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SEI Investments Company 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5.  
SEI Investments Company--Form 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)*

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2005

 

or

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from              to             

 

0-10200

(Commission File Number)

 


 

SEI INVESTMENTS COMPANY

(Exact name of registrant as specified in its charter)

 


 

Pennsylvania   23-1707341

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification Number)

 

1 Freedom Valley Drive, Oaks, Pennsylvania 19456-1100

(Address of principal executive offices)

(Zip Code)

 

(610) 676-1000

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).     Yes  x    No  ¨

 

APPLICABLE ONLY TO ISSUERS 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 Sections 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 ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of April 29, 2005: 101,069,842 shares of common stock, par value $.01 per share.

 



PART I. FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements.

 

SEI Investments Company

Consolidated Balance Sheets

(unaudited)

(In thousands)

 

     March 31, 2005

   December 31, 2004

Assets

             

Current Assets:

             

Cash and cash equivalents

   $ 158,473    $ 216,966

Restricted cash

     12,083      14,386

Receivables from regulated investment companies

     29,384      29,688

Receivables, net of allowance for doubtful accounts of $1,445 and $1,800 (Note 2)

     89,933      79,107

Deferred income taxes

     5,140      5,892

Prepaid expenses and other current assets

     9,071      9,640
    

  

Total Current Assets

     304,084      355,679
    

  

Property and Equipment, net of accumulated depreciation and amortization of $104,035 and $100,524 (Note 2)

     115,043      113,640
    

  

Capitalized Software, net of accumulated amortization of $19,911 and $19,325

     67,672      55,830
    

  

Investments Available for Sale

     42,056      39,817
    

  

Other Assets, net (Note 2)

     54,404      50,509
    

  

Total Assets

   $ 583,259    $ 615,475
    

  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 1 of 33


SEI Investments Company

Consolidated Balance Sheets

(unaudited)

(In thousands, except par value)

 

     March 31, 2005

   December 31, 2004

Liabilities and Shareholders’ Equity

             

Current Liabilities:

             

Current portion of long-term debt

   $ 9,556    $ 9,556

Accounts payable

     5,934      7,415

Payable to regulated investment companies

     2,061      4,302

Accrued liabilities (Note 2)

     114,451      139,957

Deferred gain

     1,472      —  

Deferred revenue

     846      2,339
    

  

Total Current Liabilities

     134,320      163,569
    

  

Long-term Debt

     9,000      14,389
    

  

Deferred Income Taxes

     36,312      32,103
    

  

Deferred Gain

     —        1,472
    

  

Commitments and Contingencies (Note 8)

             

Shareholders’ Equity:

             

Common stock, $.01 par value, 750,000 shares authorized; 101,058 and 102,175 shares issued and outstanding

     1,011      1,022

Capital in excess of par value

     262,241      262,174

Retained earnings

     134,697      134,595

Accumulated other comprehensive income, net

     5,678      6,151
    

  

Total Shareholders’ Equity

     403,627      403,942
    

  

Total Liabilities and Shareholders’ Equity

   $ 583,259    $ 615,475
    

  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 2 of 33


SEI Investments Company

Consolidated Statements of Operations

(unaudited)

(In thousands, except per share data)

 

    

Three Months Ended

March 31,


 
           2005

          2004

 

Revenues

         $ 185,681           $ 167,161  

Expenses:

                            

Operating and development

           94,427             78,732  

Sales and marketing

           31,896             31,070  

General and administrative

           7,729             7,786  
          


       


Income from operations

           51,629             49,573  

Equity in the earnings of unconsolidated affiliate

           15,226             9,003  

Net gain from investments

           427             2,935  

Interest income

           1,976             933  

Interest expense

           (425 )           (626 )
          


       


Income before income taxes

           68,833             61,818  

Income taxes

           25,124             22,409  
          


       


Net income

           43,709             39,409  
          


       


Other comprehensive (loss) income, net of tax:

                            

Foreign currency translation adjustments

           (47 )           949  

Unrealized holding loss on investments:

                            

Unrealized holding (losses) gains during the period net of income tax benefit (expense) of $84 and $(679)

   (157 )           1,216          

Less: reclassification adjustment for gains realized in net income, net of income tax expense of $158 and $1,178

   (269 )     (426 )   (2,007 )     (791 )
    

 


 

 


Other comprehensive (loss) income

           (473 )           158  
          


       


Comprehensive income

         $ 43,236           $ 39,567  
          


       


Basic earnings per common share

         $ .43           $ .38  
          


       


Diluted earnings per common share

         $ .42           $ .37  
          


       


 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

Page 3 of 33


SEI Investments Company

Consolidated Statements of Cash Flows

(unaudited)

(In thousands)

 

     Three Months Ended
March 31,


 
     2005

    2004

 

Cash flows from operating activities:

                

Net income

   $ 43,709     $ 39,409  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation and amortization

     4,280       4,202  

Undistributed equity in the earnings of unconsolidated affiliate

     (4,304 )     (3,690 )

Tax benefit on stock options exercised

     1,522       1,882  

Provision for losses on receivables

     (355 )     —    

Deferred income tax expense

     5,203       2,192  

Net realized (gains) losses on investments available for sale

     (427 )     2,757  

Write-off of capitalized software

     3,429       —    

Other

     (102 )     (4,860 )

Change in current assets and liabilities:

                

Decrease (increase) in

                

Restricted cash

     2,303       21,980  

Receivables from regulated investment companies

     304       (1,047 )

Receivables

     (10,471 )     (3,695 )

Prepaid expenses and other current assets

     569       (1,313 )

Increase (decrease) in

                

Accounts payable

     (1,481 )     639  

Payable to regulated investment companies

     (2,241 )     (21,946 )

Accrued expenses

     (15,288 )     5,448  

Deferred revenue

     (1,493 )     769  
    


 


Net cash provided by operating activities

     25,157       42,727  
    


 


Cash flows from investing activities:

                

Additions to property and equipment

     (5,005 )     (2,652 )

Additions to capitalized software

     (15,857 )     (6,595 )

Purchase of investments available for sale

     (2,936 )     (9,849 )

Sale of investments available for sale

     837       15,533  

Other

     (9 )     2  
    


 


Net cash used in investing activities

     (22,970 )     (3,561 )
    


 


Cash flows from financing activities:

                

Payment on long-term debt

     (5,389 )     (6,579 )

Purchase and retirement of common stock

     (46,896 )     (31,768 )

Proceeds from issuance of common stock

     1,823       2,856  

Payment of dividends

     (10,218 )     (9,439 )
    


 


Net cash used in financing activities

     (60,680 )     (44,930 )
    


 


Net decrease in cash and cash equivalents

     (58,493 )     (5,764 )

Cash and cash equivalents, beginning of period

     216,966       199,953  
    


 


Cash and cash equivalents, end of period

   $ 158,473     $ 194,189  
    


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 4 of 33


Notes to Consolidated Financial Statements

(all figures are in thousands except per share data)

 

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 affluent families in the United States, Canada, the United Kingdom, Continental Europe, and other various locations throughout the world. Investment processing solutions utilize the Company’s 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.

 

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.

 

Investment management programs consist of Company-sponsored 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.

 

The Company is organized around its primary target markets. The Company’s business segments are: Private Banking and Trust, Investment Advisors, Enterprises, Money Managers, and Investments in New Businesses. Financial information pertaining to the Company’s business segments is included in Note 9.

 

Summary Financial Information and Results of Operations

 

In the opinion of the Company, the accompanying unaudited Consolidated Financial Statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of the Company as of March 31, 2005, the results of operations and cash flows for the three months ended March 31, 2005 and 2004.

