UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)*
for the quarterly period ended June 30, 2006 or
for the transition period from to
0-10200
(Commission File Number)
SEI INVESTMENTS COMPANY
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification Number)
1 Freedom Valley Drive, Oaks, Pennsylvania 19456-1100
(Address of principal executive offices)
(Zip Code)
(610) 676-1000
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨ No ¨
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 31, 2006: 98,496,545 shares of common stock, par value $.01 per share.
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements.
SEI Investments Company
Consolidated Balance Sheets
(unaudited)
(In thousands)
Assets
Current Assets:
Cash and cash equivalents
Restricted cash
Receivables from regulated investment companies
Receivables, net of allowance for doubtful accounts of $2,691 and $1,520 (Note 4)
Other receivable
Securities owned
Deferred income taxes
Prepaid expenses and other current assets
Total Current Assets
Property and Equipment, net of accumulated depreciation and amortization of $111,634 and $109,208 (Note 4)
Capitalized Software, net of accumulated amortization of $23,439 and $21,667
Investments Available for Sale
Investments Held to Maturity
Investment in Unconsolidated Affiliate
Goodwill
Other Intangible Asset, net of accumulated amortization of $764
Other Assets
Total Assets
The accompanying notes are an integral part of these consolidated financial statements.
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(In thousands, except par value)
Liabilities and Shareholders’ Equity
Current Liabilities:
Current portion of long-term debt
Accounts payable
Payable to regulated investment companies
Accrued liabilities (Note 4)
Deferred gain
Deferred revenue
Total Current Liabilities
Long-term Debt
Deferred Income Taxes
Minority Interest
Commitments and Contingencies (Note 10)
Shareholders’ Equity:
Common stock, $.01 par value, 750,000 shares authorized; 98,330 and 98,580 shares issued and outstanding
Capital in excess of par value
Retained earnings
Accumulated other comprehensive income, net
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
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Consolidated Statements of Operations
(In thousands, except per share data)
Three Months
Ended June 30,
Revenues
Expenses:
Operating and development
Sales and marketing
General and administrative
Income from operations
Equity in the earnings of unconsolidated affiliate
Net gain (loss) from investments
Interest income
Interest expense
Minority interest
Income before income taxes
Income taxes
Net income
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments
Unrealized holding (loss) gain on investments:
Unrealized holding (losses) gains during the period net of income tax benefit (expense) of $260 and $(83)
Less: reclassification adjustment for (gains) losses realized in net income, net of income tax expense (benefit) of $663 and $(35)
Other comprehensive income (loss)
Comprehensive income
Basic earnings per common share
Diluted earnings per common share
Dividends declared per common share
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Six Months
Net gain from investments
Other income
Unrealized holding loss on investments:
Unrealized holding losses during the period net of income tax benefit of $488 and $1
Less: reclassification adjustment for gains realized in net income, net of income tax expense of $574 and $123
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Consolidated Statements of Cash Flows
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Additions to property and equipment
Additions to capitalized software
Purchase of marketable securities
Sale of marketable securities
Cash received from consolidation of LSV
Other
Net cash used in investing activities
Cash flows from financing activities:
Payment on long-term debt
Purchase and retirement of common stock
Proceeds from issuance of common stock
Tax benefit on stock options
Payment of dividends
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
Non-cash investing activity:
Unsettled transactions of marketable securities
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Notes to Consolidated Financial Statements
(all figures are in thousands except per share data)
Nature of Operations
Basis of Presentation
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Principles of Consolidation
Management’s Use of Estimates
Revenue Recognition
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Cash and Cash Equivalents
Restricted Cash
Allowances for Doubtful Accounts
Concentration of Credit Risk
Property and Equipment
Marketable Securities
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Derivative Instruments and Hedging Activities
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Capitalized Software
Goodwill and Other Intangible Asset
Income Taxes
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Foreign Currency Translation
Fair Value of Financial Instruments
Stock-Based Compensation
Earnings per Share
Income
(Numerator)
Shares
(Denominator)
Per Share
Amount
Dilutive effect of stock options
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Comprehensive Income
