SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)*
OR
0-10200(Commission File Number)
SEI INVESTMENTS COMPANY
(Exact name of registrant as specified in its charter)
(610) 676-1000(Registrant’s telephone number, including area code)
N/A(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes x No o
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes o No o
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 31, 2003: 104,924,412 shares of common stock, par value $.01 per share.
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
SEI Investments CompanyConsolidated Balance Sheets(unaudited)(In thousands)
June 30, 2003
December 31, 2002
Assets
Current Assets:
Cash and cash equivalents
$
156,271
165,724
Restricted cash
10,541
10,000
Receivables from regulated investment companies
23,341
22,588
Receivables, net of allowance for doubtful accounts of $1,700
55,158
52,054
Deferred income taxes
2,947
3,526
Prepaid expenses and other current assets
7,863
7,543
Total Current Assets
256,121
261,435
Property and Equipment, net of accumulated depreciation and amortization of $102,536 and $111,210
106,936
104,258
Capitalized Software, net of accumulated amortization of $16,071 and $15,204
14,166
12,596
Investments Available for Sale
57,383
62,433
Other Assets, net
31,057
23,425
Total Assets
465,663
464,147
The accompanying notes are an integral part of these consolidated financial statements.
2
SEI Investments CompanyConsolidated Balance Sheets(unaudited)(In thousands, except par value)
Liabilities and Shareholders’ Equity
Current Liabilities:
Current portion of long-term debt
14,365
9,556
Accounts payable
2,808
4,058
Accrued expenses
97,604
119,427
Deferred revenue
1,180
1,206
Total Current Liabilities
115,957
134,247
Long-term Debt
29,162
33,500
Deferred Income Taxes
6,207
6,393
Shareholders’ Equity:
Common stock, $.01 par value, 750,000 shares authorized; 104,860 and 106,184 shares issued and outstanding
1,049
1,062
Capital in excess of par value
227,893
216,284
Retained earnings
83,352
74,019
Accumulated other comprehensive gains (losses)
2,043
(1,358
)
Total Shareholders’ Equity
314,337
290,007
Total Liabilities and Shareholders’ Equity
3
SEI Investments CompanyConsolidated Statements of Income(unaudited)(In thousands, except per share data)
Three Months Ended June 30,
2003
2002
Revenues
153,554
158,851
Expenses:
Operating and development
68,204
68,187
Sales and marketing
28,256
31,945
General and administrative
4,835
5,972
Income from operations
52,259
52,747
Equity in the earnings of unconsolidated affiliate
4,861
3,103
Net loss from investments
(4,076
—
Interest income
1,365
1,394
Interest expense
(519
(484
Other income
509
Income before income taxes
54,399
56,760
Income taxes
20,128
21,001
Net income
34,271
35,759
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments
1,115
1,239
Unrealized holding gain (loss) on investments, Unrealized holding gains (losses) during the period net of income tax (expense) benefit of ($1,359) and $916
2,391
(1,729
Less: reclassification adjustment for losses realized in net income, net of income tax benefit of $149 and $110
254
2,645
186
(1,543
Other comprehensive income (loss)
3,760
(304
Comprehensive income
38,031
35,455
Basic earnings per common share
.33
Diluted earnings per common share
.32
.31
Dividends declared per common share
.07
.06
4
Six Months Ended June 30,
304,159
318,066
134,756
136,923
55,145
66,093
10,486
11,681
103,772
103,369
8,475
5,782
(4,182
2,607
2,544
(1,087
(965
110,094
110,730
40,735
40,970
69,359
69,760
1,097
858
Unrealized holding gain (loss) on investments, Unrealized holding gains (losses) during the period net of income tax (expense) benefit of ($918) and $609
1,584
(927
Less: reclassification adjustment for losses (gains) realized in net income, net of income tax (benefit) expense of ($423) and $31
720
2,304
(52
(979
3,401
(121
72,760
69,639
.66
.64
.61
5
SEI Investments CompanyConsolidated Statements of Cash Flows(unaudited)(In thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
8,627
9,000
Undistributed equity in the earnings of unconsolidated affiliate
(2,671
(2,116
Tax benefit on stock options exercised
6,064
13,250
Other
4,026
(1,236
Change in current assets and liabilities:
Decrease (increase) in
(753
3,162
Receivables
(3,104
(9,039
(320
8
Increase (decrease) in
(1,250
(2,464
(15,449
(7,839
(26
(210
Net cash provided by operating activities
64,503
72,276
Cash flows from investing activities:
Additions to property and equipment
(10,336
(16,766
Additions to capitalized software
(2,437
(1,230
Purchase of investments available for sale
(7,413
(12,110
Sale of investments available for sale
14,243
13,561
(367
738
Net cash used in investing activities
(6,310
(15,807
Cash flows from financing activities:
Payment on long-term debt
(6,778
(4,777
Purchase and retirement of common stock
(57,272
(44,079
Proceeds from issuance of common stock
10,106
8,545
Payment of dividends
(13,702
(12,050
Net cash used in financing activities
(67,646)
(52,361
Net (decrease) increase in cash and cash equivalents
(9,453
4,108
Cash and cash equivalents, beginning of period
163,685
Cash and cash equivalents, end of period
167,793
6
Notes to Consolidated Financial Statements(all figures are in thousands except per share data)
Nature of Operations
SEI Investments Company (the “Company”) is organized around its five primary target markets: Private Banking and Trust, Investment Advisors, Enterprises, Money Managers, and Investments in New Businesses. Private Banking and Trust provides investment processing solutions, fund processing solutions and investment management programs to banks and private trust companies. Investment Advisors provides investment management programs and investment processing solutions to affluent investors through a network of financial intermediaries, independent investment advisors and other investment professionals. Enterprises provides retirement and treasury business solutions for corporations, unions, foundations and endowments, and other institutional investors. Money Managers provides investment solutions to U.S. investment managers, mutual fund companies and alternative investment managers worldwide. Investments in New Businesses include the Company’s global asset management businesses as well as initiatives into new U.S. markets.