 

Interim Financial Information

 

While the Company believes that the disclosures presented are adequate to make the information not misleading, these Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements included in the Company’s latest Annual Report on Form 10-K.

 

Principles of Consolidation

 

The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. The Company’s principal subsidiaries are SEI Investments Distribution Co. (SIDCO), SEI Investments Management Corporation (SIMC), and SEI Private Trust Company (SPTC). All intercompany accounts and transactions have been eliminated. Investment in unconsolidated affiliate is accounted for using the equity method due to the Company’s less than 50 percent ownership. The Company’s portion of the affiliate’s operating results is reflected in Equity in the earnings of unconsolidated affiliate on the accompanying Consolidated Statements of Operations (See Note 4).

 

In 2004, the Company adopted the revised interpretation of Financial Accounting Standards Board (FASB) Interpretation No.46 (FIN 46), “Consolidation of Variable Interest Entities,” (FIN 46-R). FIN 46-R requires that certain variable interest entities be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional financial support from other parties. The Company does not have any investments in entities it believes are variable interest entities for which the Company is the primary beneficiary.

 

Page 5 of 33


Management’s 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.

 

Revenue Recognition

 

The Company’s principal sources of revenues consist of information processing and software services; management, administration, advisory, and distribution of mutual funds; brokerage and consulting services; and other asset management products and services. Revenues from these services are recognized in the periods in which they are performed provided that pervasive 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.

 

Cash and Cash Equivalents

 

The Company considers investment instruments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents includes $91,159 and $148,974 at March 31, 2005 and December 31, 2004, respectively, primarily invested in Company-sponsored open-ended money market mutual funds.

 

Restricted Cash

 

Restricted cash includes cash of $2,061 and $4,302 at March 31, 2005 and December 31, 2004, respectively, received for the benefit of customers of SIDCO in order to settle investment transactions for regulated investment companies (RICs). SIMC, in its capacity as the transfer agent, facilitates the purchase and redemption of mutual fund transactions for SIDCO customers. Corresponding liabilities are established for payment to the RICs, which is reflected in Payable to regulated investment companies on the accompanying Consolidated Balance Sheets. The total balance of cash received from such parties is typically paid the following business day.

 

Additionally, Restricted cash at March 31, 2005 and December 31, 2004 includes $10,022 and $10,084, 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.

 

Allowances for Doubtful Accounts

 

The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Company’s 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, marketable securities, 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.

 

Page 6 of 33


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. 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. 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.

 

Marketable Securities

 

The Company accounts for investments in marketable securities pursuant to Statement of Financial Accounting Standards No. 115 (SFAS 115), “Accounting for Certain Investments in Debt and Equity Securities.” Management determines the appropriate classification of marketable securities at the time of purchase and reevaluates such designation as of each balance sheet date. Currently, the Company only has marketable securities classified as available for sale. SFAS 115 requires that debt and equity securities classified as available for sale be reported at fair value as determined by the most recently traded price for each security at the balance sheet date. Unrealized holding gains and losses, net of income taxes, are reported as a separate component of comprehensive income. The specific identification method is used to compute the realized gains and losses on marketable securities (See Note 3).

 

The Company evaluates the realizable value of its marketable securities on a quarterly basis. Factors considered in determining other-than-temporary declines in value include how significant the decline in value is as a percentage of the original cost, how long the market value of the investment has been less than its original cost, and the ability of the investment to recover its original cost. If it is determined that an other-than-temporary decline exists in a marketable security, the investment is written down to its market value and an investment loss is recorded in the Statement of Operations.

 

Derivative Instruments and Hedging Activities

 

The Company holds derivative financial instruments (derivatives) in the form of equity contracts for the purpose of hedging the market risk of certain available-for-sale securities. The Company holds such derivatives only for the purpose of hedging such risks and not for speculation. The Company formally documents its risk management objective and strategy for undertaking such hedge transactions. This process includes relating all derivatives that are designated as fair value hedges to specific assets on the balance sheet.

 

The Company accounts for its derivatives in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” Statement of Financial Accounting Standards No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities – an amendment of FASB Statement No. 133,” and Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” The Company records all derivatives on its balance sheet at fair value. The Company determines if the instrument qualifies as an effective fair value hedge on the date the derivative is entered into, and on an on-going basis, in accordance with established accounting guidance and will apply hedge accounting. The Company enters into hedging relationships such that changes in the fair value of the asset being hedged are expected to be offset by corresponding changes in the fair value of the derivative through other comprehensive income.

 

The Company does not apply, or may discontinue, hedge accounting to derivatives that do not qualify as an effective fair value hedge. Changes in the entire fair value of the derivatives that do not qualify as an effective fair value hedge are recognized immediately in current period earnings while the change in the fair value of the hedged asset is recorded in other comprehensive income. The Company may continue to enter into economic hedges to support certain business strategies that may not qualify as accounting hedges which may cause some volatility in earnings.

 

 

Page 7 of 33


Currently, hedge accounting does not apply to any of the Company’s derivatives. The Company holds equity derivatives with a notional amount of $10,917 with an expected maturity date in 2006. The Company recognized net gains of $228 in the three months ended March 31, 2005 and net losses of $320 in the three months ended March 31, 2004 from changes in the fair value of derivative instruments. These gains and losses are reflected in Net gain from investments on the accompanying Consolidated Statements of Operations.

 

Capitalized Software

 

The Company accounts for software development costs in accordance with the guidance established in Emerging Issues Task Force (EITF) Issue No. 00-03 “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware,” and applies Statement of Position 98-1 (SOP 98-1) “Accounting for the Cost of Computer Software Developed or Obtained for Internal Use,” for development costs associated with software products to be provided in a hosting environment. As required by SOP 98-1, the Company capitalizes the costs incurred during the application development stage, which includes direct external and internal costs for designing, coding, installing, and testing the software configuration and interfaces. Costs incurred during the preliminary project along with post-implementation stages are expensed as incurred. Costs incurred to maintain existing product offerings are expensed 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. The Company capitalized $15,857 and $6,595 of software development costs in accordance with SOP 98-1 during the three months ended March 31, 2005 and 2004, respectively.

 

Amortization of capitalized software development costs begins when the product is placed into service. 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, which is primarily three to ten years, with a weighted average remaining life of approximately 4.7 years. Amortization expense was $586 and $538 during the three months ended March 31, 2005 and 2004, respectively, and is included in Operating and development expenses on the accompanying Consolidated Statements of Operations.

 

The Company determined in the first quarter of 2005 that software purchased from a third party vendor that was capitalized as part of the development of a new platform did not satisfy all of the expected functionality requirements. The Company has discontinued its relationship with this vendor. As a result, $3,429 of previously capitalized software development costs were written-off. Additionally, the Company removed $1,922 of unpaid liabilities to this vendor directly associated with the amount that was capitalized. As a result, the Company recorded a net charge of $1,507 to Operating and development expenses on the accompanying Consolidated Statements of Operations during the three months ended March 31, 2005.

 

Income Taxes

 

The Company applies the asset and liability approach to account for income taxes pursuant to Statement of Financial Accounting Standards No. 109 (SFAS 109), “Accounting for Income Taxes.” Under SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics.

 

Foreign Currency Translation

 

The assets and liabilities and results of operations of the Company’s foreign subsidiaries are measured using the foreign subsidiary’s local currency as the functional currency. Assets and liabilities have been translated into U.S. dollars using the rates of exchange at the balance sheet date. The results of operations have been translated into U.S. dollars at average exchange rates prevailing during the period. The resulting translation gain and loss adjustments are recorded as a separate component of comprehensive income. Transaction gains and losses that arise from exchange rate fluctuations are included in the results of operations in the periods in which they occur.