Foreign
Currency
Translation
Adjustments
Unrealized
Holding
Gains (Losses)
on Investments
Accumulated
Comprehensive
Gains
Beginning balance (Dec. 31, 2005)
Current period change
Ending balance (June 30, 2006)
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Statements of Cash Flows
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Distribution from unconsolidated affiliate
Undistributed equity in the earnings of unconsolidated affiliate
Undistributed earnings of minority interests
Tax benefit on stock options exercised
Stock-based compensation
Gain on partial sale of unconsolidated affiliate
Provision for losses on receivables
Deferred income tax expense
Net realized gains on investments
Write-off of capitalized software
Change in current asset and liabilities
Decrease (increase) in
Receivables
Increase (decrease) in
Accrued expenses
Total adjustments
Interest paid
Interest and dividends received
Income taxes paid
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New Accounting Pronouncements
Reclassifications
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For the Three Month
Period Ended
June 30, 2005
For the Six Month
Accounts receivable
Other current assets
Non-current assets
Total assets
Current liabilities
Partners’ capital
Total liabilities and partners’ capital
Basic earnings per share
Diluted earnings per share
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Intangible asset, at cost
Accumulated amortization
Net book value
Trade receivables
Fees earned, not billed
Other receivables
Less: Allowance for doubtful accounts
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Equipment
Buildings
Land
Purchased software
Furniture and fixtures
Leasehold improvements
Construction in progress
Less: Accumulated depreciation and amortization
Property and Equipment, net
Accrued Liabilities
Accrued income taxes
Accrued compensation
Accrued consulting
Accrued sub-advisor and investment officer fees
Accrued distribution fees
Other accrued liabilities
Total accrued liabilities
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Cost
Gross
Losses
Fair
Value
Company-sponsored mutual funds
Non-company-sponsored mutual funds
Other financial instruments
Equity securities
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Held-to-Maturity Securities
Securities Owned
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Expected term (in years)
Expected volatility
Expected dividend yield
Risk-free interest rate
Period
Remainder of 2006
2007
2008
2009
2010
2011
2012
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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
Pro forma
Number of
Weighted
Avg. Price
Balance as of December 31, 2005
Granted
Exercised
Expired or cancelled
Balance as of June 30, 2006
Exercisable as of June 30, 2006
Available for future grant as of June 30, 2006
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Options Outstanding
at June 30, 2006
Options Exercisable
Range of
Exercise
Prices
(Per Share)
Number
Of
Average
Price
Remaining
Contractual
Life
(Years)
$3.25 - $15.69
$16.21 - $29.42
$29.56 - $38.25
$38.55 - $42.86
$43.09 - $50.00
Guarantees and Indemnifications
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Legal Proceedings
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Private
Banking
and Trust
Investment
Advisors
Investments
In New
Businesses
Expenses (1)
Operating profit (loss)
Profit margin
Money
Managers
Expenses
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Total operating profit from segments above
General and administrative expenses
Equity in earnings of unconsolidated affiliate
LSV Employee Group (2)
Income before taxes
Private Banking and Trust
Investment Advisors
Enterprises
Money Managers
Investments in New Businesses
LSV
General and Administrative
Expenses (3)
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LSV Employee Group (4)
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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, 2006 and 2005, the consolidated results of operations for the three and six months ended June 30, 2006 and 2005 and other key factors that may affect future performance. This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements.
Overview
Our Business and Business Segments
We are a leading global provider of investment processing, fund investment processing, and investment management business outsourcing solutions that help corporations, financial institutions, financial advisors, and affluent families create and manage wealth. Investment processing fees are earned as monthly fees for contracted services including computer processing services, software licenses, and trust operations services, as well as transaction-based fees for providing securities valuation and trade-execution. Fund investment processing and investment management fees are earned as a percentage of average assets under management or administration. As of June 30, 2006, through our subsidiaries in which we have a significant interest, we administer $334.3 billion in mutual fund and pooled assets, manage $161.7 billion in assets, and operate from more than 20 offices in over a dozen countries.
