XNAS:EPHC Annual Report 10-K Filing - 6/30/2012
Effective Date 6/30/2012
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One)
For the Fiscal Year Ended June 30, 2012 OR
For the Transition Period from to . Commission File Number 1-9728
EPOCH HOLDING CORPORATION (Exact Name of Registrant as Specified in Its Charter)
640 Fifth Avenue, New York, NY 10019 (Address of Principal Executive Offices), (Zip Code) (212) 303-7200 (Registrant’s Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in rule 12b-2 of the Exchange Act. (Check one).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x As of December 30, 2011, the last trading day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of common stock held by non-affiliates of the registrant was approximately $355.2 million, computed by reference to the closing price of $22.23 on the NASDAQ Global Select Market on that day. Shares of common stock held by officers, directors and certain holders of more than 1% of the outstanding common stock have been excluded from this calculation because such persons may be deemed to be affiliates. As of September 5, 2012, there were 23,686,361 shares of the registrant’s common stock, $.01 par value per share, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated herein by reference into the Form 10-K as indicated:
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EPOCH HOLDING CORPORATION AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED JUNE 30, 2012
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Table of ContentsPART I Forward-Looking Statements Certain information included, or incorporated by reference in this Annual Report on Form 10-K and other materials filed or to be filed by Epoch Holding Corporation (“Epoch” or the “Company”) with the United States Securities and Exchange Commission (the “SEC”) contain statements that may be considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” and the negative of these terms and other comparable terminology. These forward-looking statements, which are subject to known and unknown risks, uncertainties and assumptions about the Company, may include projections of the Company’s future financial performance based on the Company’s anticipated growth strategies and trends in the Company’s business. These statements are only predictions based on the Company’s current expectations and projections about future events. There are important factors that could cause the Company’s actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements. In particular, you should consider the risks and uncertainties outlined in Item 1A. “Risk Factors.” These risks and uncertainties are not exhaustive. Other sections of this Annual Report on Form 10-K may include additional factors which could adversely impact the Company’s business and financial performance. Moreover, the Company operates in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for the Company’s management to predict all risks and uncertainties, nor can the Company assess the impact of all factors on the Company’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Although the Company believes the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, level of activity, performance or achievements. Moreover, neither the Company nor any other person assumes responsibility for the accuracy or completeness of any of these forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. The Company is under no duty to update any of these forward-looking statements after the date of this Annual Report on Form 10-K, nor to conform the Company’s prior statements to actual results or revised expectations, and the Company does not intend to do so. Forward-looking statements include, but are not limited to, statements about the Company’s:
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Table of ContentsThe Company uses a fiscal year, which ends on June 30. References to “FY 2012,” “FY 2011” and “FY 2010” in this document refer to the fiscal years ended June 30, 2012, June 30, 2011 and June 30, 2010, respectively. This Annual Report on Form 10-K may also include forward-looking statements which refer to fiscal years subsequent to the historical financial positions and results of operations contained herein. References to future fiscal years also apply to the June 30 year-end. When we use the terms the “Company,” “management,” “we,” “us,” and “our,” we mean Epoch Holding Corporation and its consolidated subsidiaries. Available Information Reports we file electronically with the SEC via the SEC’s Electronic Data Gathering, Analysis and Retrieval system (“EDGAR”) may be accessed through the internet. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, at www.sec.gov. In addition, the public may read and copy any material that we file with the SEC at the SEC’s Public Reference Room at 100 F Street NE, Washington, D.C., 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. We maintain a website which contains current information on operations and other matters. The website address is www.eipny.com. Through the Investor Relations section of our website, and the “Financial Information” tab therein, we make available, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, our Annual Proxy Statement, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. In addition, we post on our website within the Investors Relations section, and the “Corporate Governance” tab therein, our Code of Ethics and Business Conduct, as well as charters for the Audit, Nominating/Corporate Governance, and the Compensation Committees of our Board of Directors. We also make our financial statement information from our periodic SEC filings available on our website in the form of XBRL data files that may be used to facilitate computer-assisted investor analysis. The information on our website is not, and shall not be deemed to be a part hereof or incorporated into this or any other filings with the SEC. Overview Epoch Holding Corporation, incorporated in Delaware in 2004, is a holding company headquartered in New York, NY whose sole line of business is investment advisory and investment management services. The operations of the Company are conducted through its wholly owned subsidiary, Epoch Investment Partners, Inc. (“EIP”). EIP is a registered investment adviser under the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”), serving institutional, sub-advisory, and high net worth clients worldwide. EIP’s operations began in April 2004 with approximately $0.6 billion in assets under management (“AUM”) and we have grown into a global asset management firm with $23.2 billion in AUM at June 30, 2012. Our firm’s professional investment staff averages over 20 years of industry experience. Our investment philosophy is focused on achieving superior long-term, total and risk-adjusted returns by investing in companies that generate free cash flow, appropriately allocate cash to create returns for shareholders, have understandable business models, possess transparent financial statements, and are undervalued relative to our investment team’s value determinations. Risk management is integrated into each step of our investment process. Our portfolio construction process is designed to minimize stock-specific risk and manage volatility.
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Table of ContentsThe chart which follows depicts our annual AUM growth since inception as well as AUM for the last four fiscal quarters:
Our AUM growth reflects favorable long-term investment performance and quality client service, administered across multiple investment strategies and distribution channels. We believe these attributes will help us continue to expand and grow our business. Selected financial operating results for the last five years are as follows:
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Table of ContentsFiscal Year 2012 Highlights* The following items are corporate highlights and events which transpired during the fiscal year ended June 30, 2012:
Our Business Investment Management Fees We earn revenues from managing client accounts under investment advisory and sub-advisory agreements. The fees we earn depend on the type of investment strategy, account size and servicing requirements. Revenues are derived as a percentage of AUM. Net asset flows and changes in the market value of AUM affect the investment advisory fees earned. We also have certain agreements which allow us to earn performance fees in the event that investment returns meet or exceed targeted amounts during a measurement period. Clients We provide investment management services to a broad range of clients, including corporations, mutual funds, retirement plans, public pension funds, endowments, foundations, financial institutions and high net worth individuals. Our clients are located worldwide and across many industries. We strive to expand our client base by attracting new clients and earn additional business from our existing clients. Investment Philosophy Our investment philosophy is focused on achieving superior long-term, total and risk-adjusted returns by investing in companies that generate free cash flow and appropriately allocate cash in ways that create shareholder value—through dividends, share repurchases, debt-reduction, sensible internal reinvestment or accretive acquisitions. As a result, our security selection process is based on free-cash-flow metrics and capital
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Table of Contentsallocation as opposed to traditional accounting-based metrics such as price-to-book and price-to-earnings ratios. We invest in businesses with understandable operating models, transparent financial statements, and are undervalued relative to our investment team’s value determinations. Risk management is integrated into each step of our investment process. Our portfolio construction process is designed to minimize stock-specific risk and manage volatility. Investment Process Our investment strategies are managed by a team of portfolio managers supported by fundamental and quantitative research analysts. Our research analysts subject the companies they cover to detailed analysis, focusing on a company’s management, business plan, financial statements, industry position and corporate governance. Our research analysts also spend a significant amount of time interacting with and visiting company management. Our investment process incorporates the following concepts:
Investment Strategies We offer several U.S., non-U.S. and global investment strategies. Our strategies include both diversified and concentrated portfolios. All are based on the same core of bottom-up fundamental research. As of June 30, 2012, we offered the following investment strategies to our clients:
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The following chart displays our investment strategies as a percentage of AUM as of June 30, 2012:
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Table of ContentsThe table below depicts our investment strategies’ annual AUM for the past five years ended June 30, 2012 (in millions):
Investment Strategy Development We have developed several new investment strategies since our inception. Investment strategy development has stemmed from our investment team’s skill and market knowledge, as well as our responsiveness to client and market demands. We will only launch a new investment strategy if we believe that it can add value to a client’s investment portfolio, or may be attractive to our clients in the future. In certain instances we may incubate an investment strategy using our own capital, in order to test and refine our investment strategy and process before introducing the investment strategy to our clients. New Investment Vehicles During the fiscal year ended June 30, 2012, we launched and seeded three new proprietary funds: the Epoch Global Shareholder Yield Fund, LLC, the Epoch Global All-Cap Fund, LLC, and the Epoch Global Choice Fund, LLC. The primary purpose of these investment vehicles is to accommodate institutional clients who do not meet our respective separate account minimums.
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Table of ContentsPerformance Highlights We measure relative investment performance by comparing our investment returns to competing investment strategies, industry benchmarks and client investment objectives. As long-term fundamental investors, we believe that our investment strategies yield the most benefits, and are best evaluated, over a long-term time horizon. The following table shows each investment strategy’s composite returns, net of management fees, for the one, three and five year periods ended June 30, 2012 and from the investment strategy’s inception, compared to their applicable benchmarks:
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Table of ContentsDistribution Channels Our investment management services are distributed through multiple channels. Our institutional sales efforts include building strong relationships with institutional consultants and also establishing direct relationships with institutional clients. We manage certain sub-advisory mandates that provide access to market segments that we would not otherwise serve. For example, we currently serve as sub-advisor to mutual funds offered by major financial institutions in retail channels. These mandates are attractive to us because we have chosen not to build the large team of sales professionals typically required to service those channels. We typically approach the servicing of those relationships in a manner similar to our approach with other large institutional account clients. We service the high net worth channel both directly and through third-party intermediaries, such as wealth advisers who utilize our investment strategies in investment programs they construct for their clients. We maintain a limited direct sales effort in the high net worth channel, and previously raised the minimum account size for this channel. The following table provides information regarding the composition of our AUM by distribution channel for the past five years ended June 30, 2012 (in millions):
Strategic Relationship In July 2009, we entered into a strategic relationship with New York Life Investments, whereby the MainStay Group of Funds adopted our family of mutual funds (the “Epoch Funds”). The adoption was completed in November 2009. We are responsible for the day-to-day investment management of the funds through a sub-advisory relationship, while MainStay Investments (“MainStay”), the retail distribution arm of New York Life Investments, is responsible for the distribution and administration of the funds. Each former Epoch Fund is now co-branded as a “MainStay Epoch” Fund. In addition to an existing sub-advisory relationship with New York Life Investments for certain funds, and the adoption of the Epoch Funds indicated above, EIP and New York Life Investments have entered into an arrangement wherein, among other things, EIP and an affiliate of New York Life Investments have established a distribution and administration relationship with respect to certain separately managed account and unified managed account products, and for a period of three years New York Life Investments agrees to pay certain additional base fees and meet minimum distribution targets. For the fiscal year ended June 30, 2012, New York Life Investment Management, through the MainStay Epoch Funds and other funds sub-advised by EIP, accounted for approximately 17% of consolidated operating revenues. Our services and relationship with New York Life Investment Management is considered important to our ongoing growth strategy.