 

Page 8 of 33


Fair Value of Financial Instruments

 

The book value of current assets and current liabilities is considered to be representative of their fair value because of their short maturities. The recorded value of these items approximates their fair value.

 

Earnings per Share

 

The Company calculates earnings per common share in accordance with Statement of Financial Accounting Standards No. 128, “Earnings per Share.” Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per common share is computed by dividing net income available to common shareholders by the combination of the weighted average number of common shares outstanding and the dilutive potential common shares, such as stock options, outstanding during the period. The calculations of basic and diluted earnings per share for the three months ended March 31, 2005 and 2004 are:

 

     For the Three Month Period Ended March 31, 2005

     Income
(Numerator)


   Shares
(Denominator)


   Per Share
Amount


Basic earnings per common share

   $ 43,709    101,766    $ .43
                

Dilutive effect of stock options

     —      2,929       
    

  
      

Diluted earnings per common share

   $ 43,709    104,695    $ .42
    

  
  

     For the Three Month Period Ended March 31, 2004

     Income
(Numerator)


   Shares
(Denominator)


   Per Share
Amount


Basic earnings per common share

   $ 39,409    104,878    $ .38
                

Dilutive effect of stock options

     —      2,571       
    

  
      

Diluted earnings per common share

   $ 39,409    107,449    $ .37
    

  
  

 

Employee stock options to purchase 4,663,000 and 2,619,000 shares of common stock, with an average exercise price of $44.54 and $45.55, were outstanding during the three month periods ended March 31, 2005 and 2004, respectively, but not included in the computation of diluted earnings per common share because the exercise price of the options was greater than the average market price of the Company’s common stock, and the effect on diluted earnings per common share would have been anti-dilutive.

 

Stock-Based Compensation

 

The Company accounts for its employee stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company grants stock options to its employees based on the fair market value of the Company’s stock at the date of grant. Since the stock options have no intrinsic value upon grant, the Company does not record any compensation cost.

 

Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation,” as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” requires the presentation of the pro-forma effects of stock-based compensation on net income and earnings per common share. The Company uses the Black-Scholes option-pricing model to value its employee stock options.

 

Page 9 of 33


For the following pro-forma disclosures as required by SFAS 123, the estimated fair value of stock options is assumed to be amortized to expense over the stock options’ vesting period. The following table presents the pro-forma effects on net income and earnings per common share if the Company had recognized compensation expense relating to its employee stock options.

 

     For the Three Month Period
Ended March 31,


 
     2005

    2004

 

Net Income:

                

As reported

   $ 43,709     $ 39,409  

Deduct: Total stock-based employee expense determined under the fair value based method for all awards, net of related tax effects

     (4,675 )     (3,358 )
    


 


Pro forma

   $ 39,034     $ 36,051  
    


 


Basic earnings per common share

                

As reported

   $ .43     $ .38  

Pro forma

   $ .38     $ .34  

Diluted earnings per common share

                

As reported

   $ .42     $ .37  

Pro forma

   $ .37     $ .34  

 

Comprehensive Income

 

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” establishes standards for the reporting and presentation of comprehensive income and its components. Comprehensive income consists of net income and other gains and losses affecting shareholders’ equity that are excluded from net income. For the Company, comprehensive income included unrealized gains and losses on marketable securities and foreign currency translation. Components of Accumulated other comprehensive income consist of:

 

     Foreign
Currency
Translation
Adjustments


    Unrealized
Holding
Gains (Losses)
on Investments


    Accumulated
Other
Comprehensive
Gains (Losses)


 

Beginning balance (Dec. 31, 2004)

   $ 5,359     $ 792     $ 6,151  

Current period change

     (47 )     (426 )     (473 )
    


 


 


Ending balance (March 31, 2005)

   $ 5,312     $ 366     $ 5,678  
    


 


 


 

Statements of Cash Flows

 

For purposes of the Consolidated Statements of Cash Flows, the Company considers investment instruments purchased with an original maturity of three months or less to be cash equivalents.

 

Supplemental disclosures of cash paid/received during the three months ended March 31 are as follows:

 

     2005

   2004

Interest paid

   $ 758    $ 1,103

Interest and dividends received

     2,035      890

Income taxes paid

     1,890      429

 

Page 10 of 33


New Accounting Pronouncements

 

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123(R) (SFAS 123(R)), “Share-Based Payment.” SFAS 123(R) revises SFAS 123 and supersedes APB 25. SFAS 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services, incurs liabilities in exchange for goods and services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions, but does not change the accounting guidance for share-based payment transactions with parties other than employees. The accounting provisions of SFAS 123(R) are effective for the annual period beginning January 1, 2006. The primary impact that SFAS 123(R) will have on the Company’s financial statements is the requirement to expense the fair value of its employee stock options rather than disclosing that information in a set of pro-forma financial statements. The Company is in the process of evaluating the full impact that the adoption of SFAS 123(R) will have on its financial statements. Currently, the Company does not anticipate any significant changes to its equity compensation plans.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to current year presentation.

 

Note 2. Composition of Certain Financial Statement Captions

 

Receivables

 

Receivables on the accompanying Consolidated Balance Sheets consist of:

 

     March 31, 2005

    December 31, 2004

 

Trade receivables

   $ 30,699     $ 21,015  

Fees earned, not billed

     58,076       57,923  

Other receivables

     2,603       1,969  
    


 


       91,378       80,907  

Less: Allowance for doubtful accounts

     (1,445 )     (1,800 )
    


 


     $ 89,933     $ 79,107  
    


 


 

Fees earned, not billed represents receivables earned but unbilled and results from timing differences between services provided and contractual billing schedules.

 

Receivables from regulated investment companies on the accompanying Consolidated Balance Sheets primarily represent fees receivable for distribution, investment advisory, and administration services provided by two of the Company’s wholly-owned subsidiaries, SIDCO and SIMC, to various regulated investment companies sponsored by the Company.

 

Page 11 of 33


Property and Equipment

 

Property and Equipment on the accompanying Consolidated Balance Sheets consists of:

 

     March 31, 2005

    December 31, 2004

 

Equipment

   $ 63,634     $ 60,279  

Buildings

     98,189       97,767  

Land

     9,380       9,380  

Purchased software

     28,640       27,653  

Furniture and fixtures

     15,355       15,334  

Leasehold improvements

     2,865       2,803  

Construction in progress

     1,015       948  
    


 


       219,078       214,164  

Less: Accumulated depreciation and amortization

     (104,035 )     (100,524 )
    


 


Property and Equipment, net

   $ 115,043     $ 113,640  
    


 


 

Other Assets

 

Other Assets on the accompanying Consolidated Balance Sheets consist of:

 

     March 31, 2005

   December 31, 2004

Investment in unconsolidated affiliate

   $ 41,419    $ 37,672

Other, net

     12,985      12,837
    

  

Other assets

   $ 54,404    $ 50,509
    

  

 

Investment in unconsolidated affiliate relates to the Company’s 43 percent ownership in the general partnership LSV Asset Management (See Note 4).

 

Other, net consists of long-term prepaid expenses, deposits, investments carried at cost, and various other assets.

 

Accrued Liabilities

 

Accrued liabilities on the accompanying Consolidated Balance Sheets consist of:

 

     March 31, 2005

   December 31, 2004

Accrued compensation

   $ 17,202    $ 44,360

Accrued income taxes

     20,911      4,239

Accrued sub-advisor and investment officer fees

     14,351      12,751

Accrued consulting

     8,803      9,135

Other accrued liabilities

     53,184      69,472
    

  

Total accrued liabilities

   $ 114,451    $ 139,957
    

  

 

Accrued sub-advisor and investment officer fees relates to services provided by fund advisors to Company-sponsored mutual funds and other investment programs.