In January 2006, we entered into a Guaranty and Collateral Agreement to provide an unsecured loan guaranty to LSV Employee Group to assist in their purchase of partnership units from two existing partners of LSV. Under current accounting rules, LSV Employee Group meets the definition of a variable interest entity and we are considered the primary beneficiary. We have also determined that we have a controlling financial interest in LSV due to our direct 43 percent ownership in LSV and our guaranty of LSV Employee Group’s debt. As a result, we are required to consolidate the accounts of both LSV and LSV Employee Group as consolidated subsidiaries with the amount of ownership of the other existing partners reflected as minority interest. In prior periods, our proportionate share in the earnings of LSV earnings was reported in Equity in earnings of unconsolidated affiliate which was a component of other income. The presentation of LSV in our financial statements has changed due to this transaction but our proportionate share in the earnings of LSV was unaffected and remains at approximately 43 percent. LSV is now reported as its own business segment in 2006. We are not required to reclassify prior period results to conform to current year presentation (See Notes 1 and 2 to the Consolidated Financial Statements).
We reorganized our business segments in 2006 to better align new and existing solutions and corresponding processes. The Company has also begun a process to consolidate certain business activities into new, globally-managed segments when deemed appropriate. The following changes were made to the business segments: the global institutional business within the Investments in New Businesses segment is included in the Enterprises segment, the franchise offering within the Investment Advisors segment is included in the Investments in New Businesses segment, and the registered mutual fund processing business within the Private Banking and Trust segment is now included in the Money Managers segment. For comparability, the prior period’s results have been reclassified to reflect the realignment of the business segments.
The Company’s reportable business segments are:
Private Banking and Trust - provides investment processing, fund investment processing, and investment management programs to banks and other trust institutions located in the United States and Canada;
Investment Advisors - provides investment management programs to affluent investors through a network of independent registered investment advisors, financial planners and other investment professionals in the United States;
Enterprises - provides investment management programs that offer retirement and treasury solutions to corporations, unions, municipalities, and hospitals and an endowment and foundation solution for the not-for-profit market globally;
Money Managers - provides fund investment processing and institutional and separate account operations outsourcing solutions to banks, investment managers and mutual fund companies located in the United States and to investment managers worldwide of alternative asset classes such as hedge funds, fund of funds, and private equity funds;
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Investments in New Businesses - provides investment management programs to investment advisors and banks located outside the United States and investment processing solutions to banks and trust institutions in the United Kingdom and Continental Europe. This segment also includes our investment management programs offered to affluent families residing in the United States both directly and through a network of independent advisors; and
LSV Asset Management – is a registered investment advisor that provides investment advisory services to institutions, including pension plans and investment companies.
Change in Critical Accounting Policy
We adopted the provisions of SFAS 123(R) during the first quarter of 2006 to account for stock-based compensation. We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. We currently use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as various other assumptions. These assumptions include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We currently base our expectations for these assumptions from historical data. These expectations are subject to change in future periods.
Our stock options do not vest ratably over a number of years but rather vest upon the attainment of certain diluted earnings per share targets established at the date of grant. The achievement of these predetermined diluted earnings per share targets may also affect the amount of options that could vest. The amount of stock-based compensation expense is based upon our estimates of when we believe the diluted earnings per share targets may be achieved. This has the effect of recognizing more stock-based compensation expense in earlier periods. If the diluted earnings per share targets are not achieved, our stock options are scheduled to vest in their entirety after seven years from the grant date. In the first six months of 2006, we recognized approximately $8.1 million in stock-based compensation expense. Based upon our current view of how many options will vest and when they will vest, we estimate that stock-based compensation expense will be recognized according to the following schedule:
Stock-Based
Compensation
Expense
The amount of stock-based compensation expense that is recognized in a given period is dependent upon management’s estimate of when the diluted earnings per share targets are expected to be achieved. If our estimate of the attainment of the diluted earnings per share targets proves to be inaccurate, the remaining amount of stock-based compensation expense could be accelerated or spread out over a longer period. This may cause volatility in the recognition of stock-based compensation expense in future periods and could materially affect our net income and net income per share.
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Financial Results
Revenues, Expenses and Income from Operations by business segment for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005 were as follows:
Percent
Change
Revenues:
Total revenues
Total expenses
Income from business segments:
Total income from business segments
Minority interest reflected in segments
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Asset Balances
This table presents assets of our clients, or of our clients’ customers, for which we provide management or administrative services. These assets are not included in our balance sheets because we do not own them.