Summary Financial Information and Results of Operations
In the opinion of the Company, the accompanying unaudited Consolidated Financial Statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position as of June 30, 2003, the results of operations for the three and six months ended June 30, 2003 and 2002, and cash flows for the six month period ended June 30, 2003 and 2002.
Interim Financial Information
While the Company believes that the disclosures presented are adequate to make the information not misleading, these Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements included in the Company’s latest annual report on Form 10-K.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries. The Company’s principal subsidiaries are SEI Investments Distribution Company (“SIDCO”), SEI Investments Management Corporation (“SIMC”), and SEI Private Trust Company. All intercompany accounts and transactions have been eliminated. Investment in unconsolidated affiliate is accounted for using the equity method due to the Company’s less than 50 percent ownership. The Company’s portion of the affiliate’s operating results is reflected in Equity in the earnings of unconsolidated affiliate on the accompanying Consolidated Statements of Income (See Note 6).
7
Property and Equipment
Property and equipment on the accompanying Consolidated Balance Sheets consist of the following:
Estimated Useful Lives (In Years)
Buildings
77,240
75,825
25 to 39
Land
9,379
9,345
N/A
Equipment
65,312
79,260
3 to 5
Purchased software
20,687
21,256
Furniture and fixtures
15,728
15,523
Leasehold improvements
7,901
7,386
Lease Term
Construction in progress
13,225
6,873
209,472
215,468
Less: Accumulated depreciation and amortization
(102,536
(111,210
Property and Equipment, net
Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful life of each asset. Expenditures for renewals and betterments are capitalized, while maintenance and repairs are charged to expense when incurred.
Capitalized Software
The Company accounts for software development costs in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” (“SFAS 86”). Under SFAS 86, costs incurred to create a computer software product are charged to research and development expense as incurred until technological feasibility has been established. The Company establishes technological feasibility upon completion of a detail program design. At that point, computer software costs are capitalized until the product is available for general release to customers. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs require considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future revenues, estimated economic life, and changes in technology. The Company did not capitalize any software development costs during the six months ended June 30, 2003 and 2002 in accordance with SFAS 86.
In 2002, the Company adopted the guidance established in Emerging Issues Task Force Issue 00-03 “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware”, and applies Statement of Position 98-1 (“SOP 98-1”), “Accounting for the Cost of Computer Software Developed or Obtained for Internal Use,” for development costs associated with software products to be provided in a hosting environment. SOP 98-1 requires that costs incurred in the preliminary project and post implementation stages of an internal software project be expensed as incurred and that certain costs incurred in the application development stage of a project be capitalized. The Company capitalized $2,437 and $1,230 in software development costs in accordance with SOP 98-1 during the six months ended June 30, 2003 and 2002, respectively.
Amortization of capitalized software development costs begins when the product is released. Capitalized software development costs are amortized on a product-by-product basis using the straight-line method over the estimated economic life of the product or enhancement, which is primarily three to ten years, with a weighted average remaining life of approximately 5.2 years. Amortization expense was $867 during the six months ended June 30, 2003 and 2002 and is included in Operating and development expenses on the accompanying Consolidated Statements of Income.
Earnings per Share
The Company computes earnings per common share in accordance with Statement of Financial Accounting Standards No. 128, “Earnings per Share” (“SFAS 128”). Pursuant to SFAS 128, dual presentation of basic and diluted earnings per common share is required on the face of the statements of income for companies with complex capital structures. Basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution from the exercise or conversion of securities into common stock, such as stock options.
For the Three Month Period Ended June 30, 2003
Income (Numerator)
Shares (Denominator)
Per Share Amount
104,828
Dilutive effect of stock options
3,173
108,001
For the Three Month Period Ended June 30, 2002
109,632
4,670
114,302
Options to purchase 4,998 and 2,851 shares of common stock, with an average exercise price of $38.21 and $45.56, were outstanding during the second quarter of 2003 and 2002, respectively, but were excluded from the diluted earnings per common share calculation because the options’ exercise prices were greater than the average market price of the Company’s common stock.
For the Six Month Period Ended June 30, 2003
105,297
3,486
108,783
For the Six Month Period Ended June 30, 2002
109,514
5,129
114,643
9
Options to purchase 5,003 and 2,751 shares of common stock, with an average exercise price of $38.20 and $45.94 were outstanding during the first six months of 2003 and 2002, respectively, but were excluded from the diluted earnings per common share calculation because the options’ exercise prices were greater than the average market price of the Company’s common stock.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and has presented the required Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS 148”), pro forma disclosure in the table below.