 

Page 12 of 33


Note 3. Investments Available for Sale

 

Investments available for sale consist of:

 

    

As of March 31, 2005


     Cost
Amount


   Gross
Unrealized
Gains


   Gross
Unrealized
Losses


    Fair
Value


Company-sponsored mutual funds

   $ 28,309    $ —      $ (807 )   $ 27,502

Non-company-sponsored mutual funds

     4,039      —        (17 )     4,022

Equity securities

     9,137      1,395      —         10,532
    

  

  


 

     $ 41,485    $ 1,395    $ (824 )   $ 42,056
    

  

  


 

    

As of December 31, 2004


     Cost
Amount


   Gross
Unrealized
Gains


   Gross
Unrealized
Losses


    Fair
Value


Company-sponsored mutual funds

   $ 26,382    $ 5    $ (514 )   $ 25,873

Non-company-sponsored mutual funds

     3,501      —                3,501

Equity securities

     8,695      1,748      —         10,443
    

  

  


 

     $ 38,578    $ 1,753    $ (514 )   $ 39,817
    

  

  


 

 

The net unrealized holding gains at March 31, 2005 were $366 (net of income tax expense of $205) and at December 31, 2004 were $792 (net of income tax expense of $447) and are reported as a separate component of Accumulated other comprehensive gains on the accompanying Consolidated Balance Sheets.

 

The Company recognized gross realized gains from available-for-sale securities of $199 and $3,077 during the three months ended March 31, 2005 and 2004, respectively.

 

At March 31, 2005, the Company had a single investment in a Company-sponsored mutual fund that has been in an unrealized loss position longer than one year. This mutual fund primarily invests in federal agency mortgage-backed securities. The cost basis of this investment was $28,201 with a fair value of $27,394 and a gross unrealized loss of $807. The Company does not consider this unrealized loss as an other-than-temporary impairment because it is not a precipitous decline in market value.

 

Note 4. Investment in Unconsolidated Affiliate

 

The Company has an investment in the general partnership LSV Asset Management (LSV). LSV is a registered investment advisor that provides investment advisory services to institutions, including pension plans and investment companies. LSV is currently an investment sub-adviser for a number of Company-sponsored mutual funds. The Company accounts for its interest in LSV using the equity method of accounting due to its less than 50 percent ownership. The Company’s total partnership interest in LSV was approximately 43 percent for the three months ended March 31, 2005.

 

On July 1, 2004, the Company sold a small percentage of its interest in LSV to certain other partners of LSV. Total proceeds received from the sale were $6,183 and the basis of the Company’s investment relating to the sold interest was $1,614, resulting in a total gain of $4,569. Certain partners paid the Company directly whereas certain other partners elected to finance their purchase through LSV. The Company realized $3,097 of the gain in 2004 and deferred the remaining portion of the gain of $1,472, which is reflected as Deferred gain on the accompanying Consolidated

 

Page 13 of 33


Balance Sheets. The deferred portion of the gain will be recognized when the amount owed to LSV from the partners that financed their purchase is repaid in full. The final payments are due on January 1, 2006.

 

At March 31, 2005, the basis of the Company’s investment in LSV exceeded its underlying equity in the net assets of LSV by $6,665, of which $3,603 is considered finite-lived intangible assets and the remaining $3,062 is considered goodwill embedded in the investment. The finite-lived intangible assets primarily relate to customer contracts that meet the contractual-legal criterion for recognition apart from goodwill. The Company amortizes the finite-lived intangible assets on a straight-line basis over eight and a half years. The Company recorded $109 in amortization expense during the three months ended March 31, 2005. Total accumulated amortization at March 31, 2005 was $218. No amortization expense was recorded in the first quarter of 2004. The Company does not record amortization expense associated with the embedded goodwill. The Company determines on an annual basis if its investment in LSV is impaired which includes the embedded goodwill. The Company’s investment in LSV is considered General and Administrative and is not included in a business segment.

 

The following table contains the condensed statements of operations of LSV for the three months ended March 31:

 

     2005

   2004

Revenues

   $ 40,286    $ 22,715

Net income

   $ 35,732    $ 19,430

 

The following table contains the condensed balance sheets of LSV:

 

     March 31, 2005

   December 31, 2004

Cash and cash equivalents

   $ 34,418    $ 29,962

Accounts receivable

     45,863      43,413

Other current assets

     183      201

Non-current assets

     643      693
    

  

Total assets

   $ 81,107    $ 74,269
    

  

Current liabilities

   $ 3,523    $ 5,556

Partners’ capital

     77,584      68,713
    

  

Total liabilities and partners’ capital

   $ 81,107    $ 74,269
    

  

 

 

Page 14 of 33


Note 5. Line of Credit

 

On September 14, 2004, the Company entered into a three-year $200,000 Credit Agreement (the Credit Facility) replacing the Company’s $200,000 364–Day Credit Agreement which expired on September 13, 2004. The Credit Facility became available immediately and expires on September 14, 2007 at which time any aggregate principal amount of loans outstanding becomes payable in full. The Credit Facility, when utilized, will accrue interest at 0.75 percent above the London Interbank Offer Rate (LIBOR). There is also a commitment fee equal to 0.15 percent per annum on the daily unused portion of the Credit Facility. The Credit Facility contains various covenants, including, but not limited to, limitations of indebtedness, maintenance of fixed charge and leverage ratios, and restrictions on certain investments. Both the interest rate and commitment fee prices may increase if the Company’s leverage ratio reaches certain levels. None of these covenants negatively affect the Company’s liquidity or capital resources. The Company was in compliance with all covenants associated with the Credit Facility during the three month period ended March 31, 2005. During the three month period ended March 31, 2005, the Company had no borrowings under the Credit Facility.

 

Note 6. Long-term Debt

 

On February 24, 1997, the Company signed a Note Purchase Agreement authorizing the issuance and sale of $20,000 of 7.20 percent Senior Notes, Series A, and $15,000 of 7.27 percent Senior Notes, Series B (collectively, the Notes), in a private offering with certain financial institutions. The Notes are unsecured with final maturities ranging from 10 to 15 years. The proceeds from the Notes were used to repay the outstanding balance on the Company’s line of credit at that date. The Note Purchase Agreement, which was subsequently amended, contains various covenants, including limitations on indebtedness, maintenance of minimum net worth levels, and restrictions on certain investments. In addition, the Note Purchase Agreement limits the Company’s ability to merge or consolidate, and to sell certain assets. The Company was in compliance with all covenants associated with its long-term debt during the three month period ended March 31, 2005. Principal payments on the Notes are made annually from the date of issuance while interest payments are made semi-annually. The Company made its scheduled payment of $4,000 in February 2005. The remaining unpaid principal balance of the Notes at March 31, 2005 was $13,000, of which $4,000 is classified as current.

 

On June 26, 2001, the Company entered into a $25,000 Term Loan Agreement (the Agreement) with a separate lending institution which expires on March 31, 2006 and is payable in 17 equal quarterly installments. On August 2, 2001, the Company borrowed the full $25,000. The Agreement provides the Company the option to have interest accrued at either the lower of the Prime rate or one and thirty-five hundredths of one percent above LIBOR. The Agreement contains various covenants, including limitations on indebtedness and restrictions on certain investments. None of these covenants negatively affect the Company’s liquidity or capital resources. The Company was in compliance with all covenants associated with its long-term debt during the three month period ended March 31, 2005. The Company made its scheduled payment of $1,389 in March 2005. The remaining unpaid principal balance of the Agreement at March 31, 2005 was $5,556, which is classified as current. The interest rate being applied at March 31, 2005 was 3.91%.

