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As filed with the Securities and Exchange Commission on February 26, 2010
Registration No. 333-163581
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 4
 
to
 
Form S-1
 
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
 
FINANCIAL ENGINES, INC.
(Exact name of registrant as specified in its charter)
 
         
Delaware   6282   94-3250323
(State or other jurisdiction of
  (Primary Standard Industrial   (I.R.S. Employer
incorporation or organization)
  Classification Code Number)   Identification No.)
 
1804 Embarcadero Road
Palo Alto, California 94303
(650) 565-4900
 
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 
Jeffrey N. Maggioncalda
Chief Executive Officer
1804 Embarcadero Road
Palo Alto, California 94303
(650) 565-4900
(Name, address, including zip code, and telephone number, including area code, of agent for service)
 
Copies to:
 
     
  Jorge del Calvo, Esq.
Davina K. Kaile, Esq.
Pillsbury Winthrop Shaw Pittman LLP
2475 Hanover Street
Palo Alto, CA 94304
(650) 233-4500
(650) 233-4545 facsimile
  Douglas D. Smith, Esq.
Stewart L. McDowell, Esq.
Gibson, Dunn & Crutcher LLP
555 Mission Street, Suite 3000
San Francisco, CA 94105
(415) 393-8200
(415) 986-5309 facsimile
 
Approximate date of commencement of proposed sale to the public:  As soon as practicable after this Registration Statement becomes effective.
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  o
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o Accelerated filer o Non-accelerated filer þ Smaller reporting company o
(Do not check if a smaller reporting company)
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
 


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The information in this prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.
 
Subject to Completion. Dated February 26, 2010.
 
10,900,000 Shares
 
(FINANCIAL ENGINES LOGO)
 
Common Stock
 
This is an initial public offering of shares of common stock of Financial Engines, Inc.
 
Financial Engines is offering 5,868,100 of the shares to be sold in the offering. The selling stockholders identified in this prospectus are offering an additional 5,031,900 shares. Financial Engines will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders.
 
Prior to this offering, there has been no public market for the common stock. It is currently estimated that the initial public offering price per share will be between $9.00 and $11.00. Financial Engines has applied to list the common stock on The Nasdaq Global Market under the symbol “FNGN.”
 
See “Risk Factors” on page 15 to read about factors you should consider before buying shares of the common stock.
 
 
 
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
 
 
 
 
                 
   
Per Share
   
Total
 
 
Initial public offering price
  $                $        
Underwriting discounts and commissions
  $       $    
Proceeds, before expenses, to Financial Engines
  $       $    
Proceeds, before expenses, to the selling stockholders
  $       $  
 
To the extent that the underwriters sell more than 10,900,000 shares of common stock, the underwriters have the option to purchase up to an additional 1,635,000 shares from Financial Engines at the initial public offering price less the underwriting discounts and commissions.
 
 
 
 
The underwriters expect to deliver the shares against payment in New York, New York on          , 2010.
 
Goldman, Sachs & Co.
 
 
 
 
UBS Investment Bank
 
 
 
 
Piper Jaffray Cowen and Company
 
Prospectus dated          , 2010


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(GRAPHIC)
I don’t know where How much to find help. will I need when I retire? I don’t know how much to save. Will I have enough money to retire? We promise to give everyone the personalized, trusted retirement help they deserve. When can I retire and how much can I spend when I do? How should I invest my money? I don’t know where to start.


 

 
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    F-1  
 EX-1.1
 EX-23.1
 
No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus.
 
You should rely only on the information contained in this prospectus and any free writing prospectus prepared by or on behalf of us. This prospectus is an offer to sell only the shares offered hereby but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.
 
Through and including          , 2010 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscriptions.
 
The market data and certain other statistical information used throughout this prospectus are based on independent industry publications, governmental publications, reports by market research firms or other independent sources. Some data are also based on our good faith estimates.
 
FINANCIAL ENGINES®, INVESTOR CENTRAL®, FINANCIAL ENGINES INVESTMENT ADVISOR®, WE MAKE IT PERSONAL®, RETIREMENT HELP FOR LIFE®, the Financial Engines logo and a sun and cloud design mark are all trademarks or service marks owned by Financial Engines, Inc., registered in the United States and other countries. In addition, Financial Engines, Inc. owns the trademarks ADVICESERVER® and FORECASTER®, registered in Japan and FINENG®, registered in Tunisia. The mark ADVICE LIGHT is also a trademark owned by Financial Engines, Inc. All other trademarks, service marks and trade names appearing in this prospectus are the property of their respective owners.


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PROSPECTUS SUMMARY
 
This summary highlights selected information contained elsewhere in this prospectus. Because this is only a summary, it does not contain all of the information you should consider before investing in our common stock. You should carefully read the entire prospectus, especially the risks set forth under the heading “Risk Factors” and our consolidated financial statements and related notes included elsewhere in this prospectus, before making an investment decision. Our investment advisory and management services are provided through our subsidiary, Financial Engines Advisors L.L.C., a federally registered investment adviser. References in this prospectus to “Financial Engines,” “our company,” “we,” “us” and “our” refer to Financial Engines, Inc. and its consolidated subsidiaries during the periods presented unless the context requires otherwise.
 
Financial Engines, Inc.
 
Overview
 
Our company was founded to address the need for independent investment advice. Traditionally, high quality, customized investment advice had been available only to large institutions and the affluent, and providing such advice to low asset balance investors had been cost-prohibitive. We believe that our advice technology platform allows us to cost-effectively service the needs of individual investors with low asset balances, many of whom are underserved by the financial services industry. We believe shifting retirement industry trends present us with an opportunity to provide independent portfolio management services, investment advice and retirement help to retirement plan participants who previously did not have access to these services.
 
Our Company
 
We are a leading provider of independent, technology-enabled portfolio management services, investment advice and retirement help to participants in employer-sponsored defined contribution retirement plans, such as 401(k) plans. We help investors plan for retirement by offering personalized plans for saving and investing, as well as by providing assessments of retirement income needs and readiness, regardless of the investor’s personal wealth or investment account size. We use our proprietary advice technology platform to provide our services to millions of retirement plan participants on a cost-efficient basis.
 
We target three key constituencies in the retirement plan market: plan participants (employees of companies offering 401(k) plans), plan sponsors (employers offering 401(k) plans to their employees) and plan providers (companies providing administrative services to plan sponsors). We generate revenue primarily from management fees based on the value of the assets we manage for plan participants, which we refer to as Professional Management revenue. We refer to the amount of retirement plan assets that we manage for plan participants as part of our Professional Management service as Assets Under Management, or AUM. We also generate revenue from recurring, subscription-based platform fees for access to either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only, which we refer to collectively as platform revenue. Platform fees are paid by the plan sponsor, plan provider or the retirement plan itself, depending on the plan structure.
 
We offer three principal services:
 
  •  Professional Management is a discretionary managed account service designed for plan participants who want affordable, personalized and professional portfolio management services, investment advice and retirement help from an independent investment advisor without the conflicts of interest that can arise when an advisor offers proprietary products. In some cases, we provide this service by acting as a subadvisor to a plan provider acting as the investment manager to plan participants.


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  •  Online Advice is a nondiscretionary Internet-based service that offers personalized advice to plan participants who wish to take a more active role in personally managing their retirement portfolios. In some cases, we provide this service by acting as a subadvisor to a plan provider acting as the investment advisor to plan participants.
 
  •  Retirement Evaluation is a retirement readiness assessment provided to plan participants upon plan rollout and generally annually thereafter. Retirement Evaluations highlight specific risks in a plan participant’s retirement account and assess the likelihood of achieving the plan participant’s retirement income goals. The assessment also provides guidance on how to reduce these highlighted risks.
 
Our total revenue for 2009 was $85.0 million, compared to $71.3 million for 2008, an increase of 19%. We generated Professional Management revenue of $52.6 million for 2009, an increase of 35% from $39.0 million for 2008. We generated platform revenue of $30.0 million for 2009, an increase of 2% from $29.5 million for 2008. For the year ended December 31, 2009, we had net income of approximately $5.7 million. We have incurred net losses in each year through 2008. As of December 31, 2009, we had an accumulated deficit of approximately $157.4 million.
 
We target large plan sponsors across a wide range of industries. As of December 31, 2009, we had signed contracts to make our services available through 116 Fortune 500 companies and eight Fortune 20 companies. As of December 31, 2009, we were under contract to provide either our full suite of services or our Online Advice service only, through more than 760 plan sponsors with approximately 7.4 million plan participants, whose retirement savings represented more than $500 billion in assets. Within this group, we provide our full suite of services to 354 plan sponsors representing approximately 3.9 million participants and approximately $269 billion of assets in retirement plans for which we have rolled out our Professional Management service, which we refer to as Assets Under Contract, or AUC. As of December 31, 2009, we had approximately $25.7 billion in AUM, and managed the accounts of approximately 391,000 members who have delegated investment decision-making authority to us. We deliver our services to plan sponsors and plan participants primarily through existing connections with eight retirement plan providers. Based on information from Pensions and Investments, as of March 31, 2009, and from one of the plan providers, we estimate that these eight plan providers collectively service plan sponsors representing more than $1.5 trillion in plan assets, or more than 80% of the assets contained in plans with more than 10,000 participants.
 
The key steps associated with delivering our Professional Management service are as follows:
 
  •  First, we sign a contract that allows us to provide our Professional Management service to the plan sponsor’s employees;
 
  •  Second, we obtain plan and plan participant data, set up the plan on our systems and make our services available to all eligible plan participants upon completion of plan rollout;
 
  •  Third, we deliver Retirement Evaluations and enrollment materials to plan participants; and
 
  •  Fourth, for plan participants who elect to enroll in our Professional Management service, at which time the participant’s 401(k) assets become AUM, we allocate the plan participant’s 401(k) assets pursuant to the participant’s investment objectives and investment alternatives available.
 
We launched our Professional Management service in September 2004. From December 31, 2004 to December 31, 2009, we had a compound annual growth rate, or CAGR, of 90% for AUM and 92% for membership.


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The following tables illustrate the increase in our AUM and membership, and the corresponding CAGR, from December 31, 2004 to December 31, 2009.
 
     
     Assets Under Management
         Total Members
(BAR CHART)   (BAR CHART)
All data are shown as of December 31 of the applicable year.
 
Our Market Opportunity
 
We believe the following key market trends will continue to drive the growth of our business and increase the value of our service offerings:
 
Shifting Demographics Drive a Growing Need for Retirement Assistance.  The ongoing growth in retirement assets, especially 401(k) assets, is driven in part by individuals seeking to supplement retirement funds they expect to receive from Social Security and corporate defined benefit plans. According to data contained in the Federal Reserve Board’s Survey of Consumer Finances for 2007, households headed by individuals age 45 through 64 represented 45% of all retirement account holders, but accounted for 56% of the assets in retirement accounts. Members of the Baby Boomer generation, which refers to individuals born between 1946 and 1964, will start to reach traditional retirement age in 2011. However, studies suggest that many Baby Boomers are not financially prepared to support themselves in retirement. The Employee Benefits Research Institute, or EBRI, 2009 Retirement Confidence Survey indicates that approximately 36% of workers age 45 through 54, and approximately 30% of workers age 55 or older, report total savings and investments, excluding the value of their primary residence and any defined benefit plans, of less than $10,000. Despite the increased reliance on defined contribution plans, we believe many investors are not equipped to adequately formulate an investment strategy for their retirement assets.
 
Growing Reliance on Defined Contribution Plans.  As employer-sponsored retirement plans shift from defined benefit plans to defined contribution plans, the responsibility for making retirement investment decisions shifts from professional pension fund managers to individual investors. Cerulli Associates estimates that private defined contribution assets, excluding Individual Retirement Accounts, or IRAs, were approximately $2.6 trillion and constituted more than 20% of total retirement assets in the United States, excluding Social Security, in 2008. According to Cerulli Associates, there were approximately 58 million active 401(k) plan participants as of December 31, 2008.
 
Changing Legal and Regulatory Framework.  As the burden of retirement investing shifts to the individual, we believe that there is an increasing need for assistance and guidance on how to maximize retirement wealth. However, according to a 2009 survey by Hewitt Associates, the primary reason cited by plan sponsors for not making investment advice available to employees has been the fear of increased fiduciary or legal risk. We believe the Pension Protection Act of 2006 and subsequent Department of Labor regulations can reduce these concerns by further supporting the existing foundation for professional asset management of 401(k) accounts. Adherence to these new guidelines provides specific safeguards to plan sponsors from fiduciary and legal risk.
 