The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its plans, and accordingly, no compensation cost has been recognized for the Company’s fixed stock-based compensation. Had compensation cost been determined consistent with SFAS 123, as amended by SFAS 148, the Company’s net income would have been reduced to the following pro forma amounts:
For the Three Month Period Ended June 30,
For the Six Month Period Ended June 30,
Net Income:
As reported
Deduct: Total stock-based employee expense determined under the fair value based method for all awards, net of related tax effects
(2,711
(2,325
(4,913
(4,651
Pro forma
31,560
33,434
64,446
65,109
.30
.59
.29
.57
Statements of Cash Flows
For purposes of the Consolidated Statements of Cash Flows, the Company considers investment instruments purchased with an original maturity of three months or less to be cash equivalents.
Supplemental disclosures of cash paid/received during the six months ended June 30 is as follows:
Interest paid
1,324
1,414
Interest and dividends received
2,768
2,582
Income taxes paid
34,961
19,072
Management’s Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the Unites States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
10
New Accounting Pronouncements
In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 45,”Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of indebtedness of Others,” (“FIN 45”). This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified on or after January 1, 2003. The recognition and measurement provisions of FIN 45 does not, nor is it expected to, have any material effect on the results of operations, financial position or liquidity of the Company.
In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” (“FIN 46”). This interpretation provides guidance on the identification of, and financial reporting for, entities over which control is achieved through means other than voting rights. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003 and to older entities in interim periods beginning after June 30, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not have an interest in any entity that require disclosure or consolidation as a result of adopting the provisions of FIN 46.
In February 2003, the Emerging Issues Task Force ratified Issue No. 00-21,”Revenue Arrangements with Multiple Deliverables,” (“Issue 00-21”). Issue 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities and addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. The Company provides certain services that involve a series of different product offerings that can be purchased as a complete solution or as individual components. Consideration for these types of services is usually a combination of fixed and variable payment amounts. Currently, the Company is evaluating the impact Issue 00-21 could have on our results of operations, financial position, liquidity and disclosure requirements. Issue 00-21 becomes effective for revenue arrangements entered into after June 30, 2003.
Foreign Currency Translation Adjustments
Unrealized Holding Gains (Losses) on Investments
Accumulated Other Comprehensive Gains (Losses)
Beginning balance (Dec. 31, 2002)
367
(1,725
Current period change
Ending balance (June 30, 2003)
1,464
579
11
Trade receivables
21,635
20,326
Fees earned, not received
1,357
1,452
Fees earned, not billed
33,866
31,976
56,858
53,754
Less: Allowance for doubtful accounts
(1,700
Fees earned, not received represent brokerage commissions earned but not yet collected. Fees earned, not billed represent receivables earned but not billed and result from timing differences between services provided and contractual billing schedules.
Receivables from regulated investment companies on the accompanying Consolidated Balance Sheets represent fees collected from the Company’s wholly owned subsidiaries, SIDCO and SIMC, for distribution, investment advisory, and administration services provided by these subsidiaries to various regulated investment companies.
As of June 30, 2003
Cost Amount
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Company-sponsored mutual funds
47,564
1,592
(292
48,864
Equity securities
8,925
(406
8,519
56,489
(698
As of December 31, 2002
45,642
860
(331
46,171
19,543
(3,281
16,262
65,185
(3,612
The net unrealized holding gains at June 30, 2003 were $579 (net of income tax expense of $315) and the net unrealized holding losses at December 31, 2002 were $1,725 (net of income tax benefit of $1,027) and are reported as a separate component of Accumulated other comprehensive gains (losses) on the accompanying Consolidated Balance Sheets.
12
Management performs a review of all investments in marketable securities on a quarterly basis with regards to impairment. Factors considered in determining other-than-temporary impairment are significant or prolonged declines in the price of investments based on available market prices. Additional consideration is given to the ability to recover the carrying amount of the investment. During the first six months of 2003, management determined that certain investments were impaired. The Company recorded an impairment charge of $595 related to other-than temporary declines in fair value and is included in Net loss from investments on the accompanying Consolidated Statements of Income. The Company did not record an impairment charge related to other-than-temporary declines in fair value for any of its securities available-for-sale during the three months ended June 30, 2003.
During the three months ended June 30, 2003, the Company recognized gross realized gains from available-for-sale securities of $54 and gross realized losses from available-for-sale securities of $457. For the six months ended June 30, 2003, the Company recognized gross realized gains from available-for-sale securities of $64 and gross realized losses from available-for-sale securities of $612.
The Company accounts for its derivatives in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS 133” ) and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities – an amendment of FASB Statement No. 133,” (“SFAS 138”).
The Company recognizes all derivatives on the balance sheet at fair value. On the date the derivative instrument is entered into, the Company generally designates the derivative as a hedge of the fair value of a recognized asset. Changes in the fair value of a derivative that is designated as, and meets all the required criteria for, a fair value hedge, along with the gain or loss on the hedged asset attributable to the hedged risk, are recorded in current period earnings. The portion of the change in fair value of a derivative associated with hedge ineffectiveness or the component of a derivative instrument excluded from the assessment of hedge effectiveness is recorded currently in earnings. Also, changes in the entire fair value of a derivative that is not designated as a hedge are recognized immediately in earnings. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes relating all derivatives that are designated as fair value hedges to specific assets on the balance sheet.