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Table of ContentsClient Service Our client service team plays a critical role in maintaining client relations and ensuring quality client service. A dedicated client relationship manager serves as a single point of contact. Some of the key roles and responsibilities of our client service team are as follows:
Business Continuity, Technology and Information Security Business continuity and information security are high priorities for us. Our business continuity plans have been developed to provide reasonable assurance of business continuity in the event of disruptions of our facilities and to comply with regulatory requirements. The key elements of the plans are crisis management and back-up recovery facilities. In the area of information security, we have developed and implemented policies and technology to protect information of our firm and our clients. Our business and operations rely on the secure processing, storage and transmission of confidential and other information. We have made substantial investments in our technology, and are committed to the continued development and use of technology throughout our firm. Our technology initiatives are designed to enhance client service, improve our trading and execution capabilities, support risk management and increase our overall efficiency, productivity and control. Competition The investment advisory and investment management industry is highly competitive. There are few barriers to entry for new firms and consolidation within the industry continues to alter the competitive landscape. We continuously encounter competitors in the marketplace who offer similar investment strategies and services. No single or small group of competitors is dominant in the industry. We compete in the U.S. and international markets with a large number of global and U.S. investment advisors, commercial banks, broker/dealers, insurance companies and other financial institutions. We compete primarily on the basis of investment philosophy, investment performance, range of investment strategies and features, reputation, and quality of client service. We believe that our investment style, investment strategies, and distribution channels enable us to compete effectively in our industry. During the past few years we have also taken steps to increase awareness of our brand and investment strategies by prospects and clients. We believe that being an independent asset management firm provides a competitive advantage, enabling our business model to avoid conflicts that are often inherent within larger institutions that offer a wide range of services. While we believe we will continue to be successful in growing our AUM, it may be necessary to expend additional resources to compete effectively. Our competitive success will depend upon our ability to develop and market investment strategies, adopt or develop new technologies, and continue to expand our relationships with existing clients and attract new ones. Our ability to compete also depends on our ability to attract and retain key employees while managing our compensation and other costs. According to Pensions & Investments, a publication covering the money management industry, we ranked 186th worldwide out of 692 asset management firms as of December 31, 2011, based on our AUM level of $19.2 billion at that time. When comparing only the equity portion of AUM of all asset management firms, we ranked 114th out of 517 firms who had all or a portion of their AUM invested in equities. Competitive Strengths We are a global asset management firm with accomplished and experienced professionals that combines in-house research and insight. Our team of senior managers, including our investment professionals, marketing
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Table of Contentsand sales directors, and client service personnel, averages over 20 years of industry experience. We pride ourselves on being able to offer clients a high level of attention from senior personnel. We have many highly skilled professionals who have chosen to be part of a smaller firm that has flexibility and preserves an entrepreneurial environment. All of our employees are shareholders. Accordingly, our employees’ interests are aligned with those of our clients and shareholders. We foster an open, collaborative culture that encourages the sharing of ideas and insights. We believe that sharing ideas and analyses across investment teams allows us to leverage our knowledge of markets and industries worldwide. Additionally, this collaboration enables us to readily implement ideas across our range of investment strategies. We are a global firm in both investment strategy set and in distribution. We offer a set of investment strategies that allows our clients to access investment opportunities worldwide. Our AUM is distributed through multiple channels, including intermediaries such as investment consultants and through sub-advisory relationships. Our distribution model has allowed us to achieve significant leverage from our focused sales force and client service infrastructure. Our balance sheet is also a source of competitive strength. We maintain liquidity levels sufficient to weather adverse market conditions and to enable us to take advantage of growth opportunities. Growth Strategy As we enter our ninth full year of operations, our growth strategy will remain focused on generating superior risk-adjusted investment returns, providing the highest level of client service and continuing to generate operating margins consistent with seasoned, mature firms within our industry. We will continue to be focused on the development of distribution channels to enable us to offer our various investment strategies to a broad array of clients. These efforts will continue to include developing relationships with investment advisory consultants, initiating managed accounts with institutions, and maintaining strong advisory and sub-advisory relationships. We are also looking to continue to expand internationally through our established distribution partners. We routinely evaluate our strategic position and maintain a disciplined acquisition and alliance effort that seeks complementary investment strategies or new investment strategies which could benefit clients. While we continue to actively seek such opportunities, we will only act on opportunities that we believe will be accretive to our long-term business strategy. Regulation Our business is subject to various federal, state and foreign laws and regulations. As a matter of public policy, regulatory bodies are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of participants in those markets, including investment advisory clients and shareholders of investment funds. Under these laws and regulations, agencies that regulate investment advisers have broad administrative powers, including the power to limit, restrict or prohibit an investment adviser from carrying on its business in the event the adviser fails to comply with such laws and regulations. Possible sanctions that may be imposed include civil and criminal liability, the suspension of individual employees, limitations on engaging in certain lines of business for specified periods of time, revocation of investment adviser and other registrations, censures and fines. Epoch Investment Partners, Inc. (“EIP”), our sole operating subsidiary, is registered as an investment adviser with the SEC. As a registered investment adviser, EIP is subject to the requirements of the Investment Advisers Act, the SEC’s regulations thereunder, and examination by the SEC. Requirements relate to, among other things, fiduciary duties to clients, engaging in transactions with clients, disclosure obligations, record keeping and reporting obligations, and general anti-fraud prohibitions. Moreover, in our capacity as a sub-advisor to mutual funds, we are subject to the Investment Company Act of 1940 (the “Investment Company Act”) and its rules and regulations. The Investment Company Act regulates the relationship between a mutual fund and its investment adviser and imposes additional obligations, including detailed operational requirements for both the
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Table of Contentsfunds and their advisers. Additionally, an investment adviser’s agreement with a registered fund may be terminated by the fund on not more than 60 days’ notice, and is subject to renewal by the fund’s board after an initial two-year term. Under the Investment Advisers Act, our investment management agreements may not be assigned without the client’s consent. Under the Investment Company Act, advisory agreements with registered funds, such as the funds we sub-advise, terminate automatically upon assignment. The term “assignment” is broadly defined and includes direct assignment as well as assignments that may be deemed to occur, under certain circumstances, upon the transfer, directly or indirectly, of a controlling interest in us. The SEC is authorized to institute proceedings and impose sanctions for violations of the Investment Advisers Act and the Investment Company Act, ranging from fines and censures to termination of an investment adviser’s registration. The failure of EIP, or the registered funds for which EIP serves as sub-advisor, to comply with the requirements of the SEC could have a material adverse effect on us. To the extent that EIP is a “fiduciary” under the Employment Retirement Act of 1974 (“ERISA”) with respect to benefit plan clients, it is subject to ERISA, and to regulations promulgated thereunder. ERISA and applicable provisions of the Internal Revenue Code impose certain duties on persons who are fiduciaries under ERISA, prohibit certain transactions involving ERISA plan clients, and provide monetary penalties for violations of these prohibitions. The Department of Labor, which administers ERISA, has been increasingly active in proposing and adopting regulations affecting the asset management industry. Failure to comply with these requirements could have a material adverse effect on our business. Our trading activities for client accounts are regulated under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as well as the rules of various U.S. and non-U.S. securities exchanges and self-regulatory organizations, including laws governing trading on inside information, market manipulation and a broad number of trading requirements (e.g., volume limitations, reporting obligations) and market regulation policies in the United States and abroad. We are also subject to investment advisory rules and regulations internationally. EIP is registered with the Ontario Securities Commission and several other provinces in Canada, and also operates in various other foreign jurisdictions without registration in reliance upon applicable exemptions under the laws of those jurisdictions. The financial services industry has been the subject of intense regulatory scrutiny in recent years. Our business has been subject to increasing regulation in the United States and other countries, and we expect this trend to continue in the future. In particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted in July 2010, significantly altered the financial regulatory regime within which we operate. The Dodd-Frank Act is expansive in scope and the implications of the Act for our business will depend to a large extent on the rules that remain to be adopted by the SEC and other regulatory agencies implementing the legislation. Some of the aspects of the Dodd-Frank Act have already been implemented. Other aspects will be established over the next several years. It is difficult to predict the ultimate effects that the Dodd-Frank Act, or subsequent implementing regulations and decisions, will have upon our business and results of operations. Other jurisdictions outside the United States in which we operate are also in the process of devising or considering more pervasive regulation of many elements of the financial services industry, which could have an impact on us. The Dodd-Frank Act and its regulations, other new laws or regulations, changes in rules promulgated by either the SEC or other international, federal and state regulatory authorities or self-regulatory bodies, or changes in the interpretation or enforcement of existing laws and rules could materially and adversely impact the scope or profitability or our business We will continue to assess our business, risk management, and compliance practices to conform to developments in the regulatory environment. The preceding descriptions of the regulatory and statutory provisions applicable to us are not complete and are qualified in their entirety by reference to their respective statutory or regulatory provisions. Geographic Information We have clients located worldwide. One of our key priorities is to continue to expand our global distribution network and partnerships. We are building our distribution network through both direct sales to clients and sales through intermediaries, such as investment consultants, private banks, and third-party distributors.
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Table of ContentsFor the fiscal years ended June 30, 2012, 2011 and 2010, approximately 30%, 32% and 29%, respectively, of our total operating revenues were generated from clients domiciled outside the United States. Information relating to revenues by geographic region is contained in Note 17 in the Notes to our Consolidated Financial Statements in Item 8 of Part II of this Form 10-K, which is incorporated herein by reference. Employees We believe that a major strength and principal reason for our success is the quality and dedication of our employees and the shared sense of being a part of a team. We strive to maintain a work environment that fosters professionalism, excellence, diversity, cooperation among our employees, and high standards of business ethics. As of June 30, 2012, we employed 63 full-time employees, including 26 investment management, research and trading professionals, 15 marketing and client service professionals and 22 operations and business management professionals. None of our employees are subject to any collective bargaining agreements. Our team of senior managers, including our investment professionals, marketing and sales directors, and client service personnel, averages over 20 years of industry experience. Since our founding eight years ago, we have had a very low turnover rate among our portfolio managers and analysts. The majority of our portfolio managers have devoted most of their professional careers to the analysis, selection and monitoring of the types of securities held in the funds or accounts they manage. As an investment management firm, risk is an inherent part of our business. Capital markets, by their nature, are prone to uncertainty and expose participants to a variety of risks. While we devote significant resources across all of our operations to identify, measure, monitor, manage and analyze market and operating risk, our business, prospects, financial condition, results of operations, cash flow, or share price could be materially adversely affected by any of the following risks. Additionally, other risks and uncertainties that we do not presently consider to be material or of which we are not presently aware may become important factors that affect us in the future. Risks Related to Our Business Difficult market conditions can adversely affect our business in many ways, including reducing the value of our AUM and/or causing clients to withdraw funds, each of which could materially reduce our revenues and adversely affect our results of operations and our financial condition. We derive all of our revenues from investment management services. The investment management fees paid to us are typically based on the market value of AUM. Accordingly, a general or prolonged decline in securities markets, and equity markets in particular, may cause our revenues and net income to decline due to (i) the value of our AUM decreasing, and/or (ii) clients withdrawing funds in favor of investments they perceive as offering greater opportunity or lower risk. The securities markets have recently been and may continue to be highly volatile and securities prices may decrease for many reasons beyond our control, including a general economic downturn, deterioration in the credit of sovereign nations, political uncertainty or acts of terrorism or war. In addition, any such decline in the equity markets, failure of these markets to sustain their prior levels of growth, or continued volatility in these markets could result in clients withdrawing funds from our investment strategies in full or in part, or decreased demand for our investment services, which would adversely affect us. Our operating margin may also be adversely affected if we are unable to reduce fixed costs and other expenses within a time frame sufficient to match any decrease in revenue relating to changes in our AUM. Our investment style in the asset management business may underperform other investment approaches, which may result in client or asset departures or a reduction in AUM. Even when securities prices are rising, performance can be affected by investment style. Many of the equity investment strategies in our asset management business share a common investment orientation toward fundamental security selection. Our overall investment philosophy is focused on achieving superior long-term,
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Table of Contentstotal and risk-adjusted returns by investing in companies that generate free cash flow. We believe this style tends to outperform the market in some market environments and underperform it in others. In particular, a prolonged “growth” environment (i.e., a prolonged period whereby growth stocks outperform value stocks) may cause our investment strategy to be out of favor with some clients, consultants or third-party intermediaries and may result in client or asset departures or a reduction in AUM. If our investment strategies perform poorly, our results of operations, financial condition and our prospects for future growth may be materially adversely affected. The relative performance of our investment strategies is critical in retaining existing clients as well as attracting new clients. If our investment strategies perform poorly, our earnings could be reduced because:
Because our clients can remove the assets we manage on short notice, we may experience unexpected declines in revenue and profitability. Our investment advisory and sub-advisory agreements can generally be terminated upon very short notice. Institutional and individual clients, and firms with which we have strategic alliances, can terminate their relationships with us, reduce the aggregate amount of AUM or shift their funds to other types of accounts with different fee structures for a number of reasons, including investment performance, changes in prevailing interest rates, changes in investment preferences, changes in their management or control, loss of our key investment management or other personnel, and financial market performance. Further, the ability to terminate relationships may allow clients to renegotiate for lower fees paid for asset management services. The decrease in revenues that results from any such significant terminations, withdrawals or reductions in fees could have a material adverse effect on our business. In addition, in the U.S., as required by the Investment Company Act, each of our investment advisory agreements with the mutual funds we advise or sub-advise automatically terminates upon its “assignment,” or transfer of our responsibility for fund management. Each of our other investment advisory agreements subject to the provisions of the Investment Advisers Act provides that the agreement may not be “assigned” without the consent of the client. A sale of a sufficiently large block of shares of our voting securities or other transactions could be deemed an “assignment” in certain circumstances. An assignment, actual or constructive, will trigger these termination provisions and could adversely affect our ability to continue managing these client accounts. To the extent that a technical “assignment” of investment advisory agreements arises, we will take the necessary steps to provide clients an opportunity to consent to the continuation of their advisory agreements. Such new agreements may need approval by the stockholders of the respective funds. In the event that any of these clients do not consent to a renewal of their agreement, our revenue and profitability may be materially adversely impacted.
