based upon the number of trust accounts being serviced. Revenues may also be earned for contracted project-oriented services related to client implementations. These revenues are recognized in Information processing and software servicing fees on the accompanying Consolidated Statements of Operations. Securities valuation and trade execution fees are recognized as Transaction-based and trade execution fees on the accompanying Consolidated Statements of Operations. In addition, as we deploy our Global Wealth Services solution, we will attempt to price our investment processing services as a percentage of assets under management and administration.
Investment Management Programs
Investment management programs consist of money market, fixed-income and equity mutual funds, alternative investment portfolios and separate accounts. We serve as the administrator and investment advisor for many of these products. We provide these programs primarily through investment advisory firms, including investment advisors and banks, or directly to institutional or individual investors.
We have expanded these investment management programs to include other consultative, operational and technology components, creating comprehensive solutions tailored to the needs of a specific market. These components may include investment strategies, consulting services, administrative and processing services and technology tools.
Investors in our investment programs typically follow a customized investment strategy and invest in a globally diversified portfolio that consists of multiple classes and investment styles, constructed according to our disciplined investment process. Our investment process is based on five principles: asset allocation and appropriate diversification, both of which are important to investment performance; portfolio construction that consists of multiple managers with complementary approaches to achieve diversification of risk and returns; manager selection, where SEI acts as a manager-of-managers, selecting some of the best style-specific money managers from a global network of money managers; continuous portfolio management, to ensure each managers investment approach remains consistent with the objectives of the portfolio; and tax management, for an emphasis on after-tax returns.
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As of December 31, 2008, we managed $96.6 billion in total assets, net of $37.7 billion in assets managed by LSV Asset Management (LSV). Our assets under management include $67.7 billion invested in our fixed-income and equity funds or through separately managed account programs, $18.2 billion invested in our liquidity funds and $10.7 billion invested in our collective trust fund programs.
Revenues from investment management programs are primarily earned as a contractual percentage of net assets under management. These revenues are recognized in Asset management, administration and distribution fees on the accompanying Consolidated Statements of Operations.
Fund processing solutions include a full range of administration and distribution support services to mutual funds, collective trust funds, hedge funds, fund of funds, private equity funds and other types of investment funds. Administrative services include fund accounting, trustee and custodial support, legal support, transfer agency and shareholder servicing. Distribution support services range from market and industry insight and analysis to identifying distribution opportunities.
We offer these fund administration and distribution services to U.S. banks, investment management firms and investment companies that sponsor and distribute mutual funds and other U.S.-regulated investments. We also offer these services to investment managers worldwide that sponsor and distribute alternative investments, including hedge funds, fund of funds, private equity funds, and other investment vehicles. We also offer operational outsourcing solutions for the administration and management of separately managed account programs, as well as total operational outsourcing solutions for investment management firms.
As of December 31, 2008, we administered $245.3 billion in non-SEI mutual funds and other pooled assets.
Revenues from fund processing are primarily earned based upon a contractual percentage of net assets under administration. These revenues are recognized in Asset management, administration and distribution fees on the accompanying Consolidated Statements of Operations.
Business segments are generally organized around our target markets. Financial information about each business segment is contained in Note 14 to the Consolidated Financial Statements. Our business segments are:
Private Banks provides investment processing and investment management programs to banks and trust institutions worldwide and independent wealth advisers located in the United Kingdom;
Investment Advisors provides investment management programs to affluent investors through a network of independent registered investment advisors, financial planners and other investment professionals in the United States;
Institutional Investors provides investment management programs and administrative outsourcing solutions to retirement plan sponsors and not-for-profit organizations worldwide;
Investment Managers provides investment processing, fund processing and operational outsourcing solutions to investment managers, fund companies and banking institutions located in the United States and to investment managers worldwide of alternative asset classes such as hedge funds, fund of funds, and private equity funds;
Investments in New Businesses provides investment management programs to ultra-high-net-worth families residing in the United States through the SEI Wealth Network®; and
LSV Asset Management is a registered investment advisor that provides investment advisory services to institutions, including pension plans and investment companies.
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The percentage of consolidated revenues generated by each business segment for the last three years was:
The Private Banks segment delivers investment processing services and investment management programs worldwide to banks and trust institutions and independent wealth advisers in the United Kingdom.
Our investment processing services enable banks and trust institutions to reduce risk, improve quality, and gain operational efficiency thus enabling them to focus on growing their business and serving client needs. Investment processing solutions are delivered via two primary business models: the Global Wealth Technology Services (GWTS) model and the Global Wealth Services (GWS) model. In both models, we own, maintain and operate the software applications and information processing facilities.
Banks using our GWTS model outsource investment processing technology software and computer processing but retain responsibility for investment operations, client administration, and investment management. Clients operate our GWTS solution remotely while fully supported by our data center using dedicated telecommunications networks. The GWTS model includes a dedicated relationship team that supports our clients business. We assist our clients with strategically reevaluating their systems and process needs as their businesses change.
The GWS model is an extension of our GWTS solution. It was designed for private banks and other trust organizations that prefer to outsource their entire investment operation. With the GWS solution, we assume the entire back-office processing function. The GWS model includes: investment processing; account access and reporting; audit, compliance and regulatory support data generation; custody and safekeeping of assets; income collections; securities settlement; and other related trust activities.
New clients undergo a business transformation process which can take a few months for smaller institutions and up to 15 months or more for larger institutions. During the transformation process, we collaborate with new clients to understand their strategic goals and objectives. During this transformation, systems, operations, and business processes are evaluated and optimized to meet client objectives. We typically earn a one-time implementation fee for these business transformation services.
Client contracts have initial terms that are generally three to seven years in length. At December 31, 2008, we had significant relationships with approximately 125 banks and trust institutions in the United States, including trust departments of 9 of the 20 largest U.S. banks.
The Global Wealth Services solution will be further enhanced through the Global Wealth Platform. Our target markets for the enhanced Global Wealth Services solution primarily include private banks and independent wealth advisers in the United Kingdom as well as community, regional and national private banks in the United States. We believe the enhanced Global Wealth Services solution enabled by the new infrastructure will improve the client experience and place our clients in a superior position to serve the changing needs of their clients.
Our principal competitors in the investment processing business for this segment include Odyssey Technologies, Metavante Corporation, SunGard Data Systems Inc. and Temenos Group AG. We also consider in-house solutions to be a form of competition. Many large financial institutions develop, operate and maintain proprietary investment and trust accounting systems.
Our investment management programs for banks and distribution partners are offered worldwide. At December 31, 2008, there were approximately 305 investment management clients worldwide. We also had single-product relationships with approximately 185 additional banks and trust institutions. The principal competitors for this business are Dimensional Fund Advisors, Federated Investors, Inc., LPL Financial Corporation, Russell Investment Group, a subsidiary of The Northwestern Mutual Life Insurance Company, and investment manager of manager programs offered by other firms. We also consider in-house internal asset management capabilities to be a form of competition.
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The Investment Advisors segment offers wealth management solutions to registered investment advisors, many of whom are affiliated with or are registered as independent broker-dealers, financial planners, and life insurance agents located throughout the United States. These wealth management solutions include our investment management programs and back-office investment processing outsourcing services. We also help advisors manage and grow their businesses by giving them access to our marketing support programs, business assessment assistance and recommended management practices. Our solutions aim to help investment advisors reduce risk, improve quality, and gain operational efficiency to devote more of their resources to servicing their clients.
Advisors are responsible for the investor relationship which includes creating financial plans, implementing investment strategies and educating and servicing their customers. Advisors may customize portfolios to include separate account managers as well as SEI-sponsored mutual funds. Our wealth and investment programs are designed to be attractive to affluent or high-net-worth individual investors with over $250 thousand of investable assets and small to medium-sized institutional plans.
We continually enhance our offering to meet the emerging needs of our advisors and their end clients. For example, in 2008, we completed the rollout of our new proposal generation software for advisors and introduced a new statement format to our end investors.
Although we have agreements with over 6,000 financial advisors, our business is based primarily on approximately 1,100 clients who, at December 31, 2008, had at least $5.0 million each in customer assets invested in our mutual funds and separately managed accounts. Revenues are earned largely as a percentage of average assets under management.
The principal competition for our investment management products is from other money managers and mutual fund companies. In the advisor distributor channel, the principal competitors include AssetMark Investment Services Inc., Brinker Capital, EnvestNet Asset Management, Inc., Fidelity Investments, Lockwood Advisors, Inc., a subsidiary of The Bank of New York Mellon, and other broker-dealers.
The Institutional Investors segment offers investment management programs and administrative outsourcing solutions for retirement plan sponsors and not-for-profit organizations globally. Clients can outsource their entire investment management needs and the administration for defined benefit, defined contribution, funded welfare and non-qualified deferred compensation plans, as well as the administration of endowment and foundation asset pools.
The outsourcing program provides a strategic platform integrating the Manager-of-Managers investment process, plan administration services, and consulting services. Plan administration services include trustee, custodial, benefit payment services, record-keeping services, and donor administration. Consulting services include actuarial services, asset liability modeling, and the customization of an asset allocation plan that is designed to meet long-term objectives.
By outsourcing retirement plan services, we believe clients benefit from an investment approach built around an investment plan designed to meet the clients long-term business and plan objectives and an investment process that removes the responsibility of manager selection. This approach is designed to reduce business risk, provide ongoing due diligence, and increase operational efficiency.
Fees are primarily earned as a percentage of average assets under management. At December 31, 2008, we had relationships with approximately 550 institutional investor clients. The principal competitors for this segment are Frank Russell Company, a subsidiary of The Northwestern Mutual Life Insurance Company, and Northern Trust Corporation.
The Investment Managers segment provides investment managers with a suite of back and middle-office investment processing services associated with operating an investment fund or account. We offer managers based in the United States support for traditional investment products such as mutual funds, exchange-traded funds, institutional and separate accounts, and provide outsourcing services including accounting, administration, reconciliation, investor servicing and client reporting. In addition, we provide many of the same services to investment managers located worldwide who manage alternative investments such as hedge funds, funds of funds, and private equity funds. We believe our fund and investment processing outsourcing solutions help investment managers reduce risk, improve accuracy and efficiency, and receive tools and information to better manage their business.
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Contracts for our fund and investment processing services generally have terms ranging from one to five years. Fees are primarily earned as a percentage of average assets under management and administration. At December 31, 2008, we had relationships with approximately 180 investment management companies and alternative investment managers. Our principal competitors for this segment include PFPC Worldwide Inc., a member of the PNC Financial Services Group, Inc., Citco, and State Street Bank and Trust Company.
Investments in New Businesses
The Investments in New Businesses segment represents other business ventures intended to expand our investment solutions to include ultra-high-net-worth families who reside in the United States. The family wealth management solution offers flexible family-office type services through a highly personalized solution while utilizing the Manager-of-Managers investment process.