Automatic 401(k).  As a result of the Pension Protection Act of 2006 and Department of Labor guidelines, plan sponsors are now actively seeking automatic retirement savings solutions for their employees. According to a 2009 401(k) plan survey conducted by Hewitt Associates, the percentage of employers that automatically enroll new participants has increased from 19% in 2005 to 58% in


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2009. Similarly, automatic contribution escalation, where employees’ contribution rates are automatically increased over time unless the employee affirmatively elects otherwise, increased from 9% in 2005 to 44% in 2009.
 
Our Competitive Strengths
 
We believe that our market-leading position results from the following key competitive strengths:
 
Independent and Unconflicted Advice.  We believe that many plan participants value an investment advisor that is independent and free from potential conflicts of interests. We also believe that many plan fiduciaries similarly value making independent and unconflicted advice available to their plan participants. We do not receive differential compensation based on the investments we recommend. We offer no proprietary investment products. We are not affiliated with or controlled by any broker-dealer, registered investment company, insurance company or financial services organization. We base our investment advice on quantitative criteria applied through a computerized model that is consistently applied across plan participants, plan sponsors, plan providers and investment choices.
 
Proprietary Investment Advice Technology.  Our Advice Engines, which consist of our Optimization and Simulation Engines, incorporate portfolio analysis methods commonly used by large institutional investors and pioneered by our co-founder and Nobel Laureate, Professor William F. Sharpe. Our technology-based investment approach incorporates the following:
 
  •  Our Optimization Engine allows us to make personalized investment recommendations, chosen from the investment options available within each plan, with consideration of the plan participant’s individual circumstances including investment horizon, existing investment allocations and characteristics of his or her 401(k) plan, as well as the participant’s other financial assets and risk tolerance. In addition, we provide personalized savings recommendations to help plan participants reach their retirement objectives;
 
  •  Our Simulation Engine allows us to model the risk and return characteristics of more than 30,000 securities, including the funds and employer stocks in the plans to which we provide services, taking into consideration factors such as asset class exposures, expenses, turnover, manager performance, active management risk, stock specific risk and the security’s tax-efficiency;
 
  •  Our Advice Engines’ ability to manage a plan participant’s employer stock holdings is an attractive feature to plan sponsors seeking to reduce the risk of fiduciary liability that can arise when employer stock is included in a 401(k) plan. The advice produced by our Advice Engines also generally reduces plan participants’ undiversified exposure to the equity risk that results from holding an overly-high concentration in employer stock; and
 
  •  Our Advice Engines are able to provide advice that takes into consideration after-tax returns by taking into account the specific tax characteristics of securities and the tax attributes of investor households.
 
Scalable Technology Platform.  We believe our technology platform allows us to cost-effectively service the needs of large numbers of individual investors with low asset balances while providing sophisticated, personalized investment advice. As of December 31, 2009, approximately 45% of our Professional Management members had less than $20,000 of retirement assets in their accounts.
 
Significant Invested Capital.  Our services are based on our proprietary technology, which we developed over a number of years, and in which we have invested significant financial and personnel resources. We believe that any potential competitor will face significant challenges in terms of the human capital, time, money and technology required to develop a competitive offering. Furthermore, the technology interfaces that we have established with our retirement plan providers and plan


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sponsors are complex and would be time-consuming and costly for our plan providers and plan sponsors to replicate.
 
Established Relationships and Data Connections with Retirement Plan Providers.  We have built data retrieval, transaction processing and fee deduction interfaces with a number of retirement plan providers, including these eight primarily: ACS, Fidelity, Hewitt, ING, JPMorgan, Mercer, T. Rowe Price and Vanguard.
 
Large, Industry-Leading Retirement Plan Sponsor Clients.  We believe our brand recognition and experience serving large plan sponsors from a wide variety of industries provide us with a competitive advantage and enhance our position as an acknowledged leader in our markets. We believe that many plan sponsors that contemplate switching plan providers consider the availability of our services on alternative plan provider platforms in making their decisions. We believe that this in turn provides incentives to the plan providers to maintain ongoing relationships with Financial Engines.
 
Our Business Model
 
Recurring and Resilient Revenue Base.  We believe our business model has structural advantages that allow us to demonstrate resiliency in difficult environments. We currently serve investors with 401(k) accounts that, unlike other non-retirement investment accounts, generally receive consistent automatic contributions from participants and have adverse tax treatment on early withdrawals. We create portfolios with a diversified mix of equity and fixed income exposure designed to reduce volatility. Our contracts with plan sponsors typically have initial terms of three years and evergreen clauses that extend the initial term until terminated by either party after a specified notice period. In a given year, a significant portion of our Professional Management revenue consists of recurring revenue earned from contracts in place prior to the beginning of that year. Revenue from contracts in place as of December 31, 2008 accounted for approximately 99% of our total revenue for the year ended December 31, 2009.
 
While market declines may impact the value of our AUM, we believe our business model may mitigate the effects of market declines. From December 31, 2007 to December 31, 2008, our AUM declined approximately 4%. This was a challenging time for the equity markets, as shown by a decline in the S&P 500 of approximately 38% over the same period. We believe the effect on our AUM during this period was mitigated as a result of new business, ongoing participant contributions and less volatile investment performance, among other factors.
 
Attractive Economic Model.  We believe the scalability of our technology platform results in attractive per-member economics. We believe that our investments in technology allow us to manage existing member accounts at significantly lower costs and to add new plan sponsors and plan participants with less than pro rata incremental expenses.
 
Sole Access and Customer Retention.  Our business model enjoys a number of structural advantages that result in sole access to plan participants and high plan sponsor retention levels. The 354 plan sponsors representing approximately $269 billion in AUC who make available our Professional Management service have each made us the sole provider of these services to their plans. We believe this reflects the desire of plan sponsors to avoid inconsistent methodologies, to simplify choices for plan participants, and to avoid building new data connections with multiple investment advice vendors.
 
Since the launch of our Professional Management service in September 2004, we have retained over 96% of our plan sponsors each year. We believe this reflects the desire of plan sponsors to maintain continuous and consistent provision of investment advisory services for their employees.
 
Significant Growth Opportunity Within Our Existing Customer Base.  We believe our business has a significant opportunity for growth from our existing customer base. As of December 31, 2009, we had approximately $25.7 billion in AUM and approximately 391,000 members,


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while our Professional Management service was available to employees representing a total of approximately $269 billion in AUC and approximately 3.9 million potential members. This implies a participant enrollment rate of approximately 10.0% across all plans where Professional Management is available, including plans where enrollment campaigns are not yet concluded or have not been commenced.
 
Our Growth Strategy
 
Increase Penetration Within Our Existing Professional Management Plan Sponsors.  We plan to increase enrollment by both continuing to promote our services to participants in Active Enrollment campaigns and encouraging plan sponsors to initiate Passive Enrollment campaigns. Active Enrollment campaigns require that plan participants proactively sign up for our Professional Management service. Passive Enrollment campaigns automatically enroll some or all of a plan sponsor’s plan participants into our Professional Management service unless the individual participant declines or “opts-out” of the service. Our past experience indicates that in cases where a plan sponsor used Passive Enrollment, the enrollment rate of plan assets was higher and achieved at lower acquisition cost per member than in cases where a plan sponsor used Active Enrollment. We believe Passive Enrollment is attractive to plan sponsors due to the lower fees payable by plan participants who are passively enrolled, the fiduciary protection afforded to plan sponsors by participants having to affirmatively elect not to receive professional advice and the relatively higher number of participants likely to be enrolled and receiving professional management upon rollout. Depending on the proportion of the plan’s participants who are passively enrolled, we eliminate or reduce our platform fees, as well as reducing the fees payable by plan participants.
 
Enhance and Extend Our Services as Baby Boomers Enter Retirement.  We intend to expand our portfolio management, investment advisory and retirement planning services to help individual investors as they near and enter retirement. We also intend to expand our services to help members of our Professional Management program who roll over their 401(k) into an IRA account available through the plan provider and to help other individual IRA investors manage and draw down income from their IRAs. We also plan to expand our services to more fully serve the defined contribution market. We believe our established investment methodology, technology and relationships with plan providers, plan sponsors and plan participants provide us with the distribution and technological capabilities to help individuals who want ongoing, lifetime payouts from their retirement accounts.
 
Expand Number of Retirement Plan Sponsors.  We intend to sell our services to other plan sponsors that are not current clients but are serviced by the plan providers with which we have relationships. We may also seek to create data connections with additional plan providers to access defined contribution plans of educational institutions, non-profit organizations and government entities.
 
Offer Professional Management to “Online Only” Plan Sponsors.  We have an online-services-only relationship with many of our plan sponsor customers. We plan to pursue growth by seeking to convert these plan sponsors to our full Professional Management, Online Advice and Retirement Evaluation suite of services.
 
Risks Related to Our Business
 
Investing in our common stock involves substantial risk, including those risks described under the heading “Risk Factors” immediately following this summary. Our ability to execute our strategy is also subject to significant risks. Risks related to our business include, but are not limited to, fluctuations in our revenue and operating results, our reliance on fees earned on the value of assets we manage for a substantial portion of our revenue, the impact of the financial markets on our revenue and earnings, our history of losses and accumulated deficit, unanticipated delays in rollouts of our services, our ability to increase enrollment, our ability to introduce new services and accurately estimate the impact of any future services on our business, our relationships with plan providers and


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plan sponsors, the fees we can charge for our Professional Management service, our reliance on accurate and timely data from plan providers and plan sponsors, system failures, errors or unsatisfactory performance of our services, our reputation, our ability to protect the confidentiality of plan provider, plan sponsor and plan participant data and other privacy concerns, acquisition activity involving plan providers or plan sponsors, our ability to compete and risks associated with our fiduciary obligations. We also face risks related to complex regulations and changes in laws applicable to our business, including where we act as a subadvisor. Before you invest in our common stock, you should carefully consider all the information in this prospectus including matters set forth under the heading “Risk Factors.”
 
Corporate Information
 
We were incorporated in California in May 1996 and were reincorporated in Delaware in February 2010. Our principal executive offices are located at 1804 Embarcadero Road, Palo Alto, California 94303. Our telephone number at that location is (650) 565-4900. Our website address is www.FinancialEngines.com. Information on our website is not part of this prospectus and should not be relied upon in determining whether to make an investment decision.
 
Conflict of Interest; FINRA Regulations
 
As a result of their sale of shares in the offering, the certain investment partnership affiliates of Goldman, Sachs & Co. may collectively receive more than 5% of the net proceeds of the offering, not including underwriting compensation. As a result, Goldman, Sachs & Co. may be deemed to have a “conflict of interest” under Rule 2720 of the Conduct Rules of the National Association of Securities Dealers, Inc., or “Rule 2720,” as administered by the Financial Industry Regulatory Authority, or “FINRA.” This offering will therefore be made in compliance with the applicable provisions of Rule 2720. Rule 2720 requires that no sale be made to discretionary accounts by underwriters having a conflict of interest without the prior written approval of the account holder and that a “qualified independent underwriter” as defined in the rule, has participated in the preparation of the registration statement and prospectus and exercised the usual standards of due diligence with respect thereto. Cowen and Company, LLC is assuming the responsibilities of acting as the “qualified independent underwriter” in this offering. We have agreed to indemnify Cowen and Company, LLC against liabilities incurred in connection with acting as a “qualified independent underwriter” including liabilities under the Securities Act, or contribute to payments that the underwriters may be required to make in that respect.


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Terminology
 
References in this prospectus to the following terms shall have the meanings set forth below:
 
AUC:  AUC, or Assets Under Contract, is defined as the amount of assets in retirement plans under contract for our Professional Management services that have been rolled out. Our AUC does not include assets in plans where we have signed contracts but for which we have not yet rolled out our Professional Management service. The value of assets is reported by plan providers as of various points in time and is not always updated or marked to market. Some plan participants may not be eligible for our services due to plan sponsor limitations on employees treated as insiders for purposes of securities laws or other characteristics of the plan participant. Certain securities within a plan participant’s account may be ineligible for management by us, such as employer stock subject to trading restrictions, and we do not manage or charge a fee for that portion of the account. We believe that AUC both is a useful approximation of the additional plan assets available for enrollment efforts that, if successful, result in these assets becoming AUM, and also indicates the benefit of increasing our enrollment rates since this will lead to additional AUM.
 
AUM:  AUM, or Assets Under Management, is defined as the amount of retirement plan assets that we manage as part of our Professional Management service. Our quarter-end AUM is the value of assets under management as reported by plan providers at or near the end of each quarter.
 
Enrollment Rate:  When used in reference to participant enrollment rate, enrollment rate is defined as the percentage of plan participants who use our Professional Management service across all plans in which Professional Management is available, including plans in which enrollment campaigns are not concluded or have not yet commenced.
 