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Table of ContentsOur business and financial condition may be materially adversely impacted by the highly variable nature of our revenues, results of operations and cash flows. Additionally, because of market fluctuations, there may not be a consistent pattern in our financial results from period to period. Because our revenues are based on the value of our AUM, fluctuations in the equity markets and our AUM affect our revenues. A reduction in the equity markets generally has a negative impact on the level of our AUM and consequently our revenues. Additionally, asset flows, whether inflows or outflows, can be highly variable from month-to-month and quarter-to-quarter. Accordingly, our revenues, results of operations and cash flows are all highly variable. We may also experience fluctuations in our results from quarter to quarter due to a number of other factors, including changes in our operating expenses and unexpected business developments and initiatives. Such variability and unpredictability may lead to volatility or declines in the price of our common stock and cause our results for a particular period not to be indicative of our performance in a future period or particularly meaningful as a basis of comparison against results for a prior period. Access to clients through intermediaries is important to our asset management business, and reductions in referrals from such intermediaries or poor reviews of our investment strategies or our organization by such intermediaries could materially reduce our revenue and impair our ability to attract new clients. Our ability to grow our business relies, in large part, on receiving mandates from the client base of investment consultants, insurance companies, defined contribution plan administrators, international and regional securities firms, mutual fund providers, third-party distributors and other intermediaries. These intermediaries review and evaluate our investment strategies and our organization. Poor reviews or evaluations of either the particular investment strategies or of our organization may result in client withdrawals or an inability to attract new assets through such intermediaries. The inability to have this access could materially adversely affect our business. We depend on the continued services of our key personnel, and the loss of key personnel could have a material adverse effect on our business. We depend upon the skills, expertise and continued contributions of our key personnel and our management team. The loss of any such personnel, without adequate replacement, could have a material adverse effect on our business, results of operations or financial condition. Loss of key personnel may occur due to perceived external opportunity for promotion, increased compensation, work environment or other individual reasons, some of which may be beyond our control. Except for our CEO, there are no employment agreements with any other key employees. The loss of services of one or more key employees, or failure to attract, retain and motivate qualified personnel could limit our ability to successfully execute our business strategy, may prevent us from sustaining the performance of our investment strategies, or adversely affect our ability to retain existing clients and attract new clients. We do not carry any “key man” insurance that would provide us with proceeds in the event of the death or disability of any key members of senior management, our investment team, or senior marketing personnel. The market for experienced asset management professionals is extremely competitive and is increasingly characterized by the movement of employees among different firms. Compensation levels in the investment management industry are highly competitive and can fluctuate significantly from year to year. Due to the competitive market for asset management professionals and the success achieved by some of our key personnel, the costs to retain key personnel are significant and will likely increase over time. We also anticipate that it will be necessary for us to hire additional key personnel as we further develop our business. Consequently, in our efforts to attract and retain highly skilled individuals, our compensation expense could increase at a level that could adversely affect our profitability. Additionally, we use share-based awards as part of our compensation program and as a means for recruiting and retaining highly skilled talent. A decline in our share price could lessen the effectiveness of retaining employees through share-based awards. There can be no assurance that we will continue to successfully attract and retain key personnel.
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Table of ContentsIf our techniques for managing risk are ineffective, we may be exposed to material unanticipated losses. To manage the significant risks inherent in our business, we must maintain effective policies, procedures and systems that enable us to identify, assess and manage the full spectrum of our risks including market, fiduciary, operational, legal, regulatory and reputational risks. While we believe that our approach to risk management helps us to manage the risks in our business, our risk management methods may prove to be ineffective due to their design or implementation, or as a result of the lack of adequate, accurate or timely information or otherwise. If our risk management efforts are ineffective, we could suffer losses that could have a material adverse effect on our financial condition or results of operations. Additionally, we could be subject to litigation and sanctions or fines from regulators. Our techniques for managing risks in client portfolios may not fully mitigate the risk exposure in all economic or market environments, or against all types of risk, including risks that we might fail to identify or anticipate. Any failures in our risk management techniques and strategies to accurately quantify such risk exposure could limit our ability to manage risks in those portfolios or to achieve positive, risk-adjusted returns. In addition, any risk management failures could cause portfolio losses to be significantly greater than historical measures predict. If approaches to managing those risks prove insufficient, it may expose us to material unanticipated losses in the value of client portfolios, a reduction in our revenues, and a material adverse impact on our business. Our reputation is critical to our success. As a financial services firm, we depend on our reputation of integrity and high-caliber professional services. Any damage to our reputation could impede our ability to attract and retain clients and key personnel, and lead to a reduction in the amount of our AUM. In recent years, there have been a number of highly publicized cases involving fraud, conflicts of interest or other misconduct by individuals in the financial services industry, and there is the risk that our employees could engage in misconduct that adversely affects our business. For example, if an employee were to engage—or be accused of engaging—in illegal or suspicious activities (such as improper trading, disclosure of confidential information or breach of fiduciary duties), we could be subject to regulatory sanctions and serious reputational or financial harm. We are subject to a number of obligations and standards arising from our business and our authority over the assets we manage as well as our status as a public company listed on the NASDAQ Global Select Market. Accordingly, we have adopted and implemented a code of ethics and other related policies and procedures to address such obligations and standards. However, it is not always possible to deter employee misconduct, and the precautions we take to detect and prevent this activity may not be effective in all cases. Misconduct by our employees, or even unsubstantiated allegations, could result in a material adverse effect on our reputation and our business. Failure to comply with client requirements and/or guidelines could result in losses, damage awards against us and loss of revenues due to client terminations. The investment management agreements under which we provide investment advisory services specify certain guidelines or requirements that we are required to observe in the provision of our services. While we maintain various compliance procedures and controls to monitor such guidelines and prevent related errors, a failure to comply with these guidelines or requirements could result in losses to a client or investors in a fund which, depending on the circumstances, could result in our making clients or fund investors whole for such losses. If we believed that the circumstances did not justify a reimbursement, or clients and investors believed the reimbursement offered was insufficient, they could seek to recover damages from us or could withdraw assets from our management or terminate the investment management agreement. Any of these events could harm our reputation and adversely affect our results of operations.
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Table of ContentsFluctuations in foreign currency exchange rates could lower our net income or negatively impact the portfolios of our clients and may affect the levels of our AUM. Certain client portfolios include securities denominated in foreign currencies. Accordingly, foreign currency fluctuations may affect the levels of our AUM. For securities denominated in currencies other than U.S. dollars, an increase in the value of the U.S. dollar relative to those non-U.S. currencies may result in a decrease in the dollar value of our AUM, which, in turn, would result in lower U.S. dollar denominated revenues. Additionally, a limited portion of our clients are billed for management and performance fees in currencies other than U.S. dollars, and the amounts due to us are subject to foreign currency fluctuation. If the currency in which our fees are paid depreciates against the U.S. dollar, our net income could decline. While these risks could be limited by foreign currency hedging, some risks cannot be hedged and there is no guarantee that our hedging activity would be successful. Additionally, hedging would result in additional costs to us. The significant growth we have experienced in recent years may not be indicative of future growth. Our AUM increased from approximately $7.9 billion at June 30, 2009 to approximately $23.2 billion at June 30, 2012, and it represents a significant rate of growth that may be difficult to sustain. The growth of our business depends on, among other things, our success in producing attractive returns in our investment strategies, our ability to expand our distribution capabilities, the overall performance of the equity markets, and our ability to deal with changing market conditions. Our continued growth places significant demands on our legal, compliance, accounting, risk management, administrative and operational resources. Rapid growth in our AUM imposes substantial demands on our legal, compliance, accounting, risk management, administrative and operational infrastructures. We must maintain adequate infrastructure, including technological capacity, backup facilities and sufficient space for expanding staff levels. Furthermore, our future growth will depend on, among other things, our ability to maintain highly reliable operating platforms, management systems and financial reporting and compliance infrastructures that are also sufficiently flexible to promptly and appropriately address our business needs, applicable legal and regulatory requirements and relevant market and operating conditions, all of which change rapidly. Addressing these matters may require us to incur significant additional expenses and to commit additional senior management and operational resources, even during periods when we are experiencing declines in AUM. There can be no assurance that we will be able to manage our operations efficiently without incurring substantial additional expense or that we will be able to effectively grow our business and AUM, and any failure to do so could materially adversely affect our business. We derive more than 10% of our operating revenue from one client. Pursuant to a strategic relationship with New York Life Investment Management, EIP is the sub-advisor to several mutual funds within New York Life Investment Management’s MainStay group of funds. As such, New York Life Investment Management accounted for approximately 17% of revenues for FY 2012. There can be no assurance that our relationship with New York Life will remain in place. A loss of this client would significantly impact our operating revenues and net income, and we may not be able to establish relationships with other clients in order to replace the lost revenues and net income. Changes in fee levels or asset mix could reduce revenues and margins. Our profit margins and net income are dependent, in significant part, on our ability to maintain current fee levels for the investment strategies that we offer. In recent years, however, in response to market pressures, there has been a trend towards lower fees in the asset management industry and no assurances can be given that we will be able to maintain our current fee structure. Although our investment management fees vary from investment strategy to investment strategy, we compete primarily on the basis of our investment performance and not on the level of our investment management fees relative to those of our competitors. In order to maintain our fee structure in a competitive environment, we must be able to continue to provide clients with investment
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Table of Contentsreturns and client service that incentivize our clients to pay our fees. We cannot be assured that we will succeed in providing investment returns and service that will allow us to maintain our current fee structure. Additionally, a shift in the mix in our AUM from higher revenue-generating AUM to lower revenue-generating AUM may result in a decrease in revenues even if our aggregate level of AUM remains unchanged or increases. Our future results are dependent upon maintaining an appropriate level of expenses, which is subject to fluctuation. Our expenses are subject to fluctuation and may increase for various reasons, including: variations in compensation due to changes in employee staffing levels, mix, or incentive compensation, expenses incurred to support the distribution of our investment strategies, and changes in expenses and costs incurred to maintain and enhance our administrative and operating services infrastructure. We may not be able to adjust our expenses quickly enough to match a significant deterioration in revenues. If we are unable to implement appropriate expense reductions in a timely manner in response to declines in our revenues, or if we are otherwise unable to adapt to rapid changes in the global marketplace, our profitability, results of operations and financial condition may be adversely affected. We may enter into more performance-based fee arrangements with our clients in the future, which could cause greater fluctuations in our revenues. A small portion of our investment advisory revenues is currently derived from performance fees. We earn performance fees under certain client agreements if the investment performance in the portfolio meets or exceeds a specified benchmark. In these instances, we charge a base advisory fee and are eligible to earn an additional performance-based fee or incentive allocation that is calculated as a percentage of investment results in excess of a stated benchmark over a specified period of time. In addition, some performance-based fee arrangements include a high-watermark provision, which generally provide that if a client account underperforms relative to its performance target (whether absolute or relative to a specified benchmark), it must gain back such underperformance before we can collect future performance-based fees. Therefore, if we fail to achieve the performance target or underperform for a particular period, we will not earn a performance fee for that period and, for accounts with a high-watermark provision, our ability to earn future performance fees may be impaired. We earned $5.2 million, $1.8 million and $0.8 million in performance fees during fiscal years 2012, 2011 and 2010, respectively. Performance fees may become more prevalent in our industry. An increase in performance fees, or in performance-based fee arrangements with clients, could create greater fluctuations in our revenues. Expansion into international markets may increase operational, regulatory and other risks. We offer investment management services in many different regulatory jurisdictions globally and intend to continue to expand our operations. As we increase our international business activities and expand our investment strategy offerings, we will face increased operational, regulatory, compliance, reputational and other risks. Additionally, we will likely incur additional costs and expenses. A failure of our compliance and internal control systems to properly mitigate such risks, or of our operating infrastructure to support such international expansion, could result in a loss of clients or inability to attract new clients, regulatory fines or sanctions, damage to our reputation, or other material adverse impacts on our business. We are subject to numerous operational risks which may disrupt our business, result in regulatory action against us, damage our reputation, cause losses, or limit our growth. We face numerous operational risks related to our business on a day-to-day basis. Among other things, we must be able to consistently and reliably obtain securities pricing information, process investment transactions and provide reports and other customer service to our clients. Any failure to keep current and accurate books and records can render us liable to disciplinary action by governmental and self-regulatory authorities, as well as to claims by our clients. If any of our financial, portfolio accounting or other data processing systems, or the systems of third parties on whom we rely for information or communication, do not operate properly or are
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Table of Contentsdisabled or if there are other shortcomings or failures in our internal processes, people or systems, or those of third parties on whom we rely, we could suffer a financial loss, a disruption of our businesses, liability to clients, regulatory problems or damage to our reputation. These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services. Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavors to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that have a security impact. If one or more of such events occurs, it potentially could jeopardize confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our clients’, our counterparties’ or third parties’ operations. We may be required to spend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to reputational damage, litigation and financial losses that are either not insured against fully or not covered through any insurance that we maintain. Lastly, we depend on our headquarters, which is located in New York City, for the continued operation of our business. A disaster or a disruption in the infrastructure that supports our headquarters, or an event disrupting the ability of our employees to perform their job functions there, including terrorist attacks or a disruption involving electrical communications, transportation or other services used by us or third parties with whom we conduct business, directly affecting our headquarters, may have a material adverse impact on our ability to continue to operate our business without interruption. Although we have disaster recovery programs in place, there can be no assurance that these will be sufficient to mitigate the harm that may result from such a disaster or disruption. In addition, insurance and other safeguards might only partially reimburse us for our losses. Insurance coverage may not protect us from all of the liabilities that could arise from the risks inherent in our business. We maintain insurance coverage focused on reducing potential losses related to our operations. We purchase insurance in amounts, and against risks, that we consider appropriate. There can be no assurance, however, that a claim or claims will be completely covered by insurance or, if covered, will not exceed the limits of our existing insurance coverage. If a loss occurs that is partially or completely uninsured, we could be exposed to substantial liability. Insurance costs are impacted by market conditions and our risk profile and may increase significantly over relatively short periods. Renewals of insurance policies may result in additional costs through higher premiums or the assumption of higher deductibles or co-insurance liability. Various factors may prevent the declaration and payment of cash dividends. We have paid a quarterly cash dividend each quarter since the quarter ended December 31, 2007 and have paid special dividends from time to time. However, the payment of dividends in the future is subject to the discretion of our Board of Directors, and various events or factors may prevent us from paying dividends. Our Board of Directors will take into account factors such as general economic and business conditions, our financial condition and results of operations, our strategic plans and prospects, working capital requirements and anticipated cash needs, and any legal, contractual or regulatory restrictions. We may pursue strategic transactions that could create risks, present unforeseen integration obstacles or costs, and could dilute the stock ownership of our stockholders. As part of our long-term business strategy, we routinely assess our strategic position, and from time to time address potential transactions, including acquisitions, joint ventures or other transactions aimed at expanding the geography and scope of our operations, and further enhancing our competitive position. We expect to explore partnership opportunities that we believe to be accretive.