Assets invested in equity and fixed-income programs
Assets invested in collective trust fund programs
Assets invested in liquidity funds
Assets under management
Client proprietary assets under administration
Assets under management and administration
Assets under management are total assets of our clients or their customers invested in our equity and fixed-income investment programs, collective trust fund programs, and liquidity funds for which we provide asset management services. Assets under management and administration are total assets of our clients or their customers for which we provide administrative services, including client proprietary fund balances for which we provide administration and/or distribution services.
Consolidated Summary
Consolidated revenues increased $94.9 million, or 50 percent, to $285.0 million for the three months ended June 30, 2006 compared to the three months ended June 30, 2005. For the six month period ended, revenues increased $186.4 million, or 50 percent, to $562.2 million compared to the prior year period. Net income increased $13.7 million, or 31 percent, to $57.9 million for the three month period and $24.9 million, or 28 percent, to $112.8 million for the six month period. Diluted earnings per share for the three month period were $.57 per share as compared to $.43 per share a year ago, an increase of 33 percent. In the six month period, diluted earnings per share increased to $1.11 per share as compared to $.84 per share a year ago, an increase of 32 percent. Revenues increased significantly primarily as a result of consolidating the accounts of LSV into our financial statements beginning in 2006 as a result of the Guaranty and Collateral Agreement previously described. This had the effect of increasing revenues and expenses in 2006 for the results of LSV. Prior to 2006, our proportionate share in the net earnings of LSV was shown in a single line, Equity in the earnings of unconsolidated affiliate, which was classified as other income. In our opinion, the following items had a significant impact on our financial results for the three and six month periods:
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Business Segments
Revenues increased $2.7 million, or four percent, in the three month period and $3.4 million, or two percent, in the six month period ended June 30, 2006 compared to the prior year corresponding period and were primarily affected by:
Operating margins decreased to 35 percent, compared to 37 percent in both the three and six month periods. Operating income decreased by $800 thousand, or three percent, in the three month period and $2.6 million, or five percent, in the six month period and was primarily affected by:
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Revenues increased $6.4 million, or 13 percent, in the three month period and $13.3 million, or 14 percent, in the six month period ended June 30, 2006 and were primarily affected by:
Operating margins decreased to 48 percent, as compared to 56 percent in the three month period and to 50 percent, as compared to 56 percent in the six month period. Operating income decreased by $1.1 million, or four percent, in the three month period and increased by $900 thousand, or two percent, in the six month period and was primarily affected by:
Revenues increased $6.8 million, or 21 percent, in the three month period and $15.6 million, or 25 percent, in the six month period ended June 30, 2006 and were primarily affected by:
Operating margins declined to 32 percent, as compared to 33 percent in the three month period and increased to 34 percent, as compared to 32 percent in the six month period. Operating income increased $2.0 million, or 19 percent, in the three month period and $6.6 million, or 33 percent, in the six month period and was primarily affected by:
Revenues increased $3.8 million, or 15 percent, in the three month period and $6.8 million, or 14 percent, in the six month period ended June 30, 2006 and were primarily affected by:
Operating margins increased to 22 percent, as compared to 16 percent in the three month period and to 20 percent, as compared to 18 percent in the six month period. Operating income increased $2.5 million, or 61 percent, in the three month period, and $2.5 million, or 29 percent in the six month period, and was primarily affected by:
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Revenues increased $5.7 million, or 34 percent, in the three month period and $11.6 million, or 37 percent, in the six month period ended June 30, 2006 and were primarily affected by:
Losses from operations decreased by $1.6 million, or 22 percent, in the three month period and $5.2 million, or 35 percent in the six month period and were primarily affected by:
Total revenues were $69.7 million, compared to $46.3 million in the three month period, an increase of 51 percent. In the six month period, revenues were $135.7 million, compared to $86.5 million, an increase of 57 percent. The increase in revenues was primarily due to increased assets under management from new sales and capital market appreciation in 2005 and the first quarter of 2006. Our earnings from LSV were $26.8 million, compared to $17.6 million in the three month period, an increase of 52 percent. In the six month period, our earnings were $51.9 million, compared to $32.9 million, an increase of 59 percent.
General and administrative expenses primarily consist of corporate overhead costs and other costs not directly attributable to a reportable business segment and were $8.9 million and $18.8 million for the three and six months ended June 30, 2006, respectively, compared to $9.4 million and $17.1 million for the same periods a year ago. The increase in these expenses in the six month period was primarily due to the recognition of stock-based compensation expense, general overhead costs and resources and associated expenses for our corporate compliance program and adherence to regulations of the Sarbanes-Oxley Act of 2002.