 

 

Page 15 of 33


Note 7. Common Stock Buyback

 

The Company’s Board of Directors has authorized the repurchase of the Company’s common stock on the open market or through private transactions of up to an aggregate of $903,365, which includes an additional authorization of $50,000 on February 15, 2005. Through March 31, 2005, a total of 115,421,000 shares at an aggregate cost of $884,154 have been purchased and retired. The Company purchased 1,277,000 shares at a total cost of $46,896 during the three months ended March 31, 2005.

 

The Company immediately retires its common stock when purchased. Upon retirement, the Company reduces Capital in excess of par value for the average capital per share outstanding and the remainder is charged against Retained earnings. If the Company reduces its Retained earnings to zero, any subsequent purchases of common stock will be charged entirely to Capital in excess of par value.

 

Note 8. Contingencies

 

In the normal course of business, the Company is party to various claims and legal proceedings. On September 30, 2004, SIDCO was named as a defendant in a putative consolidated amended class action complaint filed in the United States District Court for the District of Maryland titled “Stephen Carey v. Pilgrim Baxter & Associates, LTD, et. al.” This complaint is 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 relates generally to various market timing practices allegedly permitted by the PBHG Funds. The complaint alleges 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. While the outcome of this litigation is uncertain, SIDCO believes that it has valid defenses to plaintiffs’ claims and intends to defend the lawsuits vigorously. The Company has not made any provision relating to this legal proceeding.

 

In April, 2005, the Company and a subsidiary were named as defendants in a complaint (the “Vermeg Complaint”) filed by Vermeg Services S.A.R.L., a Tunisian company, in the United States District Court for the Eastern District of Pennsylvania. The subsidiary of the Company terminated a software license and services contract with Vermeg in March, 2005 citing failure of the Vermeg software to meet acceptance and performance criteria under the contract. The Vermeg Complaint seeks monetary damages which it alleges arose out of the purported breach of such contract by the Company and its subsidiary as well as various other relief arising from the alleged misappropriation of Vermeg software and related information that Vermeg alleges is proprietary to Vermeg. While the outcome of this litigation is uncertain, the Company and its subsidiary believe that they have valid defenses to plaintiff’s claims and intend to defend the lawsuit vigorously. The Company has not made any provision relating to this legal proceeding.

 

Note 9. Business Segment Information

 

The Company defines its business segments in accordance with Statement of Financial Accounting Standards No. 131 (SFAS 131), “Disclosures about Segments of an Enterprise and Related Information.” SFAS 131 establishes standards for the way public business enterprises report financial information about business segments in financial statements. SFAS 131 also requires additional disclosures about product and services, geographic areas, and major customers.

 

The Company evaluates financial performance of its business segments based on Income from operations. The operations and organizational structure of the Company are established into separate business units that offer business solutions tailored for particular markets. Reportable business segments are: Private Banking and Trust, Investment Advisors, Enterprises, Money Managers, and Investments in New Businesses. The accounting policies of the reportable business segments are the same as those described in Note 1.

 

Page 16 of 33


Private Banking and Trust provides investment processing, fund processing, and investment management programs to banks and other trust institutions located in the United States and Canada. 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. Enterprises provides retirement and treasury solutions to corporations, unions, municipalities, and hospitals and an endowment and foundation solution for the not-for-profit market in the United States. Money Managers provides investment processing and fund processing to investment managers and mutual fund companies 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 and fund processing to investment advisors, corporations, and money managers located outside the United States, private banking outsource solutions to institutions in the United Kingdom and Continental Europe, as well as expanding our investment management programs to include affluent families who reside in the United States.

 

The information in the following tables is derived from the Company’s internal financial reporting used for corporate management purposes. There are no inter-segment revenues for the three months ended March 31, 2005 and 2004. Management evaluates Company assets on a consolidated basis during interim periods.

 

The following tables highlight certain unaudited financial information about each of the Company’s business segments for the three months ended March 31, 2005 and 2004.

 

     Private
Banking
and Trust


   Investment
Advisors


   Enterprises

   Money
Managers


   Investments
In New
Businesses


   

General

and
Administrative


    Total

     For the Three Month Period Ended March 31, 2005

Revenues

   $ 72,381    $ 48,723    $ 20,235    $ 20,144    $ 24,198             $ 185,681
    

  

  

  

  


         

Operating income (loss)

   $ 26,717    $ 25,902    $ 9,387    $ 3,488    $ (6,136 )   $ (7,729 )   $ 51,629
    

  

  

  

  


 


 

Other income, net

                                               $ 17,204
                                                

Income before income taxes

                                               $ 68,833
                                                

Depreciation and amortization

   $ 2,255    $ 581    $ 158    $ 413    $ 496     $ 377     $ 4,280
    

  

  

  

  


 


 

Capital expenditures

   $ 10,038    $ 4,442    $ 2,019    $ 1,416    $ 1,672     $ 1,275     $ 20,862
    

  

  

  

  


 


 

 

     Private
Banking
and Trust


   Investment
Advisors


   Enterprises

   Money
Managers


   Investments
In New
Businesses


   

General

and
Administrative


    Total

     For the Three Month Period Ended March 31, 2004

Revenues

   $ 74,593    $ 43,183    $ 16,235    $ 16,904    $ 16,246             $ 167,161
    

  

  

  

  


         

Operating income (loss)

   $ 27,503    $ 23,821    $ 7,844    $ 2,916    $ (4,725 )   $ (7,786 )   $ 49,573
    

  

  

  

  


 


 

Other income, net

                                               $ 12,245
                                                

Income before income taxes

                                               $ 61,818
                                                

Depreciation and amortization

   $ 2,384    $ 665    $ 203    $ 318    $ 386     $ 246     $ 4,202
    

  

  

  

  


 


 

Capital expenditures

   $ 4,905    $ 1,584    $ 720    $ 506    $ 1,078     $ 454     $ 9,247
    

  

  

  

  


 


 

 

Page 17 of 33


Note 10. Income Taxes

 

On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the Act). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret numerous provisions of the Act. As such, the Company is not yet in a position to decide on whether, and to what extent, foreign earnings that have not yet been remitted to the U.S. may be repatriated. The Company expects to be in a position to finalize its assessment by the third quarter of 2005.

 

Page 18 of 33


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

(In thousands, except asset balances and per share data)

 

This discussion reviews and analyzes the consolidated financial condition at March 31, 2005 and 2004, the consolidated results of operations for the three months ended March 31, 2005 and 2004 and other key factors that may affect future performance. This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements.

 

Overview

 

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 affluent families create and manage wealth. Our outsourcing business solutions consist mainly of investment processing, fund processing, and investment management. 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 March 31, 2005, through our subsidiaries and partnerships in which we have a significant interest, we administer $291.1 billion in mutual fund and pooled assets, manage $123.9 billion in assets, and operate 22 offices in 12 countries.

 

We conduct business through five business segments offering our business solutions to specific target markets. These business segments are:

 

Private Banking and Trust – provides investment processing, fund processing, and investment management programs to banks and other trust institutions located in the United States and Canada;

 

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;

 

Enterprises – provides retirement and treasury solutions to corporations, unions, municipalities, and hospitals, and an endowment solution for the not-for-profit market in the United States;

 

Money Managers – provides investment processing and fund processing to investment managers and mutual fund companies 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

 

Investments in New Businesses – provides investment management programs and fund processing to investment advisors, corporations, and money managers located outside the United States and private banking outsource solutions to institutions in the United Kingdom and Continental Europe. This segment also includes our investment programs offered to affluent families who reside in the United States.