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Table of ContentsAny such strategic transactions involve a number of risks and present financial, managerial and operational challenges, including potential disruption of our ongoing business and distraction of management, difficulty with integrating personnel and operating infrastructure, and increasing the scope, geographic diversity and complexity of our operations. Our clients may react unfavorably to any such strategic transaction, we may not realize anticipated benefits, and may be exposed to additional liabilities of any acquired business or joint venture, any of which could materially adversely affect our revenue and results of operations. In addition, strategic transactions may involve the issuance of additional shares of our common stock, which would dilute our existing ownership. The market price and trading volume of our common stock may be volatile, which could result in rapid and substantial losses for our stockholders. The market price of our common stock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur, which may limit or prevent investors from readily selling their common stock and may otherwise negatively affect the liquidity of our common stock. Some of the factors that could negatively affect the price of our common stock or result in fluctuations in the price or trading volume of our common stock include:
Our officers and directors own a substantial amount of our common stock and therefore exercise significant control over our corporate governance and affairs. Our executive officers and directors control approximately 30% of our outstanding common stock (including exercisable stock options held by them). These shareholders, if they act together, may be able to exercise substantial influence over the outcome of corporate actions requiring approval of our shareholders, including the election of directors and approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying or preventing a change in control and might affect the market price of our common stock. Our ability to issue “blank check” preferred stock without approval by the holders of our common stock could adversely affect the rights of common shareholders and could be used as an anti-takeover device. Our charter allows our Board of Directors to issue preferred stock and to determine its rights, powers, and preferences without shareholder approval (“blank check preferred stock”). Future preferred stock issued under the Board’s authority could contain preferences over our common stock as to dividends, distributions, and voting power. Holders of preferred stock could, for example, be given the right to separately elect some number of our
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Table of Contentsdirectors in all or specified events or an independent veto right over certain transactions, and redemption rights and liquidation preferences assigned to preferred shareholders could affect the residual value of common stock. We could also use the preferred stock to deter or delay a change in control that may be opposed by management. Risks Related to Our Industry We face strong competition from numerous and sometimes larger companies, many of whom have greater resources and the ability to offer clients a wider range of investment strategies and services than we can offer. We compete with numerous investment management firms, mutual fund companies, commercial banks, investment banks, hedge funds, insurance companies and other financial institutions. Some of these institutions have greater capital, marketing and other resources, and offer more strategies and services than we do. Our competitors seek to expand their market share in many of the strategies and services we offer. If these competitors are successful, we may lose clients or fail to attract new clients and our revenues and profitability could be adversely affected. In addition, there are relatively few barriers to entry by new investment management firms, and the successful efforts of new entrants into our various distribution channels globally have also resulted in increased competition. In recent years there have been several instances of industry consolidation. Further consolidation may occur in the future. The increasing size and market influence of certain competitors may have a negative impact on our prospects for growth and our profit margins in the future. Extensive regulation of our business affects our activities and results in ongoing exposure to the potential for significant penalties, including fines or limitations on our ability to conduct our business. The financial services industry is subject to extensive and complex regulation. We are subject to regulation by governmental and self-regulatory organizations in the jurisdictions in which we operate around the world. The regulatory bodies with jurisdiction over us, including U.S. and non-U.S. government agencies and self-regulatory organizations, as well as state securities commissions in the U.S., have the authority to grant, and in specific circumstances to cancel, permissions to carry on our business. Our failure to comply with applicable laws or regulations could result in censure, fines, suspension of personnel, or the suspension or revocation of our registration as an investment adviser. Even if a sanction imposed against us or our personnel is small in monetary amount, the adverse publicity arising from the imposition of sanctions against us by regulators could harm our reputation, cause us to lose existing clients or impede our ability to obtain new client relationships, which may reduce our revenues. The requirements imposed by our regulators are designed to ensure the integrity of the financial markets and to protect clients and other third parties who deal with us and are not designed to protect our stockholders. Consequently, these regulations often serve to limit our activities. We face the risk of significant intervention by regulatory authorities, including extended investigation and surveillance activity, adoption of costly or restrictive new regulations and judicial or administrative proceedings that may result in substantial penalties. In addition, the regulatory environment in which we operate is subject to modifications and further regulation. New laws, regulations, or changes in the enforcement of existing laws or regulations applicable to our Company and our clients may also adversely affect our business, and our ability to function in this environment will depend on our ability to constantly monitor and react to these changes. In addition, the regulatory environment in which our clients operate may impact our business. For example, changes in antitrust laws or the enforcement of antitrust laws could affect the level of mergers and acquisitions activity and changes in state laws may limit investment activities of state pension plans. Instances of criminal activity and fraud by participants in the asset management industry, disclosures of trading and other abuses by participants in the financial services industry, and the previously required massive governmental intervention and investment in the financial markets and financial firms have lead the U.S. government and regulators to increase the rules and regulations governing, and oversight of, the U.S. financial system. The cumulative effect of these actions may result in increased expenses, or lower management fees, and therefore, adversely affect the revenues or profitability of our business. In addition, financial services firms are subject to numerous conflicts of interests or perceived conflicts, and we have adopted various policies, controls and procedures to address or limit actual or perceived conflicts and
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Table of Contentsregularly seek to review and update our policies, controls and procedures. These policies and procedures may result in increased costs, additional operational personnel, and increased regulatory risk. Failure to adhere to our policies and procedures could result in regulatory sanctions or client litigation. Specific regulatory changes may also have a direct impact on our revenue. In addition to regulatory scrutiny and potential fines and sanctions, regulators continue to examine different aspects of the asset management industry. These regulatory changes and other proposed or potential changes may result in a reduction of revenue or an increase in expenses associated with asset management. The financial services industry faces substantial litigation risks which could materially adversely affect our business, financial condition or results of operations or cause significant harm to our reputation. We depend to a large extent on our network of relationships and on our reputation in order to attract and retain clients. If a client is not satisfied with our services, such dissatisfaction may be more damaging in our business than in other types of businesses. In our business, we make investment decisions on behalf of our clients which could result in substantial losses to them. If our clients suffer significant losses, or are otherwise dissatisfied with our services, we could be subject to the risk of legal liabilities or actions alleging negligent misconduct, breach of fiduciary duty or breach of contract. Our agreements typically include broad indemnities from our clients and provisions designed to limit our exposure to legal claims relating to our services, but these provisions may not protect us or may not be adhered to in all cases. Separately, we may also be subject to claims arising from disputes with employees for alleged discrimination or harassment, among other things. The above risks often may be difficult to assess or quantify, and their existence and magnitude often remain unknown for substantial periods of time. As a result, we may incur significant legal expenses in defending against litigation. Substantial legal liability or significant regulatory action against us could materially adversely affect our business, financial condition or results of operations or cause significant reputational harm to us. Item 1B. Unresolved Staff Comments. None. Our current operations are located at 640 Fifth Avenue, New York, NY. Business is conducted at this location with approximately 20,000 rentable square feet under long-term leases that expire in September 2015. We believe our present office space is adequate for our immediate operating needs. However, due to recent business expansion and to support our growth plans, in June 2012 we entered into a lease agreement for new corporate offices of approximately 39,500 rentable square feet, located at 399 Park Avenue, New York, NY. This lease commences September 1, 2012 and we expect to relocate to the new location once construction is completed, on or about February 1, 2013. The new lease expires on June 1, 2023. Upon the expiration of the lease term, the lease may be renewed at our option, for an additional five or ten years. We are currently searching for a sub-tenant for our present location and do not expect to incur material costs in conjunction with the termination of our existing lease agreements. For a discussion of occupancy expense, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7. Additional information about our occupancy costs, including commitments under non-cancellable leases, is provided under the caption Lease Commitments in Note 10 to the consolidated financial statements included under Item 8 of Part II of this Form 10-K. From time to time, we may become parties to claims, legal actions and complaints arising in the ordinary course of business. We are not aware of any claims which would have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Item 4. Mine Safety Disclosures. Not applicable.
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Table of ContentsPART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Our common stock is listed on the NASDAQ Global Select Market under the ticker symbol “EPHC.” The following table sets forth for the periods indicated the high, low, and quarter-end closing reported sale prices based on data reported by Bloomberg, as well as dividends declared per share for our Common Stock:
The closing price for our common stock as reported on the NASDAQ Global Select Market on September 5, 2012 was $22.27. As of September 5, 2012 there were approximately 900 holders of record of our common stock. Since many of the shares are held in street nominee name, we believe the number of beneficial owners of our common stock is substantially higher. Dividend Policy Regular Cash Dividends We have been paying quarterly dividends since November 2007. Quarterly dividends are generally paid in February, May, August and November of each fiscal year. We currently expect to continue paying regular quarterly dividends. However, the actual declaration and payment of any future cash dividends is subject to determination by our Board of Directors each quarter after their review of our financial performance, as well as general business conditions, capital requirements, and any legal or regulatory restrictions. We may change our dividend policy at any time. Special Cash Dividends To date, we have paid four special dividends. As with regular dividends, the declaration of special dividends is subject to the determination by our Board of Directors. Rule 10b5-1 Plans Our executive officers may purchase or sell shares of our common stock in the open market from time to time. We encourage these officers to make these transactions through plans that comply with Exchange Act Rule 10b5-1(c). We do not receive any proceeds related to these transactions.
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Table of ContentsEquity Compensation Plan Information As of June 30, 2012, there were 4,823,296 shares issued under the Company’s Amended and Restated 2004 Omnibus Long-Term Incentive Compensation Plan (the “2004 Plan”). There were 676,704 shares available for issuance comprising the following:
Recent Sales of Unregistered Securities None. Issuer Purchases of Equity Securities Common Stock Repurchase Plan The following table summarizes on a monthly basis, share repurchases under the Company’s Share Repurchase Plan(1) during the fourth quarter ended June 30, 2012:
Employee Tax Withholding To satisfy statutory employee tax withholding requirements related to the vesting of common shares, employees may elect to have the Company withhold shares and remit the necessary tax withholding on their behalf. We may promptly sell these shares in the open market on behalf of the employee or acquire them as treasury shares. Any resulting gain or loss on sale is accounted for as an adjustment to additional paid-in capital. During the fourth quarter ended June 30, 2012, a total of 3,175 employee relinquished shares related to employee tax withholding were acquired as treasury shares at a weighted-average price of $23.93 per share.