Other Income
Other income on the accompanying Consolidated Statements of Operations consists of the following:
Total other (expense) income, net
Beginning in 2006, we consolidated the accounts of LSV and LSV Employee Group into our financial statements as a result of the unsecured loan guaranty. The ownership percentage of the other existing partners of LSV and LSV Employee Group is reflected in Minority interest. Prior to 2006, our proportionate share of the earnings from LSV was reflected in Equity in the earnings of unconsolidated affiliate.
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Minority interest includes the amount owned by other shareholders in which we have a significant or controlling interest. The accounts of these entities are included in our consolidated financial statements. Minority interest consists of the following:
Three Months Ended
June 30,
LSV Asset Management
LSV Employee Group
Other entities
Total minority interest
Net gain (loss) from investments consists of the following:
2006
2005
Realized gain from sales of marketable securities
Increase (decrease) in fair value of derivative financial instruments
Other realized losses
Net gain (loss) on investments
Derivative financial instruments are used to minimize the price risk associated with changes in the fair value of our seed investments in new investment management programs. These derivative financial investments did not qualify for hedge accounting under current accounting rules. As a result, changes in the fair value of these derivative financial instruments were recorded in current period earnings whereas the change in the fair value of the hedged asset will be realized upon sale in future period earnings. Management’s decision to enter into derivative financial instruments that do not qualify for hedge accounting may cause volatility in quarterly earnings (See Note 1 to the Consolidated Financial Statements).
Other realized losses in 2006 include the write-down of approximately $1.5 million of an equity investment in a private company carried at cost.
Interest income is earned based upon the amount of cash that is invested daily. Fluctuations in interest income recognized for one period in relation to another is due to changes in the average cash balance invested for the period and/or changes in interest rates. The increase in interest income in the six month period of 2006 was primarily due to an increase in interest rates and investments of cash into higher-yielding investment vehicles. Interest income for the six month period of 2006 includes approximately $647 thousand of interest earned by LSV from their average outstanding cash balance.
Interest expense is directly attributable to our long-term debt and other borrowings. Interest expense for our borrowings was approximately $300 thousand for the six months ended June 30, 2006 and decreased over the comparable period mainly due to the lower principal balances of our debt outstanding. Interest expense for the six months of 2006 includes approximately $2,058 thousand in interest costs associated with the borrowings of LSV Employee Group.
Our effective tax rates were 32.1 percent and 36.3 percent for the three months ended June 30, 2006 and 2005, respectively. For the six months ended June 30, 2006 and 2005, our effective tax rates were 34.4 percent and 36.4 percent, respectively. The decrease in effective tax rates was due to scheduling of certain deferred tax assets associated with state net operating loss carryforward and the corresponding reduction of valuation allowance against these assets.
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Liquidity and Capital Resources
Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing. We currently have a Credit Facility that provides for borrowings of up to $200.0 million. The availability of the Credit Facility is subject to the compliance with certain covenants set forth in the agreement. At June 30, 2006, our unused sources of liquidity consisted of unrestricted cash and cash equivalents of $177.3 million and the full amount available through the Credit Facility of $200.0 million.
Beginning in 2006, we are now required under accounting rules to consolidate the accounts of LSV and LSV Employee Group which had a significant impact on the presentation of our cash flows. This increased our cash balance by $60.9 million at June 30, 2006. In July 2006, LSV distributed $59.5 million to its partners of which $25.4 million was our portion of the cash distributed by LSV. The remaining $1.4 million was kept by LSV for current working capital requirements. We recognized $16.9 million in cash flow from operations as a distribution in 2006 that related to our proportionate share of the earnings of LSV in the prior year. Additionally, $38.7 of Minority interest primarily relates to the other partners in LSV that has not yet been distributed and significantly boosted our cash flow from operations. These two items increased cash flow from operations $55.6 million in 2006.
In January 2006, LSV Employee Group purchased an eight percent interest from two existing partners in LSV for $92.0 million by borrowing $82.8 million in order to finance the majority of the purchase price. These items are excluded from our cash flow statement as it had no impact on cash.