The principal competitors for the family wealth solution are diversified financial services providers focused on the ultra-high-net-worth market.
LSV Asset Management
LSV is a registered investment advisor that provides investment advisory services to institutions, including pension plans and investment companies. LSV is a value-oriented, contrarian money manager offering a deep-value investment alternative utilizing a proprietary equity investment model to identify securities generally considered to be out of favor by the market. LSV is currently the specialist advisor to a number of our equity mutual funds. In addition, LSV is a portfolio manager to a portion of our global investment products. At December 31, 2008, LSV managed approximately $37.7 billion in total assets, of which $1.1 billion were assets in our mutual funds.
Research and Development
We are devoting significant resources to research and development, including expenditures for new technology platforms, enhancements to existing technology platforms, and new investment products and services. We spent approximately $117.5 million in 2008, $141.9 million in 2007, and $139.1 million in 2006, of which we capitalized approximately $56.2 million in 2008, $61.4 million in 2007, and $73.3 million in 2006 relating to the development of new technology platforms. Total research and development expenditures as a percentage of revenues were 11.9 percent in 2008, 13.9 percent in 2007, and 15.7 percent in 2006. All percentages exclude the revenues of LSV.
The majority of our research and development spending is related to building our Global Wealth Platform (GWP). GWP combines our proprietary applications with those built by third-party providers, and integrates them into a single technology solution, providing a common user experience. In order to achieve this, we developed enterprise technology architecture to support component acquisition, integration, operation, and communication. This integration supports straight-through business processing and enables the transformation of front, middle and back-office operations.
The solution will serve European and U.S. markets. GWP provides the technology platform for the business solutions now being marketed to private banks and independent wealth adviser organizations in the United Kingdom and continental Europe. The TRUST 3000® platform does not meet certain requirements of European markets such as trade date reporting, trade date investment accounting, and multi-lingual reporting. In U.S. markets, we believe the demand for the advanced capabilities of the new platform will enable us to market our services to global wealth managers and existing clients in the Private Banks segment and improve the services we offer in the Investment Advisors segment.
GWP will eventually be used at some level by all business segments, except LSV. The front-end components will be used by us and by our clients to manage customer administration and portfolio management. The back-office components will streamline all investment-related activities and will eliminate manual processes and perform trade order execution and settlement activities.
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Marketing and Sales
Our business solutions are directly marketed to potential clients in our target markets. We employ approximately 100 sales representatives who operate from offices located throughout the United States, Canada, the United Kingdom, continental Europe, South Africa, Asia and other locations.
In 2008, no single customer accounted for more than ten percent of revenues in any business segment.
At February 20, 2009, we had approximately 2,200 full-time and 60 part-time employees. None of our employees is unionized. Management considers employee relations to be generally good.
Our principal wholly-owned subsidiaries are SEI Investments Distribution Co., or SIDCO, SEI Investments Management Corporation, or SIMC, SEI Private Trust Company, or SPTC, and SEI Investments (Europe) Limited, or SIEL. SIDCO is a broker-dealer registered with the SEC under the Securities and Exchange Act of 1934 and is a member of the Financial Industry Regulatory Authority. SIMC is an investment advisor registered with the SEC under the Investment Advisers Act of 1940. SPTC is a limited purpose federal thrift chartered and regulated by the United States Office of Thrift Supervision. SIEL is an investment manager and financial institution subject to regulation by the Financial Services Authority of the United Kingdom. In addition, various SEI subsidiaries are subject to the jurisdiction of regulatory authorities in Canada, the Republic of Ireland and other foreign countries. The Company has a minority ownership interest in LSV, which is also an investment advisor registered with the SEC.
SIDCO and SIMC are subject to various federal and state laws and regulations that grant supervisory agencies, including the SEC, broad administrative powers. In the event of a failure to comply with these laws and regulations, the possible sanctions that may be imposed include the suspension of individual employees, limitations on the permissibility of SIDCO, SIMC, SEI, and our other subsidiaries to engage in business for specified periods of time, the revocation of applicable registration as a broker-dealer or investment advisor, as the case may be, censures, and fines. SPTC and SEI Trust Company, a state chartered trust company, are subject to laws and regulations imposed by federal and state banking authorities. In the event of a failure to comply with these laws and regulations, restrictions, including revocation of applicable banking charter, may be placed on the business of these companies. Additionally, the securities and banking laws applicable to us and our subsidiaries provide for certain private rights of action that could give rise to civil litigation. Any litigation could have significant financial and non-financial consequences including monetary judgments and the requirement to take action or limit activities that could ultimately affect our business.
Compliance with existing and future regulations and responding to and complying with recent regulatory activity affecting broker-dealers, investment advisors, investment companies and their service providers and financial institutions could have a significant impact on us. We have responded and are currently responding to various regulatory examinations, inquiries and requests. As a result of these examinations, inquiries and requests, we review our compliance procedures and business operations and make changes as we deem necessary.
We offer investment and banking products that also are subject to regulation by the federal and state securities and banking authorities, as well as foreign regulatory authorities, where applicable. Existing or future regulations that affect these products could lead to a reduction in sales of these products.
Our bank clients are subject to supervision by federal and state banking authorities concerning the manner in which such clients purchase and receive our products and services. Our plan sponsor clients and our subsidiaries providing services to those clients are subject to supervision by the Department of Labor and compliance with employee benefit regulations. Investment advisor and broker-dealer clients are regulated by the SEC and state securities authorities. Existing or future regulations applicable to our clients may affect our clients purchase of our products and services.
In addition, see the discussion of governmental regulations in Item 1A Risk Factors for a description of the risks that proposed regulatory changes may present for our business.
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We maintain a website at www.seic.com and make available free of charge through the Investors section of this website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We include our website in this Annual Report on Form 10-K only as an inactive textual reference and do not intend it to be an active link to our website. The material on our website is not part of this Annual Report on Form 10-K.
Item 1A. Risk Factors.
We believe that the risks and uncertainties described below are those that impose the greatest threat to the sustainability of our business. However, there are other risks and uncertainties that exist that may be unknown to us or, in the present opinion of our management, do not currently pose a material risk of harm to us. The risk and uncertainties facing our business, including those described below, could materially adversely affect our business, results of operations, financial condition and liquidity.
Our revenues and earnings are affected by changes in capital markets. A majority of our revenues are earned based on the value of assets invested in investment products that we manage or administer. Significant fluctuations in securities prices may materially affect the value of these assets and may also influence an investors decision to invest in and maintain an investment in a mutual fund or other investment product. As a result, our revenues and earnings derived from assets under management and administration could be adversely affected.
A majority of the securities held by our investment products are valued using quoted prices from active markets gathered by external pricing services. Securities for which market prices are not readily available are valued in accordance with procedures established by the Funds Board of Trustees and monitored by a Fair Value Committee designated by the Funds Board of Trustees. These procedures may utilize unobservable inputs that are not gathered from any active markets and involve considerable judgment. If these valuations prove to be inaccurate, our revenues and earnings from assets under management could be adversely affected.
We are exposed to product development risk. We continually strive to increase revenues and meet our customers needs by introducing new products and services. As a result, we are subject to product development risk, which may result in loss if we are unable to develop and deliver fully functional products to our target markets that address our clients needs and that are developed on a timely basis and reflect an attractive value proposition. Our spending related to developing new products is for the purpose of enhancing our competitive position in the industry. A significant portion of this spending has been capitalized. In the event that we fail to develop products or services at an acceptable cost or on a timely basis or if we fail to deliver functional products and services which are of sound, economic value to our clients and our target markets, or an inability to support the product in a cost-effective manner, we could suffer significant financial loss.
We intend to implement enhancements and upgrades to the Global Wealth Platform through a series of releases. Future releases may include enhancements that could replace significant components that currently exist in the platform. If this occurs, we may incur significant costs due to the requirement to immediately expense the remaining net book value of previously capitalized development costs of those components that were replaced.
We are dependent upon third-party service providers in our operations. We utilize numerous third-party service providers in our operations, in the development of new products, and in the maintenance of our proprietary systems. A failure by a third-party service provider could expose us to an inability to provide contractual services to our clients in a timely basis. Additionally, if a third-party service provider is unable to provide these services, we may incur significant costs to either internalize some of these services or find a suitable alternative.
During the past several months, the financial services industry has faced an extremely difficult economic environment. Many of the challenges posed by this environment have raised serious concerns related to the financial health of banks. We utilize the services of banks in our operations. Although we have undertaken measures to reduce the potential disruption to our operations and the delivery of services to our clients in the event that any of these banks should fail, our revenues and earnings could be significantly affected if the financial health of certain banks continues to deteriorate or if they become insolvent.
Liquidity issues in the credit markets may affect our earnings and liquidity resources. Certain of our money market funds hold senior notes issued by structured investment vehicles which have ceased making payments on its outstanding notes on the scheduled maturity dates. We entered into support agreements to protect the shareholders of our money market funds from the liquidity risk associated with these securities. The amount of our obligation under these agreements and the corresponding charge against our earnings is dependent upon prevailing conditions
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in the credit markets that affect the value of structured investment vehicles, on the creditworthiness of the structured investment vehicle securities and the overall asset levels of our money market funds. Additionally, in the event the fund realizes a loss from the sale or disposition of a structured investment vehicle, we would be required to pay an amount to the funds of our obligation that could negatively impact our liquidity resources.
Poor fund performance may affect our revenues and earnings. Our ability to maintain our existing clients and attract new clients may be negatively affected if the performance of our mutual funds and other investment products, relative to market conditions and other comparable competitive investment products, is lower. Investors may decide to place their investable funds elsewhere which would reduce the amount of assets we manage resulting in a decrease in our revenues.
Consolidation within our target markets may affect our business. Merger and acquisition activity between banks and other financial institutions could reduce the number of existing and prospective clients. Consolidation activities may also cause larger institutions to internalize some or all of our services. These factors may negatively impact our ability to generate future growth in revenues and earnings.
The Company and our clients are subject to extensive governmental regulation. Our various business activities are conducted through entities which may be registered with the Securities and Exchange Commission (SEC) as an investment advisor, a broker-dealer, a transfer agent, an investment company or with the United States Office of Thrift Supervision or state banking authorities as a trust company. Our broker-dealer is also a member of the Financial Industry Regulatory Authority and is subject to its rules and oversight. In addition, various subsidiaries of the Company are registered with, and subject to the oversight of, regulatory authorities primarily in the United Kingdom and the Republic of Ireland. Many of our clients are subject to substantial regulation by federal and state banking, securities or insurance authorities or the Department of Labor. Compliance with existing and future regulations and responding to and complying with recent regulatory activity affecting broker-dealers, investment advisors, investment companies and their service providers and financial institutions could have a significant impact on us. We have responded and are currently responding to various regulatory examinations, inquiries and requests. As a result of these examinations, inquiries and requests, we review our compliance procedures and business operations and make changes as we deem necessary.