When used in reference to asset enrollment rate, enrollment rate is defined as AUM as a percentage of AUC across all plans in which Professional Management is available, including plans in which enrollment campaigns are not concluded or have not yet commenced.
 
In addition to measuring enrollment in all plans that have been rolled out, we measure enrollment in plans that have been actively rolled out for at least 14 months and in plans that have been actively rolled out for at least 26 months. We consider a plan to be actively rolled out upon mailing of initial enrollment materials. We measure enrollment in plans that have been rolled out for at least 14 months and at least 26 months because we generally seek to commence annual campaigns 12 months after the start of the prior campaign, and each campaign typically lasts 45-60 days. We may not always maintain this schedule.
 
Members:  Members are defined as plan participants who are enrolled in our Professional Management service.
 
401(k) Plans:  401(k) plans collectively refer to defined contribution plans, such as 401(k), 403(b) and 457 plans, in which participants contribute a specified dollar amount into the plan on a regular basis and, upon retirement, can draw from the amount of money resulting from these contributions and the investment return earned on those contributions.


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THE OFFERING
 
Shares of common stock offered by Financial Engines 5,868,100 Shares
 
Shares of common stock offered by the selling stockholders 5,031,900 Shares
 
Total shares of common stock offered 10,900,000 Shares
 
Shares of common stock to be outstanding immediately after this offering 39,505,577 Shares
 
Option to purchase additional shares offered by Financial Engines 1,635,000 Shares
 
Use of proceeds We intend to use the net proceeds from this offering for general corporate purposes, including working capital and capital expenditures. See “Use of Proceeds.”
 
Dividend Policy We do not currently intend to declare dividends on shares of our common stock. See “Dividend Policy.”
 
Risk Factors You should carefully read the “Risk Factors” section of this prospectus for a discussion of factors that you should consider carefully before deciding to invest in shares of our common stock.
 
Proposed Nasdaq Global Market symbol “FNGN”
 
The number of shares of common stock to be outstanding immediately after this offering is based on 33,088,846 shares outstanding on an as-converted basis as of December 31, 2009, and excludes:
 
  •  11,630,440 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009, at a weighted average exercise price of $6.07 per share;
 
  •  2,000,000 shares of common stock reserved for future issuance under our 2009 Stock Incentive Plan following the date of this offering, as well as shares originally reserved for issuance under our 1998 Stock Plan, but which may become available for awards under our 2009 Stock Incentive Plan as described below; and
 
  •  25,000 shares reserved for future issuance under our Special Executive Restricted Stock Purchase Plan.
 
The number of shares to be outstanding immediately after this offering will include 456,643 shares of common stock to be issued to holders of Series E preferred stock upon the completion of this offering and 91,988 shares to be issued and sold in this offering upon the exercise of vested stock options.
 
Unless otherwise stated, all information in this prospectus assumes:
 
  •  the conversion of all of our outstanding shares of preferred stock into an aggregate of 22,441,623 shares of common stock effective upon the completion of this offering, assuming a one-to-one conversion ratio of our outstanding shares of preferred stock into common stock;
 
  •  the filing of our restated certificate of incorporation prior to the completion of this offering; and
 
  •  no exercise of the option to purchase additional shares granted to the underwriters.
 
As of December 31, 2009, 1,326,788 shares remained available for future issuance under our 1998 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1998 Stock Plan. Shares originally reserved for issuance under our 1998 Stock Plan, but which are not subject to outstanding options on the effective date of our 2009 Stock Incentive Plan, and shares subject to outstanding options under our 1998 Stock Plan on the effective date of our 2009 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, up to a number of additional shares not to exceed 2,000,000, will also become available for awards under our 2009 Stock Incentive Plan.


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SUMMARY CONSOLIDATED FINANCIAL INFORMATION
 
The information set forth below should be read together with “Capitalization,” “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.
 
The summary consolidated statements of operations data for the years ended December 31, 2007, 2008 and 2009 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Historical results are not necessarily indicative of the results to be expected in the future, and results of interim periods are not necessarily indicative of results for the entire year.
 
                         
    Year Ended December 31,  
   
2007
   
2008
   
2009
 
    (In thousands, except share and per share data)  
 
Statements of Operations Data:
                       
Total revenue
  $ 63,350     $ 71,271     $ 84,982  
Costs and expenses
    64,849       74,310       78,198  
                         
Income (loss) from operations
    (1,499 )     (3,039 )     6,784  
Interest income (expense) and other, net
    (274 )     (563 )     (261 )
                         
Income (loss) before income tax expense
    (1,773 )     (3,602 )     6,523  
Income tax expense
    31       12       834  
                         
Net income (loss)
    (1,804 )     (3,614 )     5,689  
Less: Preferred stock dividend
          2,362       1,082  
                         
Net income (loss) attributable to holders of common stock
  $ (1,804 )   $ (5,976 )   $ 4,607  
                         
Net income (loss) per share attributable to holders of common stock:
                       
Basic
  $ (0.19 )   $ (0.61 )   $ 0.46  
Diluted
  $ (0.19 )   $ (0.61 )   $ 0.13  
Shares used to compute net income (loss) per share attributable to holders of common stock:
                       
Basic
    9,427       9,767       10,106  
Diluted:
    9,427       9,767       34,866  
Pro forma net income per share (unaudited):
                       
Basic (1)
                  $ 0.17  
Diluted (1)
                  $ 0.16  
Shares used to compute pro forma net income per share (unaudited):
                       
Basic (1)
                    33,005  
Diluted (1)
                    35,401  
 
 
(1)   See Note 2 to our consolidated financial statements for an explanation of the method used to calculate basic and diluted net income per share and the unaudited pro forma basic and diluted net income per share for the year ended December 31, 2009. All shares to be issued in the offering were excluded from the unaudited pro forma basic and diluted net income per share calculation since the proceeds will be used for general corporate purposes.
 


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    As of December 31, 2009  
                Pro Forma
 
    Actual     Pro Forma     as Adjusted  
    (In thousands, unaudited)  
 
Balance Sheet Data:
                       
Cash and cash equivalents (1)
  $   20,713     $   20,713     $ 73,386  
Working capital
    16,562       16,562       68,809  
Total assets (1)
    58,352       58,352       109,446  
Bank borrowings
    8,055       8,055       8,055  
Total liabilities
    34,086       34,086       32,933  
Total stockholders’ equity (1)
    24,266       24,266       76,513  
 
                         
    Year Ended December 31,  
   
2007
   
2008
   
2009
 
    (In thousands, unaudited)  
 
Non-GAAP Financial Data:
                       
Adjusted EBITDA (2)
  $   8,333     $   8,409     $   19,553  
Adjusted net income (2)
    2,612       3,006       11,592  
 
 
Notes to Summary Balance Sheet Data and Other Data
 
(1)   The table above presents a summary of our balance sheet data as of December 31, 2009:
 
  •  on an actual basis;
 
  •  on a pro forma basis to give effect to the issuance of 22,441,623 shares of common stock issuable upon the conversion of all of our outstanding shares of preferred stock upon completion of this offering and 456,643 shares of common stock to be issued to holders of Series E preferred stock upon the completion of this offering; and
 
  •  on a pro forma basis to give effect to the issuance of 22,441,623 shares of common stock issuable upon the conversion of all of our outstanding shares of preferred stock upon completion of this offering and 456,643 shares of common stock to be issued to holders of Series E preferred stock upon the completion of this offering, as adjusted to further reflect the sale by stockholders of 91,988 shares of common stock to be issued upon exercise of vested stock options immediately prior to the completion of this offering with net proceeds to us of $0.3 million and the sale by us of 5,868,100 shares of common stock in this offering at an assumed initial public offering price of $10.00 per share, the mid-point of the price range set forth on the cover of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. This amount will increase cash and cash equivalents, working capital, total assets and total stockholders’ equity by $52.7 million, $52.2 million, $51.1 million and $52.2 million, respectively.
 
Upon completion of the offering, each share of our preferred stock will convert into one share of our common stock in accordance with the automatic conversion provisions under Section 4 of our charter in effect upon completion of the offering. Specifically, in accordance with Section 4(b) of our charter, a majority of the outstanding shares of our Series A, Series B, Series C and Series D preferred stock, voting together as a class, and of the Series D, Series E and Series F preferred stock, each voting as a separate class, have approved the automatic conversion of each share of preferred stock into common stock on a one-for-one basis. In January 2010, our board of directors and shareholders approved the issuance of an aggregate of 456,643 shares of our common stock to holders of Series E preferred stock immediately following the closing of this offering such that each share of preferred stock, including the Series E preferred stock, would maintain a one-for-one conversion ratio to

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common stock. Accordingly, the same exchange ratio of 1:1 will be used for all holders of all series of preferred stock and no holders of preferred stock will increase or decrease their proportionate ownership levels relative to other owners as a result of these conversion terms except to the extent that the aggregate ownership level of holders of Series E preferred stock will increase upon the issuance of the 456,643 shares of common stock. The 456,643 shares of our common stock are included in the pro forma as adjusted and pro forma earnings per share calculations in this prospectus. These shares will be accounted for as a dividend to existing holders of Series E preferred stock when issued and will be measured at the then fair-value of the common stock.
 
A $1.00 increase (decrease) in the assumed initial public offering price of $10.00 per share would increase (decrease), on a pro forma as adjusted basis, each of cash and cash equivalents, total assets and total stockholders’ equity by approximately $5.5 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
 
(2)   “Adjusted EBITDA” represents net income (loss) before interest (income) expense, net, income tax expense, depreciation, withdrawn offering expense, amortization of internal use software, direct response advertising and deferred sales commissions and stock-based compensation.
 
“Adjusted Net Income (Loss)” represents net income (loss) before stock-based compensation expense, net of tax, and withdrawn offering expense.
 
Our management uses adjusted EBITDA and adjusted net income (loss):
 
  •  as measures of operating performance;
 
  •  for planning purposes, including the preparation of annual budgets;
 
  •  to allocate resources to enhance the financial performance of our business;
 
  •  to evaluate the effectiveness of our business strategies; and
 
  •  in communications with our board of directors concerning our financial performance.
 
Management may also consider adjusted EBITDA and adjusted net income (loss), among other factors, when determining management’s incentive compensation beginning in 2010.
 
We also present adjusted EBITDA and adjusted net income (loss) as supplemental performance measures because we believe that these measures provide our board of directors, management and investors with additional information to measure our performance. Adjusted EBITDA provides comparisons from period to period by excluding potential differences caused by variations in the age and book depreciation of fixed assets (affecting relative depreciation expense) and amortization of internal use software, direct response advertising and commissions, and changes in interest expense and interest income that are influenced by capital structure decisions and capital market conditions. Management also believes it is useful to exclude stock-based compensation expense from adjusted EBITDA and adjusted net income (loss) because non-cash equity grants made at a certain price and point in time do not necessarily reflect how our business is performing at any particular time.
 
We believe adjusted EBITDA and adjusted net income (loss) are useful to investors in evaluating our operating performance because securities analysts use adjusted EBITDA and adjusted net income (loss) as supplemental measures to evaluate the overall performance of companies and we anticipate that our investor and analyst presentations after we are public will include adjusted EBITDA and adjusted net income (loss).


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Adjusted EBITDA and adjusted net income (loss) are not measurements of our financial performance under U.S. GAAP and should not be considered as an alternative to net income (loss), operating loss or any other performance measures derived in accordance with U.S. GAAP, or as an alternative to cash flows from operating activities as a measure of our profitability or liquidity.
 
We understand that, although adjusted EBITDA and adjusted net income (loss) are frequently used by securities analysts, lenders and others in their evaluation of companies, adjusted EBITDA and adjusted net income (loss) have limitations as an analytical tool, and you should not consider them in isolation, or as a substitute for an analysis of our results as reported under U.S. GAAP. In particular you should consider:
 
  •  Adjusted EBITDA and adjusted net income (loss) do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;
 
  •  Adjusted EBITDA and adjusted net income (loss) do not reflect changes in, or cash requirements for, our working capital needs;
 
  •  Adjusted net income (loss) does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our debt;
 
  •  Adjusted EBITDA and adjusted net income (loss) do not reflect the non-cash component of employee compensation;
 
  •  Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements;
 
  •  Due to either net losses before income tax expenses or the use of federal and state net operating loss carryforwards in 2007, 2008 and 2009, we had income tax payments of approximately $9,000, $150,000 and $48,000, respectively. Income tax payments will be higher if we generate net income before income tax expenses and our existing net operating loss carryforwards for federal and state income taxes of approximately $134 million and $60 million, respectively, as of December 31, 2009, have been fully utilized or expired; and
 
  •  Other companies in our industry may calculate adjusted EBITDA and adjusted net income (loss) differently than we do, limiting their usefulness as a comparative measure.
 