Net cash provided by operating activities was also affected by the adoption of SFAS 123(R). Tax benefits recognized is now recorded as a financing activity. Prior to adoption of SFAS 123(R), this was recorded as an operating activity.
Net cash used in investing activities primarily includes the capitalization of costs incurred in developing computer software, purchases and sales of marketable securities, and capital expenditures. We continued to make substantial investments in the development of our new Global Wealth Platform. We are currently in the application development stage of the project and a substantial portion of our expenditures are for development, rather than research and design, and are eligible for capitalization under accounting rules. Capitalized software development costs were $36.8 million in 2006 as compared to $32.7 million in 2005. The increase in capitalized software development costs was primarily due to a higher level of spending. We expect this level of spending to continue through the remainder of 2006 and 2007.
In 2006, we had $3.4 million in net purchases of marketable securities versus $14.5 million in net purchases in 2005. Purchases of marketable securities in 2005 mainly comprised additional investments made into a company-sponsored mutual fund for regulatory compliance purposes. Capital expenditures in 2006 and 2005 primarily include computer systems and equipment to support our ongoing operations. During the third quarter of 2005, we began construction of an additional building and parking facility at our corporate headquarters. The expansion is estimated to cost at least $24.0 million and is expected to be completed in the second half of 2006. Payments related to the expansion may extend into 2007. Through June 30, 2006, we have spent approximately $6.7 million related to the expansion project, of which $2.7 million was spent in the first six months of 2006.
Net cash used in financing activities primarily includes principal payments of our debt, the repurchase of our common stock and dividend payments. Principal payments on our long-term debt were $9.2 million in 2006 and $6.8 million in 2005. We made our final payment on the term loan in the first quarter of 2006. We still owe $9.0 million on our Senior Notes, of which $4.0 million is due in February 2007. Our long-term debt is subject to various covenants contained in each lending agreement. Currently, these covenants do not negatively affect our liquidity.
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Our Board of Directors has authorized the repurchase of up to $1.1 billion worth of our common stock. Through July 31, 2006, we repurchased approximately 120.2 million shares of our common stock at a cost of just under $1.1 billion and had $33.6 million of authorization remaining for the purchase of our common stock under this program. We spent approximately $68.4 million during the first six months of 2006 and $87.2 million during the first six months of 2005 for the repurchase of our common stock. Currently, there is no expiration date for our common stock repurchase program.
Cash dividends paid were $22.7 million or $.23 per share in the first six months of 2006 and $21.3 million or $.21 per share in the first six months of 2005. Our Board of Directors intends to declare future dividends on a semi-annual basis.
We believe our operating cash flow, available borrowing capacity, and existing cash and cash equivalents should provide adequate funds for continuing operations; continued investment in new products and equipment; our common stock repurchase program; expansion of our corporate campus; future dividend payments; and principal and interest payments on our long-term debt.
Off Balance Sheet Arrangements
On January 24, 2006, we entered into a Guaranty and Collateral Agreement (the Guaranty Agreement) with LSV Employee Group, LLC (the Borrower), LaSalle Bank National Association as administrative agent (the Agent), and certain other lenders party thereto. We entered into the Guaranty Agreement in order to facilitate the Borrower’s acquisition of certain partnership interest of LSV.
We and other investors are partners of LSV. Some partners of LSV, excluding SEI, sold in the aggregate an eight percent interest (the Transferred Interests) in LSV to the Borrower, which is owned by several current employees of LSV. In order to finance a portion of the purchase price for such interests, the Borrower obtained financing from the Agent and other lenders in the form of a term loan pursuant to the terms of a Credit Agreement dated January 24, 2006. LSV is party to the Credit Agreement to confirm certain representations, warranties and agreements. The principal amount of the term loan is $82.8 million. Principal and interest payments are made by the Borrower in quarterly installments. The principal balance on the term loan must be paid in full by the Borrower by January 24, 2011.
According to the terms and conditions of the Guaranty Agreement, we agreed to provide an unsecured guaranty to the lenders of all obligations of the Borrower under the Credit Agreement. Our obligations under the Guaranty Agreement are triggered in the event of default which includes non-payment of the loan by the Borrower, non-payment by the Borrower or LSV of other Borrower debt or LSV debt, certain events of bankruptcy or insolvency with respect to the Borrower of LSV, and a change of control. Upon the occurrence of an event of default, in addition to the rights of the lenders to seek repayment from the Borrower and exercise all rights as secured creditors against the Borrower, the lenders have the right to seek payment from us of the Borrower’s obligations under the Credit Agreement. As recourse for such payment, we will be subrogated to the rights of the lenders under the Credit Agreement and the Guaranty Agreement, including the security interest in the pledged Transferred Interests.