 

Page 19 of 33


Financial Results

 

Revenues, Expenses and Income from Operations by business segment for the three months ended March 31, 2005 compared to the three months ended March 31, 2004 were as follows:

 

     For the Three Months Ended March 31,

 
                

Percent

Change


 
     2005

    2004

   
Revenues:                       

Private Banking and Trust

   $ 72,381     $ 74,593     (3 )%

Investment Advisors

     48,723       43,183     13 %

Enterprises

     20,235       16,235     25 %

Money Managers

     20,144       16,904     19 %

Investments in New Businesses

     24,198       16,246     49 %
    


 


     

Total revenues

     185,681       167,161     11 %

Operating and development expenses:

                      

Private Banking and Trust

     36,449       37,810     (4 )%

Investment Advisors

     16,534       12,496     32 %

Enterprises

     5,921       4,070     45 %

Money Managers

     13,325       10,474     27 %

Investments in New Businesses

     22,198       13,882     60 %
    


 


     

Total operating and development expenses

     94,427       78,732     20 %

Sales and marketing expenses:

                      

Private Banking and Trust

     9,215       9,280     (1 )%

Investment Advisors

     6,287       6,866     (8 )%

Enterprises

     4,927       4,321     14 %

Money Managers

     3,331       3,514     (5 )%

Investments in New Businesses

     8,136       7,089     15 %
    


 


     

Total sales and marketing expenses

     31,896       31,070     3 %

Income from business segments:

                      

Private Banking and Trust

     26,717       27,503     (3 )%

Investment Advisors

     25,902       23,821     9 %

Enterprises

     9,387       7,844     20 %

Money Managers

     3,488       2,916     20 %

Investments in New Businesses

     (6,136 )     (4,725 )   (30 )%
    


 


     

Total income from business segments

     59,358       57,359     3 %

General and administrative expenses

     7,729       7,786     (1 )%
    


 


     

Income from operations

     51,629       49,573     4 %

Other income, net

     17,204       12,245     40 %
    


 


     

Income before income taxes

     68,833       61,818     11 %

Income taxes

     25,124       22,409     12 %
    


 


     

Net income

   $ 43,709     $ 39,409     11 %

Diluted earnings per share

   $ .42     $ .37     14 %

 

Page 20 of 33


Asset Balances

 

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.

 

Asset Balances

(In millions)


   As of March 31,

  

Percent

Change


 
   2005

   2004

  

Assets invested in equity and fixed-income programs

   $ 65,514    $ 52,907    24 %

Assets of unconsolidated affiliate invested in equity and fixed-income programs

     33,781      18,444    83 %

Assets invested in collective trust fund programs

     12,715      11,321    12 %

Assets invested in liquidity funds

     11,902      13,380    (12 )%
    

  

      

Assets under management

     123,912      96,052    29 %

Client proprietary assets under administration

     167,203      176,421    (5 )%
    

  

      

Assets under management and administration

   $ 291,115    $ 272,473    7 %
    

  

      

 

Assets of unconsolidated affiliate are assets of their clients or their customers for which they provide management services. 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 which we provide administrative services, including client proprietary fund balances for which we provide administration and/or distribution services.

 

Consolidated Summary

 

Consolidated revenues for the three months ended March 31, 2005 increased $18.5 million, or 11 percent, to $185.7 million as compared to the prior year period. Income from operations increased $2.1 million, or four percent, to $51.6 million; however, operating margin decreased to 32 percent from 34 percent. Net income increased $4.3 million, or 11 percent, to $43.7 million and diluted earnings per share increased to $.42 per share as compared to $.37 per share a year ago, an increase of 14 percent. In our opinion, the following items had a significant impact on our financial results for the current period:

 

    Revenue growth was primarily driven by increased asset-based fees due to higher levels of assets under management and administration due to rising capital markets during 2004 and sales of new business. Rising capital markets increased the value of assets we manage and administer for our existing clients, causing our base revenues to increase. New asset sales from our Enterprises, Money Mangers and Investments in New Businesses segments contributed to our revenue growth. We believe these new sales were due to a growing acceptance of our new and existing solutions in our target markets.

 

    Non-recurring investment processing project fees in our Private Banking and Trust segment increased $2.7 million during 2005 from conversions of new bank clients. Once the conversions of these bank clients are completed, our recurring investment processing fees are expected to increase.

 

    Fund processing fees in the Private Banking and Trust segment decreased $5.1 million primarily due to the loss of a large fund processing bank client in mid-2004. The loss of this client also caused a corresponding significant reduction in direct fund processing expenses, minimizing the effect on our margins.

 

    In the Investment Advisors and Enterprises segment, revenues in 2005 were affected by the recognition on a gross basis of $3.2 million of third party advisory fees related to our separate account program and pass-through fees associated with our 401(k) recordkeeping offering beginning in mid-2004. In the prior year comparable period, these revenues were reported net of the costs. This had the effect of increasing revenues and expenses by the same amount.

 

Page 21 of 33


    We continued to make significant expenditures for the development of our Global Wealth Platform. We are currently in the development phase of this platform and expect to incur significant development costs throughout 2005. The majority of these costs are eligible for capitalization; however, a large portion is not eligible and is expensed as incurred. We capitalized $15.9 million in 2005 as compared to $6.6 million in 2004 of software development costs for this platform.

 

    In 2005, it was determined that software purchased from a third party vendor intended for use in our Global Wealth Platform did not satisfy all of the expected functionality requirements. Prior capitalized development costs and associated unpaid liabilities were written-off, resulting in a net charge against earnings of $1.5 million. This charge impacted all of our business segments.

 

    Net income during the period was primarily boosted by our investment in LSV. LSV recorded significant growth in revenues and earnings, mainly due to new sales. We currently have a 43 percent interest in LSV. Our earnings from LSV grew $6.2 million, or 69 percent, as compared to the prior year period.

 

    We continued our stock repurchase repurchase program during 2005 and purchased approximately 1.3 million shares at an average price of about $37 per share. This caused our diluted earnings per common share to grow at a faster rate than our earnings.

 

Business Segments

 

Private Banking and Trust

 

     For the Three Months Ended March 31,

 
              

Percent

Change


 
     2005

   2004

  

Revenues:

                    

Investment processing fees

   $ 59,206    $ 55,853    6 %

Fund processing fees

     4,591      9,701    (53 )%

Investment management fees

     8,584      9,039    (5 )%
    

  

      

Total revenues

   $ 72,381    $ 74,593    (3 )%
    

  

      

 

Revenues declined $2.2 million, or three percent, and were primarily affected by:

 

    The loss of a large fund processing bank client in mid-2004; partially offset by

 

    An increase in non-recurring investment processing project fees associated with the conversions of several large bank clients;

 

Operating margins were 37 percent in 2005 and 2004. Operating income decreased by $800 thousand, or three percent, and was primarily affected by:

 

    Increased non-capitalized development costs and the write-off of previously capitalized development costs for our Global Wealth Platform; offset by

 

    A corresponding decrease in direct expenses associated with the loss of the fund processing bank client noted above; and

 

    One-time costs in 2004 associated with the relocation of our data center processing facility.

 

Investment Advisors

 

Revenues increased $5.5 million, or 13 percent, and were primarily affected by:

 

    Increased investment management fees from existing clients due to the appreciation of assets under management because of the general improvement of capital markets during 2004; and

 

    The recognition on a gross basis of $2.6 million of pass-through revenue associated with our 401(k) recordkeeping offering and third party advisory fees related to our separate account program (this had the effect of increasing revenues and expenses by the same amount and negatively impacting operating margin).