We offer investment and banking products that also are subject to regulation by the federal and state securities and banking authorities, as well as foreign regulatory authorities, where applicable. Existing or future regulations that affect these products could lead to a reduction in sales of these products. Directed brokerage payment arrangements offered by us are also subject to the SEC and other federal regulatory authorities. Changes in the regulation of directed brokerage or soft dollar payment arrangements or strategic decisions of our clients regarding these arrangements could affect sales of some services, primarily our brokerage services.
As a result of the recent economic and political developments, there has been an unusual amount of speculation about governmental regulation of financial institutions and financial products. Changes in laws or regulations and changes in the identity or policies of the regulators having jurisdiction over our regulated subsidiaries, products or clients could have a material impact on our markets, customers, solutions, revenues and costs.
We are exposed to systems and technology risks. Through our proprietary systems, we maintain and process data for our clients that is critical to their business operations. An unanticipated interruption of service may have significant ramifications, such as lost data, damaged software codes, or inaccurate processing of transactions. As a result, the costs necessary to rectify these problems may be substantial.
We are exposed to data security risks. A failure to safeguard the integrity and confidentiality of client data and our proprietary data from the infiltration by an unauthorized user that is either stored on or transmitted between our proprietary systems or to other third party service provider systems may lead to modifications or theft of critical and sensitive data pertaining to us or our clients. The costs incurred to correct client data and prevent further unauthorized access to our data or client data could be extensive.
We are dependent upon third party approvals. Many of the investment advisors through which we distribute our investment offerings are affiliated with independent broker-dealers or other networks, which have regulatory responsibility for the advisors practice. As part of the regulatory oversight, these broker-dealers or networks must approve the use of our investment products by affiliated advisors within their networks. Failure to receive such approval, or the withdrawal of such approval, could adversely affect the marketing of our investment products.
We are exposed to operational risks. Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions and inadequacies or breaches in our internal control processes. We operate different businesses in diverse markets and are reliant on the ability of our employees and
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systems to process large volumes of transactions often within short time frames. In the event of a breakdown or improper operation of systems, human error or improper action by employees, we could suffer financial loss, regulatory sanctions or damage to our reputation. In order to mitigate and control operational risk, we continue to enhance policies and procedures that are designed to identify and manage operational risk.
Changes in, or interpretation of, accounting principles could affect our revenues and earnings. We prepare our consolidated financial statements in accordance with generally accepted accounting principles. A change in these principles can have a significant effect on our reported results and may even retroactively affect previously reported results.
Changes in, or interpretations of, tax rules and regulations may adversely affect our effective tax rates. Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates could be adversely affected by changes in tax laws or the interpretation of tax laws. We are subject to possible examinations of our income tax returns by the Internal Revenue Service and state and foreign tax authorities. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes, however, there can be no assurance that the final determination of any examination will not have an adverse effect on our operating results or financial position.
Currency fluctuations could negatively affect our future revenues and earnings as our business grows globally. We operate and invest globally to expand our business into foreign markets. Our foreign subsidiaries use the local currency as the functional currency. As these businesses evolve, our exposure to changes in currency exchange rates may increase. Adverse movements in currency exchange rates may negatively affect our operating results, liquidity and financial condition.
We rely on our executive officers and senior management. Most of our executive officers and senior management personnel do not have employment agreements with us. The loss of these individuals may have a material adverse affect on our future operations.
Item 2. Properties.
Our corporate headquarters is located in Oaks, Pennsylvania and consists of nine buildings situated on approximately 90 acres. We own and operate the land and buildings, which encompass approximately 486,000 square feet of office space and 34,000 square feet of data center space. We lease other offices which aggregate 60,000 square feet. We also own a 3,400 square foot condominium that is used for business purposes in New York, New York.
Item 3. Legal Proceedings.
On September 30, 2004, SIDCO was named as a defendant in a putative consolidated amended class action complaint (the PBHG Complaint) filed in the United States District Court for the District of Maryland titled Stephen Carey v. Pilgrim Baxter & Associates, LTD, et. al. The PBHG Complaint was purportedly made on behalf of all persons that purchased or held PBHG mutual funds during the period from November 1, 1998 to November 13, 2003 and related generally to various market timing practices allegedly permitted by the PBHG Funds. The suit named as defendants some 36 persons and entities, including various persons and entities affiliated with Pilgrim Baxter & Associates, Ltd., various PBHG Funds, various alleged market timers, various alleged facilitating brokers, various clearing brokers, various banks that allegedly financed the market timing activities, various distributors/underwriters and others. The PBHG Complaint alleged that SIDCO was the named distributor/underwriter from November 1998 until July 2001 for various PBHG funds in which market timing allegedly occurred during that period. The PBHG Complaint generally alleged that the prospectus for certain PBHG funds made misstatements and omissions concerning market timing practices in PBHG funds. The PBHG Complaint alleged that SIDCO violated Sections 11 and 12(a)(2) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 34(b) and 36(a) of the Investment Company Act of 1940, and that SIDCO breached its fiduciary duties, engaged in constructive fraud and aided and abetted the breach by others of their fiduciary duties. The PBHG Complaint did not name SIDCO or any of its affiliates as a market timer, facilitating or clearing broker or financier of market timers. The PBHG Complaint sought unspecified compensatory and punitive damages, disgorgement and restitution. In 2006, the plaintiffs submitted a proposed form of order dismissing SIDCO from the action, but the Court has not yet acted on the proposed order.
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Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the fourth quarter of 2008.
Executive Officers of the Registrant
Information about our executive officers is contained in Item 10 of this report and is incorporated by reference into this Part I.
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Price Range of Common Stock and Dividends:
Our common stock is traded on The Nasdaq Global Select Market® (NASDAQ) under the symbol SEIC. The following table shows the high and low sales prices for our common stock as reported by NASDAQ and the dividends declared on our common stock for the last two years. Our Board of Directors intends to declare future dividends on a semiannual basis.
As of January 30, 2009, we estimate that we had approximately 510 shareholders of record.
For information on our equity compensation plans, refer to Note 10 to the Consolidated Financial Statements and Item 12 of this Annual Report on Form 10-K.
Comparison of Cumulative Total Return of Common Stock, Industry Index and Nasdaq Market Index:
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Issuer Purchases of Equity Securities:
Our Board of Directors has authorized the repurchase of up to $1.53 billion of our common stock. Currently, there is no expiration date for our common stock repurchase program.
Information regarding the repurchase of common stock during the three months ended December 31, 2008 is:
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(In thousands, except per-share data)
This table presents selected consolidated financial information for the five-year period ended December 31, 2008. This data should be read in conjunction with the financial statements and Managements Discussion and Analysis of Financial Condition and Results of Operations included in this Annual Report on Form 10-K.
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(In thousands, except per-share data)
This discussion reviews and analyzes the consolidated financial condition at December 31, 2008 and 2007, the consolidated results of operations for the years ended December 31, 2008, 2007, and 2006, and other factors that may affect future financial performance. This discussion should be read in conjunction with the Selected Financial Data included in Item 6 of this Annual Report and the Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report.
Our Business and Business Segments
We are a leading global provider of investment processing, fund processing, and investment management business outsourcing solutions that help corporations, financial institutions, financial advisors, and ultra-high-net-worth families create and manage wealth. Investment processing fees are earned as monthly fees for contracted services, including computer processing services, software licenses, and trust operations services, as well as transaction-based fees for providing securities valuation and trade-execution. Fund processing and investment management fees are earned as a percentage of average assets under management or administration. As of December 31, 2008, through our subsidiaries and partnerships in which we have a significant interest, we administer $379.6 billion in mutual fund and pooled assets, manage $134.3 billion in assets, and operate from numerous offices worldwide.
Our reportable business segments are:
Private Banks provides investment processing and investment management programs to banks and trust institutions worldwide and independent wealth advisers located in the United Kingdom and accounts for 33 percent of consolidated revenues in 2008;
Investment Advisors provides investment management programs to affluent investors through a network of independent registered investment advisors, financial planners and other investment professionals in the United States and accounts for 18 percent of consolidated revenues in 2008;
Institutional Investors provides investment management programs and administrative outsourcing solutions to retirement plan sponsors and not-for-profit organizations worldwide and accounts for 16 percent of consolidated revenues in 2008;
Investment Managers provides investment processing, fund processing and operational outsourcing solutions to investment managers, fund companies and banking institutions located in the United States and to investment managers worldwide of alternative asset classes such as hedge funds, fund of funds, and private equity funds and accounts for 11 percent of consolidated revenues in 2008;
Investments in New Businesses provides investment management programs to ultra-high-net-worth families residing in the United States through the SEI Wealth Network®. This segment accounts for one percent of consolidated revenues in 2008; and
LSV Asset Management is a registered investment advisor that provides investment advisory services to institutions, including pension plans and investment companies. This segment accounts for 21 percent of consolidated revenues in 2008.
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Results of Operations
Revenues, Expenses, Income from operations and Income before income taxes by business segment for the year ended 2008 compared to the year ended 2007, and for the year ended 2007 compared to the year ended 2006 are:
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This table presents assets of our clients, or of our clients customers, for which we provide management or administrative services. These assets are not included in our balance sheets because we do not own them.
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Assets under management are total assets of our clients or their customers invested in our equity and fixed-income investment programs, collective trust fund programs, and liquidity funds for which we provide asset management services. Assets under management and administration are total assets of our clients or their customers for whom we provide administrative services, including client proprietary fund balances for which we provide administration and/or distribution services.
Recent events in 2008 had unprecedented effects on the capital markets and greatly impacted the values of our assets under management and administration. During most of 2008, the equity markets declined steadily but then rapidly deteriorated beginning in September and throughout the remainder of the year. The S&P 5001 and the Dow Jones Industrial Average2 declined by over 35 percent and 30 percent, respectively, in 2008. Both measures declined by approximately 20 percent in the fourth quarter. Asset management, administration and distribution fees trended downward in 2008, following the decline of the capital markets. New client activity in our Institutional Investors and Investment Managers segments served to offset some of the devaluation in our assets under management and administration caused by the capital markets.
The lack of confidence in the capital markets also drove investors to seek highly-liquid, stable investments, such as money market funds, U.S. Treasury securities and alternative investments such as commodities. Our revenues were negatively impacted by this trend as some clients transferred their assets from our higher margin investment products, such as equity and fixed-income funds, into our lower margin investment products, such as money market funds. This tendency was especially true for our assets under management of U.S. investors in our Investment Advisors segment. Our revenues were also negatively impacted by withdrawals of assets from our investment products entirely by international investors in our Private Banks segment.