Management compensates for the inherent limitations associated with using adjusted EBITDA and adjusted net income (loss) measures through disclosure of such limitations, presentation of our financial statements in accordance with GAAP and reconciliation of adjusted EBITDA and adjusted net income (loss) to the most directly comparable GAAP measure, net income (loss). Further, management also reviews GAAP measures and evaluates individual measures that are not included in adjusted EBITDA, such as our level of capital expenditures, equity issuance and interest expense, among other measures.


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The table below sets forth a reconciliation of net income (loss) to adjusted EBITDA based on our historical results:
 
                         
    Year Ended December 31,  
   
2007
   
2008
   
2009
 
    (In thousands, unaudited)  
 
Net income (loss)
  $  (1,804 )   $  (3,614 )     5,689  
Interest expense, net
    352       563       605  
Income tax expense
    31       12       834  
Depreciation
    1,284       1,641       1,729  
Withdrawn offering expense (1)
          3,031        
Amortization of internal use software (2)
    3,020       2,196       2,711  
Amortization of direct response advertising
                64  
Amortization of deferred sales commissions
    1,034       991       1,153  
Stock-based compensation expense (3)
    4,416       3,589       6,768  
                         
Adjusted EBITDA
  $ 8,333     $ 8,409     $ 19,553  
                         
 
(1)   As of November 2008, we had incurred approximately $3.0 million of costs directly attributable to a planned initial public offering. These costs were being deferred until the completion of the offering. In the quarter ended December 31, 2008, these costs were charged to expense as a result of our decision in November 2008 to cease efforts to pursue an initial public offering because of the disruption in the equity capital markets and general adverse economic conditions present at that time.
 
(2)   Amortization of internal use software expense excluding stock-based compensation includes engineering costs associated with developing and enhancing our internal software systems as well as our advisory service platform. Associated direct development costs are capitalized and amortized using the straight-line method over their estimated lives. Costs in this area include compensation and related expenses and fees for external consulting services.
 
(3)   Stock-based compensation expense is included in:
 
                         
    Year Ended December 31,  
   
2007
   
2008
   
2009
 
    (In thousands, unaudited)  
 
Cost of revenue
  $ 648     $ 817     $ 1,391  
Research and development
    1,134       796       1,721  
Sales and marketing
    1,150       1,112       1,942  
General and administrative
    1,434       801       1,612  
Amortization of internal use software
    50       63       102  
                         
Total stock-based compensation expense
  $  4,416     $  3,589     $  6,768  
                         
 
The table below sets forth a reconciliation of net income (loss) to adjusted net income (loss) on our historical results:
 
                         
    Year Ended December 31,  
   
2007
   
2008
   
2009
 
    (In thousands, unaudited)  
 
Net income (loss)
  $  (1,804 )   $  (3,614 )   $ 5,689  
Stock-based compensation expense, net of tax(1)
    4,416       3,589       5,903  
Withdrawn offering expense
          3,031        
                         
Adjusted net income (loss)
  $ 2,612     $ 3,006     $ 11,592  
                         
 
 
(1)   In 2009, we adjusted stock-based compensation at our effective tax rate of 12.8%. In 2007 and 2008, we did not adjust stock-based compensation as income taxes were minimal for each of these periods.


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RISK FACTORS
 
Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below before making a decision to buy our common stock. If any of the following risks actually occurs, our business, financial condition, results of operations or growth prospects could be harmed. In that case, the trading price of our common stock could decline and you might lose all or part of your investment in our common stock. You should also refer to the other information set forth in this prospectus, including our consolidated financial statements and the related notes.
 
Risks Related to Our Business
 
Our revenue and operating results can fluctuate from period to period, which could cause our share price to fluctuate.
 
Our revenue and operating results have fluctuated in the past and may fluctuate from period-to-period in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following factors, as well as other factors described elsewhere in this prospectus:
 
  •  a decline or slowdown of the growth in the value of financial market assets, which may reduce the value of assets we have under management and therefore our revenue and cash flows;
 
  •  negative public perception and reputation of the financial services industry;
 
  •  variations in expected enrollment rates for our Professional Management service;
 
  •  unanticipated delays of anticipated rollouts of our services;
 
  •  unanticipated changes to economic terms in contracts with plan providers or plan sponsors, including renegotiations;
 
  •  downward pressure on fees we charge for our portfolio management, investment advisory and retirement planning services;
 
  •  changes in laws or regulatory policy that could impact our ability to offer services to plan providers as a subadvisor;
 
  •  failure to enter into contracts with new plan sponsors;
 
  •  cancellations or non-renewal of existing contracts with plan providers or plan sponsors;
 
  •  fluctuations in quarterly revenue due to changes in fees paid by Professional Management members based on performance incentives in contract terms;
 
  •  changes in fees paid by us to plan providers for whom we are not acting as a subadvisor for data retrieval, transaction processing and fee deduction interfaces based on performance incentives in contract terms;
 
  •  mix in plan sponsors that choose our Active Enrollment or Passive Enrollment options;
 
  •  changes in the number of Professional Management members who withdraw all assets from their 401(k) plan, effectively terminating their relationship with us, or who decide to cancel their Professional Management program participation;
 
  •  elimination or reduction of sponsor matching contributions into members’ 401(k) plans, which could reduce the growth rate of assets under management;
 
  •  unanticipated changes in the timing or cost of our enrollment and member materials or mix of subadvised, advised and Passive Enrollment materials sent to our Professional Management members and postage costs;


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  •  unanticipated delays in recognizing revenue based on timing of meeting specified milestones under contracts with customization and consulting services; and
 
  •  changes in our pricing policies or the pricing policies of our competitors to which we have to adapt.
 
As a result of these and other factors, the results of any prior quarterly or annual periods should not be relied upon as indications of our future revenue or operating performance.
 
We have an accumulated deficit and have incurred net losses in the past. We may incur net losses in the future.
 
As of December 31, 2009, we had an accumulated deficit of approximately $157.4 million. We have incurred net losses in each year through 2008. We may continue to incur net losses in the future.
 
A substantial portion of our revenue is based on fees earned on the value of assets we manage. Our revenue and earnings could suffer if the financial markets experience a downturn or a slowdown in growth that reduces the value, or slows the growth, of our Assets Under Management.
 
We derive a significant and growing portion of our revenue from asset management fees based on the assets in the retirement accounts we manage, which we refer to as Assets Under Management, or AUM. We allocate these assets among the investments available to each particular plan participant. The investment alternatives for a particular plan are selected by the plan’s fiduciary, not by us, and may include retail mutual funds, institutional funds, exchange-traded funds, fixed-income investments and potentially higher volatility employer stock, if it is an investment alternative in a particular plan. In addition, our business is highly concentrated in the 401(k) plans of plan sponsors in the United States and the United States subsidiaries of international companies. The value of these investments can be affected by the performance of the financial markets globally, currency fluctuations, interest rate fluctuations and other factors. Currently, our fees are generally based on AUM on a day within the last 10 days of a quarter. The exact date is agreed to in advance with the plan provider, but varies by plan provider. As a result, a decline in the financial markets at the end of a quarter could have an adverse effect on our revenue, even if the financial markets had performed well earlier in the quarter. In addition, an economic downturn or slowdown in growth could cause plan participants or their employers to contribute less to their 401(k) plans and cause fewer eligible employees to participate in 401(k) plans, which could adversely affect the amount of AUM. If plan participants are not satisfied with the performance of their retirement portfolios due to a decline in the financial markets or otherwise, our cancellation rates could increase, which in turn would cause our AUM to decline. As of October 1, 2008, our voluntary cancellation rate over the preceding 12 months was 6.7% of our total number of members, and as of April 30, 2009, our voluntary cancellation rate had increased to 8.7% of our total number of members. As of December 31, 2009, our voluntary cancellation rate over the preceding 12 months was 5.2% of our total number of members. A voluntary cancellation occurs when a member proactively terminates their membership in our Professional Management service. This differs from a rollover or involuntary cancellation when a member is no longer eligible for our Professional Management service, either because the member has rolled out of the retirement plan or because the plan sponsor has cancelled the Professional Management service. If any of these factors reduces the value of assets we have under management, the amount of fees we would earn for managing those assets would decline, which in turn would harm our revenue, operating results and financial condition. These percentages may not be indicative of future voluntary cancellation rates, which may increase.
 
Our revenue could be harmed if we experience unanticipated delays in rollouts of our services.
 
We generally do not earn platform fees from a plan sponsor until our services are available to plan participants and we do not earn fees for our Professional Management service until we begin to


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manage a participant’s account. If rollouts are delayed, our receipt of revenue would be delayed. This in turn would affect our operating results for a particular period.
 
Our revenue could suffer if we experience unanticipated variations in new enrollment campaigns or if we fail to enroll plan participants.
 
Unanticipated variations in the number, size or timing of new enrollment campaigns as well as ongoing annual campaigns at our existing plan sponsors could also affect our revenue for a particular period.
 
Our revenue could be harmed if we do not grow enrollment in our Professional Management service.
 
Our enrollment rate, and therefore our revenue, depend on plan participants signing up for or, in the case of a Passive Enrollment campaign, not declining, the Professional Management service. If we are unable to continue to grow our enrollment, our business may not grow as we anticipate. Increasing plan participant enrollment in our Professional Management service increases the AUM on which we earn fees. We may not be able to generate expected enrollment under a particular contract, which would negatively affect our revenue growth. For example, we have found that if plan sponsors do not use our standard enrollment campaign, enrollment rates tend to be lower. If fewer plan sponsors elect Passive Enrollment for their plan participants, which typically generates higher enrollment rates, our revenue may not grow at anticipated rates. Even when we have rolled out our Professional Management service at a particular plan sponsor, some plan participants may not be eligible for our services due to plan sponsor limitations on employees treated as insiders for purposes of securities laws or other characteristics of the plan participant. Certain securities within a plan participant’s account may be ineligible for management by us, such as employer stock subject to trading restrictions, and we do not manage or charge a fee for that portion of the account. Further, individual plan participants whose accounts we manage may choose at any time to stop having us manage those accounts. If large numbers of plan participants choose to stop using or are not able to continue using our Professional Management service, our revenue, operating results and financial condition would suffer. The voluntary cancellation rate by plan participants whose accounts we manage, measured as a percentage of AUM, was approximately 15% in 2008 and has averaged approximately 1% per month during our history and less than 1% per month during 2009. The overall average voluntary cancellation rate during the first year of membership in our Professional Management service is approximately 7.4% of such members. The overall average voluntary cancellation rate is approximately 6.6% of such members and approximately 3.2% of such members in the second and third year of service, respectively. These percentages may not be indicative of future voluntary cancellation rates, which may increase.
 
We plan to extend and expand our services and may not accurately estimate the impact of developing and introducing these services on our business.
 
We plan to extend our services into new areas, including helping investors turn their retirement assets into retirement income. For example, we intend to work within the existing 401(k) plans we service to help our Professional Management members manage their defined contribution assets and maintain their retirement goals while directing payouts from their retirement accounts. We also recently introduced the Financial Engines Retirement Evaluation, a personalized retirement assessment designed to let plan participants know how close they are to reaching their retirement income goals based on their current savings and investments. We intend to invest significant resources to the research, development, sales and marketing of these new services. We have limited experience in these areas, including the determination of income payments from defined contribution accounts. If our assessments or forecasts with respect to the expected duration and sufficiency of assets to support retirement income payments to participants are inaccurate, or if we fail to ensure that payouts are made at the times expected, our business and reputation could suffer. We may not


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be able to anticipate or manage new risks and obligations or legal, compliance or other requirements that may arise if we offer investment management or retirement income payout services for accounts other than 401(k) accounts. We may not be able to accurately estimate the impact of these future services on our business or how the benefits of these services will be perceived by our clients. In addition, the anticipated benefits of these services on our business may not outweigh the resources and costs associated with their development. If we do not realize the anticipated benefits of these services, our business would suffer.
 
Our revenue is highly dependent upon a small number of plan providers with which we have relationships, and the renegotiation or termination of our relationship with any of these plan providers could significantly impact our business.
 
Our relationships and data connections with plan providers allow us to effectively manage plan participant accounts and integrate our services into plan providers’ current service platforms. These relationships also provide us with an advantage in trying to sign potential plan sponsors. If a plan provider were to terminate our contract, reduce its volume of business or substantially renegotiate the terms of its contract with us, our revenue could be reduced.
 