The Company also formally assesses, both at the inception of the hedge and on an ongoing basis, whether each derivative is highly effective in offsetting changes in fair values of the hedged item. If it is determined that a derivative is not highly effective as a hedge or if a derivative ceases to be a highly effective hedge, the Company will discontinue hedge accounting prospectively. During 2002, the Company discontinued hedge accounting prospectively for certain derivatives utilized to manage economic exposure because of hedge ineffectiveness. The Company may continue to enter into economic hedges to support certain business strategies but may not designate such derivatives as accounting hedges. Management’s decision to no longer apply hedge accounting to certain derivatives as well as hedge ineffectiveness may cause volatility in quarterly earnings and equity. Currently, the Company does not apply hedge accounting to any of its derivative instruments.
At June 30, 2003, Net loss from investments on the accompanying Consolidated Statements of Income includes a net loss of $2,575 and $1,917 from hedge ineffectiveness for the three and six months ended June 30, 2003, respectively.
The Company currently holds futures contracts with a notional amount of $1,285 with a financial institution with various terms. The Company also currently holds equity derivatives with a notional amount of $8,519 with a financial institution with various terms. During the period ending June 30, 2003, the Company did not enter into or hold derivative financial instruments for trading purposes.
13
Investment in unconsolidated affiliate
18,455
8,535
Other, net
12,602
14,890
Other assets
Other, net consists of long-term prepaid expenses, deposits and other investments carried at cost.
During the second quarter 2003, the Company recorded an impairment charge for $1,196 related to an equity investment in a private technology company and is reflected in Net loss from investments on the accompanying Consolidated Statements of Income.
Investment in Unconsolidated Affiliate – LSV Asset Management (“LSV”) is a partnership formed between the Company and several leading academics in the field of finance. LSV is a registered investment advisor, which provides investment advisory services to institutions, including pension plans and investment companies. LSV is currently the portfolio manager for a number of Company-sponsored mutual funds. The Company’s interest in LSV was approximately 44 percent for the first six months in 2003 and 2002. LSV is accounted for using the equity method of accounting due to the Company’s less than 50 percent ownership. The Company’s portion of LSV’s net earnings is reflected in Equity in the earnings of unconsolidated affiliate on the accompanying Consolidated Statements of Income.
On June 30, 2003, the Company entered into an Assignment and Purchase Agreement (the “Purchase Agreement”) to acquire an additional 2 percent interest in LSV. As a result of the Purchase Agreement, the Company’s total partnership interest in LSV is approximately 46 percent. At June 30, 2003, the basis of the Company’s investment in LSV exceeded its underlying equity in the net assets of LSV by $8,048. The Company accounts for this amount as goodwill embedded in their investment in LSV. The Company does not record amortization expense associated with such embedded goodwill but assesses whether such embedded goodwill is impaired on an annual basis. The embedded goodwill in LSV was not deemed impaired during the six month period ended June 30, 2003. In addition, the Purchase Agreement contains a contingent payment provision and occurs in the event of the sale of a certain percentage of the Partnership’s business and assets. The contingent payment provision expires on January 1, 2006.
The following table contains the condensed statements of income of LSV for the three and six months ended June 30:
Three Month Period, Ended June 30,
Six Month Period Ended June 30,
13,704
9,276
24,492
17,867
11,091
7,079
19,334
13,190
14
The following table contains the condensed balance sheets of LSV:
Current assets
23,375
18,193
Non-current assets
405
280
Total assets
23,780
18,473
Current liabilities
2,285
2,383
Partners’ capital
21,495
16,090
Total liabilities and partners’ capital
Accrued compensation
19,086
33,612
Accrued brokerage services
9,161
9,103
Accrued income taxes
8,534
9,281
Accrued proprietary fund services
6,000
8,403
Other accrued expenses
54,823
59,028
Total accrued expenses
On June 26, 2001, the Company entered into a term loan agreement (the “Loan Agreement”) with a separate lending institution. The Loan Agreement provides for borrowing up to $25,000 in the form of a term loan, and expires on March 31, 2006 and is payable in seventeen equal quarterly installments. On August 2, 2001, the Company borrowed the entire $25,000. The Loan Agreement accrues interest at the Prime Rate or one and thirty-five hundredths of one percent above LIBOR. The Loan Agreement contains various covenants, including limitations on indebtedness and restrictions on certain investments. None of these covenants negatively affect the Company’s liquidity or capital resources. The Company was in compliance with all covenants during the first six months of 2003. The Company made its scheduled principal payments of $1,389 in March and June of 2003. The current portion of the notes amounted to $5,556 at June 30, 2003. The interest rate being applied at June 30, 2003 was 2.45%.
15
At June 30, 2003, the Company had a payable to LSV in relation to the Purchase Agreement (See Note 6) in the amount of $7,250 which bears interest at the rate of 4 percent per annum and is to be repaid in six quarterly installments beginning July 1, 2003. The current portion of the debt amounted to $4,809 at June 30, 2003.
The Company immediately retires its common stock when purchased. Upon retirement, the Company reduces Capital in excess of par value for the average capital per share outstanding and the remainder is charged against Retained earnings. If the Company reduces its Retained earnings to zero, any subsequent purchases of common stock will be charged entirely to Capital in excess of par value.
The Company’s management evaluates financial performance of its operating segments based on Income from operations. The Company’s operations are organized into separate business units that offer products and services tailored for particular market segments. The Company’s reportable segments are Private Banking and Trust, Investment Advisors, Enterprises, Money Managers, and Investments in New Businesses. The accounting policies of the reportable segments are the same as those described in Note 1. The information in the following tables is derived from the Company’s internal financial reporting used for corporate management purposes.