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Table of ContentsStock Performance Graph The graph and table that follow compare the performance of an investment in our Common Stock from June 30, 2007 through June 30, 2012 with the Russell 2000 Index, the Dow Jones U.S. Asset Managers Total Stock Market Index* (“Dow Jones US Asset Managers TSM”), a composite of publicly traded asset management companies, and an index comprised of public companies with the Standard Industrial Classification (“SIC”) Code 6282, Investment Advice. The graph and table assume a $100 investment in our Common Stock on June 30, 2007, and an equal investment in each of the selected indices, including reinvestment of dividends, if any. The performance shown in the graph and table represents past performance and should not be considered an indication of future performance.
The foregoing graph and table shall not be deemed to be “soliciting material” or “filed” or incorporated by reference in any previous or future documents filed by the Company with the SEC under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates the information by reference in any such document.
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Table of ContentsItem 6. Selected Financial Data. The table that follows presents our selected financial data. This data was derived from our consolidated financial statements and reflects our operations and financial position at the dates and periods indicated. The following selected historical consolidated financial data should be read in conjunction with Part II, Item 7. ‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’ and Item 8. ‘Financial Statements and Supplementary Data’ included in this Annual Report on Form 10-K. Selected Financial Data (dollars in thousands, except per share and AUM data)
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Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion together with our Consolidated Financial Statements and related notes included in this Annual Report on Form 10-K and the information set forth under Item 6, “Selected Financial Data.” The discussion contains forward-looking statements that involve known and unknown risks and uncertainties. For additional information regarding some of the risks and uncertainties that affect our business and the industry in which we operate, please read “Item 1A.—Risk Factors” included in this Annual Report on Form 10-K. Our actual results may differ materially from those estimated or projected in any of these forward-looking statements. Overview We are a global asset management firm with accomplished and experienced professionals. Our professional investment staff averages over 20 years of industry experience. Our Company was formed with the specific goal of responding to paradigm shifts occurring within the sources of global equity investment returns and within the structure of the investment management business as a whole. Headquartered in New York City, we had approximately $23.2 billion in assets under management (“AUM”) as of June 30, 2012. We remain debt-free and continue to have substantial capital resources available to fund current operations and implement our long-term growth strategy. Distribution Channels Our operating subsidiary, Epoch Investment Partners (“EIP”), is a registered investment adviser under the Investment Advisers Act of 1940, as amended. Our sole line of business is to provide investment advisory and investment management services to clients including corporations, public pension funds, retirement plans, foundations, endowments, financial institutions and high net worth individuals. These services are provided through separately managed accounts and commingled vehicles, such as sub-advised mutual funds and our proprietary private investment funds. Our investment strategies are primarily distributed through three distribution channels. These channels and the relative percentage of managed assets at June 30, 2012 are: institutional (52%), sub-advisory (47%) and high net worth (1%). All of the assets we manage are invested utilizing our investment strategies. We do not invest assets of our clients in any investment strategies of third parties. Nearly all the assets we manage for our institutional and high net worth clients are managed as separate accounts. To the extent that any of our institutional or high net worth clients are invested in mutual funds for which we serve as sub-advisor or proprietary investment funds for which we serve as investment advisor, the assets are included in the reported AUM of the respective fund. In particular, mutual funds for which we serve as investment sub-advisor are reported as ‘Sub-advisory’ and our proprietary funds are reported as ‘Institutional’. For those assets that are invested in funds that we manage, the fees are assessed strictly at the fund level, as part of the contractual management fee or related sub-advisory fee of the respective fund. There is no additional management fee. Investment Philosophy Our investment philosophy is focused on achieving superior long-term, total and risk-adjusted returns by investing in companies that generate free cash flow, appropriately allocate cash to create returns for shareholders, have understandable business models, possess transparent financial statements, and are undervalued relative to our investment team’s value determinations. Risk management is integrated into each step of our investment process. Our portfolio construction process is designed to minimize stock-specific risk and manage volatility. Revenue We earn revenues from managing client accounts under investment advisory and sub-advisory agreements. These agreements specify, among other things, the investment strategy for the account and the management fees to be paid, and are generally terminable by either party on relatively short notice. Fees vary by investment
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Table of Contentsstrategy, account size and servicing requirements. Fees are generally higher for international or global equity investment strategies than for U.S. investment strategies. Agreements remain in effect indefinitely, with the exception of sub-advised funds which are typically subject to annual approval by the respective fund’s board of directors. Revenues are generally derived as a percentage of AUM. The majority of accounts pay us management fees pursuant to a tiered fee schedule in which the fee rate declines as the amount of AUM increases. The fees we earn on institutional and high net worth separate accounts are typically based on the value of AUM at the end of the quarter. Our institutional separate account investment advisory agreements generally provide for fees ranging from 45 to 100 basis points of AUM annually, and our high net worth investment advisory agreements generally provide for fees ranging from 100 to 125 basis points of AUM annually. Fees earned from services to mutual funds under sub-advisory agreements are typically calculated based on the average of the daily net asset value of the fund. Due to the generally reduced client distribution and servicing requirements and the typically larger account size, the average advisory fees we earn on sub-advisory accounts as a percentage of AUM are lower than the advisory fees we earn on our institutional accounts, and generally range from 35 to 85 basis points of AUM annually. Fees earned for services provided to our proprietary funds (i.e. limited liability companies) are calculated based upon net asset values at the end of the month, and range from 80 to 150 basis points of AUM annually. Accordingly, notwithstanding an increase or decrease in AUM from quarter-end to quarter-end, significant fluctuations in asset values within a given quarter may have a more pronounced impact on revenues generated from sub-advised mutual funds than on revenues generated from separate accounts or our proprietary funds. Under some circumstances, particularly in connection with the introduction of a new proprietary fund, we may waive a portion of a fund’s management fee and/or pay some expenses of the fund. Our proprietary funds currently represent less than 1% of our AUM. Some of the institutional client accounts and proprietary funds we manage provide for performance fees according to the performance of the account or fund relative to certain agreed-upon benchmarks, which typically results in a lower base fee, but may permit us to earn higher fees if the relevant investment strategy outperforms the agreed-upon benchmark. Generally, if an agreement includes a performance fee, the performance fee ranges from 10% to 20% of the investment performance in excess of the relative benchmark. Several of our accounts with performance fees include a high-watermark provision which generally provides that if the account underperforms relative to its performance target, it must gain back such underperformance before we can collect future performance-based fees. Typically, investment advisory agreements may not be assigned (including as a result of transactions, such as a direct or indirect change of control of the asset manager that would constitute an assignment under the Investment Advisers Act of 1940 or other applicable regulatory requirements) without the prior consent of the client. When the asset management client is a U.S. registered mutual fund or closed end fund, the fund’s board of directors generally must annually approve the investment management contract, and any material changes to the contract, and the board and fund shareholders must approve any assignment of the contract (including as a result of transactions that would constitute an assignment under the Investment Company Act of 1940). Investment advisory agreements are generally terminable upon thirty or fewer days’ notice. Our clients may elect to terminate their relationships with us, reduce the aggregate amount of assets under our management, or shift their funds to other types of accounts with different fee structures. As revenues are derived as a percentage of AUM, among other factors, they are dependent upon:
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Table of ContentsExpenses Our most significant operating expense is employee compensation and benefits, comprising fixed salaries, variable incentive compensation, share-based compensation, and employee benefits. Variable incentive compensation is based upon our operating results, including AUM growth, investment performance, and operating income. Our level of compensation reflects our plan to maintain competitive compensation levels to retain key personnel. Other operating expenses include occupancy and technology costs, professional fees and services, general and administrative costs, and distribution and servicing fees. AUM Fair Value Measurement AUM consists of actively traded securities. The fair value of these securities that comprise our AUM, and materially impacts the determination of revenue, is measured using Level 1 inputs, as defined by the Fair Value Topic in the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”), which are publicly available, unadjusted quoted prices in active markets. These prices are obtained from an independent pricing service. We substantiate the values obtained with another independent pricing service to confirm all prices are valid. There is no estimation involved in the calculation of AUM that materially impacts our revenue recognition. Key Priorities for Driving Growth We remain committed to the development and growth of our business. Our main objectives are to achieve consistent and superior long-term investment performance for our clients, while further developing our distribution channels, both in the U.S. and abroad. Management has identified the following key priorities for driving growth:
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Table of ContentsKey Financial Performance Indicators We monitor a variety of key financial performance indicators to evaluate our business results. The charts that follow depict our annual growth in certain key financial performance measures over the past five years:
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Table of ContentsFinancial Highlights For the fiscal year ended June 30, 2012, we reached several operating milestones. AUM exceeded $23 billion, annual operating revenues were in excess of $90 million, and our operating margin continued to grow. Some noteworthy accomplishments and items during the past year were as follows:
Key Performance Indicators The table below presents financial results from what we consider to be our key operating and financial drivers for the past three fiscal years ended June 30:
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NM Not meaningful.
We consider the use of the non-GAAP measures presented above to be helpful in assessing the performance of the continuing operations of our business. By continuing operations we mean the ongoing revenue and expenses of the business, excluding certain items that render comparisons with prior periods or analysis of on-going operating trends more difficult, such as expenses or benefits not directly related to the delivery of our services. In particular, in fiscal year 2011 the release of a valuation allowance on certain deferred tax assets significantly impacted Net Income and Earnings Per Share. These adjusted measures are not presented in accordance with, nor are they a substitute for GAAP. The non-GAAP financial measures used in the table should not be considered in isolation from measures of financial performance prepared in accordance with GAAP and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP. Consistent with this approach, we believe that disclosing these non-GAAP financial measures to the readers of our financial statements provides such readers with useful supplemental data that, while not a substitute for financial measures prepared in accordance with GAAP, allows for greater transparency in the review of our financial and operational performance. Business Environment As an investment management and advisory firm, our results are impacted by the prevailing global economic climate, including such factors as corporate profitability, investor confidence and interest rates. These factors can directly affect investor sentiment and global equity markets and, accordingly, our investment returns and AUM. During the year ended June 30, 2012, markets globally exhibited significant volatility, impacted by the most difficult and challenging conditions since 2008. The European sovereign debt crisis and a slowdown in economic growth globally resulted in significantly heightened investor concerns. Performance across equity markets worldwide varied. In the U.S., returns were positive despite worries about persistent economic weakness and high unemployment. In contrast, returns in Europe and Asia were negative. The economic environment in which we operate continues to be challenging as we move into fiscal 2013. Investment returns for select broad market indices were as follows:
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Table of ContentsAssets under Management (“AUM”) Our AUM has continued to increase, experiencing positive net inflows every year since inception. The graph below depicts the quarterly AUM and revenue growth for the past two fiscal years.