 

 

Page 22 of 33


Operating margins decreased to 53 percent, as compared to 55 percent in the prior year comparable period. Operating income increased $2.1 million, or nine percent, and was primarily affected by:

 

    An increase in revenues, partially offset by

 

    Increased non-capitalized investment spending and the write-off of previously capitalized development costs for our Global Wealth Platform; partially offset by

 

    One-time cost in 2004 for $1.2 million in connection with the migration of client data to a new platform for processing third party mutual funds.

 

Enterprises

 

Revenues increased $4.0 million, or 25 percent, and were primarily affected by:

 

    Asset funding from new sales of our retirement solutions, mainly to large corporations;

 

    Market appreciation of assets under management from existing clients because of the general improvement of the capital markets during 2004; and

 

    The recognition on a gross basis of $600 thousand of pass-through revenue associated with our 401(k) recordkeeping offering in mid-2004 (this had the effect of increasing revenues and expenses by the same amount and negatively impacting operating margin).

 

Operating margins decreased to 46 percent, as compared to 48 percent in the prior year comparable period. Operating income increased $1.5 million, or 20 percent, and was primarily affected by:

 

    An increase in revenues; less

 

    Increased personnel costs and other operating costs associated with new business.

 

Money Managers

 

Revenues increased $3.2 million, or 19 percent, and were primarily affected by:

 

    Sales of new business in the alternative investments marketplace; and

 

    Improved cash flows into product offerings from existing clients; partially offset by

 

    Client losses in the traditional and alternative investments marketplaces.

 

Operating margins were 17 percent in 2005 and 2004. Operating income increased $600 thousand, or 20 percent, and was primarily affected by:

 

    An increase in revenues; less

 

    Increased spending on personnel and other operating costs to support new business.

 

Investments in New Businesses

 

Revenues increased $7.9 million, or 49 percent, and were primarily affected by:

 

    New and existing investment management relationships with institutions and investment advisors in Continental Europe, the United Kingdom, Canada and Hong Kong; and

 

    Market appreciation of assets under management from existing clients because of the general improvement of the capital markets.

 

Losses from operations increased $1.4 million, or 30 percent, in 2005 compared with 2004 and were primarily affected by:

 

    Increased direct expenses associated with higher levels of assets from new and existing clients;

 

    Increased non-capitalized investment spending and the write-off of previously capitalized development costs for our Global Wealth Platform; and

 

    Increased spending on personnel and other operating costs to support new business; partially offset by

 

    An increase in revenues.

 

Other

 

General and administrative expenses

 

General and administrative expenses primarily consist of corporate overhead costs and other costs not directly attributable to a reportable business segment.

 

Page 23 of 33


Other Income

 

Other income on the accompanying Consolidated Statements of Operations consists of the following:

 

     For the Three Months Ended March 31,

 
          

Percent

Change


 
     2005

    2004

   

Equity in the earnings of unconsolidated affiliate

   $ 15,226     $ 9,003     69 %

Net gain from investments

     427       2,935     (85 )%

Interest income

     1,976       933     112 %

Interest expense

     (425 )     (626 )   (32 )%
    


 


     

Total other income, net

   $ 17,204     $ 12,245     40 %
    


 


     

 

Equity in the earnings of unconsolidated affiliate on the accompanying Consolidated Statements of Operations includes our less than 50 percent ownership in the general partnership of LSV (See Note 4 to the Consolidated Financial Statements). The increase in LSV’s net earnings is due to an increase in assets under management.

 

Net gain from investments consists of the following:

 

     For the Three
Months Ended
March 31,


 
     2005

   2004

 

Net realized gain from sales of marketable securities

   $ 199    $ 3,077  

Increase (decrease) in fair value of derivative financial instruments

     228      (320 )

Other realized gains

     —        178  
    

  


Net gain on investments

   $ 427    $ 2,935  
    

  


 

Derivative financial instruments are used to minimize the price risk associated with changes in the fair value of our seed investments in new investment management programs. These derivative financial investments did not qualify for hedge accounting under current accounting rules. As a result, changes in the fair value of these derivative financial instruments were recorded in current period earnings whereas the change in the fair value of the hedged asset will be realized upon sale in future period earnings. Management’s decision to enter into derivative financial instruments that do not qualify for hedge accounting may cause volatility in quarterly earnings (See Note 1 to the Consolidated Financial Statements).

 

Interest income is earned based upon the amount of cash that is invested daily. Fluctuations in interest income recognized for one period in relation to another is due to changes in the average cash balance invested for the period and/or changes in interest rates. The increase in interest income was primarily due to an increase in interest rates in 2005 as compared to 2004.

 

Interest expense is directly attributable to our long-term debt and other borrowings. Interest expense for the three months ended March 31, 2005 decreased over the comparable period mainly due to the lower principal balances of debt outstanding.

 

Income Taxes

 

Our effective tax rates were 36.50 and 36.25 percent for the three months ended March 31, 2005 and 2004, respectively. The rate increase in 2005, compared to 2004, was due to a slight decrease in the amount of the tax credit claimed for research and development expenditures. Certain expenditures associated with research and development which qualified for a tax credit had previously reduced our tax liability and effective tax rate in 2004.

 

 

Page 24 of 33


Liquidity and Capital Resources

 

     For the Three Months Ended
March 31,


 
     2005

    2004

 

Net cash provided by operating activities

   $ 25,157     $ 42,727  

Net cash used in investing activities

     (22,970 )     (3,561 )

Net cash used in financing activities

     (60,680 )     (44,930 )
    


 


Net decrease in cash and cash equivalents

     (58,493 )     (5,764 )

Cash and cash equivalents, beginning of period

     216,966       199,953  
    


 


Cash and cash equivalents, end of period

   $ 158,473     $ 194,189  
    


 


 

Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing. We currently have a Credit Facility that provides for borrowings of up to $200.0 million. The availability of the Credit Facility is subject to the compliance with certain covenants set forth in the agreement. At March 31, 2005, our unused sources of liquidity consisted of unrestricted cash and cash equivalents of $158.5 million and the full amount available through the Credit Facility of $200.0 million.

 

Net cash provided by operating activities decreased $17.6 million during the first three months in 2005 as compared to 2004 due to the net change in working capital accounts, mainly receivables and accrued expenses. Net cash from operating activities was also affected by an increase in non-cash items including additional deferred taxes from the higher amount of software development costs eligible for capitalization and currently deductible for tax purposes and the write-off of previously capitalized software development costs.

 

Net cash used in investing activities primarily includes the purchases and sales of available-for-sale securities, the capitalization of costs incurred in developing computer software, and capital expenditures. Net cash used in investing activities increased about $19.4 million during the first three months in 2005 as compared to the prior year period. Purchases and sales of our mutual funds and other securities are mainly for the testing and subsequent start-up of new investment programs to be offered to our clients. We will redeem our investments as clients subscribe to these new investment programs. In 2005, we had $2.1 million in net purchases of available-for-sale securities verses $5.7 million in net redemptions of available-for-sale securities in 2004.

 

During the past several years, we have been investing in the development of our new Global Wealth Platform. Many of these expenditures in prior years were not eligible for capitalization until 2004. As we progress through the project, a larger portion of our expenditures are for development, rather than research and design, and are eligible for capitalization under accounting rules. Capitalized software development costs were $15.9 million in 2005 as compared to $6.6 million in 2004.

 

Net cash used in financing activities primarily includes principal payments of our debt, the repurchase of our common stock, and dividend payments. Principal payments on our long-term debt were $5.4 million in 2005 and $6.6 million in 2004. Our long-term debt is subject to various covenants contained in each lending agreement. Currently, these covenants do not negatively affect our liquidity. In late-2004, our $200.0 million 364-day credit facility expired and was replaced with a new three-year $200.0 million credit facility. The three-year credit facility was generated through a syndicate of lenders and may be used for general corporate purposes, including the repurchase of our common stock.