16
The following tables highlight certain unaudited financial information about each of the Company’s segments for the three months ended June 30, 2003 and 2002.
Private Banking and Trust
Investment Advisors
Enterprises
Money Managers
Investments In New Businesses
General and Administrative
Total
For the Three-Month Period Ended June 30, 2003
77,619
37,079
14,367
13,106
11,383
Operating income (loss)
33,436
20,182
6,317
2,309
(5,150
(4,835
Other income, net
2,140
2,496
805
205
305
301
135
4,247
Capital expenditures
3,900
1,362
619
427
974
390
7,672
For the Three-Month Period Ended June 30, 2002
82,878
39,229
14,295
10,804
11,645
33,652
20,457
5,792
2,151
(3,333
(5,972
4,013
2,854
757
267
251
133
4,567
4,655
1,494
715
441
791
299
8,395
17
The following tables highlight certain unaudited financial information about each of the Company’s segments for the six months ended June 30, 2003 and 2002.
For the Six-Month Period Ended June 30, 2003
154,514
72,992
28,391
25,438
22,824
67,037
39,785
12,753
4,279
(9,596
(10,486
6,322
5,086
1,629
415
617
614
266
6,628
2,185
993
711
627
12,773
For the Six-Month Period Ended June 30, 2002
165,836
78,120
29,027
21,601
23,482
67,477
38,440
11,180
4,575
(6,622
(11,681
7,361
5,601
1,495
528
494
268
9,710
3,296
1,577
1,034
1,433
946
17,996
18
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(In thousands, except asset balances and per share data)
This discussion reviews and analyzes the consolidated financial condition at June 30, 2003 and 2002, the consolidated results of operations for the three and six months ended June 30, 2003 and 2002 and other key factors that may affect future performance. This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements.
Results of Operations
Three and Six Months Ended June 30, 2003 compared to Three and Six Months Ended June 30, 2002
Consolidated Overview
Our operations are organized into business units that offer various products and services tailored for particular market segments. Our reportable segments are Private Banking and Trust, Investment Advisors, Enterprises, Money Managers, and Investments in New Businesses. The accounting policies of our business segments are the same as those used in preparation of the consolidated financial statements. Management evaluates financial performance of its operating segments based on Income from operations.
Three Months ended June 30,
Six Months ended June 30,
Percent Change
Private Banking and Trust:
(6
%)
(7
(1
Investment Advisors:
(5
%
Enterprises:
1
(2
Money Managers:
21
Investments in New Businesses:
(3
Loss from operations
(55
(45
General and Administrative:
19
Consolidated Segment Totals:
(4
(47
(14
Diluted earnings per share
Consolidated revenues decreased $5.3 million, or 3 percent, to $153.6 million for the three months ended June 30, 2003 compared with the three months ended June 30, 2002. For the six months ended June 30, 2003, consolidated revenues decreased $13.9 million, or 4 percent, to $304.2 million as compared to the prior year comparable period. The decrease in our revenues for both comparable periods was primarily due to lower asset-based fees. Asset-based fees are earned as a percentage of the average value of assets we manage and administer. The primary reason for the decrease in our asset-based fees was due to the significant decrease in our average client proprietary assets under administration. This decrease resulted from client losses in our fund processing business. Improved capital market conditions and new business activity has contributed to the growth in our average asset balances under management. However, our percentage earned from average assets under management decreased in both comparable periods. This was primarily due to a shift in some assets from higher-fee products into lower-fee products. Also, our revenues were adversely affected by a reduction in transaction-based fees from our brokerage services.
Operating margins improved in both comparable periods to 34 percent for the three and six months ended June 30, 2003, as compared to 33 percent for the three and six months ended June 30, 2002. Operating margin improvement was accomplished through our cost containment efforts, improved productivity in our operations and lower direct expenses associated with reduced revenues in our fund processing and brokerage services businesses. Our cost containment efforts were primarily focused at discretionary spending, mainly marketing, consulting and compensation. Our investment spending increased during the second quarter 2003 for the development of new products and services but a large portion of this increased spending was capitalized and margins were unaffected. Our investments in new products and services are aimed at building outsourced business solutions that can be leveraged across most of our businesses.
Other income primarily includes the earnings from unconsolidated affiliate, interest income, interest expense and realized gains and losses from available-for-sale securities. The decrease in other income was primarily due to hedge ineffectiveness, realized losses from the sale of available-for-sale securities and the write-down in the value of investments considered other than temporary. However, these losses were partially mitigated by the significant increase in earnings from our unconsolidated affiliate as a result of a substantial increase in average assets under management by our unconsolidated affiliate. All revenues and expenses of our unconsolidated affiliate are reflected as one net amount in other income and as such are excluded from our revenues and expenses.
Diluted earnings per share increased 3 percent during the three months ended June 30, 2003 compared with the three months ended June 30, 2002 and increased 5 percent during the six months ended June 30, 2003, as compared to the prior year comparable period despite the decrease in net income. This increase was due to a decrease in the number of shares used to calculate diluted earnings per share as a result of our stock repurchase program.
Although we remain optimistic about our long-term prospects, the outlook for the capital markets remains uncertain. This could lead to the continued devaluation in the assets we manage and/or administer, continued redemption rates, and prolonged buying decisions among our clients.