Volatility in the capital markets in 2007 was driven mainly by the onset of the subprime mortgage crisis in the later half of the year. The gains achieved in the first half of 2007 were largely offset by the decline in equity prices from fears of a broadening economic slowdown which led to negative returns in the fourth quarter. For the year, the S&P 500 and Dow Jones Industrial Average reported only modest gains. The appreciation in market values throughout most of 2007 increased the value of the assets we manage and administer thereby increasing our base revenues from existing clients. Even with the poor fourth quarter in 2007, our revenues increased relative to prior year comparable periods. Cash flows into our funds exceeded redemptions during 2007 from new and existing clients. The capital markets in 2007 were significantly different than 2008. This trend is evident in our revenues as well.
In late 2007, we entered into Capital Support Agreements with several of our money market funds. Among other money market instruments, these funds held senior notes issued by structured investment vehicles (SIV or SIVs) which failed to make payments on their outstanding notes on the scheduled maturity dates. Prolonged illiquidity in the credit markets during 2008 significantly reduced the market value of the collateral underlying the SIV securities owned by our money market funds, which greatly increased our obligation under the Capital Support Agreements (See Money Market Fund Support later in this discussion).
Of primary importance to our strategic initiatives is the successful deployment of the Global Wealth Platform. The initial version of the platform was delivered in July 2007. Our plan is to provide additional significant functionality for the platform through a series of releases that are expected to offer a complete global investment processing solution to private banks and non-bank wealth management firms. Our efforts in 2008 were primarily focused on major investment processing enhancements and building the operational infrastructure necessary to support the platform and our clients. The additional functionality built during 2008 was placed into service through a large release in January 2009.
Significant Items Impacting Our Financial Results in 2008
Revenues decreased $121.1 million, or nine percent, to $1.25 billion in 2008 compared to 2007. Net income declined $120.6 million, or 46 percent, to $139.3 million and diluted earnings per share dropped to $0.71 per share in 2008 compared to $1.28 per share in 2007. We believe the following items were significant to our business during 2008:
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Significant Items Impacting Our Financial Results in 2007
Revenues increased $193.3 million, or 16 percent, to $1.37 billion in 2007 compared to 2006. Net income increased $22.8 million, or 10 percent, to $259.8 million and diluted earnings per share improved to $1.28 per share in 2007 compared to $1.17 per share in 2006. We believe the following items were significant to our business during 2007:
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Forward Looking Information and Risk Factors
Certain information contained in this discussion is or may be considered forward-looking. Forward-looking statements relate to future operations, strategies, financial results or other developments. Forward-looking statements are based upon estimates and assumptions that involve certain risks and uncertainties, many of which are beyond our control or are subject to change. Although we believe our assumptions are reasonable, they could be inaccurate. Our actual future revenues and income could differ materially from our expected results. We have no obligation to publicly update or revise any forward-looking statements.
Among the risks and uncertainties which may affect our future operations, strategies, financial results or other developments are those risks described in Item 1A Risk Factors of this Annual Report. The following items are, in our opinion, anticipated to occur in the next 12 to 18 months:
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Money Market Fund Support
In late 2007, we entered into Capital Support Agreements with the SEI Daily Income Trust Prime Obligation Fund (the SDIT PO Fund), the SEI Daily Income Trust Money Market Fund (the SDIT MM Fund), and the SEI Liquid Asset Trust Prime Obligation Fund (the SLAT PO Fund) (each a Fund or, together, the Funds). We are the advisor to the Funds. The sub-advisor to the Funds is Columbia Management, which is the primary investment management division of Bank of America Corporation. Many of our clients are investors in the Funds. SDIT PO Fund is rated AAA and Aaa by Standards & Poors Corporation (S&P) and Moodys Investor Services Inc. (Moodys), respectively, and the SDIT MM Fund is rated Aaa by Moodys. The SLAT PO Fund is not rated by S&P or Moodys.
Among other money market instruments, the Funds hold senior notes issued by SIVs. SIVs issue commercial paper and other debt securities and use the proceeds to purchase bonds and other long-term debt instruments that are used to collateralize the obligations of the vehicle. The senior notes are collateralized by residential mortgage-backed securities, commercial mortgage-backed securities, corporate collateralized debt obligations and collateralized debt obligations of asset-backed securities. Some of the SIVs ceased making payments on their outstanding notes on the scheduled maturity dates.
In October 2007, S&P stated that it would place any mutual fund that had an AAA rating and owned certain SIV securities on credit watch with negative implications unless the fund was provided credit support having an A-1 short-term rating by S&P. Although we were not obligated to provide the credit support required by S&P, in order to avoid a credit watch by S&P on the SDIT PO Fund, and to address the needs of our customers who require an S&P AAA rating of the SDIT PO Fund, we entered into the Capital Support Agreements to satisfy S&Ps requirement. We entered into similar agreements with the SDIT MM and SLAT PO Funds.
Since the time we entered into the Capital Support Agreements in late 2007, significant illiquidity issues persisted in the credit markets which caused the market values of the collateral underlying the SIV securities to decline. This triggered ratings downgrades on the SIV securities from the principal rating agencies which required us to post additional capital support to the SDIT PO Fund in order for it to maintain a AAA rating by S&P. In late 2008, we amended the Capital Support Agreements with the SDIT PO Fund and the SLAT PO Fund. We also amended our credit facility to increase the aggregate amount available for borrowings up to $300.0 million (See Liquidity and Capital Resources section later in this discussion and Note 8 to the Consolidated Financial Statements).
On September 30, 2008, we purchased the Gryphon (formerly Cheyne) notes directly from the SDIT MM Fund. The Gryphon notes were the last remaining SIV securities held by this Fund. The cash purchase price paid to the SDIT MM Fund of $15.3 million was equal to the amortized cost of the Gryphon notes. The market value on that date was $8.7 million and as of December 31, 2008 was $5.7 million. The total loss recognized through December 31, 2008 was $9.3 million. The Gryphon notes were received by the SDIT MM Fund in exchange for the Cheyne notes through a restructuring in July 2008. We have received cash distributions on the Gryphon notes since our purchase of the notes in September 2008. The Capital Support Agreement with the SDIT MM fund was allowed to lapse after the purchase of the Gryphon notes.
On November 5, 2008, we amended the Capital Support Agreement that was entered into on November 8, 2007 with the SDIT PO Fund. The Amended and Restated Capital Support Agreement (the SDIT PO Amended Agreement) requires us to provide additional support to the SDIT PO Fund. The SDIT PO Amended Agreement provides that if the SDIT PO Fund realizes payments or sales proceeds from the ultimate disposition of any of the specified SIV securities which are less than its amortized cost, we will be required to provide capital to the SDIT PO Fund equal to the amount by which the amortized cost of the specified SIV securities exceeds the amount realized from the sale or other disposition of the SIV securities. Also, we must maintain collateral in the form of a letter of credit and/or a segregated cash account equal to the difference between the amortized cost value and the market value of the specified SIV securities plus an amount equal to ten percent of the market value of the specified SIV securities. The SDIT PO Amended Agreement is scheduled to expire on November 6, 2009.
On November 28, 2008, we amended the Capital Support Agreement that was entered into on December 3, 2007 with the SLAT PO Fund. The Amended and Restated Capital Support Agreement (the SLAT PO Amended Agreement) requires us to commit capital to the SLAT PO Fund subject to an aggregate limit of $30.0 million if the fund realizes payments or sales proceeds from the ultimate disposition of any specified SIV securities held by the Fund which are less than the amortized cost of the specified SIV securities. Upon the sale or other disposition of the SIV securities, the amount of required capital commitment would be the least of the following amounts: (i) the amount, if any, by which the amortized cost of the SIV securities exceeds the amount realized from the sale or other disposition of the SIV securities; (ii) the amount, if any, necessary to restore the net asset value per share of the Fund to $0.9950, or (iii) the remaining amount of the aggregate limit of the Capital Support Agreement applicable to the Fund, taking into account all prior contributions. Under the SLAT PO Amended Agreement, we must maintain collateral in the form of a letter of credit and/or segregated cash account equal to the aggregate limit of committed capital. The SLAT PO Amended Agreement is scheduled to expire on November 6, 2009.
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In the event we are required to commit capital to either Fund, we will not receive any consideration from the Fund, in the form of shares of the Fund or any other form, for the contributed capital. If the market value of the SIV securities is less than its amortized cost (and in the case of the SLAT PO Fund, the aggregate net asset value of the SLAT PO Fund is less than $0.9950), then, even though the loss has not been realized through the sale or other disposition of the SIV securities, we will be obligated to commit the required amount of capital for the amount that the market value of the SIV securities are less than its amortized cost (or in the case of the SLAT PO Fund, the net asset value is at least $.9950). However, in this case, we would not be required to pay the capital contribution to the Funds. As of December 31, 2008, the amount of our obligation to commit capital to the Funds was $174.0 million, but this amount was not required to be paid since the Funds did not realize any loss from the sale of the SIV securities. The amount of our obligations recognized is reflected in Net loss from investments on the Consolidated Statements of Operations.
The following table summarizes our obligations from the Amended Capital Support Agreements as of December 31, 2008.
The obligations under the Amended Capital Support Agreements are secured by letters of credit of a third party bank rated A-1 by S&P. The letters of credit were issued under our existing credit facility that provides for borrowings up to $300.0 million. The letters of credit have a term of one year. As of December 31, 2008, we have $190.0 million of letters of credit outstanding (See Liquidity and Capital Resources section later in this discussion).
All SIV securities that remain on the books of the two Funds covered by the Amended Capital Support Agreements are in technical default. The Funds currently hold five SIV securities, three of which have already restructured. Gryphon is the largest SIV security held by the Funds. As of February 20, 2009, the aggregate par value of the Gryphon notes represent 74 percent of the total par value of all SIV securities held by the SDIT PO Fund and 11 percent of the total par value of all SIV securities held by the SLAT PO Fund. The next largest SIV security held by the Funds is Stanfield Victoria. Stanfield Victoria is currently in receivership and has not yet fully restructured. The ultimate outcome of the restructuring is currently unknown. As of February 20, 2009, the aggregate par value of Stanfield Victoria represents the remaining 26 percent of the total par value of all SIV securities held by the SDIT PO Fund and 24 percent of the total par value of all SIV securities held by the SLAT PO Fund. Gryphon and Stanfield Victoria represent 86 percent of the total par value of the SIV securities held, in aggregate, by the Funds. No other SEI-sponsored fund holds any SIV securities.
According to the terms of the Amended Capital Support Agreements, we are required to purchase any SIV securities held by the Funds which have not completed restructuring by April 1, 2009. We anticipate that the SIV securities that have not restructured as of February 20, 2009 may not complete restructuring by March 31, 2009 and; therefore, we expect that we will be required to purchase these SIV securities.