As a result of the guaranty provided to LSV Employee Group, we must reflect the total remaining amount of debt outstanding under the terms of the Credit Agreement until the balance is paid in full. As of June 30, 2006, the total remaining unpaid principal balance owed by LSV Employee Group was $79.0 million, of which the current portion is $10.0 million which is reflected in Current portion of long-term debt and the remaining $69.0 million is reflected in Long-term Debt on the accompanying Consolidated Balance Sheets.
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Forward-Looking Information and Risk Factors
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information contained in this discussion is or may be considered forward-looking. Forward-looking statements relate to future operations, strategies, financial results or other developments. Forward-looking statements are based upon estimates and assumptions that involve certain risks and uncertainties, many of which are beyond our control or are subject to change. Although we believe our assumptions are reasonable, they could be inaccurate. Our actual future revenues and income could differ materially from our expected results. We have no obligation to publicly update or revise any forward-looking statements.
Among the risks and uncertainties which may affect our future operations, strategies, financial results or other developments are those risks described in our latest Annual Report on Form 10-K in Part I, Item 1A. These risks include the following:
The Company and our clients are subject to extensive governmental regulation. Our various business activities are conducted through entities which may be registered with the Securities and Exchange Commission (SEC) as an investment adviser, a broker-dealer, a transfer agent, an investment company or with the United States Office of Thrift Supervision or state banking authorities as a trust company. Our broker-dealer is also a member of the National Association of Securities Dealers and is subject to its rules and oversight. In addition, various subsidiaries of the Company are registered with, and subject to the oversight of, regulatory authorities primarily in the United Kingdom and the Republic of Ireland. Many of our clients are subject to substantial regulation by federal and state banking, securities or insurance authorities or the Department of Labor. Compliance with existing and future regulations and responding to and complying with recent regulatory activity affecting broker-dealers, investment companies and their service providers could have a significant impact on us. We have responded and are currently responding to various regulatory examinations, inquiries and requests. One of these regulatory requests and inquiries relate to the payment by certain of our subsidiaries of expenses related to the marketing and distribution of shares of certain mutual fund clients of our fund administration and distribution business. As a result of these examinations, inquiries and requests, we are generally implementing changes and reviewing our compliance procedures and business operations. These activities resulted in an increased level of general and administrative costs.
We offer investment and banking products that also are subject to regulation by the federal and state securities and banking authorities, as well as non-United States regulatory authorities, where applicable. Existing or future regulations that affect these products could lead to a reduction in sales of these products. Directed brokerage payment arrangements offered by us are also subject to the SEC and other federal regulatory authorities. Changes in the regulation of directed brokerage or soft dollar payment arrangements or strategic decisions of our clients regarding these arrangements could affect sales of some services, primarily our brokerage services.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk - Our exposure to changes in interest rates primarily relates to our investment portfolio and long-term debt obligations. Our excess cash is principally invested in short-term, highly liquid financial instruments, mainly money market funds, with a substantial portion of such investments having initial maturities of three months or less. Our investment portfolio also includes some long-term fixed-income mutual funds, principally invested in federal government agency securities. We place our investments in financial instruments that meet high credit quality standards. A portion of our long-term debt is based upon a variable rate which renews every three months. While changes in interest rates could decrease interest income or increase interest expense, we do not believe that we have a material exposure to changes in interest rates. We do not undertake any specific actions to cover our exposure to interest rate risk and are not a party to any interest rate risk management transactions.
Foreign Currency Risk – We transact business in the local currencies of various foreign countries, principally Canada, Ireland, the United Kingdom and South Korea. Most of our foreign operations match local currency revenues with local currency costs. Due to these reasons, we do not currently hedge against foreign operations.