Asset Balances(In millions)
As of June 30,
Assets invested in equity and fixed income programs
54,782
49,263
Assets of unconsolidated affiliate invested in equity and fixed income programs
10,755
7,099
52
Assets invested in liquidity funds
20,156
20,420
Assets under management
85,693
76,782
Client proprietary assets under administration
149,484
172,763
(13
Assets under management and administration
235,177
249,545
The asset figures shown above represent assets of our clients or their customers for which we provide management and/or administrative services and are excluded from the accompanying balance sheets, since we do not own these assets. Assets of unconsolidated affiliate represent assets of their clients or their customers for which they provide management services. Assets under management consist of our clients or their customers
20
assets invested in our equity and fixed income investment programs and liquidity funds for which we provide management services. Assets under management and administration consist of our clients or their customers assets for which we provide management and administrative services, including client proprietary fund balances for which we provide administration and/or distribution services.
Private Banking and Trust provides investment processing solutions, fund processing solutions, and investment management programs to banks and private trust companies. Investment processing solutions primarily include outsourcing services as an application service provider, or ASP, through our TRUST 3000 product line and as a business service provider, or BSP, through our trust company. TRUST 3000 includes integrated systems that provide a complete investment accounting and management information system for private banks and trust institutions. Revenues are primarily earned from monthly processing and software servicing fees and non-recurring project fees.
Fund processing solutions include administration and distribution services provided to bank proprietary mutual funds. These services primarily include fund administration and accounting, regulatory and compliance services, shareholder recordkeeping, and marketing. Revenues are earned primarily as a percentage of the average asset values of the proprietary funds.
Investment management fees are earned primarily as a percentage of the average asset value of assets under management.
Three Months Ended
Six Months Ended
June 30, 2002
Revenues:
Investment processing fees
56,554
57,930
111,067
114,329
Fund processing fees
11,236
14,743
(24
23,571
30,336
(22
Investment management fees
9,829
10,205
19,876
21,171
Total revenues
35,251
38,839
(9
70,392
77,263
8,932
10,387
17,085
21,096
(19
Operating margin
43
41
Percent of Revenue:
45
47
46
Investment processing fees decreased $1.4 million, or 2 percent, during the three months ended June 30, 2003, as compared to the corresponding prior year period. For the six months ended June 30, 2003, investment processing fees decreased $3.3 million, or 3 percent, as compared to the prior year comparable period. This decrease was primarily due to a decrease in transaction-based fees from our brokerage services. Our recurring revenue base and our non-recurring project fees remained relatively flat in both comparable periods.
Fund processing fees decreased $3.5 million, or 24 percent, during the three months ended June 30, 2003, as compared to the corresponding prior year period. For the six months ended June 30, 2003, fund processing fees decreased $6.8 million, or 22 percent. The decline in our fund processing fees was mainly due to client losses.
Operating margins improved in both comparable periods despite total revenues decreasing in both comparable periods, about $5.3 million during the three months ended June 30, 2003 and about $11.3 million during the six months ended June 30, 2003. Along with the decrease in revenues, there was a corresponding decrease in direct expenses associated with the decline in transaction-based fees and fund processing fees. In addition, our cost containment efforts reduced certain other expenses, mainly compensation and consulting. These factors contributed to maintaining profit levels and improving operating margin.
Investment Advisors provides investment management programs and investment processing solutions to affluent investors distributed through a network of independent registered investment advisors, financial planners and other investment professionals. Revenues are primarily earned as a percentage of the average asset values under management.
Total Revenues
10,355
9,635
20,383
19,910
6,542
9,137
(28
12,824
19,770
(35
54
55
49
28
25
27
26
23
Revenues decreased $2.2 million, or 5 percent, for the three months ended June 30, 2003 compared with the three months ended June 30, 2002. For the six months ended June 30, 2003, revenues decreased $5.1 million, or 7 percent, as compared with the corresponding prior year period. The decline in our revenues in both comparable periods was primarily due to lower average asset balances relative to prior year average asset balances for the same time periods. Even though the capital markets have improved in the second quarter 2003, this has not yet resulted in a positive net inflow of assets into our mutual funds because of increased redemptions. The increase in redemptions was partially due to our decision to eliminate a variable-annuity product as well as the normal tendency for investors to redeem shares during the second quarter to pay taxes.
Operating profits and operating margin improvement was primarily due to the management of discretionary expenses, mainly marketing and compensation.
22
Enterprises provides business solutions to pension plan sponsors, hospitals, foundations, unions, endowment funds and other institutional investors. We also provide treasury business solutions to corporations. Revenues are earned primarily as a percentage of the average asset values under management.
3,503
4,252
(18
7,065
8,870
(20
4,547
4,251
8,573
8,977
44
39
24
30
32
29
31
Revenues during the three months ended June 30, 2003, as compared to the prior year quarter, remained relatively flat but were down about 2 percent for the six months ended June 30, 2003 relative to the same period a year ago. Average asset balances for the second quarter and year-to-date increased slightly over prior year comparable balances. New business activity and improved capital markets helped boost average assets levels. Even though average asset balances have increased, revenues were affected by a slight change in the mix between treasury and retirement revenues.
Income from operations and operating margin in both comparable periods increased due to management of discretionary spending, primarily for technology, marketing and personnel expenses.
Money Managers provides investment solutions to U.S investment managers, U.S. based mutual fund companies and to investment managers worldwide of alternative asset classes (e.g., hedge funds and private equity funds). Revenues are earned primarily as a percentage of the average asset values under management and administration.