Our total risk of loss from SIV securities is limited to the aggregate remaining par value held by the Funds and on our balance sheet. As of February 20, 2009, the aggregate par value of these securities totaled $336.5 million. We do not engage in any lending activities or any other activity that exposes us to a risk of loss associated with the illiquidity issues in the credit markets.
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The following table summarizes our obligations from the Amended Capital Support Agreements as of February 20, 2009.
When we entered into the Capital Support Agreements, the Funds became variable interest entities and we were considered to have a significant variable interest in the Funds. Therefore, we needed to determine if we were the primary beneficiary according to the provisions established in FIN 46(R). Our analysis concluded that we were not the primary beneficiary because the support we provide under the Capital Support Agreements would not absorb a majority of the variability created by the assets of the Funds. As a result, we were not required to consolidate the accounts of the Funds into our Consolidated Financial Statements. We perform this analysis at each reconsideration event (See Note 1 to the Consolidated Financial Statements).
The Amended Capital Support Agreements are considered derivative contracts in accordance with applicable accounting guidance and are categorized as Level 3 liabilities as specified by SFAS No. 157 (SFAS 157), Fair Value Measurements (See Fair Value Measurements section later in this discussion). These Level 3 liabilities comprise 53 percent of our total current liabilities at December 31, 2008. The fair value of the derivative contracts approximates the value of our actual obligation at December 31, 2008. The value of the Capital Support Agreements will be determined at least quarterly. In the event payments are not required to be paid to the Funds, such expense may be reversed in a subsequent period.
Our future obligation under the Amended Capital Support Agreements is affected by a number of factors including, but not limited to, prevailing conditions in the credit markets as they impact the value of the SIV securities owned by the Funds, the creditworthiness of the SIV securities and the overall asset level of the SLAT PO Fund. A change in the net asset value of the SLAT PO Fund is dependent upon net investments or redemptions in the Fund and the net asset value of the portfolio assets of the Funds. Changes in these amounts, including changes in portfolio assets resulting from mark-to-market adjustments, will affect the per share net asset value of the Funds. The fair market value of the SIV securities is derived from current market prices or, in the event no market price exists, from external valuation sources (See Fair Value Measurements section later in this discussion).
The market value of the SIV securities has the most significant impact on the amount of our obligation under the Capital Support Agreements. Our obligation can fluctuate on a daily basis. The following table, based on actual values as of February 20, 2009, is included to give an indication of the impact of a one percent movement in the value of securities issued by SIVs held by the Funds on our obligation under the Capital Support Agreements:
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Our stock based compensation consists of stock option grants to board members, senior management and key employees. We believe that stock based compensation serves as an important means of aligning the interest of management and employees with the interests of our shareholders. The 2007 Equity Compensation plan became effective June 1, 2007 and provides for the grant of incentive stock options, non-qualified stock options and stock appreciation rights of up to 20 million shares of common stock. Upon the effective date of the 2007 Equity Compensation Plan, our 1998 Equity Compensation plan was terminated. No options are available for grant under the 1998 Plan and any grants outstanding under the 1998 Plan continue in effect under the terms of the grant and the applicable plan. Currently, our stock based compensation consists of only non-qualified stock options. For more information on our option plans, see Note 10 to the Consolidated Financial Statements and Item 12 of this Annual Report.
We account for stock based compensation in accordance with SFAS 123(R). Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. We currently use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as various other assumptions. These assumptions include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We currently base our expectations for these assumptions from historical data. These expectations are subject to change in future periods.
All outstanding stock options have performance based vesting provisions that tie the vesting of stock options to our financial performance. Our stock options vest at a rate of 50 percent when a specified diluted earning per share target is achieved, and the remaining 50 percent when a second, higher specified diluted earnings per share target is achieved. Stock options granted prior to 2006 fully vest after seven years from the date of grant. Beginning in 2006, the seven year vesting trigger was eliminated and, as a result, options do not vest due to the passage of time but solely as a result of achievement of the financial vesting targets. Earnings per share targets are calculated exclusive of stock-based compensation expense, net of tax. The diluted earnings per share targets are established at time of grant and are measured annually on December 31. The amount of stock-based compensation expense is based upon our estimates of when we believe the earnings per share targets may be achieved. If our estimate of the attainment of the earnings per share targets proves to be inaccurate, the remaining amount of stock-based compensation expense could be accelerated, spread out over a longer period, or reversed. This may cause volatility in the recognition of stock-based compensation expense in future periods and could materially affect our net income and net income per share.
In 2008 and 2007, we recognized approximately $16.0 million and $28.2 million, respectively, in stock-based compensation expense, a decrease of $12.2 million. This decrease consisted of the following components:
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Based upon our current estimate of how many options will vest and when they will vest, we estimate that stock-based compensation expense will be recognized according to the following schedule:
Revenues decreased $5.4 million, or one percent, in 2008 compared to 2007. Revenues during 2008 were primarily affected by:
Revenues increased $46.5 million, or 13 percent, in 2007 compared to 2006. Revenues during 2007 were primarily affected by:
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Operating margins were 20 percent in 2008 and 2007. Operating income decreased $1.2 million, or one percent, in 2008 compared with 2007. Operating income in 2008 was primarily affected by:
Operating margins were 20 percent in 2007 as compared to 24 percent in 2006. Operating income decreased $5.4 million, or six percent, in 2007, compared with 2006. Operating income during 2007 was primarily affected by:
Revenues decreased $36.1 million, or 14 percent, in 2008 compared with 2007. Revenues during 2008 were primarily affected by:
Revenues increased $33.6 million, or 15 percent, in 2007 compared with 2006. Revenues during 2007 were primarily affected by:
Operating margins were 45 percent in 2008 and 52 percent in 2007. Operating income decreased $33.4 million, or 25 percent, in 2008 compared with 2007. Operating income in 2008 was primarily affected by:
Operating margins were 52 percent in 2007 as compared to 50 percent in 2006. Operating income increased $20.5 million, or 18 percent, in 2007 compared with 2006. Operating income during 2007 was primarily affected by:
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Revenues decreased $1.4 million, or one percent, in 2008 compared with 2007. Revenues during 2008 were primarily affected by:
Revenues increased $34.6 million, or 21 percent, in 2007 compared with 2006. Revenues during 2007 were primarily affected by:
Operating margins were 43 percent in 2008 and 39 percent in 2007. Operating income increased $7.0 million, or nine percent, in 2008 compared with 2007. Operating income during 2008 was primarily affected by:
Operating margins were 39 percent in 2007 and 36 percent in 2006. Operating income increased $19.6 million, or 34 percent, in 2007 compared with 2006. Operating income during 2007 was primarily affected by:
Revenues increased $4.6 million, or three percent, in 2008 compared with 2007 and $24.4 million, or 21 percent, in 2007 compared with 2006. Revenues during 2008 and 2007 were primarily affected by:
Operating margins were 32 percent in 2008, 29 percent in 2007 and 24 percent in 2006. Operating income increased $4.9 million, or 12 percent, in 2008 compared with 2007, and $13.8 million, or 49 percent, in 2007 compared with 2006. Operating income during 2008 and 2007 was primarily affected by:
Revenues decreased $82.4 million, or 24 percent, in 2008 compared with 2007. Revenues during 2008 were primarily affected by:
Revenues increased $54.5 million, or 19 percent, in 2007 compared with 2006. Revenues during 2007 were primarily affected by:
Operating margins were 37 percent in 2008 and 38 percent in 2007. Our earnings from LSV decreased $33.2 million, or 25 percent, in 2008 compared with 2007. Operating income during 2008 was primarily affected by:
Operating margins were 38 percent in 2007 and 39 percent in 2006. Our earnings from LSV increased $19.3 million, or 17 percent, in 2007 compared with 2006. Operating income during 2007 was primarily affected by:
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Corporate overhead expenses
Corporate overhead expenses primarily consist of corporate units such as executive management, accounting, regulatory compliance, workforce development and other general administrative costs not directly associated with a reportable business segment. The decrease in these expenses in 2008 was primarily due to lower incentive compensation and stock-based compensation expenses and other discretionary costs. The increase in corporate overhead expenses in 2007 was primarily due to costs and resources associated with our corporate compliance program and employee development programs.
Other Income and Expense Items
Other income and expense items on the accompanying Consolidated Statements of Operations consist of:
Net loss from investments
Net loss from investments consists of:
Losses from Capital Support Agreements include non-cash charges pertaining to our obligation to provide capital support to our money market funds that hold SIV securities (See Money Market Fund Support earlier in this discussion).
We elected to apply the fair value option under SFAS 159 to certain securities acquired in 2008. SFAS 159 requires these securities be reported at their fair value and any unrealized gains and losses be recognized in current period earnings. The net amount of all unrealized losses on these securities for which we have elected the fair value option is reflected in Decrease in fair value of financial instruments on the above table. These securities are classified as Trading Securities on our Consolidated Balance Sheet and primarily include: a) the last remaining SIV securities that were held by our SDIT MM Fund; b) seed money investment in a LSVsponsored mutual fund; and c) futures contracts purchased to hedge our investment in the LSV-sponsored fund.
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As of December 31, 2008, the market value of the SIV security purchased from the SDIT MM Fund was $5.7 million and the cost basis was $15.0 million resulting in an unrealized loss of $9.3 million. The value of this SIV security is dependent on the market value of the underlying collateral which involves assumptions and estimates. This SIV security is classified as a Level 3 security in the fair value hierarchy (See Fair Value Measurements section later in this discussion).
Our seed money investment in the LSV-sponsored mutual fund is intended to facilitate the startup of the fund. This mutual fund is a U.S. dollar denominated fund that invests primarily in securities of Canadian and Australian companies as well as various other global securities. The underlying securities held by the fund are translated into U.S. dollars within the fund. In order to provide some protection for our original investment in this fund, we purchased equity and currency futures contracts as part of an economic hedging strategy to minimize our exposure to price and currency risk. We hold equity futures contracts with a notional value of $4.1 million that are expected to hedge the price risk associated with movements of certain Canadian, Australian and global indices. We also purchased currency futures contracts with a notional value of $2.7 million that are expected to hedge the currency risk associated with movements of the U.S. dollar against the Canadian and Australian dollars since the underlying securities of the fund are predominately denominated in those currencies. The fair value of the futures contracts are netted against the fair value of the investment in the LSV-sponsored fund. Changes in the fair value of the LSV-sponsored fund and the related futures contracts are recognized in Net loss from investments on the accompanying Consolidated Statements of Operations.
In consideration of a hypothetical change in the value of the LSV-sponsored fund, a change in the value of our futures contracts are expected to substantially offset the gains or losses associated with the investment and minimize the impact to our earnings.