Of our eight primary retirement plan provider relationships, we refer to three as subadvisory relationships. For the full suite of services offered in these subadvisory relationships, we generally act as subadvisor to the plan provider acting as investment advisor, even though we may contract directly with the plan sponsor to act as investment advisor for online-only service offerings. The fees we earn through these three subadvisory relationships are based on services to more than 640 plan sponsors as of December 31, 2009. However, among the plan sponsors that work with these three providers, in those cases where we act as subadvisor, we do not have a direct relationship with the plan sponsors and therefore may be less able to influence decisions by those plan sponsors to use or continue to use our services, and for online-only sponsors, we may be less able to influence plan sponsor decisions to add our full suite of services. We have historically earned, and expect to continue to earn on a combined basis, a significant portion of our revenue through these three retirement plan providers. The renegotiation or termination of our relationship with any of these plan providers could negatively impact our business. In 2009, 19%, 12% and 10% of our total revenue was attributable to JPMorgan, ING and Vanguard, respectively, the three retirement plan providers with whom we have subadvisory relationships. Revenue attributable to these three plan providers includes subadvisory fees they pay to us directly, as well as revenue from certain plan sponsors that work with these plan providers but pay us directly. JPMorgan, Vanguard and ING directly accounted for approximately 18%, 10% and 8%, respectively, of our total revenue in 2009.
 
Our contracts with plan providers generally have terms ranging from three to five years, and have successive automatic renewal terms of one year unless terminated in accordance with prior notice requirements. Certain of the plan provider agreements are in or will soon be in renewal periods. For example, our contract with Fidelity will enter a renewal period on April 1, 2010, and our contract with Vanguard will enter a renewal period on December 31, 2010, unless a notice of termination is received by June 30, 2010. A plan provider may also terminate its contract with us at any time for specified breaches. In addition, there are unpredictable factors, other than our performance, that could cause the loss of a plan provider. If we lose one of our plan providers with whom we have a relationship or if one of those plan providers significantly reduces its volume of business with us or renegotiates the economic terms of its contract with us, our revenue, operating results and financial condition could be harmed.
 
Some plan providers with whom we have relationships also provide or may provide competing services.
 
Some plan providers with whom we have relationships, such as Fidelity, offer or may offer directly competing investment guidance, advice and portfolio management services to plan participants. We also face indirect competition from products that could potentially substitute for our


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portfolio management, investment advisory and retirement planning services, most notably target-date retirement funds, which are offered by a number of plan providers with whom we have relationships, including J.P. Morgan, Fidelity and Vanguard.
 
Our revenue is highly dependent upon the plan sponsors with whom we have relationships, and the renegotiation or termination of our relationship with any of these plan sponsors could significantly impact our business.
 
A substantial portion of our revenue is generated as a result of contracts with plan sponsors. Under these contracts, we earn annual platform fees that are paid by the plan sponsor, plan provider or the retirement plan itself as well as fees based on AUM that are generally paid by plan participants. Revenue from contracts in place as of December 31, 2008 accounted for approximately 99% of our total revenue for the year ended December 31, 2009. Our contracts with plan sponsors typically have initial terms of three years and evergreen clauses that extend the initial term until terminated by either party after a specified notice period. At any time during the initial term or thereafter, a plan sponsor can cancel a contract for fiduciary reasons or breach of contract. A plan sponsor can generally terminate a contract after the initial term upon 90 days notice. As of December 31, 2009, the cancellation rate for plan sponsors that offered our Professional Management service over the past 12 months was approximately 3% of our plan sponsors. If a plan sponsor cancels or does not renew a contract, we would no longer earn platform fees under that contract. In addition, we would no longer manage any assets in that plan, and consequently would no longer earn fees based on AUM in that plan. If a significant number of plan sponsors were to cancel their contracts with us or fail to renew those contracts, our revenue, operating results and financial condition would be adversely affected.
 
Our Professional Management service makes up a significant and growing part of our revenue base. Our business could suffer if fees we can charge for these services decline.
 
We earn fees for our Professional Management service based on the value of assets in the accounts we manage. In 2009, asset management fees from our Professional Management service accounted for approximately 62% of our total revenue. We believe that these services will continue to make up a substantial and growing portion of our revenue for the foreseeable future. There are many investment advisory and management services and other financial products available in the market place, which could result in downward pressure on fees for our Professional Management service. Government regulation, such as legislative constraints on fees, could also limit the fees we can charge for our Professional Management service. Performance incentives in contract terms may reduce the fees we charge for our Professional Management service. If we are forced to lower the fees we charge for our Professional Management service, it could harm our revenue, operating results and financial condition.
 
Our failure to increase the number of plan sponsors with whom we have relationships could harm our business.
 
Our future success depends on increasing the number of plan sponsors with whom we have relationships. If the market for our services declines or develops more slowly than we expect, or the number of plan sponsors that choose to provide our services to their plan participants declines or fails to increase as we expect, our revenue, operating results or financial condition could suffer.
 
We rely on plan providers and plan sponsors to provide us with accurate and timely plan and plan participant data in order for us to provide our portfolio management services, investment advice and retirement help, and we rely on plan providers to execute transactions in the accounts we manage.
 
Our ability to provide high-quality portfolio management services, investment advice and retirement help depends on plan sponsors and plan providers supplying us with accurate and timely data. Errors or delays in the data we receive from plan providers or plan sponsors, or missing data,


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could lead us to make advisory or transaction errors that could harm our reputation or lead to financial liability, or may prevent us from providing our services to, or earning revenue from, otherwise eligible plan participants. In addition, when we make changes in an account we manage, we instruct the plan provider to execute the transactions. If a plan provider fails to execute transactions in an accurate and timely manner, it could harm our reputation or lead to financial liability.
 
We may be liable to our plan sponsors, plan participants or plan providers for damages caused by system failures, errors or unsatisfactory performance of services.
 
If we fail to prevent, detect or resolve errors in our services, our business and reputation could suffer. Errors in inputs or processing, such as plan set-ups, transaction instructions or plan participant data, could be magnified across many accounts. Concentrated positions held by many plan participants, particularly in employer stock, could result in a large liability if a systematic input or processing error was to cause us to make errors in transactions relating to those positions. We may not be able to identify or resolve these errors in a timely manner. Since inception of the Professional Management service in 2004 through December 31, 2009, we have made payments to plan participants in an aggregate amount of approximately $360,000 due to system errors and other incidents. In addition, failure to perform our services for Professional Management members on a timely basis could result in liability. We may also have liability to the plan provider where we have a subadvisory relationship with the plan provider. After an error is identified, resolving the error and implementing remedial measures would likely divert the attention and resources of our management and key technical personnel from other business concerns. Any errors in the performance of services for a plan sponsor or plan provider, or poor execution of these services, could result in a plan sponsor or plan provider terminating its agreement. Although we attempt to limit our contractual liability for consequential damages in rendering our services, these limitations on liability may be unenforceable in some cases, or may be insufficient to protect us from liability for damages. ERISA and other applicable laws require that we meet a fiduciary obligation to plan participants. We maintain general liability insurance coverage, including coverage for errors or omissions; however, this coverage may not continue to be available on reasonable terms or may be unavailable in sufficient amounts to cover one or more large claims. An insurer might disclaim coverage as to any future claim. A successful assertion of one or more large claims against us that exceeds our available insurance coverage or changes in our insurance policies, including premium increases or the imposition of a large deductible or co-insurance requirement, could harm our operating results and financial condition.
 
If our reputation is harmed, we could suffer losses in our business and revenue.
 
Our reputation, which depends on earning and maintaining the trust and confidence of plan providers, plan sponsors and plan participants that are current and potential customers, is critical to our business. Our reputation is vulnerable to many threats that can be difficult or impossible to control, and costly or impossible to remediate. Regulatory inquiries or investigations, lawsuits initiated by other plan fiduciaries or plan participants, employee misconduct, perceptions of conflicts of interest and rumors, among other developments, could substantially damage our reputation, even if they are baseless or satisfactorily addressed. In addition, any perception that the quality of our investment advice may not be the same or better than that of other providers can also damage our reputation. Any damage to our reputation could harm our ability to attract and retain plan providers, plan sponsor customers and key personnel. This damage could also cause plan participants to stop using or enrolling in our Professional Management service, which would adversely affect the amount of AUM on which we earn fees.


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Any failure to ensure and protect the confidentiality of plan provider, plan sponsor or plan participant data could lead to legal liability, adversely affect our reputation and have a material adverse effect on our business, financial condition or results of operations.
 
Our services involve the exchange of information, including detailed information regarding plan participants provided by plan providers and plan sponsors, through a variety of electronic and non-electronic means. In addition, plan participants routinely input personal investment and financial information, including portfolio holdings and, in some instances, credit card data, into our systems. We rely on a complex network of process and software controls to protect the confidentiality of data provided to us or stored on our systems. If we do not maintain adequate internal controls or fail to implement new or improved controls, this data could be misappropriated or confidentiality could otherwise be breached. We could be subject to liability if we inappropriately disclose any plan participant’s personal information, or if third parties are able to penetrate our network security or otherwise gain access to any plan participant’s name, address, portfolio holdings, credit card number or other personal information. Any such event could subject us to claims for unauthorized credit card purchases, identity theft or other similar fraud claims or claims for other misuses of personal information, such as unauthorized marketing or unauthorized access to personal information.
 
Many of our agreements with plan sponsors and plan providers do not limit our potential liability for breaches of confidentiality and consequential damages. If any person, including any of our employees, penetrates our network security, misappropriates or mishandles sensitive data, inadvertently or otherwise, we could be subject to significant liability from our plan sponsors and plan providers for breaching contractual confidentiality provisions or privacy laws. In addition, our agreements with plan sponsors and plan providers require us to meet specified minimum system security and privacy standards. Given the growing concern over privacy and identity theft, we have been and expect to continue to be subject to increased scrutiny by both plan providers and plan sponsors, which have increased the frequency and thoroughness of their audits. If we fail to meet these standards, our plan sponsors and plan providers may seek to terminate their agreements with us. Unauthorized disclosure of sensitive or confidential data, whether through breach of our computer systems, systems failure or otherwise, could damage our reputation, expose us to litigation, cause us to lose business, harm our revenue, operating results or financial condition and subject us to regulatory action, which could include sanctions and fines.
 
Privacy concerns could require us to modify our operations.
 
As part of our business, we use plan participants’ personal data. For privacy or security reasons, privacy groups, governmental agencies and individuals may seek to restrict or prevent our use of this data. We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols imposed by law, regulation, industry standards or contractual obligations. Increased domestic or international regulation of data utilization and distribution practices, including self-regulation, could require us to modify our operations and incur significant additional expense, which could have an adverse effect on our business, financial condition and results of operations.
 
Acquisition activity involving plan providers or plan sponsors could adversely affect our business.
 
Acquisitions or similar transactions involving our plan providers or plan sponsors could negatively affect our business in a number of ways. After such a transaction, the plan provider or plan sponsor might terminate, not renew or seek to renegotiate the economic terms of its contract with us. Companies involved in these transactions may experience integration difficulties that could increase the risk of providing us inaccurate or untimely data or delay rollout of our services. Any of our existing plan sponsors may be acquired by an organization or a plan sponsor with no relationship with us, effectively terminating our relationship, or be acquired by a plan sponsor with an online services-only relationship rather than a Professional Management relationship which might cause us to lose business and harm our revenue, operating results or financial condition. Plan providers could be


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acquired by a company offering competing services to ours, which could increase the risk that they terminate their relationship with us, or be acquired by an organization with no relationship with us which might cause us to lose that plan provider, have to renegotiate the economic terms of their contract with us and harm our revenue, operating results or financial condition. For example, in late 2009, ING Groep N.V. announced a restructuring of its business to reduce debt, including the potential sale of certain divisions. Twelve percent of our total revenue in 2009 was attributable to ING Investment Advisors, L.L.C., an indirect subsidiary of ING Groep N.V. We cannot predict the impact, if any, that these corporate actions may have on our revenue, operating results or financial condition.
 
Our ability to compete, succeed and generate profits depends, in part, on our ability to obtain accurate and timely data from third-party vendors on commercially reasonable terms.
 
We currently obtain market and other financial data we use to generate our investment advice from a number of third-party vendors. Termination of one or more of our agreements or exclusion from, or restricted use of a data provider’s information could decrease the information available for us to use and offer our clients and may have a material adverse effect on our business, financial condition or results of operations. For example, we obtain mutual fund data from Lipper, corporate action data from Interactive Data, stock data from MSCI Inc.’s Barra unit and stock price data from FTID. We do not currently have secondary sources or other suppliers for some of these data items. If these data feed agreements were terminated, backup services would take time to set up and our business and results of operations would be harmed. We rely on these data suppliers to provide timely and accurate information and their failure to do so could harm our business.
 