7,827
5,619
15,141
11,086
37
2,970
3,034
6,018
5,940
59
51
Revenues increased $2.3 million, or 21 percent, for the three months ended June 30, 2003 compared with the three months ended June 30, 2002. For the six months ended June 30, 2003, revenues increased $3.8 million, or 18 percent, as compared to the prior year comparable period. Our average asset balances increased in both comparable periods contributing to the increase in revenues. The increase in average asset balances and revenues was mainly due to new business activity. Also, second quarter 2003 average asset balances were impacted by improved capital markets.
Income from operations and profit margin in both comparable periods were negatively affected by increased levels of spending associated with building the necessary infrastructure to provide a complete business solution for this market. A substantial portion of this spending was for increased personnel and other operating costs.
Investments in New Businesses
Investments in New Businesses provides investment management, fund processing, and investment processing solutions to non-U.S. banks, investment advisors, enterprises and money managers located outside the United States. This segment also includes other initiatives in new U.S. markets. Revenues are earned primarily as a percentage of the average asset values under management.
11,268
9,842
21,775
19,794
5,265
5,136
10,645
10,310
(29
(42
99
85
95
84
Revenues decreased in both comparable periods because of some non-recurring revenue events recognized in prior year periods. We continue to experience positive market acceptance of our investment solution offerings in Canada and Europe. New business activity in these regions has increased during the past year.
Operating losses in each period include significant investments in technology, our Dublin-based operations, and other operating costs to further enhance our product offerings. We also continue to invest in expanding our distribution channels in our target markets and other U.S. based initiatives. We expect continued investment in these regions to build our distribution network and enhance our product offerings throughout the remainder of 2003 and into 2004 and should continue to incur losses.
General & Administrative
General and administrative expense primarily consists of corporate overhead costs and other costs not directly attributable to a reportable business segment.
(10
Percent of Consolidated Revenue
Other Income
Other income on the accompanying Consolidated Statements of Income consist of the following:
Three Months ended
Six Months ended
57
Net gain (loss) on investments
(100
100
Total other income, net
Equity in the earnings of unconsolidated affiliate on the accompanying Consolidated Statements of Income includes our less than 50 percent ownership in the general partnership of LSV Asset Management (“LSV”) (See Note 6 to the Consolidated Financial Statements). The increase in LSV’s net earnings is due to an increase in assets under management.
Net loss from investments for the six months ended June 30, 2003 includes a loss of $1.9 million from hedge ineffectiveness, a charge for $.6 million for other-than-temporary declines in market value, $1.2 million for the write-down of an equity investment in a private technology firm and $0.5 million in realized losses from sales of marketable securities.
Interest income is earned based upon the amount of cash that is invested daily and fluctuations in interest income recognized for one period in relation to another is due to changes in the average cash balance invested for the period and/or changes in interest rates.
Interest expense is directly attributable to our long-term debt and other borrowings. Interest expense for the three and six months ended June 30, 2003 increased over both comparable periods due to the capitalization of interest costs in 2002 associated with the term loan agreement that was attributable to borrowings used in the expansion of our corporate headquarters.
Income Taxes
Our effective tax rate was 37.0 percent for the periods ending June 30, 2003 and 2002.
Liquidity and Capital Resources
Six Months
Ended June 30,
(67,646
Net increase (decrease) in cash and cash equivalents
Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing. At June 30, 2003, our unused sources of liquidity consisted of unrestricted cash and cash equivalents of $156.3 million. We are currently in the process of generating a credit facility through a syndicate of lenders to provide for borrowings of up to $200.0 million. We expect the credit facility will be available by September 30, 2003. The credit facility will be used for general corporate purposes, including the repurchase of our common stock.
Net cash provided by operating activities decreased during 2003 relative to 2002. The decrease in cash flow from operations was primarily due to a reduction in the tax benefit received from stock options exercised and various accrued expenses.
Net cash used in investing activities primarily includes capital expenditures and purchases and sales of available-for-sale securities. Net cash used in investing activities decreased about $9.5 million during the first six months in 2003 as compared to the prior year period. This decrease was due to lower capital expenditures for property, plant and equipment and fewer purchases of available-for-sale securities during 2003 relative to 2002. Capital expenditures for property, plant and equipment, including capitalized software development costs, were $12.8 million for the first six months in 2003 verses $18.0 million for the first six months in 2002. Capital expenditures in the first six months of 2003 included $7.8 million related to the expansion of our corporate headquarters. This expansion is being done to relocate our data center from a facility that we are currently leasing. We expect this project to be completed by the beginning of 2004. Purchases of available-for-sale securities in the first six months of 2003 were approximately $7.4 million, as compared to $12.1 million in the first six months of 2002, whereas sales of available-for-sale securities totaled $14.2 million in the first six months of 2003, as compared to $13.6 million in the first six months of 2002.
Net cash used in financing activities primarily includes principal payments on our debt, the repurchase of our common stock and dividend payments. Net cash used in financing activities increased approximately $15.3 million during the first six months in 2003 relative to the same period in 2002. This increase was primarily due to an increase in stock repurchases. Our board of directors had authorized the repurchase of our common stock up to $703.4 million. During the first six months of 2003, the Company purchased 2.3 million shares at a cost of $57.3 million, as compared to purchases of 1.4 million shares at a cost of $44.1 million during the first six months of 2002. As of July 31, 2003, we still had $39.8 million of authorization remaining for the purchase of our common stock under this program.