Price Risk - We are exposed to price risk associated with changes in the fair value of investments in marketable securities relating to the startup of new pooled investment offerings. The length of time that our funds remain invested in these new pooled investment offerings is dependent on client subscriptions. We will redeem our investments as clients subscribe to these new investment offerings. To provide protection against potential fair value changes for these investments, we have entered into various derivative financial instruments. As of June 30, 2006, we held derivative financial instruments with a notional amount of $11.2 million. We bought out this derivative financial instrument in early July 2006 for approximately $1.1 million. Additionally, LSV Employee Group entered into interest rate swap agreements to convert its floating rate long-term debt to fixed rate debt. These swaps have a total notional value of $58.1 million and an expected maturity date of January 2011. Changes in the fair value of the derivative financial instruments are recognized in current period earnings, whereas, the change in the fair value of the investment is recorded on the balance sheet in other comprehensive income. Therefore, changes in the fair value of the derivative financial instrument and changes in the fair value of the investment are not recognized through earnings in the same period. We did not enter into or hold any derivative financial instruments for trading purposes during 2006 or 2005.
Income before income taxes include losses of $82 thousand and gains of $86 thousand in the six month periods of 2006 and 2005, respectively, relating to changes in the fair value of derivative financial instruments. The aggregate effect of a hypothetical ten percent change in the fair value of our investments would be:
Hypothetical
In Value
Mutual Funds
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Item 4. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls systems are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during the quarter ended June 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
On September 30, 2004, SIDCO was named as a defendant in a putative consolidated amended class action complaint (the “PBHG Complaint”) filed in the United States District Court for the District of Maryland titled “Stephen Carey v. Pilgrim Baxter & Associates, LTD, et. al.” The PBHG Complaint was purportedly made on behalf of all persons that purchased or held PBHG mutual funds during the period from November 1, 1998 to November 13, 2003 and related generally to various market timing practices allegedly permitted by the PBHG Funds. The suit named as defendants some 36 persons and entities, including various persons and entities affiliated with Pilgrim Baxter & Associates, Ltd., various PBHG Funds, various alleged market timers, various alleged facilitating brokers, various clearing brokers, various banks that allegedly financed the market timing activities, various distributors/underwriters and others. The PBHG Complaint alleged that SIDCO was the named distributor/underwriter from November 1998 until July 2001 for various PBHG funds in which market timing allegedly occurred during that period. The PBHG Complaint generally alleged that the prospectus for certain PBHG funds made misstatements and omissions concerning market timing practices in PBHG funds. The PBHG Complaint alleged that SIDCO violated Sections 11 and 12(a)(2) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 34(b) and 36(a) of the Investment Company Act of 1940, and that SIDCO breached its fiduciary duties, engaged in constructive fraud and aided and abetted the breach by others of their fiduciary duties. The PBHG Complaint did not name SIDCO or any of its affiliates as a market timer, facilitating or clearing broker or financier of market timers. The PBHG Complaint sought unspecified compensatory and punitive damages, disgorgement and restitution. In 2006, the plaintiffs submitted a proposed form of order dismissing SIDCO from the action, but the Court has not yet acted on the proposed order.
Item 1A. Risk Factors
Information regarding risk factors appears in Part I - Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. There have been no material changes in our risk factors from those disclosed in our Annual Report on
Form 10-K for 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
April 1 – 30, 2006
May 1 – 31, 2006
June 1 – 30, 2006
Total
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Item 4. Submission of Matters to a Vote of Security Holders
On May 24, 2006, we held our annual meeting of shareholders (the “2006 Annual Meeting”) at our corporate headquarters in Oaks, Pennsylvania. At our 2006 Annual Meeting, the shareholders voted on the following matters:
1. The election of three directors with a term expiring at our 2008 Annual Meeting of Shareholders:
Name of Director
Number of Votes
Withheld
Richard B. Lieb
Carmen V. Romeo
Thomas W. Smith
The terms of office of each of the following directors continued after the meeting:
Sarah W. Blumenstein
William M. Doran
Kathryn M. McCarthy
Henry H. Porter, Jr.
Howard D. Ross
Alfred P. West, Jr.
2. Ratification of the appointment of PricewaterhouseCoopers LLP as independent registered public accountants to examine SEI’s consolidated financial statements for 2006:
For
67,015,997
Item 6. Exhibits.
The following is a list of exhibits filed as part of the Form 10-Q.
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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 8, 2006
/s/ Dennis J. McGonigle
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