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Table of ContentsThe following table sets forth the changes in our AUM for the past three fiscal years (dollars in millions):
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For the Twelve Months Ended June 30, 2012 AUM increased to $23.2 billion at June 30, 2012 from $17.1 billion at June 30, 2011. This increase was primarily attributable to the ongoing expansion of our client base and flows into existing accounts. We continued to expand our Institutional and Sub-advisory channels. Gross inflows into our Institutional distribution channel were approximately $4.7 billion and gross outflows were approximately $0.9 billion. Market appreciation on assets in our Institutional channel was approximately $0.1 billion. Growth in the Institutional channel included several new Institutional accounts, totaling approximately $3.4 billion, particularly in our Global Equity Shareholder Yield, Global Choice, U.S. Value and International Small Cap investment strategies. Gross inflows into our Sub-advisory distribution channel were approximately $3.3 billion and gross outflows were approximately $1.3 billion. Market appreciation on assets in our Sub-advisory channel was approximately $0.2 billion. Growth in the Sub-advisory channel primarily represented flows into existing Sub-advisory relationships, particularly in our Global Equity Shareholder Yield, U.S. Value and Global Choice investment strategies. During fiscal year 2012, we saw an increase in investor preference for global portfolios. In particular, there has been increasing demand for our Global Equity Shareholder Yield strategy – a diversified, global, dividend yield portfolio, and our Global Choice strategy – a concentrated portfolio of global equity securities. Net inflows into our Global Equity Shareholder Yield and Global Choice strategies were approximately $4.9 billion and $0.8 million, respectively. As of June 30, 2012, nearly all of our strategies had outperformed their respective benchmarks for the 5-year and since-inception periods. For the 1-year period ended June 30, 2012, our investment strategies had both positive and negative returns ranging from approximately 3% in Global Equity Shareholder Yield to -18% in International Small Cap. Global Equity Shareholder Yield comprised the majority of the total market appreciation as a result of its proportionate share of total AUM during the period. Overall market appreciation was primarily reduced by the negative return in the International Small Cap strategy. For further information regarding the performance of our investment strategies and their applicable benchmarks, please see Item 1. ‘Performance Highlights’ included in this Annual Report on Form 10-K. For the Twelve Months Ended June 30, 2011 AUM increased to $17.1 billion at June 30, 2011 from $11.3 billion at June 30, 2010. This increase was attributable to market performance, coupled with the ongoing expansion of our client base and flows into existing accounts. Gross inflows into our Institutional distribution channel were approximately $2.0 billion and gross outflows were approximately $0.5 billion. Market appreciation on assets in our Institutional channel was approximately $1.7 billion. Growth in the Institutional channel included several new Institutional accounts, totaling approximately $1.3 billion, particularly in our Global Equity Shareholder Yield, U.S. Value, U.S. All Cap, International Small Cap and Global Choice investment strategies. Gross inflows into our Sub-advisory distribution channel were approximately $1.3 billion and gross outflows were approximately $1.0 billion. Market appreciation on assets in our Sub-advisory channel was approximately $2.2 billion. Growth in the Sub-advisory channel primarily represented flows into existing Sub-advisory relationships, particularly in our Global Equity Shareholder Yield, U.S. Value, U.S. All Cap and Global Choice investment strategies. Net inflows into our Global Equity Shareholder Yield, U.S. Value and U.S. All Cap Value strategies were approximately $1.1 billion, $0.3 billion and $0.3 billion, respectively.
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Table of ContentsAs of June 30, 2011, nearly all of our strategies had outperformed their respective benchmarks for the 1-year, 5-year, and since-inception periods. All of our investment strategies had significant positive returns in the fiscal year ended June 30, 2011, ranging from approximately 25% to 40%. U.S. Value, U.S. All Cap Value, Global Equity Shareholder Yield and Global Choice comprised the majority of the total market appreciation, primarily as a result of their proportionate share of total AUM during the period. For the Twelve Months Ended June 30, 2010 AUM increased to $11.3 billion at June 30, 2010 from $7.9 billion at June 30, 2009. This increase was primarily attributable to the expansion of our client base and flows into existing accounts, along with market appreciation. Gross inflows into our Institutional distribution channel were approximately $2.2 billion. Gross outflows were approximately $0.2 billion. Separately, approximately $0.8 billion of AUM previously classified as Institutional was reclassified to Sub-advisory in conjunction with the adoption of the Epoch Funds by New York Life Investment Management. Market appreciation on assets in our Institutional channel was approximately $0.4 billion. Growth in the Institutional channel included several new Institutional accounts, totaling approximately $1.5 billion, particularly in our Global Choice, U.S. Value and U.S. All Cap investment strategies. Gross inflows into our Sub-advisory distribution channel were approximately $1.5 billion. Gross outflows were approximately $1.0 billion. Separately, approximately $0.8 billion of AUM previously classified as Institutional was reclassified to Sub-advisory, as noted above. Market appreciation on assets in our Sub-advisory channel was approximately $0.5 billion. Growth in the Sub-advisory channel represented both new Sub-advisory relationships as well as flows into existing Sub-advisory relationships, particularly in our U.S. Value, U.S. All Cap, Global Equity Shareholder Yield and Global Choice investment strategies. Net inflows into our Global Choice and U.S. Value strategies were approximately $0.9 billion and $0.8 billion, respectively. As of June 30, 2010, nearly all of our strategies had outperformed their respective benchmarks for the 3-year, 5-year, and since-inception periods. All of our investment strategies had positive returns in the fiscal year ended June 30, 2010, ranging from approximately 10% to 18%. Global Equity Shareholder Yield, U.S. Value, U.S. All Cap Value and U.S. Smid Cap Value comprised the majority of the total market appreciation, primarily as a result of their proportionate share of total AUM during the period. Our revenues are correlated with the levels of our AUM. Our AUM fluctuates based on changes in the market value of accounts advised and managed by us, and on our fund flows. As a long-only equity manager, a general or prolonged decline in equity markets may cause our revenues and net income to decline due to the value of our AUM decreasing, and/or clients withdrawing funds in favor of investments they perceive as offering greater opportunity or lower risk. We believe that market conditions and our investment performance are critical elements in our attempts to grow our AUM and business. Since we are long-term fundamental investors, we believe that our investment strategies yield the most benefits, and are best evaluated, over a long-term timeframe. We believe that our investment strategies are generally evaluated by our clients and our potential future clients based on their relative performance since inception, and the previous 1-year, 3-year, and 5-year periods. There has typically been a correlation between our strategies’ investment performance and the size and direction of asset flows. To the extent that our returns for these periods outperform client benchmarks or peers, we would generally anticipate increased asset flows. Correspondingly, negative returns relative to client benchmarks or peers could cause existing clients to reduce their exposure to our products and hinder new client acquisitions. For a description of our investment strategies and their respective performance, please see Item 1. ‘Investment Strategies’ and ‘Performance Highlights’ included in this Annual Report on Form 10-K. For a further discussion of risks related to our AUM, please see Item 1A. ‘Risk Factors’ and Item 7A. ‘Quantitative and Qualitative Disclosures About Market Risk’ included in this Annual Report on Form 10-K.
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Table of ContentsStrategic Relationship In July 2009, we entered into a strategic relationship with New York Life Investments, whereby the MainStay Group of Funds adopted our family of mutual funds (the “Epoch Funds”). The adoption was completed in November 2009. We are responsible for the day-to-day investment management of the funds through a sub-advisory relationship, while MainStay Investments (“MainStay”), the retail distribution arm of New York Life Investments, is responsible for the distribution and administration of the funds. Each former Epoch Fund is now co-branded as a “MainStay Epoch” Fund. In addition to an existing sub-advisory relationship between EIP and New York Life Investments for certain funds, and the adoption of the Epoch Funds indicated above, EIP and New York Life Investments have entered into an arrangement wherein, among other things, EIP and an affiliate of New York Life Investments have established a distribution and administration relationship with respect to certain separately managed account and unified managed account products, and for a period of three years New York Life Investments agrees to pay certain additional base fees and meet minimum distribution targets. For the fiscal years ended June 30, 2012, 2011 and 2010, New York Life Investment Management, through the MainStay Epoch Funds and other funds sub-advised by EIP, accounted for approximately 17%, 19% and 16% of consolidated operating revenues, respectively. Our services and relationship with New York Life Investment Management is considered important to our ongoing growth strategy.
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Table of ContentsDistribution Channels The following charts show our AUM by distribution channel and annual changes, as well as their percentage of AUM as of the end of the last three fiscal years (dollars in millions):
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Table of ContentsInvestment Strategies The following charts show our AUM by investment strategy and annual changes, as well as their percentage of AUM as of the end of the last three fiscal years (dollars in millions):
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Table of ContentsRevenue by Geographic Region The following charts show our operating revenue by geographic region and annual changes, as well as their percentage of total operating revenues for the last three fiscal years (dollars in thousands):
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Table of ContentsResults of Operations For the Fiscal Years Ended June 30, 2012, 2011 and 2010 Revenues
The 27% increase in investment advisory and management fees for the fiscal year ended June 30, 2012 primarily reflects a 35% increase in average AUM, partly offset by a decrease in our annualized effective fee rate to 45 basis points in fiscal 2012 from 48 basis points in fiscal 2011. The increase in AUM is primarily a result of net inflows from new and existing clients. Net inflows for the fiscal year were approximately $5.8 billion. Average AUM for the year ended June 30, 2012 was approximately $19.3 billion compared with $14.4 billion for the prior year. The 31% increase in investment advisory and management fees for the fiscal year ended June 30, 2011 primarily reflects a 33% increase in average AUM, partly offset by a decrease in our annualized effective fee rate to 48 basis points in fiscal 2011 from 49 basis points in fiscal 2010. The increase in AUM is primarily a result of market performance and net inflows from new and existing clients. Net inflows for the fiscal year were approximately $1.8 billion. Average AUM for the year ended June 30, 2011 was approximately $14.4 billion compared with $10.8 billion for the prior year. Our average effective fee rate (investment advisory and management fees, excluding performance fees, as a percentage of average assets under management) overall was approximately 45, 48 and 49 basis points in fiscal years 2012, 2011 and 2010, respectively. Differences in investment strategies, investment size, fee structure, and distribution channel affect our average effective fee rate. Institutional separate accounts had an average effective fee rate of approximately 52, 57 and 58 basis points in fiscal years 2012, 2011 and 2010, respectively. Institutional separate accounts were approximately 49%, 43% and 43% of AUM during those years, respectively. Institutional separate accounts increased to 52% of AUM as of June 30, 2012 as a result of several new institutional separate account mandates during the latter portion of the fiscal year ended June 30, 2012. Sub-advisory AUM had an average effective fee rate of approximately 38, 40 and 42 basis points in fiscal years 2012, 2011 and 2010, respectively. Sub-advisory AUM was approximately 50%, 55% and 55% of AUM during those years, respectively. Sub-advisory AUM decreased to approximately 47% of AUM as of June 30, 2012 as a result of several new institutional separate account mandates during the latter portion of the fiscal year ended June 30, 2012. As our tiered fee schedules or negotiated fees typically allow for lower fee rates as account size increases, additional inflows from existing institutional clients and from existing sub-advisory relationships, as well as a general increase in the size of new mandates, have gradually reduced the effective fee rates. Additionally, the agreements on certain separate accounts which commenced in fiscal 2010 and fiscal 2011, and which have a performance fee component, generally have a reduced base management fee. Although growth in our global and international product AUM has been a key contributor to our overall increase in AUM and therefore management fees, effective fee rates have slightly declined due to the impact of larger mandates from new and existing clients in all strategies, as well as the addition of several accounts with performance fee arrangements. While the average effective fee rate has declined gradually, our margins and profitability have increased. In assessing profitability, we generally focus on marginal revenues and marginal costs.
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Table of ContentsFor the fiscal years ended June 30, 2012, 2011 and 2010, New York Life Investment Management, through the MainStay Epoch Funds and other funds sub-advised by EIP, accounted for approximately 17%, 19% and 16% of consolidated operating revenues, respectively. For a further discussion of risks related to our fees, please see Item 1A. ‘Risk Factors’ included in this Annual Report on Form 10-K.
We have certain fee agreements that allow us to earn performance fees in the event that investment returns meet or exceed certain pre-established benchmarks specified in the agreements. Revenues for these incentives are recognized only when such performance targets are met or exceeded at the end of the measurement period. The period in which performance fees are recognized may vary by account, based upon the particular client arrangement (i.e. quarterly or annual measurement period), commencement date of the agreement, and performance criteria. Most of our performance fee agreements are based upon an annual measurement period. However, that period may vary across contracts (i.e. June 1 through May 31 for a client that commences on June 1, and December 1 through November 30 for a client that commences on December 1). We have several performance fee arrangements with a quarterly measurement period, typically based on three-year rolling cumulative performance through the end of the respective quarter. For the fiscal years ended June 30, 2012, 2011 and 2010, approximately 10%, 10% and 8% of AUM, respectively, had the ability to generate performance fees with varying measurement periods and criteria. The increase in performance fees during the fiscal year ended June 30, 2012 stemmed from the addition of new accounts with performance fee agreements, coupled with relative performance on both the new and existing performance fee agreements. The increase in the fiscal year ended June 30, 2011 over the previous year was the result of relative performance on new and existing accounts with performance fee agreements. Expenses We are continuously managing and reviewing our resource allocation. Our largest expense is compensation. Our ability to compete depends, in part, on our ability to attract and retain key employees while managing our compensation and other costs.
Employee compensation and related benefits include salaries, share-based compensation, incentive compensation, benefits, signing bonuses, severance, commissions and payroll taxes. Maintaining and recruiting high-caliber, experienced employees are critical to our growth strategy. We place a high emphasis on pay for performance. As such, changes in our Company’s performance as well as changes in the underlying performance of our investment strategies have an impact on compensation and benefits. Incentive compensation and share-based compensation are primarily based on our operating results, including AUM growth, net inflows, investment performance, operating income and margins. However, there are no predetermined formulas or weighting factors used to determine compensation. The Company also reviews peer compensation surveys but does not specifically set any compensation elements or pay levels versus the survey results. Rather, the Company uses the comparative survey data as part of its decision-making process in the determination of the appropriate level and mix of each component of compensation in any given year.