In addition, some data suppliers may seek to increase licensing fees for providing content to us. If we are unable to renegotiate acceptable licensing arrangements with these data suppliers or find alternative sources of equivalent content, we may experience a reduction in our profit margins or market share.
 
Our portfolio management and investment advisory operations may subject us to liability for losses that result from a breach of our fiduciary duties.
 
Our portfolio management and investment advisory operations involve fiduciary obligations that require us to act in the best interests of the plan participants to whom we provide advice or for whom we manage accounts. We may face liabilities for actual or claimed breaches of our fiduciary duties. We may not be able to prevent plan participants, plan sponsors or the plan providers to or through whom we provide investment advisory services from taking legal action against us for an actual or claimed breach of a fiduciary duty. Because we currently provide investment advisory services on substantial assets, we could face substantial liability to plan participants or plan sponsors if we breach our fiduciary duties. In addition, we may face liabilities for actual or claimed deficiencies in the quality or outcome of our investment advisory recommendations, investment management and other services, even in the absence of an actual or claimed breach of fiduciary duty. While we believe that we would have substantial and meritorious defenses against such a claim, we cannot predict the outcome or consequences of any such potential litigation.
 
Competition could reduce our share of the portfolio management, investment advisory and retirement planning market and hurt our financial performance.
 
We operate in a highly competitive industry, with many investment advice providers competing for business from individual investors, financial advisors and institutional customers. Direct competitors that offer independent portfolio management and investment advisory services to plan participants in the workplace include Morningstar, Inc., GuidedChoice and ProManage LLC. Plan providers that offer directly competing portfolio management and investment advisory services to investors in the workplace include Fidelity and Merrill Lynch. We currently have a relationship with Fidelity that allows us to provide our services to plan sponsors that elect to hire us, for which Fidelity is the plan provider. We also face indirect competition from products that could potentially substitute for our portfolio


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management services, investment advice and retirement help, most notably target-date retirement funds. Target-date funds are offered by multiple financial institutions, including BlackRock (formerly Barclays Global Investors), T. Rowe Price, Fidelity and Vanguard. These funds provide generic asset allocation based on the investment horizon of the investor. Target-date funds, managed accounts and balanced funds have been granted Qualified Default Investment Alternative, or QDIA, status by the Department of Labor. Plan providers offer or may choose to offer directly and indirectly competitive products in the future. The plan providers with which we do not have contractually exclusive relationships may enter into similar relationships with our competitors. This in turn may harm our business.
 
Many of our competitors have larger customer bases and significantly greater resources than we do. This may allow our competitors to respond more quickly to new technologies and changes in demand for services, to devote greater resources developing and promoting their services and to make more attractive offers to potential plan providers, plan sponsors and plan participants. Industry consolidation may also lead to more intense competition. Increased competition could result in price reductions or loss of market share, either of which could hurt our business.
 
Our future success depends on our ability to recruit and retain qualified employees, including our executive officers.
 
Our ability to provide portfolio management services, investment advice and retirement help and maintain and develop relationships with plan participants, plan providers and plan sponsors depends largely on our ability to attract, train, motivate and retain highly skilled professionals, particularly professionals with backgrounds in sales, technology and financial and investment services. We believe that success in our business will continue to be based upon the strength of our intellectual capital. For example, due to the complexity of our services and the intellectual capital invested in our investment methodology and technology, the loss of personnel integral to our investment research, product development and engineering efforts would harm our ability to maintain and grow our business. Consequently, we must hire and retain employees with the technical expertise and industry knowledge necessary to continue to develop our services and effectively manage our growing sales and marketing organization to ensure the growth of our operations. We believe there is significant competition for professionals with the skills necessary to perform the services we offer. We experience competition for analysts and other employees from financial institutions and financial services organizations such as hedge funds and investment management companies that generally have greater resources than we do and therefore may be able to offer higher compensation packages. Competition for these employees is intense, and we may not be able to retain our existing employees or be able to recruit and retain other highly qualified personnel in the future. If we cannot hire and retain qualified personnel, our ability to continue to expand our business would be impaired and our revenue could decline.
 
If our intellectual property and technology are not adequately protected to prevent use or appropriation by our competitors, our business and competitive position would suffer.
 
Our future success and competitive position depend in part on our ability to protect our proprietary technology and intellectual property. We rely and expect to continue to rely on a combination of trademark, copyright, patent and trade secret protection laws to protect our proprietary technology and intellectual property. We also require our employees, consultants, vendors, plan sponsors and plan providers to enter into confidentiality agreements with us. We have nine issued U.S. patents, three of which have been issued on our user interface, four of which relate to outcomes-based investing, including our financial advisory system, our pricing module and load-aware optimization, and two of which have been issued on advice palatability. We also have seven pending U.S. patent applications. In addition, we have issued patents and pending applications in foreign jurisdictions. One or more of our issued patents or pending patent applications may be deemed to be directed to methods of doing or conducting business, and may therefore be categorized as so-called


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“business method” patents. The general validity of software patents and “business method” patents has been challenged in a number of jurisdictions, including the United States. The United States Supreme Court is currently considering a case that may impact the scope of patent eligible subject matter. Our patents may become less valuable if software or business methods are found to be a non-patentable subject matter or if additional requirements are imposed that our patents do not meet.
 
The steps we have taken may be inadequate to prevent the misappropriation of our proprietary technology. Our patent and trademark applications may not lead to issued patents and registered trademarks. There can be no assurance that others will not develop or patent similar or superior technologies, products or services, or that our patents, trademarks and other intellectual property will not be challenged, invalidated or circumvented by others. The legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and still evolving. Unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for doing so, which could harm our business. Policing unauthorized use of proprietary technology is difficult and expensive and our monitoring and policing activities may not be sufficient to identify any misappropriation and protect our proprietary technology. In addition, third parties may knowingly or unknowingly infringe our patents, trademarks and other intellectual property rights, and litigation may be necessary to protect and enforce our intellectual property rights. If litigation is necessary to protect and enforce our intellectual property rights, any such litigation could be very costly and could divert management attention and resources.
 
We also expect that the more successful we are, the more likely it becomes that competitors will try to develop products that are similar to ours, which may infringe on our proprietary rights. If we are unable to protect our proprietary rights or if third parties independently develop or gain access to our or similar technologies, our business, revenue, reputation and competitive position could be harmed.
 
Third parties may assert intellectual property infringement claims against us, or our services may infringe the intellectual property rights of third parties, which may subject us to legal liability and harm our reputation.
 
Assertion of intellectual property infringement claims against us, plan providers or plan sponsors could result in litigation. We might not prevail in any such litigation or be able to obtain a license for the use of any infringed intellectual property from a third party on commercially reasonable terms, or at all. Even if obtained, we may be unable to protect such licenses from infringement or misuse, or prevent infringement claims against us in connection with our licensing efforts. We expect that the risk of infringement claims against us will increase if more of our competitors are able to obtain patents for software products and business processes, and if we hire employees who possess third party proprietary information. Any such claims, regardless of their merit or ultimate outcome, could result in substantial cost to us, divert management’s attention and our resources away from our operations and otherwise harm our reputation. Our process for controlling employees’ use of third party proprietary information may not be sufficient to prevent assertions of intellectual property infringement claims against us.
 
Any inability to manage our growth could disrupt our business and harm our operating results.
 
We expect our growth to place significant demands on our management and other resources. Our success will depend in part upon the ability of our senior management to manage growth effectively. Expansion creates new and increased management and training responsibilities for our employees. In addition, continued growth increases the challenges involved in:
 
  •  recruiting, training and retaining sufficient skilled technical, marketing, sales and management personnel;
 
  •  preserving our culture, values and entrepreneurial environment;


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  •  successfully expanding the range of services offered to our plan sponsors and plan participants;
 
  •  developing and improving our internal administrative infrastructure, particularly our financial, operational, compliance, recordkeeping, communications and other internal systems; and
 
  •  maintaining high levels of satisfaction with our services among plan sponsors and plan participants.
 
Our ability to raise capital in the future may be limited, and our failure to raise capital when needed could prevent us from executing our growth strategy.
 
In the absence of this offering, we believe that our existing cash and cash equivalents will be sufficient to fund our planned capital expenditures and other anticipated cash needs for at least the next 12 months. If our capital resources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or obtain debt financing. We have not made arrangements to obtain additional financing and there is no assurance that financing, if required, will be available in amounts or on terms acceptable to us, if at all.
 
We will be subject to additional regulatory compliance requirements, including section 404 of the Sarbanes-Oxley Act of 2002, as a result of becoming a public company, and our management has limited experience managing a public company.
 
We have never operated as a public company and will incur significant legal, accounting and other expenses that we did not incur as a private company. The individuals who constitute our management team have limited experience managing a publicly traded company, and limited experience complying with the increasingly complex and changing laws pertaining to public companies. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives, and we may not successfully or efficiently manage our transition into a public company. We expect rules and regulations such as the Sarbanes-Oxley Act of 2002 to increase our legal and finance compliance costs and to make some activities more time-consuming and costly. We will need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company. For example, Section 404 of the Sarbanes-Oxley Act of 2002 requires that our management report on, and our independent auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting in our annual report on Form 10-K for the fiscal year ending December 31, 2011. Section 404 compliance may divert internal resources and will take a significant amount of time and effort to complete. We may not be able to successfully complete the procedures and certification and attestation requirements of Section 404 by the time we will be required to do so. If we fail to do so, or if in the future our chief executive officer, chief financial officer or independent registered public accounting firm determines that our internal controls over financial reporting are not effective as defined under Section 404, we could be subject to sanctions or investigations by The NASDAQ Stock Market, the Securities and Exchange Commission, or the SEC, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our stock. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent auditors.
 
Our insiders who are significant stockholders may control the election of our board and may have interests that conflict with those of other stockholders.
 
Our directors and executive officers, together with members of their immediate families, beneficially owned, in the aggregate, approximately 47% of our outstanding capital stock as of


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February 1, 2010. As a result, acting together, this group has the ability to exercise significant control over most matters requiring our stockholders’ approval, including the election and removal of directors and significant corporate transactions.
 
We could face liability for certain information we disclose, including information based on data we obtain from other parties.
 
We may be subject to claims for securities law violations, negligence, or other claims relating to the information we disclose, such as the mutual fund assessments we call “scorecards.” Individuals who use our services may take legal action against us if they rely on information that contains an error, or a company may claim that we have made a defamatory statement about it or its employees. We could also be subject to claims based upon the content that is accessible from our website through links to other websites. We rely on a variety of outside parties as the original sources for the information we use in our published data. These sources include securities exchanges, fund companies and transfer agents. Accordingly, in addition to possible exposure for publishing incorrect information that results directly from our own errors, we could face liability based on inaccurate data provided to us by others. Defending claims based on the information we publish could be expensive and time-consuming, and could adversely impact our business, operating results and financial condition.
 
If our operations are interrupted as a result of service downtime or interruptions, our business and reputation could suffer.
 
The success of our business depends upon our ability to obtain and deliver time-sensitive, up-to-date data and information. Our operations and those of our plan providers and plan sponsors are vulnerable to interruption by technical breakdowns, computer hardware and software malfunctions, software viruses, infrastructure failures, fire, earthquake, power loss, telecommunications failure, terrorist attacks, wars, Internet failures and other events beyond our control. Any disruption in our services or operations could harm our ability to perform our services effectively which in turn could result in a reduction in revenue or a claim for substantial damages against us, regardless of whether we are responsible for that failure. We rely on our computer equipment, database storage facilities and other office equipment, which are located primarily in the seismically active San Francisco Bay Area. We maintain off-site back-up facilities in Phoenix, Arizona for our database and network equipment, but these facilities could be subject to the same interruptions that may affect our headquarters. If we suffer a significant database or network facility outage, our business could experience disruption until we fully implement our back-up systems. We also depend on certain significant vendors for facility storage and related maintenance of our main technology equipment and data at these locations. Any failure by these vendors to perform those services, any temporary or permanent loss of our equipment or systems or any disruptions to basic infrastructure like power and telecommunications could impede our ability to provide services to our plan participants, harm our reputation, cause plan participants to stop using our investment advisory or Professional Management services, reduce our revenue and harm our business. Our agreements with our plan providers or plan sponsors also require us to meet specified minimum system security and privacy standards. If we fail to meet these standards, our plan sponsors and plan providers may seek to terminate their agreements with us. This in turn could damage our reputation and harm our market position and business.
 
Risks Related to Our Industry
 
Changes in laws applicable to our portfolio management, investment advisory and retirement planning services may adversely affect our business.
 