We made principal payments of $4.0 million for the Senior Notes and $2.8 million for the term loan during the first six months of 2003. We made principal payments of $2.0 million for the Senior Notes and $2.8 million for the term loan during the first six months of 2002 (See Note 9 to the Consolidated Financial Statements).
Cash dividends paid were $13.7 million or $.13 per share in the first six months of 2003 and $12.1 million or $.11 per share in the first six months of 2002. Our Board of Directors has indicated its intention to continue making cash dividend payments.
Forward-Looking Information
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information contained in this discussion is or may be considered forward-looking. Forward-looking statements relate to future operations, strategies, financial results or other developments. Forward-looking statements are based upon estimates and assumptions that involve certain risks and uncertainties, many of which are beyond our control or are subject to change. Although we believe our assumptions are reasonable, they could be inaccurate. Our actual future revenues and income could differ materially from our expected results. We have no obligation to publicly update or revise any forward-looking statements.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk - Our exposure to changes in interest rates primarily relates to our investment portfolio and long-term debt obligations. Our excess cash is principally invested in short-term, highly liquid financial instruments, mainly money market funds, with initial maturities of three months or less. Our investment portfolio also includes some long-term fixed income mutual funds, principally invested in federal government agency securities. We place our investments in financial instruments that meet high credit quality standards. A portion of our long-term debt is based upon a variable rate which renews every three months. While changes in interest rates could decrease interest income or increase interest expense, we do not believe that we have a material exposure to changes in interest rates. We do not undertake any specific actions to cover our exposure to interest rate risk and are not a party to any interest rate risk management transactions.
Concentration of Credit Risk – Financial instruments which potentially expose us to concentrations of credit risk consist primarily of cash equivalents, marketable securities and trade receivables. Cash equivalents are principally invested in short-term money market funds or placed with major banks and high credit qualified financial institutions. Concentrations of credit risk with respect to our receivables are limited due to the large number of clients and their dispersion across geographic areas. No single group or customer represents greater than 10 percent of total accounts receivable.
Foreign Currency Risk – We transact business in the local currencies of various foreign countries, principally Canada, Europe and Asia. The total of all of our foreign operations only accounts for approximately 7 percent of total consolidated revenues. Also, most of our foreign operations match local currency revenues with local currency costs. Due to these reasons, we do not hedge against foreign operations nor do we expect any material loss with respect to foreign currency risk.
Price Risk - We are exposed to price risk associated with changes in the fair value of our investment portfolio. To provide some protection against potential fair value changes for some of these investments, we have entered into various derivative financial instruments. We currently hold derivative financial instruments with a notional amount of $9.8 million with various terms, generally less than one year. The effectiveness of these hedging relationships is evaluated on a retrospective and prospective basis using quantitative measures of correlation. If a hedge is ineffective, any excess gains or losses attributable to such ineffectiveness are recognized in current period earnings. During the first six months of 2003, we did not enter into or hold any derivative financial instruments for trading purposes.
During the first six months of 2003, we recorded a $0.6 million impairment charge related to other-than-temporary declines in the fair value of certain securities held within our investment portfolio. Also, the amount of hedge ineffectiveness that was charged to current period earnings was a loss of $1.9 million. The aggregate effect of a hypothetical 10 percent change in the fair value of these derivative financial instruments would not be material to our results of operations, financial position, or liquidity.
A significant portion of our revenues are based upon the market value of assets we manage or administer. A decline in the market value of these assets as a result of changes in market conditions, the general economy or other factors will negatively impact our revenues and earnings.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On May 28, 2003, we held our annual meeting of shareholders (the “2003 Annual Meeting”) at our corporate headquarters in Oaks, Pennsylvania. At our 2003 Annual Meeting, the shareholders voted on the following matters:
1. The election of two directors for a term expiring at our 2006 Annual Meeting:
Name of Director
Number of Votes For
Number of Votes Withheld
Richard B. Lieb
79,461,040
17,251,208
Carmen V. Romeo
79,059,861
17,652,387
The terms of office of each of the following directors continued after the meeting:
Alfred P. West, Jr.William M. DoranHenry H. Porter, Jr.Kathryn M. McCarthySarah W. Blumenstein
2. Approval of a 10,000,000 share increase in the number of shares of Common Stock authorized for issuance under the SEI Investments Company 1998 Equity Compensation Plan, and of the amendment and restatement thereof:
Number of Votes Against
55,680,515
28,246,318
621,973
3. Ratification of the appointment of PricewaterhouseCoopers LLP as independent public accountants to examine SEI’s consolidated financial statements for 2003:
94,322,715
2,268,549
120,954
Item 6. Exhibits and Reports on Form 8-K
31.1 Certification of Alfred P. West, Jr, Chairman and Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Page 32)
31.2 Certification of Dennis J. McGonigle, Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Page 33)
32.1 Certification of Alfred P. West, Jr., Chairman and Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Page 34)
32.2 Certification of Dennis J. McGongile, Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Page 35)
On April 21, 2003, we furnished a report on Form 8-K for our First Quarter 2003 earnings announcement.
On June 13, 2003, our Capital Accumulation Plan filed a report on Form 8-K reporting under Item 4 a change in Registrant’s certifying accountant.
On July 3, 2003, our Capital Accumulation Plan filed an amended report on Form 8-K reporting under Item 4 a change in Registrant’s certifying accountant.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date August 14, 2003
By:
/s/ DENNIS J. MCGONIGLE
Dennis J. McGonigle Chief Financial Officer