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Table of ContentsWe generally issue share awards to employees shortly following the calendar year and these awards facilitate employee retention through multi-year vesting. Commissions are paid to certain sales persons and are based on a percentage of management fees earned on the respective assets under management. For the fiscal year 2012, these expenses included salary expense of $10.8 million, incentive compensation of $13.5 million, amortization of stock-based compensation of $7.2 million, commissions of $1.4 million and benefits and payroll taxes of $2.7 million. The increase during fiscal year 2012 was driven by additions to professional staff, merit increases, and our operating results, including AUM growth and increased operating income and margins. Average headcount increased approximately 8% during the year ended June 30, 2012, when compared with the prior year period. Several additions were made to our investment and client relations teams to support our business expansion. As a percentage of total revenue, employee compensation and related benefits declined from the previous year. For the fiscal year 2011, these expenses included salary expense of $9.3 million, incentive compensation of $11.9 million, amortization of stock-based compensation of $6.3 million, commissions of $1.1 million and benefits and payroll taxes of $2.2 million. Similar to fiscal year 2012, the increase during fiscal year 2011 was driven by additions to professional staff, merit increases, and our operating results, including AUM growth and increased operating income and margins. Average headcount increased approximately 12% during the year ended June 30, 2011, when compared with the prior year period. Several additions were made to our investment and client relations teams to support our business expansion. As a percentage of total revenue, employee compensation and related benefits declined from the previous year. We anticipate employee compensation and related benefits cost to increase in the upcoming fiscal year in conjunction with an increase in our professional staff to support the planned growth of our business.
Occupancy and technology expenses consist primarily of office rent and related costs, market data services, information technology costs and depreciation. Increases in market data services and software costs were the primary reasons for the increase in these costs for the fiscal year ended June 30, 2012. In conjunction with anticipated growth, we recently entered into a lease agreement for expanded new corporate headquarters. The lease commences on September 1, 2012. The Company will relocate upon completion of construction in the new location, which is expected to be on or about February 1, 2013. As a result, rent expense is expected to increase by approximately $3.0 million for the fiscal year ended June 30, 2013. The Company is currently searching for a sub-tenant for our present headquarters and does not expect to incur material costs in conjunction with the termination of its existing lease agreements, which expire in September 2015.
These expenses include outside legal fees, independent accountants’ fees, consulting fees, employee placement fees and other professional services. An increase in legal and consulting fees was the primary reason for the increase in the fiscal year ended June 30, 2012. A reduction in employee placement fees partially offset the increase. Increased employee placement fees during the fiscal year ended June 30, 2011 were the primary reason for the increase during that period.
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The increase in the provision for income taxes and the effective income tax rate for the fiscal year ended June 30, 2012 compared with the fiscal year ended June 30, 2011 reflects both higher pre-tax income and the release of a valuation allowance of $5.0 million against certain deferred tax assets during the fiscal year ended June 30, 2011. During the fiscal year ended June 30, 2011 management determined that a valuation allowance against certain deferred tax assets, relating to acquired net operating losses and alternative minimum tax credits, was no longer appropriate as it was more likely than not that these deferred tax assets will be realized in future operating periods. Accordingly, the Company released a valuation allowance of approximately $5.0 million. This determination was made based upon factors such as earnings history, pre-tax income growth rates, and operating income levels. The release reduced the income tax provision and increased the deferred tax assets, but had no effect on cash flows. Similarly, the release of the valuation allowance was the primary factor for the decrease in the provision for income taxes and the effective income tax rate for the fiscal year ended June 30, 2011 compared to the fiscal year ended June 30, 2010. The release resulted in an increase in our basic earnings per share of $0.22 and diluted
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Table of Contentsearnings per share of $0.21 for the fiscal year ended June 30, 2011. Excluding the effect of the valuation allowance release, our effective income tax rate would have been approximately 44% for the fiscal year ended June 30, 2011. Liquidity and Capital Resources Sources of Liquidity Our principal source of liquidity is cash flows from operating activities, particularly investment management fees. Our current financial condition is highly liquid, with a significant amount of our assets comprised of cash and cash equivalents and accounts receivable. While it is currently our intention to hold the held-to-maturity securities until maturity and our other investments long term, we have the ability to convert these items into cash and cash equivalents during any fiscal year. Cash and cash equivalents, accounts receivable, held-to-maturity securities, and our other investments accounted for approximately 81% of total assets at June 30, 2012 and June 30, 2011. The following table summarizes our principal and potential sources of liquidity as of June 30, 2012 and June 30, 2011 (dollars in thousands):
We believe that the sources of liquidity described above as well as our continuing cash flows from operations will be sufficient to meet our operating needs for the foreseeable future and will enable us to continue implementing our growth strategy. We do not anticipate a need for an external source of liquidity. Uses of Liquidity We remain committed to growing our business in this challenging market environment and to returning value to our stockholders, therefore we expect that our main uses of cash will be to pay corporate operating expenses, recruit key personnel, enhance our operating and technology infrastructure, pay dividends, and repurchase shares of our common stock when appropriate. Our philosophy regarding the maintenance of a balance sheet with a large component of cash and cash equivalents reflects our views on potential future capital requirements relating to enhancement of our investment capabilities, creation and expansion of distribution channels, potential strategic acquisitions or transactions, support of our infrastructure growth, and possible challenges to our business. If we believe that we have sufficient capital for the aforementioned needs and circumstances, our approach is to return a portion of our excess liquidity to our shareholders. Accordingly, we declared a special dividend of $0.75 per share, or $17.5 million in aggregate, in November 2011, paid in January 2012. We regularly assess our liquidity position in view of our current and potential future needs.
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Table of ContentsCash Flow Analysis A summary of the Statements of Cash Flows for the fiscal years ended June 30 is as follows (dollars in thousands):
Cash Flows from Operating Activities Our cash flows from operating activities are calculated by adjusting net income to reflect other significant operating sources and uses of cash, certain significant non-cash items such as share-based compensation, and timing differences in the cash settlement of operating assets and liabilities. Significant operating sources and uses of cash that are not reflected in net income include net cash flows associated with the purchase and sale of investments in Company-sponsored vehicles classified as trading securities. For the fiscal years ended June 30, 2012, 2011 and 2010, our net cash provided by operating activities totaled $25.8 million, $18.6 million and $14.2 million, respectively. The increases in each fiscal year were primarily driven by the increases in revenues and related operating income, coupled with timing differences in the cash settlement of assets and liabilities. Accounts receivable increased by $3.5 million at June 30, 2012 when compared with the prior year and is reflective of higher management fees during the fourth quarter ended June 30, 2012 as a result of the significantly increased level of AUM. Net cash used in conjunction with the purchase and sale of investments in Company-sponsored vehicles classified as trading securities was $4.8 million. The purpose of these investments was primarily seed capital for new investment vehicles. Accrued compensation and benefits increased by $0.9 million from the comparable period a year ago, and primarily represents accruals for incentive compensation. This liability is generally paid shortly after the calendar year. Accounts receivable increased by $6.0 million at June 30, 2011 when compared with the prior year and is reflective of higher management fees during the fourth quarter ended June 30, 2011 as a result of the significantly increased level of AUM. Accrued compensation and benefits increased by $1.5 million when compared with the prior year, and primarily represents accruals for incentive compensation. Cash Flows from Investing Activities Our cash flows from investing activities consist primarily of capital expenditures, the purchase and redemption of held-to-maturity securities, and investments in Company-sponsored products and a non-affiliated limited partnership. Cash flows used in investing activities totaled $3.0 million for the fiscal year ended June 30, 2012. Investments of $2.3 million in Company-sponsored investment products accounted for most of the cash flows used in investing activities during the fiscal year. The purpose of these investments was primarily seed capital for new investment products. A security deposit in conjunction with a new lease agreement accounted for $1.2 million of the cash flows used in investing activities. Cash flows used in investing activities totaled $3.8 million for the fiscal year ended June 30, 2011. Investments of $4.0 million in a non-affiliated investment limited partnership, partially offset by the return of
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Table of Contentssecurity deposits on leased premises, accounted for most of the cash flows used in investing activities during the fiscal year. The purpose of the investment in the limited partnership is to generate additional returns on our cash balances during the current period of relatively low interest rates. Cash flows used in investing activities for the fiscal year ended June 30, 2010 totaled $3.8 million. During the year we purchased $2.4 million of high-grade debt securities yielding higher interest rates than money market instruments. These securities are classified as held-to-maturity securities on the Consolidated Balance Sheets as it is our intention to hold these securities until they mature. Capital expenditures of approximately $1.6 million for leasehold improvements and office equipment also contributed to the use of funds. Cash Flows from Financing Activities Our cash flows from financing activities primarily reflect the payment of common stock dividends, the repurchase of our common stock, and the recognition of excess tax benefits associated with share-based compensation. Net cash used in financing activities was $27.3 million, $22.2 million and $11.0 million for the fiscal years ended June 31, 2012, 2011 and 2010, respectively. The primary cash flows used in financing activities for those periods were dividends of $24.5 million, $22.2 million and $10.2 million, respectively. Included in the dividends were regular dividends of $7.0 million, $5.1 million and $3.5 million, respectively, and special dividends of $17.5 million, $17.1 million and $6.7 million, respectively. During those same periods, we repurchased a total of $6.0 million, $1.5 million, and $1.7 million of common shares, respectively, pursuant to our authorized common stock repurchase plan and in conjunction with employee tax withholding obligations on the vesting of common shares. See ‘Common Stock Repurchase Plan’ and ‘Employee Tax Withholding’ sections below for additional detail. Working Capital Our working capital for the past two years is set forth in the table below (dollars in thousands):
Deferred Tax Assets As of June 30, 2012, the Company had $8.9 million in long-term deferred tax assets, primarily relating to acquired net operating losses and alternative minimum tax credits. The Company believes there is sufficient positive evidence existing from earnings history, pre-tax income growth rates, current operating income levels, and the outlook for sustained profitability, to conclude that it is more likely than not that these deferred tax assets will be fully realized in future operating periods. Capital Expenditures In June 2012 we entered into a lease agreement for a new corporate headquarters of approximately 39,500 rentable square feet, located at 399 Park Avenue, New York, NY. This lease commences September 1, 2012 and we anticipate leasehold improvements and the purchases of additional office equipment, net of the landlord’s contribution, to be in the range of $4.0 million to $5.0 million. Any related capital expenditures and obligations for such office space will be paid from our cash flows from operations.
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Table of ContentsRegular Cash Dividends We have been paying regular quarterly dividends since the quarter ended December 31, 2007. Regular quarterly dividends declared per share totaled $0.30, $0.22, and $0.16 for the fiscal years ended June 30, 2012, 2011 and 2010, respectively. The aggregate dividend payments were approximately $7.0 million, $5.1 million, and $3.5 million, respectively. During the second quarter of fiscal year 2012, we increased the quarterly dividend rate from $0.06 to $0.08 per share. We expect regular quarterly cash dividends going forward to be paid in February, May, August and November of each fiscal year. However, the actual declaration of future cash dividends, and the establishment of record and payment dates, is subject to determination by the Board of Directors each quarter after their review of our financial performance, as well as general business conditions, capital requirements, and any legal or regulatory restrictions. We may change our dividend policy at any time. Special Cash Dividends The Board of Directors declared special cash dividends per share of $0.75, $0.75 and $0.30 during the fiscal years ended June 30, 2012, 2011 and 2010, respectively. The aggregate dividend payments were $17.5 million, $17.1 million and $6.7 million, respectively. We have paid four special dividends to date. As with regular dividends, the declaration of special dividends is subject to the determination by our Board of Directors. Common Stock Repurchase Plan We maintain a stock repurchase plan with the objective of maximizing shareholder value. Subject to applicable law, the shares may be purchased from time to time in the open market and/or in privately negotiated transactions. Such purchases will be at times and in amounts as we deem appropriate, based on factors such as prevailing market conditions, legal requirements and other business considerations. As of June 30, 2012, we have repurchased a cumulative total of 659,516 shares and have 490,484 shares remaining for repurchase under the existing repurchase plan. The table below presents annual shares repurchased and the weighted-average price per share:
For additional information regarding repurchases of our equity securities, see Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities.” Employee Tax Withholding To satisfy statutory employee tax withholding requirements related to the vesting of common shares, employees may elect to have the Company withhold shares and remit the necessary tax withholding on their behalf. We may promptly sell these shares in the open market on behalf of the employee or acquire them as treasury shares. Any resulting gain or loss on sale is accounted for as an adjustment to additional paid-in capital. During the year ended June 30, 2012, a total of 209,364 employee relinquished shares related to employee tax withholding were acquired as treasury shares at a weighted-average price of $22.96 per share.