We may be adversely affected as a result of new or revised legislation or regulations imposed by the SEC, Department of Labor or other U.S. regulatory authorities or self-regulatory organizations that supervise the financial markets and retirement industry. In addition, we may be adversely affected by


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changes in the interpretation of existing laws and rules by these governmental authorities and self-regulatory organizations. It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law. It is difficult to predict the future impact of the broad and expanding legislative and regulatory requirements affecting our business. For example, legislation or regulation regarding fees may affect our business. Future legislation or regulation could change or eliminate certain existing restrictions relating to conflicts of interest, which might lower the relative value of our independence. Changes to laws or regulations could increase our potential liability for offering portfolio management services, investment advice and retirement help, affect our ability to offer our Passive Enrollment option or invalidate pre-dispute arbitration clauses in our agreements, leading to increased costs to litigate any claims against us. Changes to laws or regulations could also increase our legal compliance costs, divert internal resources and make some activities more time-consuming and costly. The laws, rules and regulations applicable to our business may change in the future, and we may not be able to comply with any such changes. If we fail to comply with any applicable law, rule or regulation, we could be fined, sanctioned or barred from providing investment advisory services in the future, which could materially harm our business and reputation.
 
We are subject to complex regulation, and any compliance failures or regulatory action could adversely affect our business.
 
The financial services industry is subject to extensive regulation at the federal and state levels. It is very difficult to predict the future impact of the legislative and regulatory requirements affecting our business. The securities laws and other laws that govern our activities as a registered investment advisor are complex and subject to rapid change. The activities of our investment advisory and management operations are primarily subject to provisions of the Investment Advisers Act of 1940, referred to as the Investment Advisers Act, and the Employee Retirement Income Security Act of 1974, as amended, referred to as ERISA, as well as certain state laws. We are a fiduciary under ERISA. Our investment advisory services are also subject to state laws including anti-fraud laws and regulations. The Investment Advisers Act addresses, among other things, fiduciary duties, recordkeeping and reporting requirements and disclosure requirements and also includes general anti-fraud prohibitions. If we fail to comply with any applicable law, rule or regulation, we could be fined, sanctioned or barred from providing investment advisory services in the future, which could materially harm our business and reputation. We may also become subject to additional regulatory and compliance requirements as a result of any expansion or enhancement of our existing services or any services we may offer in the future. For example, we may be subject to insurance licensing or other requirements in connection with our retirement planning services, even if our activities are limited to describing regulated products. Compliance with any new regulatory requirements may divert internal resources and take significant time and effort. Any claim of noncompliance, regardless of merit or ultimate outcome, could subject us to investigation by the SEC or other regulatory authorities. This in turn could result in substantial cost to us and divert management’s attention and other resources away from our operations. Furthermore, investor perceptions of us may suffer, and this could cause a decline in the market price of our common stock. Our compliance processes may not be sufficient to prevent assertions that we failed to comply with any applicable law, rule or regulation.
 
We face additional scrutiny when we act as subadvisor, and any failure to comply with regulations or meet expectations could harm our business.
 
Some of the plan providers to whom we are subadvisors are broker-dealers registered under the Securities Exchange Act of 1934, referred to as the Exchange Act, and are subject to the rules of the Financial Industry Regulatory Authority, or FINRA. When we act as a subadvisor, we may be subject to the oversight by regulators of another advisor. We may be affected by any regulatory examination of that plan provider.


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In addition, our subadvisory arrangements are structured to follow Advisory Opinion 2001-09A, a Department of Labor opinion provided to SunAmerica Retirement Markets. Although an advisory opinion provides guidance about the Department of Labor’s interpretation of ERISA, it is directly applicable only to the entity to whom it is issued. SunAmerica Retirement Markets is an entity unrelated to us or the plan providers to which we act as subadvisor. We could be adversely affected if the Department of Labor increases examination of these subadvisory arrangements or changes the interpretive positions described in the Advisory Opinion. We could be adversely affected if ERISA is amended in a way that overturns or materially changes the Department of Labor’s position in Advisory Opinion 2001-09A, such as the imposition of additional requirements relating to conflicts of interest on the plan providers to which we act as a subadvisor. Future legislation or regulation could impose additional requirements relating to conflicts of interest on some of the plan providers to which we act as a subadvisor. These plan providers may not be able to comply with these requirements, and we may therefore not be able to continue to provide our services on a subadvised basis. In such event, we could incur additional costs to transition our services for affected plan providers and their plan sponsors to another structure. Legislation has been introduced in Congress and there have been several Congressional hearings addressing these issues, although final versions of these bills have not been adopted and signed into law, and the final scope and wording of the legislation, or the implementing rules and regulations, are not yet known.
 
If government regulation of the Internet or other areas of our business changes or if consumer attitudes toward use of the Internet change, we may need to change the manner in which we conduct our business or incur greater operating expenses.
 
The adoption, modification or interpretation of laws or regulations relating to the Internet or other areas of our business could adversely affect the manner in which we conduct our business or the overall popularity or growth in use of the Internet. Such laws and regulations may cover sales and other procedures, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts, consumer protection, broadband residential Internet access and the characteristics and quality of services. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses, make it more difficult to renew subscriptions automatically, make it more difficult to attract new subscribers or otherwise alter our business model. Any of these outcomes could have a material adverse effect on our business, financial condition or results of operations.
 
Our business will suffer if we do not keep up with rapid technological change, evolving industry standards or changing requirements of plan sponsors and plan participants.
 
We expect technological developments to continue at a rapid pace in our industry. Our success will depend, in part, on our ability to:
 
  •  continue to develop our technology expertise;
 
  •  recruit and retain skilled investment and technology professionals;
 
  •  enhance our current services;
 
  •  develop new services that meet changing plan sponsor and plan participant needs;
 
  •  advertise and market our services; and
 
  •  influence and respond to emerging industry standards and other technological changes.
 
In addition, we must continue to meet changing plan provider and plan sponsor expectations and requirements, including addressing plan complexities and meeting plan provider and plan sponsor demands for specific features and delivery dates. We must accomplish all of these tasks in a timely


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and cost-effective manner, and our failure to do so could harm our business, including materially reducing our revenue and operating results. Further, a key aspect of our growth strategy is to expand our investment research capabilities and introduce new services. In 2009, our research and development expense represented 18% of our total revenue, as compared to 19% in 2008. We expect that our research and development expense will continue to represent a meaningful percentage of our revenue in the future. A viable market for our new service offerings may not exist or develop, and our offerings may not be well received by potential plan sponsor customers or individual plan participants or investors.
 
Risks Related to this Offering and our Common Stock
 
Our share price may be volatile and you may be unable to sell your shares at or above the offering price.
 
Prior to this offering, there has not been a public market for our common stock. We cannot predict the extent to which a trading market will develop or how liquid that market might become. The initial public offering price for our shares will be determined by negotiations between us and the representative of the underwriters and may not be indicative of prices that will prevail in the trading market. The market price of shares of our common stock could be subject to wide fluctuations in response to many risk factors listed in this section, many of which are beyond our control, including:
 
  •  actual or anticipated fluctuations in our financial condition and operating results;
 
  •  changes in the economic performance or market valuations of other companies engaged in providing portfolio management services, investment advice and retirement help;
 
  •  loss of a significant amount of existing business;
 
  •  actual or anticipated changes in our growth rate relative to our competitors;
 
  •  actual or anticipated fluctuations in our competitors’ operating results or changes in their growth rates;
 
  •  issuance of new or updated research or reports by securities analysts;
 
  •  our announcement of actual results for a fiscal period that are higher or lower than projected results or our announcement of revenue or earnings guidance that is higher or lower than expected;
 
  •  regulatory developments in our target markets affecting us, our plan sponsors or our competitors;
 
  •  fluctuations in the valuation of companies perceived by investors to be comparable to us;
 
  •  share price and volume fluctuations attributable to inconsistent trading volume levels of our shares;
 
  •  sales or expected sales of additional common stock;
 
  •  terrorist attacks or natural disasters or other such events impacting countries where we or our plan sponsors have operations; and
 
  •  general economic and market conditions.
 
Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, interest rate changes or international currency fluctuations, may cause the market price of shares of our common stock to decline. If the market price of shares of our common stock after this offering does not exceed the initial public offering price, you may not


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realize any return on your investment in us and may lose some or all of your investment. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.
 
If securities or industry analysts do not publish research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline.
 
The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
 
Substantial future sales of our common stock in the public market could cause our stock price to fall.
 
Additional sales of our common stock in the public market after this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline. Upon completion of this offering, we will have 39,505,577 shares of common stock outstanding. All shares sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933. The remaining 28,605,577 shares of common stock outstanding after this offering will be available for sale as follows:
 
     
Number of Shares
 
Date of Availability for Sale
 
     
28,148,934
  163 days after the date of this prospectus, subject to extension as described below, due to the release of the lock-up agreements these stockholders have with the underwriters.
     
456,643
  At some point after 163 days after the date of this prospectus, subject to extension as described below, and subject to vesting requirements and the requirements of Rule 144 (subject, in the case of affiliates, to volume limitations) or Rule 701.
 
Our directors, executive officers and substantially all of our stockholders have agreed, with limited exceptions, that they will not sell any shares of common stock owned by them without the prior written consent of Goldman, Sachs & Co., on behalf of the underwriters, for a period of 163 days from the date of this prospectus; provided, however, that if (1) during the last 17 days of the initial lock-up period, we release earnings results or announce material news or a material event or (2) prior to the expiration of the initial lock-up period, we announce that we will release earnings results during the 15-day period following the last day of the initial lock-up period, then in each case the lock-up period will be automatically extended until the expiration of the 17-day period beginning on the date of release of the earnings results or the announcement of the material news or material event, as applicable, unless Goldman, Sachs & Co. waives, in writing, such extension. As a result, the maximum possible lock-up period is 180 days beginning on the date of this prospectus. At any time and without public notice, Goldman, Sachs & Co. may in its sole discretion release some or all of the securities from these lock-up agreements. As resale restrictions end, the market price of our common stock could decline if the holders of those shares sell them or are perceived by the market as intending to sell them. In addition, after this offering, the holders of approximately 23,688,603 shares of common stock, excluding the shares sold in this offering by the selling stockholders, including shares of common stock issuable upon conversion of our preferred stock upon the completion of this offering, will be entitled to rights to cause us to register the sale of those shares under the Securities


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Act. All of these shares are subject to the 163-day lock-up, subject to extension as described above. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration.
 
We intend to file a registration statement under the Securities Act covering 3,326,788 shares of common stock reserved for issuance under our stock plans. This registration statement is expected to be filed soon after the date of this prospectus and will automatically become effective upon filing. Accordingly, shares registered under this registration statement will be available for sale in the open market unless those shares are subject to vesting restrictions with us or the contractual restrictions described above.
 
As a new investor, you will experience immediate and substantial dilution.
 
Purchasers in this offering will immediately experience substantial dilution in net tangible book value. Because our common stock has been sold in the past at prices substantially lower than the initial public offering price that you will pay, you will suffer immediate dilution of $8.39 per share in net tangible book value, based on an assumed initial offering price of $10.00 per share of common stock. The exercise of outstanding options may result in further dilution. In addition, we may raise additional capital through public or private equity or debt offerings, subject to market conditions. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance could result in further dilution to our stockholders.
 
Management may apply our net proceeds from this offering to uses that do not increase our market value or improve our operating results.
 
We intend to use our net proceeds from this offering for general corporate purposes, including as yet undetermined amounts related to working capital and capital expenditures. Our management will have considerable discretion in applying our net proceeds, and you will not have the opportunity, as part of your investment decision, to assess whether we are using our net proceeds appropriately. Until the net proceeds we receive are used, they may be placed in investments that do not produce income or that lose value. We may use our net proceeds for purposes that do not result in any increase in our results of operations, which could cause the price of our common stock to decline.
 
Delaware law and our corporate charter and bylaws will contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.
 
Provisions in our certificate of incorporation and bylaws that we intend to adopt before the completion of this offering may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:
 
  •  the right of the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors;
 
  •  the classification of our board of directors so that only a portion of our directors are elected each year, with each director serving a three-year term;
 
  •  the requirement for advance notice for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;
 
  •  the ability of the board of directors to alter our bylaws without obtaining stockholder approval;
 
  •  the ability of the board of directors to issue, without stockholder approval, up to 10,000,000 shares of preferred stock with rights set by the board of directors, which rights could be senior to those of common stock;
 
  •  the required approval of holders of at least two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or amend or repeal the provisions of


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  our certificate of incorporation regarding the election and removal of directors and the ability of stockholders to take action by written consent; and
 
  •  the elimination of the right of stockholders to call a special meeting of stockholders and to take action by written consent.
 