 

Our Board of Directors has authorized the repurchase of our common stock of up to $903.4 million. Through April 29, 2005, we repurchased approximately 115.4 million shares of our common stock at a cost of $884.2 million and had $19.2 million of authorization remaining for the purchase of our common stock under this program. Currently, there is no expiration date for our common stock repurchase program.

 

Cash dividends paid were $10.2 million or $.10 per share in 2005 and $9.4 million or $.09 per share in 2004. Our Board of Directors intends to declare future dividends on a semi-annual basis.

 

We have no off-balance sheet financing arrangements or transactions with structured finance and special purpose entities. Our off-balance sheet commitments are generally limited to future payments under non-cancelable operating leases for facilities, data processing equipment, and software and other maintenance agreements.

 

Page 25 of 33


We believe our operating cash flow, available borrowing capacity, and existing cash and cash equivalents should provide adequate funds for continuing operations; continued investment in new products and equipment; our common stock repurchase program; future dividend payments; and principal and interest payments on our long-term debt.

 

Forward-Looking Information and Risk Factors

 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. 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 our latest Annual Report on Form 10-K. These risks include the following:

 

    changes in capital markets that may affect our revenues and earnings;

 

    changes in currency exchange rates;

 

    changes in interest rates;

 

    the performance of the funds we manage;

 

    consolidation within our target markets, including consolidations between banks and other financial institutions;

 

    systems and technology risks;

 

    development risks associated with the introduction of new products and services to our clients and target markets;

 

    operational risks associated with the processing of investment transactions;

 

    third party approval of our investment products with advisors affiliated with independent broker-dealers or other networks;

 

    retention of senior management personnel; and

 

    the effect of extensive governmental regulation.

 

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 adviser, 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 National Association of Securities Dealers 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 companies and their service providers could have a significant impact on us. We have responded and are currently responding to various regulatory examinations, inquiries and requests. One of these regulatory requests and inquiries relate to the payment by certain of our subsidiaries of expenses related to the marketing and distribution of shares of certain mutual fund clients of our fund administration and distribution business. As a result of these examinations, inquiries and requests, we are generally implementing changes and reviewing our compliance procedures and business operations. These activities resulted in an increased level of general and administrative costs that continued during the three month period ended March 31, 2005.

 

We offer investment and banking products that also are subject to regulation by the federal and state securities and banking authorities, as well as non-United States 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.

 

Page 26 of 33


Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Interest Rate Risk - Our exposure to changes in interest rates primarily relates to our investment portfolio and long-term debt obligations. 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. Our investment portfolio also includes some long-term fixed-income mutual funds, principally invested in federal government agency securities. We place our investments in financial instruments that meet high credit quality standards. A portion of our long-term debt is based upon a variable rate which renews every three months. While changes in interest rates could decrease interest income or increase interest expense, 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.

 

Concentration of Credit Risk – Financial instruments which potentially expose us to concentrations of credit risk consist primarily of cash equivalents, marketable securities and trade receivables. Cash deposits are maintained with financial institutions in excess of federally insured limits. Cash equivalents are principally invested in short-term money market funds or placed with major banks and high credit qualified financial institutions. 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 customer represents greater than ten percent of total accounts receivable.

 

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 currently hedge against foreign operations.

 

Price Risk - We are exposed to price risk associated with changes in the fair value of investments in marketable securities relating to the startup of new pooled investment offerings. The length of time that our funds remain invested in these new pooled investment offerings is dependent on client subscriptions. We will redeem our investments as clients subscribe to these new investment offerings. To provide protection against potential fair value changes for these investments, we have entered into various derivative financial instruments. As of March 31, 2005, we held derivative financial instruments with a notional amount of $10.9 million with terms of less than one year. Changes in the fair value of the derivative financial instruments are recognized in current period earnings, whereas, the change in the fair value of the investment is recorded on the balance sheet in other comprehensive income. Therefore, changes in the fair value of the derivative financial instrument and changes in the fair value of the investment are not recognized through earnings in the same period. We did not enter into or hold any derivative financial instruments for trading purposes during 2005 or 2004.

 

Earnings include gains of $200 thousand in the three months ended March 31, 2005 and losses of $300 thousand in the comparable period in 2004 relating to changes in the fair value of derivative financial instruments. The aggregate effect of a hypothetical ten percent change in the fair value of our investments would be:

 

Investment


  

Hypothetical

Change

In Value


Mutual Funds

   $ 3,152

Equities

     1,091
    

     $ 4,243
    

 

In consideration of the hypothetical change in value, our derivative financial instruments related to equities would substantially offset the change in fair value of the equity securities.

 

Page 27 of 33


Item 4. Controls and Procedures.

 

(a) Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls systems are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

 

(b) Change in Internal Control over Financial Reporting

 

No change in our internal control over financial reporting occurred during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Page 28 of 33


PART II. OTHER INFORMATION

 

Item 1. 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 is 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 relates generally to various market timing practices allegedly permitted by the PBHG Funds. The suit names 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 alleges 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 alleges that the prospectus for certain PBHG funds made misstatements and omissions concerning market timing practices in PBHG funds. The PBHG Complaint alleges 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 does not name SIDCO or any of its affiliates as a market timer, facilitating or clearing broker or financier of market timers. The PBHG Complaint seeks unspecified compensatory and punitive damages, disgorgement and restitution. While the outcome of this litigation is uncertain, SIDCO believes that it has valid defenses to plaintiffs’ claims and intends to defend the lawsuits vigorously.

 

In April, 2005, the Company and a subsidiary were named as defendants in a complaint (the “Vermeg Complaint”) filed by Vermeg Services S.A.R.L., a Tunisian company, in the United States District Court for the Eastern District of Pennsylvania. The subsidiary of the Company terminated a software license and services contract with Vermeg in March, 2005 citing failure of the Vermeg software to meet acceptance and performance criteria under the contract. The Vermeg Complaint seeks monetary damages which it alleges arose out of the purported breach of such contract by the Company and its subsidiary as well as various other relief arising from the alleged misappropriation of Vermeg software and related information that Vermeg alleges is proprietary to Vermeg. While the outcome of this litigation is uncertain, the Company and its subsidiary believe that they have valid defenses to plaintiff’s claims and intend to defend the lawsuit vigorously.

 

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.

 

(e) Our Board of Directors has authorized the repurchase of up to $903.4 million 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 March 31, 2005 is as follows:

 

Period


   Total Number
of Shares
Purchased


   Average
Price Paid
per Share


   Total Number of
Shares Purchased as
Part of Publicly
Announced Program


   Approximate Dollar
Value of Shares that
May Yet Be Purchased
Under the Program


January 1 – 31, 2005

   —      —      —      $ 16,107,000

February 1 – 28, 2005

   752,000    36.68    752,000      38,524,000

March 1 – 31, 2005

   525,000    36.79    525,000      19,210,000
    
       
      

Total

   1,277,000    36.72    1,277,000       
    
       
      

 

Item 6. Exhibits.

 

The following is a list of exhibits filed as part of the Form 10-Q.

 

31.1    Rule 13a-15(e)/15d-15(e) Certification of Chief Executive Officer.
31.2    Rule 13a-15(e)/15d-15(e) Certification of Chief Financial Officer.
32    Section 1350 Certifications.

 

 

Page 29 of 33


SIGNATURES

 

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

 

 

    SEI INVESTMENTS COMPANY

Date May 6, 2005

  By  

/s/ Dennis J. McGonigle


        Dennis J. McGonigle
        Chief Financial Officer

 

 

Page 30 of 33

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