We have investments in two SEI-sponsored mutual funds which primarily invest in fixed-income securities, including debt securities issued by municipalities and mortgage-backed securities. The market value of these securities has steadily decreased since the initial purchase in 2007. In August 2008, we concluded that the earnings potential and near term prospects of some of the issuers of the underlying securities held in the funds are uncertain and that it was unlikely the investments will fully recover from a loss position in the foreseeable future. Due to these factors, we recorded an impairment charge of $2.0 million during the third quarter of 2008 and classified this charge as an Other-than-temporary decline in market value. Subsequently, the market value of these securities declined an additional $3.3 million by December 31, 2008. We did not record an other-than-temporary impairment charge at December 31, 2008 due to our assessment of several factors including the volatility in the capital markets, the short duration of time since the impairment charge recorded in August 2008 and our ability and intent to hold onto these securities for a sufficient period to allow for a recovery. We will closely monitor the market value of these securities and may record an other-than-temporary impairment charge at a future date.
The other-than-temporary decline in market value of $2.0 million in 2006 related to an investment in a SEI-sponsored mutual fund that had been in an unrealized loss position for an extended period of time. The market value of this investment eventually increased. We liquidated our entire holdings in this investment and realized a gain in 2008.
Other losses in 2007 and 2006 include write-downs of approximately $0.5 million in 2007 and $1.5 million in 2006, respectively, related to an investment in a private company. The write down in 2007 represented the remaining balance of the investment in the company.
Interest and dividend income
Interest and dividend income is earned based upon the amount of cash that is invested daily. The decrease in interest income in 2008 compared to 2007 was due to a decline in interest rates and lower cash balances. The increase in 2007 was due to higher overall cash balances and interest rates as compared to those in 2006.
Interest expense in 2008 includes the borrowings of LSV Employee Group and fees for our lines of credit. Interest expense for the debt associated with LSV Employee Group was approximately $2.3 million in 2008, $3.8 million in 2007 and $4.4 million in 2006. The decline in interest expense in 2008 compared to 2007 is due to the lower amount of outstanding debt of LSV Employee Group and the inclusion of interest expenses associated with our Senior Notes in 2007. We made a voluntary payment for the remaining balance on our Senior Notes in August 2007. The decrease in interest expense in 2007 compared to 2006 is due to lower balances of outstanding debt.
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Other income in 2008 relates to an adjustment for interest costs associated with borrowings in prior years at a time when various capital projects were underway. We incorrectly expensed all interest costs rather than capitalizing these costs as part of the cost basis of these capital projects (See Note 1 to the Consolidated Financial Statements).
Minority interest primarily includes the amount owned by other shareholders or partners of LSV and LSV Employee Group in which we have a significant or controlling interest. The accounts of these entities are included in our consolidated financial statements.
Our effective tax rate was 38.1 percent in 2008, 36.6 percent in 2007 and 33.9 percent in 2006. The 2008 effective tax rate is higher than prior years due to state tax impact relating to the expense associated with the Capital Support Agreements. For Pennsylvania state tax purposes, we are required to defer the tax deduction on this expense until cash payment is made. This deferred deduction gives rise to a deferred tax asset, which generally provides future tax savings. However, the usage of this asset is substantially limited due to Pennsylvanias net operating loss carryforward rules. Therefore, we cannot deduct this expense because the future benefit of this deduction is uncertain.
Fair Value Measurements
The fair value of our financial assets and liabilities is determined in accordance with the fair value hierarchy established in SFAS 157. The fair value of most of our financial assets are determined using Level 1 or Level 2 inputs and consist mainly of investments in equity or fixed-income mutual funds that are quoted daily and Government National Mortgage Association (GNMA) securities that are single issuer pools that are valued based on current market data of similar assets. Our Level 3 financial assets and liabilities consist mainly of SIV securities and the Capital Support Agreements. The Capital Support Agreements are considered derivative liabilities for accounting purposes, for which the fair value is based principally on changes in the fair value of SIV securities held by our money market funds.
The underlying collateral of the SIV securities is mainly comprised of asset-backed securities and collateralized debt obligations. Recent liquidity issues surrounding collateralized debt obligations and asset-backed securities has greatly affected the fair value of SIV securities. Given the lack of any reliable market data on the SIV securities owned by us or held by our money market funds, the fair value of these SIV securities is determined using a net asset value approach which considers the value of the underlying collateral. We utilize external pricing services that incorporate market data, where available, or through the use of matrix pricing or other acceptable measures. The valuation methodology used by these service providers considers various characteristics of the underlying collateral including, but not limited to, the issuer, collateral attributes, prepayment speeds, and credit ratings. The underlying collateral that lack any market data are grouped by sector and valued using the most recent quoted price, which may be longer than one year, and adjusting that price by the percentage change in the respective sector using relative benchmarks. Prices for the SIV securities as well as the underlying collateral are subject to internal reviews that consider broker quotes, current market observations and other analyses to verify the fair value. In the event a market transaction does exist, we will evaluate the circumstances surrounding the transaction in order to assess if the price used represents the fair value according to the guidance in SFAS 157. In our opinion, the price of SIV securities used in recent transactions were from distressed sales and did not represent the implied fair value of the SIV securities held by us or by our money market funds.
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The table below presents a reconciliation for all of our financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period from January 1, 2008 to December 31, 2008:
Liquidity and Capital Resources
Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing. At December 31, 2008, our unused sources of liquidity consisted of cash and cash equivalents and the amount available under our credit facility. Cash and cash equivalents of $416.6 million includes $60.5 million at December 31, 2008 from LSV, of which we have a 43 percent partnership interest (See Note 2 to the Consolidated Financial Statements). Our cash and cash equivalents include accounts managed by our subsidiaries and minority-owned subsidiaries that are used in their operations or to cover specific business and regulatory requirements. The availability of this cash for other purposes beyond the operations of these subsidiaries may be limited. The actual amount of cash and cash equivalents that is free and available for other general corporate purposes is reduced by these cash accounts.
We have capacity for additional borrowings through a five year unsecured senior revolving credit facility with JPMorgan Chase Bank, N.A., individually and as agent and a syndicate of other lenders. We have no reason to believe that any of the participating lenders will be unable to honor their respective commitments relating to all of the terms of the credit facility. The credit facility became effective in July 2007 and initially provided for borrowings up to $200.0 million. Three amendments to the credit facility were executed in 2008. The primary changes to the credit facility from the amendments included: 1) an increase of $100.0 million in the total aggregate borrowing amount to $300.0 million with an option for an additional increase of $100.0 million to $400.0 million under certain conditions; 2) an allowance for the incurrence of the contingent obligation represented by the Amended Capital Support Agreements; 3) the exclusion of purchases of SIV securities held by SDIT PO and SLAT PO of up to $346.0 million and purchases of GNMA securities to satisfy applicable regulatory requirements of SPTC, our wholly-owned subsidiary, of up to $100.0 million from the calculation of certain investments; and 4) an increase in the allowable leverage ratio for the additional contingent obligations required under the Amended Capital Support Agreements. These amendments were completed as part of our effort to manage our SIV exposure for the benefit of our clients and ultimately for our shareholders (See Money Market Fund Support earlier in this discussion).
The availability of the credit facility is subject to the compliance with certain covenants set forth in the agreement. Currently, our ability to borrow from the credit facility is not limited by any covenant of the agreement. Of all of the covenants, we believe satisfying the leverage ratio could be the most difficult in the future. The leverage ratio is calculated as consolidated indebtedness divided by earnings before interest, taxes, depreciation, amortization and other items as defined by the covenant during the last four quarters (EBITDA). The amount of consolidated
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indebtedness according to the terms of the covenant include the capital commitment under the Capital Support Agreements and the outstanding debt of LSV Employee Group. We must maintain at all times prior to and including September 30, 2009, a ratio of consolidated indebtedness of not more than 2.25 times the amount of EBITDA, at all times from October 1, 2009 through and including December 31, 2009, not more than 2.00 times EBITDA, and at all times thereafter, not more than 1.75 times EBITDA. As of December 31, 2008, our leverage ratio is 1.10 times EBITDA. Although we expect this ratio to increase in 2009 if unfavorable market conditions persist, we do not anticipate that this covenant or any covenant of the credit facility will restrict our ability to borrow from the credit facility.
The obligations under the Amended Capital Support Agreements are secured by letters of credit of a third party bank rated A-1 by S&P. The letters of credit were issued under the credit facility. The letters of credit have a term of one year with various expiration dates beyond the expiration date of the Amended Capital Support Agreements. In the event that capital must be provided to the Funds or we have to purchase any of the SIV securities, we may at our discretion utilize the credit facility or use our available cash on hand. However, so long as the letters of credit remain outstanding, the amount available under the credit facility will be reduced by the total amount of the letters of credit. As of February 20, 2009, we had $195.0 million of letters of credit outstanding. Therefore, only the remaining $105.0 million of the credit facility is unrestricted and may be used for general purposes.
Cash flows from operations decreased $76.7 million in 2008 compared to 2007 and increased $15.3 million in 2007 compared to 2006. The decrease in 2008 was primarily due to the decline in net income and the net change in working capital accounts. Our working capital accounts were primarily affected by lower expected payments for incentive compensation in 2008 compared to 2007, lower accounts receivable balances from the decline in revenues and the change in deferred taxes in 2008 due to the non-cash charge related to the Amended Capital Support Agreements. The increase in cash flows in 2007 was primarily caused by the increase in net income.
We have long-term contractual agreements with banks and other financial institutions, especially within our Private Banks segment. These banks and financial institutions continue to meet the scheduled payment terms under these contracts. We have no reason to believe that these clients will be unable to satisfy current and future obligations. Additionally, the Investment Managers segment has contractual agreements with managers of hedge funds. There have been recent concerns and issues within the hedge fund industry. We believe our clients are stable and well-respected managers that will continue to remain viable entities over the long-term. These firms continue to meet all of their obligations. Our clients continue to meet their current financial obligations with us. We do not have any significant collectibility issues regarding our receivables as of December 31, 2008 and we have not received any indications that we should anticipate significant collectibility issues regarding our receivables in the near term.
Net cash used in investing activities includes:
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Net cash used in financing activities includes:
We believe our operating cash flow, available borrowing capacity, and existing cash and cash equivalents should provide adequate funds for ongoing operations; our obligations with respect to the Capital Support Agreements, continued investment in new products and equipment; our common stock repurchase program; and future dividend payments.
On January 24, 2006, we entered into a Guaranty and Collateral Agreement with LSV Employee Group, LaSalle Bank National Association and certain other lenders. We entered into the agreement in order to facilitate the acquisition of certain partnership interests of LSV by LSV Employee Group. Additional information pertaining to the agreement is presented in Note 2 to the Consolidated Financial Statements.