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Table of ContentsFair Value Measurements Our investments classified as trading securities and available-for-sale securities are measured at fair value. Fair value for these investments is measured using Level 1 inputs, as defined by the Fair Value Topic in the FASB ASC, which are publicly available, unadjusted quoted prices in active markets. We do not hold any derivative instruments or financial liabilities. See Note 5 to the Consolidated Financial Statements for a further discussion on Fair Value Measurements. Contractual Obligations Office Space Our current operations are located at 640 Fifth Avenue, New York, New York. Business is conducted at this location with approximately 20,000 rentable square feet under long-term leases that expire in September 2015. We believe our present office space is adequate for our immediate operating needs. However, due to recent business expansion and to support our growth plans, in June 2012 we entered into a lease agreement for new corporate offices of approximately 39,500 rentable square feet, located at 399 Park Avenue, New York, NY. This lease commences September 1, 2012 and we expect to relocate to the new location once construction is completed, on or about February 1, 2013. The new lease expires on June 1, 2023. Upon the expiration of the lease term, the lease may be renewed at our option, for an additional five or ten years. We are currently searching for a sub-tenant for our present location and do not expect to incur material costs in conjunction with the termination of our existing lease agreements. Employment Agreement We renewed our employment agreement with our Chief Executive Officer in December 2010, effective January 1, 2011. The term of the agreement is for two years, with automatic two year renewals thereafter. Both our Company and the Chief Executive Officer have the option not to renew the term of the agreement within forty-five days of the end of the term or renewal term. The agreement calls for a minimum base salary of $375 thousand per annum, and bonus compensation in accordance with our Company’s bonus and incentive compensation plans. The agreement also calls for certain payments in the event of termination. The payments could vary depending on the cause of termination and whether or not our Board of Directors elects to enforce a non-compete agreement. The agreement was reviewed and approved by our Compensation Committee and our Board of Directors. Summary of Contractual Obligations We have contractual obligations to make future payments, primarily in connection with non-cancelable operating lease agreements. The following table summarizes all contractual obligations (dollars in thousands):
Included in the table above is $4.5 million in aggregate commitments through September 2015 related to the Company’s present headquarters, but for which sub-tenants are being pursued. See Note 10 the Consolidated Financial Statements for additional disclosures related to our commitments. Off-Balance Sheet Arrangements As of June 30, 2012, we had no off-balance sheet arrangements.
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Table of ContentsCritical Accounting Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and disclosure of contingent assets and liabilities. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that we feel to be relevant at the time our consolidated financial statements are prepared. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with U.S. GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. Our significant accounting policies and estimates are discussed in Note 2, Summary of Significant Accounting Policies, of the Notes to the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data of this Annual Report on Form 10-K. We believe that the following accounting estimates are the most subjective, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board of Directors. Income Taxes Our judgment is required in developing our provision for income taxes, including the determination of deferred tax assets and liabilities and any valuation allowances that might be required against deferred tax assets. Due to certain tax rules, we have annual limitations on certain acquired net operating losses. As such, their utilization prior to their expiration cannot be reasonably assured. Incentive Compensation Based upon Company and individual employee performance, we provide annual incentive-based cash awards to employees, generally following the calendar year. Because Company and individual employee performance is subject to change over the course of the year, estimates may differ from the actual amounts ultimately recognized. With some employees there are written agreements which provide for sales commissions or bonuses, subject to the attainment of certain performance criteria or continuation of employment. In such instances, the estimate of commissions and bonuses is generally governed by the terms of the agreement. Share-Based Compensation Share-based compensation expense reflects the fair value of share based awards measured at grant date, is recognized over the relevant service period, and is adjusted each period for anticipated forfeitures. The fair value of stock options are measured at grant date using the Black-Scholes option-pricing model. Implementation of the Black-Scholes option-pricing model requires us to make certain assumptions, including expected volatility, risk-free interest rate, expected dividend yield and expected life of the options. We utilize assumptions that we believe to be most appropriate at the time of the valuation. Recently Issued Accounting Standards In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. ASU No. 2011-04 generally provides a uniform framework for fair value measurements and related disclosures between U.S. GAAP and International Financial Reporting Standards (“IFRS”). Additional disclosure requirements in the update include, among other things, the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. ASU No. 2011-04 is effective for the interim and annual periods beginning on or after December 15, 2011. Early adoption is not permitted. The Company adopted this standard during the three months ended March 31, 2012. The adoption of this standard did not have a material impact on its consolidated financial position, results of operations, or cash flows.
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Table of ContentsIn December 2011, the FASB issued ASU No. 2011-11, Disclosures About Offsetting Assets and Liabilities. ASU No. 2011-11 provides new disclosure requirements regarding the nature of an entity’s right of setoff and related arrangements associated with its derivative and other financial instruments. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required. The new disclosures are designed to make financial statements that are prepared under U.S. GAAP more comparable to those prepared under IFRS. The Company does not anticipate that the adoption of the new disclosure requirements will have a material impact on its consolidated financial position, results of operations, or cash flows. Effects of Inflation Because our assets are, to a large extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation can directly affect various expenses, including employee compensation and occupancy and technology costs, which may not be readily recoverable in the fees we charge for asset management. Further, to the extent inflation adversely affects the securities markets, it may impact revenues. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. In the normal course of business, our results of operations and financial position are subject to different types of risk, including market risk. Market risk is the risk that we will incur losses primarily due to adverse changes in equity prices, interest rates, or currency exchange rates. As an investment manager, we continuously identify, assess, and manage market and other risks. The following information, together with information included in other parts of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” illustrates the significant characteristics of certain items that cause market risk to us. In evaluating market risk, it is important to note that substantially all of our revenue is based on the market value of AUM. As noted in “Risk Factors” in Item 1A, declines of equity market values negatively impact our revenue and net income. The management of market risk on behalf of our clients and its impact on fees is a significant focus for us. We use a variety of risk measurement techniques to identify and manage market risk within client portfolios. However, at the corporate level, we have historically not attempted to hedge revenue fluctuations that arise from changes in the fair value of our overall AUM. Equity Price Risk Revenues and Net Income Our predominant exposure to market risk is directly related to our role as an investment adviser to the separate accounts we manage and funds we sub-advise. Substantially all of our management fees are based upon the market value of our AUM. Accordingly, our investment management fees will change in proportion to changes in the market price of equity securities underlying our AUM. Declines in equity security market prices could cause our revenues and net income to decline by causing:
In addition, a decline in the price of securities may present market conditions that could preclude us from increasing AUM and prevent us from realizing higher revenue associated with such growth. Underperformance of client accounts relative to competing investment strategies could exacerbate these factors. Our AUM was approximately $23.2 billion as of June 30, 2012. At June 30, 2012 we performed a sensitivity analysis to assess the potential loss in the fair value and associated revenue of our market-risk sensitive AUM. Assuming a 10% decrease in the value of AUM solely due to market declines and the change proportionally
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Table of Contentsdistributed over all of our investment strategies, the fair value of our AUM would decrease by an estimated $1.8 billion, which would cause an annualized decrease in total investment advisory and management fees of approximately $8.2 million. We do not hedge equity price risk on this exposure. We earn performance fees on certain client accounts in the event that investment returns meet or exceed targeted amounts specified in the investment management agreements. Our performance fees will be impacted by changes in the market values of those accounts, which in turn are affected by changes in market risk factors. However, several other factors may influence the degree of impact, including: the performance criteria for the respective investment portfolio, the period over which the performance fee applies, and, to the extent applicable, the previous performance of the investment portfolio. As a result, the impact of changes in market risk factors on performance fees may vary widely and is therefore not readily predicted or estimated. Historically, less than 5% of our revenues have been generated from performance fees. Company Investments We are exposed to fluctuations in the market security price of the Company’s investments. Company investments primarily consist of investments in Company-sponsored investment vehicles, including mutual funds, investment strategy separate accounts, and affiliated limited liability companies. Company investments also include an investment in a non-affiliated investment limited partnership. We do not hedge our market security price risk related to these investments and do not intend to do so in the future. At June 30, 2012 and June 30, 2011, we performed a sensitivity analysis to assess the potential loss in the fair value of these market-risk sensitive securities. The following table represents the estimated impact on our financial position assuming a hypothetical 10% decline in associated market indices (in thousands):
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Interest Rate Risk Revenues and Net Income Our AUM is also subject to interest rate risk. Changes in both domestic and global interest rates may impact the valuation of equities, and thus our AUM, operating revenues and net income. Held-to-Maturity Investments We have invested in and continue to hold high-grade debt securities. Since it is our intent to hold these securities until they mature, we have accounted for them as held-to-maturity securities. We do not hedge our interest rate risk related to these securities and we do not intend to do so in the future. We believe that a hypothetical change in interest rates of 100 basis points would not have a material impact on our consolidated results of operations, financial condition or cash flows. The table below provides information about our investment securities held-to-maturity, including expected principal flows for the fiscal years June 30, 2013 through June 30, 2018 and thereafter (in thousands):
Cash and Cash Equivalents Cash consists of amounts held in checking and money market accounts. Cash equivalents include highly liquid investments in money market funds consisting of short-term securities of the U.S. government and its agencies with maturities of three months or less when acquired. Cash and cash equivalents are exposed to market risk due to changes in interest rates, which impacts interest income. We monitor the quality of the institutions where our cash is deposited, the balance of which, at times, may be in excess of the Federal Deposit Insurance Corporation insurance limits. While changes in interest rates could decrease our interest income, we do not believe 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 transactions. Foreign Currency Exchange Risk Certain client portfolios include securities denominated in foreign currencies. Accordingly, foreign currency fluctuations may affect the levels of our AUM. For securities denominated in currencies other than U.S. dollars, an increase in the value of the U.S. dollar relative to those non-U.S. currencies may result in a decrease in the dollar value of our AUM, which, in turn, would result in lower U.S. dollar denominated revenues. We estimate
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Table of Contentsthat, as of June 30, 2012, a 10% weakening or strengthening of the U.S. dollar against all or any combination of currencies to which our portfolios have exposure to exchange rates would not have a material effect on our revenues. While we operate in the U.S., we have clients in several countries outside the U.S. However, nearly all of our revenue from these clients and the associated expenses are denominated in U.S. dollars. Therefore, only a limited portion of our revenues and expenses are impacted by movements in currency exchange rates. The effect of a 10% change in exchange rates on such revenues and expenses would not have a material effect on our results of operations. Our exposure to currency movements may likely increase as our business outside the U.S. grows, and we will continue to monitor our foreign currency exposure accordingly.
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Table of ContentsItem 8. Financial Statements and Supplementary Data. The financial statements and supplementary financial information required by this Item are listed in the Index to Financial Statements below: EPOCH HOLDING CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS, SUPPLEMENTARY DATA AND FINANCIAL STATEMENT SCHEDULES
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Table of ContentsREPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of Epoch Holding Corporation and Subsidiaries (“the Company”) is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in conformity with accounting principles generally accepted in the United States of America and include those policies and procedures that:
There are inherent limitations in the effectiveness of internal control over financial reporting, including the possibility that misstatements may not be prevented or detected. Accordingly, even effective internal controls over financial reporting, no matter how well designed and operated, can provide only reasonable, not absolute, assurance with respect to financial statement preparation. Furthermore, the effectiveness of internal controls can change with circumstances. Management has assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2012 based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework. Based on that assessment, management has concluded that, as of June 30, 2012, the Company’s internal control over financial reporting is effective. CF & Co., L.L.P., an independent registered public accounting firm, has issued an attestation report on the effective operation of the Company’s internal control over financial reporting as of June 30, 2012. As stated in their report appearing herein, CF & Co., L.L.P. has expressed an unqualified opinion on the effective operation of internal control over financial reporting as of June 30, 2012.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Epoch Holding Corporation and Subsidiaries: We have audited the accompanying consolidated balance sheets of Epoch Holding Corporation and Subsidiaries as of June 30, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended June 30, 2012. We also have audited Epoch Holding Corporation and Subsidiaries’ internal control over financial reporting as of June 30, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Epoch Holding Corporation and Subsidiaries’ management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management report on internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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Table of ContentsIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Epoch Holding Corporation and Subsidiaries as of June 30, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2012, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Epoch Holding Corporation and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of June 30, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
CF & Co., L.L.P. Dallas, Texas September 10, 2012
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Table of ContentsEPOCH HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
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