Contractual Obligations and Contingent Obligations
As of December 31, 2008, the Company is obligated to make payments in connection with its lines of credit, debt obligations, operating leases, maintenance contracts and other commitments in the amounts listed below. The contractual obligation table below excludes $4,067 of the Companys FIN 48 liabilities because the Company cannot make a reasonable estimate of the timing of the related cash payment. The Company has no unrecorded obligations other than the items noted in the following table:
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In November 2008, we amended the Capital Support Agreements with the SDIT PO Fund and the SLAT PO Fund. These amended agreements provide that if either of the Funds realize payments or sales proceeds from the ultimate disposition of specified SIV securities which are less than its amortized cost, we will be required to provide capital to the Fund equal to the amount by which the amortized cost of the specified SIV security exceeds the amount realized from the sale or other disposition of the SIV securities (See Money Market Fund Support earlier in this discussion).
Critical Accounting Policies
The accompanying consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted in the United States. Our significant accounting policies are discussed in Note 1 to the Consolidated Financial Statements. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. Materially different financial results can occur as circumstances change and additional information becomes known. We believe that the following accounting policies require extensive judgment by our management to determine the recognition and timing of amounts recorded in our financial statements.
Revenues are recognized in the periods in which the related services are performed provided that persuasive evidence of an agreement exists, the fee is fixed or determinable, and collectibility is reasonably assured. Cash received by us in advance of the performance of services is deferred and recognized as revenue when earned. Our principal sources of revenues are: (1) asset management, administration and distribution fees calculated as a percentage of the total average daily net assets under management or administration; (2) information processing and software servicing fees that are recurring in nature and earned based upon the number of trust accounts being serviced and non-recurring project fees that are earned based upon contractual agreements related to client implementations; and (3) transaction-based fees for providing securities valuation and trade-execution services. The majority of our revenues are based on contractual arrangements. Certain portions of our revenues require managements consideration of the nature of the client relationship in determining whether to recognize as revenue the gross amount billed or net amount retained after payments are made to vendors for certain services related to the product or service offering.
Allowance for Doubtful Accounts:
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of some of our clients to make their scheduled payments. The allowance for doubtful accounts is based on the total amount of outstanding receivables and an aging analysis at each balance sheet date. Other factors are considered in determining the adequacy of the allowance for doubtful accounts, such as historical trends, the financial condition of our clients and other factors that may be deemed appropriate. Based upon this analysis, the allowance for doubtful accounts is adjusted to an amount that is sufficient to cover expected losses from doubtful accounts.
Fair Value of Financial Assets and Liabilities:
The fair value of our financial assets and liabilities are determined in accordance with the fair value hierarchy established in SFAS 157, Fair Value Measurements. SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy of SFAS 157 requires an entity to maximize the use of observable inputs when measuring fair value and classifies those inputs into three levels:
Level 1 Quoted prices in active markets for identical assets and liabilities without adjustment;
Level 2 Observable inputs other than level 1 prices, such as quoted prices for similar assets, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; and
Level 3 Unobservable inputs that are supported by little or no market activity and are significant to the fair value of those assets or liabilities.
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The use of Level 3 inputs to determine the fair value of our financial assets and liabilities requires consider judgment by management. Our Level 3 financial assets and liabilities consist of SIV securities we own and the Capital Support Agreements, which are largely dependent on the fair value of the SIV securities held by our money market funds (See Fair Value Measurements section earlier in this discussion).
We review our investments in marketable securities on a quarterly basis with regard to impairment. Factors considered in determining other-than-temporary impairment are significant or prolonged declines in the fair value of our investments, our ability and intent to retain the investment for a period sufficient to allow the value to recover, and the financial condition of the investment. After considering these factors, if we believe that a decline is other-than-temporary, the carrying value of the investment is written down to its fair value through current period earnings.
Computer Software Development Costs:
We utilize internally developed computer software as part of our product offering. In the development of a new software product, substantial consideration must be given by management to determine whether costs incurred are research and development costs, or internal software development costs eligible for capitalization. Management must consider a number of different factors during their evaluation of each computer software development project that includes estimates and assumptions. Costs considered to be research and development are expensed as incurred. After meeting specific requirements, internal software development costs are capitalized as incurred. The capitalization and ongoing assessment of recoverability of software development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility, and estimated economic life. Amortization of capitalized software development costs begins when the product is ready for its intended use. Capitalized software development costs are amortized on a product-by-product basis using the straight-line method over the estimated economic life of the product or enhancement.
We evaluate the carrying value of our capitalized software when circumstances indicate the carrying value may not be recoverable. The review of capitalized software for impairment requires significant assumptions about operating strategies, underlying technologies utilized, and external market factors. Our capitalized software was developed using mainstream technologies that are industry standards and are based on technology developed by multiple vendors that are significant industry leaders. External market factors include, but not limited to, expected levels of competition, barriers to entry by potential competitors, stability in the target market and governmental regulations. In 2008, we determined that no events or change in circumstances had occurred that would indicate that our capitalized software development costs were impaired.
Goodwill and Intangible Assets:
The goodwill and intangible assets on our Consolidated Balance Sheets were generated from the purchase of partnership interest by LSV Employee Group of LSV. Under the provisions of SFAS 142, we perform assessments for impairment of goodwill at least annually or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The impairment assessment is performed using a two-step, fair value based test. The first step is to compare the fair value of the reporting unit to its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the second step is performed. The second step requires an allocation of fair value to the individual assets and liabilities using a purchase price allocation in order to determine the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount, an impairment loss is recognized. We estimate the fair value of the LSV reporting unit primarily based upon an earnings multiple approach. This approach requires an estimate of future expected cash flows from the LSV reporting unit which involves significant assumptions by management. This approach has been consistently applied since inception of the goodwill.
A review of the carrying value of our intangible assets is performed during our assessment of goodwill since both were generated by LSV Employee Groups purchase of an interest in LSV. For purposes of recognizing and measuring an impairment loss, a long-lived asset shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent. It is impossible to distinguish between the cash flows generated by goodwill and intangible assets and therefore the impairment analysis of the intangible assets are grouped with all of the other assets of LSV, including goodwill. To date, we have not recognized any impairment charge pertaining to our goodwill or intangible assets.
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Income Tax Accounting:
We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Management must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset.
Our assumptions, judgments and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.
Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. We currently use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as various other assumptions. These assumptions include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The amount of stock-based compensation expense that is recognized in a given period is dependent upon managements estimate of when the earnings per share targets are expected to be achieved. If this estimate proves to be inaccurate, the remaining amount of stock-based compensation expense could be accelerated, spread out over a longer period, or reversed. We currently base our expectations for these assumptions from historical data and other applicable factors. These expectations are subject to change in future periods.
The assessment of critical accounting policies is not meant to be an all-inclusive discussion of the uncertainties to financial results that can occur from the application of the full range of our accounting policies. Materially different financial results could occur in the application of other accounting policies as well. Also, materially different results can occur upon the adoption of new accounting standards.
New Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007) (SFAS 141R), Business Combinations, which replaces SFAS No.141, Business Combinations. SFAS 141R will change how to account for business acquisitions. SFAS 141R requires the assets acquired, the liabilities assumed and any non-controlling interest in the acquiree at the acquisition date to be measured at their fair values as of that date, with limited exceptions. SFAS 141R makes various other amendments intended to provide additional guidance or to confirm existing guidance. SFAS 141R will become effective for us beginning in the first quarter of 2009. Early adoption is not permitted. We are currently evaluating the impact SFAS 141R will have on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160 (SFAS 160), Noncontrolling Interest in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No.51. SFAS 160 establishes accounting and reporting standards that require the ownership interests in subsidiaries not held by the parent to be clearly identified, labeled and presented in the consolidated statement of financial position within equity, but separate from the parents equity. This statement also requires the amount of consolidated net income attributable to the parent and to the non-controlling interest to be clearly identified and presented on the face of the consolidated statement of income. Changes in a parents ownership interest while the parent retains its controlling financial interest must be accounted for consistently, and when a subsidiary is deconsolidated, any retained non-controlling equity investment in the former subsidiary must be initially measured at fair value. The gain or loss on the deconsolidation of the subsidiary is measured using the fair value of any non-controlling equity investment. SFAS 160 also requires entities to provide
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sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS 160 will become effective for us beginning in the first quarter of 2009. Early adoption is not permitted. We are currently evaluating the impact SFAS 160 will have on our consolidated financial statements but we do not believe it will have a significant impact upon adoption.
In March 2008, the FASB issued FASB Statement No. 161 (SFAS 161), Disclosures about Derivative Instruments and Hedging Activities. SFAS 161 requires companies with derivative instruments to disclose information that should enable financial-statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 Accounting for Derivative Instruments and Hedging Activities and how derivative instruments and related hedged items affect a companys financial position, financial performance and cash flows. SFAS 161 will become effective for us beginning in the first quarter of 2009. We are currently evaluating the impact SFAS 161 will have on our consolidated financial statements but we do not believe it will have a significant impact upon adoption.
In April 2008, the FASB issued FSP 142-3 (FSP 142-3), Determination of the Useful Life of Intangible Assets. FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142 (SFAS 142), Goodwill and Other Intangible Assets. The intent of this new guidance is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under other accounting pronouncements. FSP 142-3 will become effective for us beginning in the first quarter of 2009. We are currently evaluating the impact, if any, that FSP 142-3 will have on our consolidated financial statements but we do not believe it will have a significant impact upon adoption.
In October 2008, the FASB issued FSP FAS 157-3 (FSP FAS 157-3), Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP FAS 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial instrument when the market for that financial asset is not active. FSP 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. The adoption of FSP FAS 157-3 did not have a material impact on our consolidated financial statements.
In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8 (FSP 140-4 and FIN 46R-8), Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities. FSP 140-4 and FIN 46R-8 requires additional disclosures related to variable interest entities in accordance with SFAS 140 and FIN 46R. These disclosures include significant judgments and assumptions, restrictions on assets, risks and the affects on financial position, financial performance and cash flows. This FSP became effective for the first reporting period ending after December 15, 2008. We adopted FSP 140-4 and FIN 46R-8 as of December 31, 2008. Disclosures required by FSP 140-4 and FIN 46R-8 are included in Note 1 to our consolidated financial statements. The adoption of FSP 140-4 and FIN 46R-8 did not have any financial impact on our consolidated financial statements.
See the discussion of New Accounting Pronouncements in Note 1 to the Consolidated Financial Statements.
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Interest Rate Risk - Our exposure to changes in interest rates primarily relates to our investment portfolio. Our excess cash is principally invested in short-term, highly liquid financial instruments, mainly money market funds, with a substantial portion of such investments having initial maturities of three months or less. The holdings in our investment portfolio most sensitive to interest rate risk include Government National Mortgage Association (GNMA) securities and a short-term mutual fund principally invested in securities of U.S. and foreign commercial banks and government agencies. We place our investments in financial instruments that meet high credit quality standards. While changes in interest rates could decrease interest income, we do not believe that we have a material exposure to changes in interest rates. We do not undertake any specific actions to cover our exposure to interest rate risk and are not a party to any interest rate risk management transactions.
Additionally, LSV Employee Group entered into two interest rate swap agreements to convert its floating rate long-term debt to fixed rate debt. These swaps have a total notional value of $30.5 million. Payments are made every 90 days and the termination dates of the swaps are March 2009 and January 2011. The net effect from the interest rate swaps on the Companys earnings was minimal.
Foreign Currency Risk We transact business in the local currencies of various foreign countries, principally Canada, Ireland, the United Kingdom and South Korea. The total of all of our foreign operations accounts for approximately 11 percent of total consolidated revenues. Also, most of our foreign operations match local currency revenues with local currency costs. Due to these reasons, we do not, at this time, hedge against foreign operations.
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All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements or notes thereto.
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
of SEI Investments Company:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders equity and comprehensive income, and of cash flows present fairly, in all material respects, the financial position of SEI Investments Company and its subsidiaries (the Company) at December 31, 2008 and December 31, 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control over Financial Reporting under Item 9A. Our responsibility is to express opinions on these financial statements and on the Companys internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
February 24, 2009
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The accompanying notes are an integral part of these financial statements.
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The accompanying notes are an integral part of these financial statements.
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The accompanying notes are an integral part of these financial statements.
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The accompanying notes are an integral part of these financial statements.
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The accompanying notes are an integral part of these financial statements.
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The accompanying notes are an integral part of these financial statements.
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The accompanying notes are an integral part of these financial statements.
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Note 1 - Summary of Significant Accounting Policies:
Nature of Operations
SEI Investments Company (the Company), a Pennsylvania corporation, provides investment processing, fund processing, and investment management business outsourcing solutions to corporations, financial institutions, financial advisors, and ultra-high-net-worth families in the United States, Canada, the United Kingdom, continental Europe, and other various locations throughout the world. Investment processing solutions utilize the Companys proprietary software system to track investment activities in multiple types of investment accounts, including personal trust, corporate trust, institutional trust, and non-trust investment accounts, thereby allowing banks and trust companies to outsource trust and investment related activities. Revenues from investment processing solutions are recognized in Information processing and software servicing fees on the accompanying Consolidated Statements of Operations, except for fees earned associated with trade execution services.
The fund processing solution offers a full range of administration and distribution support services to mutual funds, collective trust funds, hedge funds, fund of funds, private equity funds and other types of investment funds. Administrative services include fund accounting, trustee and custodial support, legal support, transfer agency and shareholder servicing. Distribution support services range from market and industry insight and analysis to identifying distribution opportunities. Revenues from fund processing solutions are recognized in Asset management, administration and distribution fees on the accompanying Consolidated Statements of Operations.
Investment management programs consist of mutual funds, alternative investments and separate accounts. These include a series of money market, equity, fixed-income and alternative investment portfolios, primarily in the form of registered investment companies. The Company serves as the administrator and investment advisor for many of these products. Revenues from investment management programs are recognized in Asset management, administration and distribution fees on the accompanying Consolidated Statements of Operations.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries and entities in which it holds a controlling financial interest. The Company determines whether it has a controlling financial interest either by its decision-making ability through voting interests in accordance with Statement of Financial Accounting Standards (SFAS) No. 94, Consolidation of All Majority-Owned Subsidiaries, or by the extent of the Companys participation in the economic risks and rewards of the entity through variable interests pursuant to the revised interpretation of Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. The Company provides for minority interests in consolidated entities for which the Companys controlling financial interest is less than 100 percent. The Companys principal subsidiaries are SEI Investments Distribution Co. (SIDCO), SEI Investments Management Corporation (SIMC), SEI Private Trust Company (SPTC) and SEI Investments (Europe) Limited (SIEL). All intercompany accounts and transactions have been eliminated.
Variable Interest Entities
The Company has involvement with various variable interest entities (VIE or VIEs). These VIEs consist of LSV Employee Group, two SEI-sponsored money market funds, and other investment products in the form of Cayman Island investment companies (Cayman companies) and collective investment trusts.
The Company provided an unsecured guaranty with the lenders of LSV Employee Group in order to facilitate the acquisition of partnership interest in LSV. It was determined that LSV Employee Group is a VIE because the partners of LSV Employee Group do not have any equity at risk because the Company guaranteed the loan. The Company determined it was the primary beneficiary through its guaranty of the debt (See Note 2).
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The Company entered into Capital Support Agreements with some of its money market funds to protect the money market fund shareholders from absorbing the credit losses associated with senior notes issued by structured investment vehicles (SIV or SIVs). At the time the Company provided the Capital Support Agreements, the funds became VIEs; however, management concluded the Company was not the primary beneficiary. Management compared the credit risk absorbed through the Capital Support Agreements due to the SIV securities and the interest rate and credit risk associated with the non-SIVs absorbed by the money market funds shareholders to determine if the Companys risk represented the majority. This analysis determined that the interest rate and credit risk absorbed by the money market fund shareholders was more variable than the credit risk absorbed by the Company. Therefore, the Company is not bearing more than 50 percent of the expected losses on the money market funds and the Company is not the primary beneficiary (See Note 7).
Other variable interest entities are in the form of Cayman companies and collective investment trusts established for the purpose of offering alternative investment products to clients. Clients of the Company are the equity holders in all of these VIEs. The Company governs all decision making authority of the Cayman companies and the collective investment trusts. The Company has no equity investment in the Cayman companies or the collective investment trusts. As a result, the Company has no variable interest in these entities and, therefore, is not the primary beneficiary.
Managements Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Out of Period Adjustments
During the three month period ended December 31, 2008, the Company recorded an adjustment related to interest costs associated with borrowings in prior years when the Company was involved with various capital projects. The Company incorrectly expensed all interest costs rather than capitalizing these costs as part of the cost basis of these capital projects. The Company did not have any interest costs in 2008 eligible for capitalization. The Company does not believe these prior period adjustments were quantitatively or qualitatively material to the financial results for any of its previously issued annual or interim financial statements through September 30, 2008. Had these errors been recorded in the proper periods, Net income would increase by $41 in 2007 and increase by $3,699 for years prior to 2006. Retained earnings on January 1, 2006 would increase by $3,265. As a result, the Company did not restate any previously issued annual or interim financial statements. The net impact of the adjustments was an increase in Net income before taxes of $5,577 and an increase in Net income of $3,453 ($.02 diluted earnings per share) in the fourth quarter 2008. These non-cash adjustments were recognized in Other income on the accompanying Consolidated Statements of Operations and did not have any effect on any of the Companys business segments.
The Companys principal sources of revenues are: (1) asset management, administration and distribution fees earned based upon a contractual percentage of net assets under management or administration; (2) information processing and software servicing fees that are either recurring and primarily earned based upon the number of trust accounts being serviced or non-recurring and based upon project-oriented contractual agreements related to client implementations; and (3) transaction-based fees for providing securities valuation and trade-execution services. The majority of the Companys revenues are based on contractual arrangements. Revenues are recognized in the periods in which the related services are performed provided that persuasive evidence of an agreement exists, the fee is fixed or determinable, and collectibility is reasonably assured. Cash received by the Company in advance of the performance of services is deferred and recognized as revenue when earned. Reimbursements received for out-of-pocket expenses incurred are recorded as revenue. Certain portions of the Companys revenues require managements consideration of the nature of the client relationship in determining whether to recognize as revenue the gross amount billed or net amount retained after payments are made to suppliers for certain services related to the product or service offering.
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Cash and Cash Equivalents
The Company considers investment instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents include $282,155 and $185,536 at December 31, 2008 and 2007, respectively, primarily invested in SEI-sponsored open-ended money market mutual funds. Cash includes $60,515 and $82,374 at December 31, 2008 and 2007, respectively, from LSV.
Restricted cash includes $14,000 and $10,000 at December 31, 2008 and 2007, respectively, segregated in special reserve accounts for the benefit of SIDCO customers in accordance with certain rules established by the Securities and Exchange Commission for broker-dealers. Restricted cash at December 31, 2007 includes $250 segregated for regulatory purposes related to trade-execution services conducted by SIEL.
Allowances for Doubtful Accounts
The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Companys estimate is based on historical collection experience and a review of the current status of trade accounts receivable.
Concentration of Credit Risk
Financial instruments which potentially expose the Company to concentrations of credit risk consist primarily of cash equivalents and trade receivables. Cash equivalents are principally invested in short-term money market funds or placed with major banks and high-credit qualified financial institutions. Cash deposits maintained with institutions are in excess of federally insured limits. Concentrations of credit risk with respect to our receivables are limited due to the large number of clients and their dispersion across geographic areas. No single group or customer represents greater than ten percent of total accounts receivable.
Property and Equipment
Property and Equipment are recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance, and repairs are charged to expense as incurred. Construction in progress includes the cost of construction and other direct costs attributable to the construction. When property and equipment are retired or disposed of, the related cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective period. Depreciation is provided over the estimated useful lives using the straight line method for financial statement purposes. No provision for depreciation is made for construction in progress until such time as the relevant assets are completed and put into service. The Company uses other depreciation methods, generally accelerated, for tax purposes where appropriate. Buildings and building improvements are depreciated over 25 to 39 years. Equipment, purchased software and furniture and fixtures have useful lives ranging from three to five years. Amortization of leasehold improvements is computed using the straight line method over the shorter of the remaining lease term or the estimated useful lives of the improvements.
The Companys non-broker-dealer subsidiaries account for investments in marketable securities pursuant to Statement of Financial Accounting Standards (SFAS) No. 115 (SFAS 115), Accounting for Certain Investments in Debt and Equity Securities. Management determines the appropriate classification of investments in marketable securities at the time of purchase and reevaluates such designation at each balance sheet date. Debt and equity securities classified as available-for-sale are reported at fair value as determined by the most recently traded price of each security at the balance sheet date. Unrealized gains and losses, net of income taxes, are reported as a separate component of comprehensive income. SIDCO, the Companys broker-dealer subsidiary, reports changes in fair value of marketable securities through current period earnings due to specialized accounting practices related to broker-dealers in securities. The Company has elected the fair value option under SFAS 159 for all of its trading securities and the amount on the accompanying Consolidated Balance Sheet represents the fair value of all trading securities. Unrealized gains and losses from the change in fair value of these securities are recognized in current period earnings. The specific identification method is used to compute the realized gains and losses on all of the Companys marketable securities (See Note 6).
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The Company evaluates the realizable value of its marketable securities on a quarterly basis. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis for the investment is established. Factors considered in determining other-than-temporary declines in value include the duration and extent to which the fair value has been less than the carrying value; the ability of the investment to recover to its original cost, and the Companys intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value.
Derivative Instruments and Hedging Activities