In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit or restrict large stockholders, in particular, those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our certificate of incorporation and bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future and result in our market price being lower than it would without these provisions.
 
We do not currently intend to pay dividends on our common stock, and consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.
 
We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. In addition, the provisions of our term loan prohibit us from paying cash dividends. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future and the success of an investment in shares of our common stock will depend upon any future appreciation in their value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” In some cases, you can identify forward-looking statements by terms such as “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “design,” “estimate,” “predict,” “potential,” “plan,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements include, but are not limited to, statements about:
 
  •  anticipated trends and challenges in our business and the markets in which we operate;
 
  •  the capabilities, benefits and effectiveness of our services;
 
  •  our plans for future services and enhancements of existing services;
 
  •  our expectations regarding our expenses and revenue;
 
  •  our anticipated cash needs and our estimates regarding our capital requirements and our needs for additional financing;
 
  •  our anticipated growth strategies;
 
  •  our ability to retain and attract customers;
 
  •  our regulatory environment;
 
  •  our legal proceedings;
 
  •  intellectual property;
 
  •  our expectations regarding competition;
 
  •  use of proceeds; and
 
  •  sources of new revenue.
 
These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements.
 
We discuss many of these risks in this prospectus in greater detail under the heading “Risk Factors.” Also, these forward-looking statements represent our estimates and assumptions only as of the date of this prospectus. Unless required by U.S. federal securities laws, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made.
 
You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.


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USE OF PROCEEDS
 
We estimate that we will receive net proceeds from this offering of approximately $52.2 million, based on an assumed initial public offering price of $10.00 per share, the mid-point of the range set forth on the cover of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price of $10.00 per share would increase (decrease) the net proceeds to us from this offering by approximately $5.5 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
 
The principal purposes for this offering are to increase our working capital, create a public market for our common stock, facilitate our access to the public capital markets and increase our visibility in our markets.
 
We currently intend to use our proceeds from this offering for general corporate purposes, including working capital and capital expenditures.
 
As of the date of this prospectus, however, we have not determined all of the anticipated uses for the proceeds of this offering or the amounts that we will actually spend on the uses set forth above. The amount and timing of actual expenditures may vary significantly depending upon a number of factors, including the amount of cash generated from our operations, competitive and technological developments and the rate of growth, if any, of our business. Accordingly, our management will have significant flexibility in applying the net proceeds of this offering. Pending use of the net proceeds as described above, we intend to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities.
 
We will not receive any proceeds from the sale of shares of common stock by the selling stockholders.
 
DIVIDEND POLICY
 
We have never declared or paid any cash dividends on our capital stock. We expect to retain all of our earnings to finance the expansion and development of our business and we do not currently intend to pay any cash dividends on our capital stock in the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Our board of directors will determine future dividends, if any. Our term loan currently prohibits us from paying dividends. See the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”


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CAPITALIZATION
 
The following table describes our capitalization as of December 31, 2009:
 
  •  on an actual basis;
 
  •  on a pro forma basis to give effect to the issuance of 22,441,623 shares of common stock upon the conversion of all of our outstanding shares of preferred stock, 456,643 shares of common stock to be issued to holders of Series E preferred stock upon the completion of this offering and the filing of our amended and restated certificate of incorporation upon the completion of this offering; and
 
  •  on a pro forma basis to give effect to the issuance of 22,441,623 shares of common stock issuable upon the conversion of all of our outstanding shares of preferred stock upon completion of this offering and 456,643 shares of common stock to be issued to holders of Series E preferred stock upon the completion of this offering, as adjusted to further reflect the sale by stockholders of 91,988 shares of common stock to be issued upon exercise of vested stock options immediately prior to the completion of this offering with net proceeds to us of $0.3 million and the sale by us of 5,868,100 shares of common stock in this offering at an assumed initial public offering price of $10.00 per share, the mid-point of the price range set forth on the cover of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
 
You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.
 
                         
    As of December 31, 2009  
                Pro Forma
 
   
Actual
   
Pro Forma
   
As Adjusted
 
    (In thousands, except share data, unaudited)  
 
Cash and cash equivalents
  $ 20,713     $ 20,713     $ 73,386  
                         
Bank borrowings
  $ 8,055     $ $8,055     $ 8,055  
Stockholders’ equity:
                       
Convertible preferred stock, $0.0001 par value per share; 24,192,000 shares authorized, 22,441,623 shares issued and outstanding, actual; 10,000,000 shares authorized; no shares issued or outstanding, pro forma; no shares issued or outstanding, pro forma as adjusted
    2              
Common stock, $0.0001 par value per share; 47,650,000 shares authorized, 10,647,223 shares issued and outstanding, actual; 33,545,489 shares issued and outstanding, pro forma; 500,000,000 shares authorized, 39,505,577 shares issued and outstanding, pro forma as adjusted
    1       3       4  
Additional paid-in capital
    182,018       182,018       234,264  
Deferred compensation
    (394 )     (394 )     (394 )
Accumulated deficit
    (157,361 )     (157,361 )     (157,361 )
                         
Total stockholders’ equity
    24,266       24,266       76,513  
                         
Total capitalization
  $ 32,321     $ 32,321     $ 84,568  
                         


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The actual, pro forma and pro forma as adjusted information set forth in the table above:
 
  •  excludes 11,630,440 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009, at a weighted average exercise price of $6.07 per share;
 
  •  excludes 2,000,000 shares of common stock reserved for future issuance under our 2009 Stock Incentive Plan following the date of this offering, as well as shares originally reserved for issuance under our 1998 Stock Plan, but which may become available for awards under our 2009 Stock Incentive Plan as described below; 
 
  •  excludes 25,000 shares reserved for future issuance under our Special Executive Restricted Stock Plan; and
 
  •  assumes no exercise of the option to purchase additional shares granted to the underwriters.
 
As of December 31, 2009, 1,326,788 shares remained available for future issuance under our 1998 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1998 Stock Plan. Shares originally reserved for issuance under our 1998 Stock Plan, but which are not subject to outstanding options on the effective date of our 2009 Stock Incentive Plan, and shares subject to outstanding options under our 1998 Stock Plan on the effective date of our 2009 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, up to a number of additional shares not to exceed 2,000,000, will also become available for awards under our 2009 Stock Incentive Plan.
 
If the underwriters exercise their option to purchase additional shares of common stock in full, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, net proceeds to us would increase by approximately $15.2 million.
 
A $1.00 increase (decrease) in the assumed initial public offering price of $10.00 per share would increase (decrease) the net proceeds to us from this offering by approximately $5.5 million, or by approximately $7.0 million if the underwriters exercise their option to purchase additional shares of common stock in full, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.


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DILUTION
 
Our pro forma net tangible book value as of December 31, 2009 was $11.3 million, or $0.34 per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the pro forma number of shares of common stock outstanding, assuming the issuance of 22,441,623 shares of common stock upon the conversion of all of our outstanding shares of series A preferred stock, series B preferred stock, series C preferred stock, series D preferred stock, series E preferred stock and series F preferred stock and the issuance of 456,643 shares of common stock to be issued to holders of series E preferred stock upon the completion of this offering. Net tangible book value dilution per share represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after completion of this offering on a pro forma as adjusted basis. After giving effect to the sale by stockholders of 91,988 shares of common stock to be issued upon exercise of vested stock options immediately prior to the completion of this offering and the sale of the 5,868,100 shares of common stock by us at an assumed initial public offering price of $10.00 per share, which is the mid-point of the price range set forth on the cover of this prospectus, and the application of our estimated net proceeds from the offering, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our net tangible book value as of December 31, 2009 would have been $63.5 million, or $1.61 per share of common stock. This represents an immediate increase in net tangible book value of $1.27 per share of common stock to existing common stockholders and an immediate dilution in net tangible book value of $8.39 per share to new investors purchasing shares of common stock in this offering. The following table illustrates this per share dilution:
 
                 
Assumed initial public offering price per share
          $ 10.00  
Pro forma net tangible book value per share before this offering
  $ 0.34          
Increase in pro forma net tangible book value per share attributable to new investors
    1.27          
                 
Pro forma net tangible book value per share after this offering
            1.61  
                 
Dilution in pro forma net tangible book value per share to new investors
          $ 8.39  
                 
 
A $1.00 increase (decrease) in the assumed initial public offering price of $10.00 per share would increase (decrease) the net proceeds to us from this offering by approximately $5.5 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
 
The following table summarizes as of December 31, 2009, on the pro forma basis described above, the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing and new investors purchasing shares of common stock in this offering, before deducting the estimated underwriting discounts and commissions and estimated offering expenses.
 
                                         
                            Average
 
    Shares Purchased     Total Consideration     Price
 
   
Number
   
Percent
   
Amount
   
Percent
   
per Share
 
 
Existing stockholders
    33,545,489       84.9 %   $ 166,494,474       73.9 %   $  4.96  
New investors (shares sold upon exercise of stock options)
    91,988       0.2       273,866       0.1       2.98  
New investors (shares sold by us)
    5,868,100       14.9       58,681,000       26.0       10.00  
                                         
Total
    39,505,577       100.0 %   $ 225,449,340       100.0 %   $ 5.71  
                                         


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The table above:
 
  •  excludes 11,630,440 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009, except 91,988 shares to be issued and sold in this offering upon the exercise of vested stock options, at a weighted average exercise price of $6.07 per share;
 
  •  excludes 2,000,000 shares of common stock reserved for future issuance under our 2009 Stock Incentive Plan following the date of this offering, as well as shares originally reserved for issuance under our 1998 Stock Plan, but which may become available for awards under our 2009 Stock Incentive Plan as described below;
 
  •  excludes 25,000 shares reserved for future issuance under our Special Executive Restricted Stock Plan;
 
  •  includes 456,643 shares of common stock to be issued by us upon the completion of this offering;
 
  •  assumes no exercise of the option to purchase additional shares granted to the underwriters; and
 
  •  excludes amounts paid by us in connection with the repurchase, forfeiture or cancellation of shares of our common stock.
 
To the extent that any outstanding options are exercised, there will be further dilution to new investors.
 
As of December 31, 2009, 1,326,788 shares remained available for future issuance under our 1998 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1998 Stock Plan. Shares originally reserved for issuance under our 1998 Stock Plan, but which are not subject to outstanding options on the effective date of our 2009 Stock Incentive Plan, and shares subject to outstanding options under our 1998 Stock Plan on the effective date of our 2009 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, up to a number of additional shares not to exceed 2,000,000, will also become available for awards under our 2009 Stock Incentive Plan.
 
Sales by selling stockholders in this offering will reduce the number of shares of common stock held by existing stockholders to 28,605,577 or approximately 72.4% of the total number of shares of common stock outstanding after this offering and will increase the number of shares of common stock held by new investors by 5,031,900 to approximately 27.6% of the total number of shares of common stock outstanding after this offering.


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SELECTED CONSOLIDATED FINANCIAL DATA
 
The following selected consolidated financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2008 and 2009, and the selected consolidated statements of operations data for each of the years ended December 31, 2007, 2008 and 2009, have been derived from our audited consolidated financial statements which are included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2005, 2006 and 2007 and the selected consolidated statements of operations data for the years ended December 31, 2005 and 2006 have been derived from our audited consolidated financial statements not included in this prospectus. Historical results are not necessarily indicative of the results to be expected in the future.
 
                                         
    Year Ended December 31,  
   
2005
   
2006
   
2007
   
2008
   
2009
 
    (In thousands, except per share data)  
 
Statements of Operations Data:
                                       
Revenue:
                                       
Professional Management
  $ 4,302     $ 14,597     $ 28,226     $ 38,963     $ 52,579  
Platform
     26,636        28,950        31,374        29,498        30,048  
Other
    7,887       4,686       3,750       2,810       2,355  
                                         
Total revenue
    38,825       48,233       63,350       71,271       84,982  
                                         
Costs and expenses:
                                       
Cost of revenue (exclusive of amortization of internal use software)
    12,990       15,691       20,602       27,588       29,573  
Research and development
    11,732       14,233       14,643       13,663       15,618  
Sales and marketing
    15,728       18,807       19,871       21,157       22,515  
General and administrative
    5,257       5,557       6,663       6,613       7,679  
Withdrawn offering expense
                      3,031        
Amortization of internal use software
    1,756       2,499       3,070       2,258       2,813  
                                         
Total costs and expenses
    47,463       56,787       64,849       74,310       78,198  
                                         
Income (loss) from operations
    (8,638 )     (8,554 )     (1,499 )     (3,039 )     6,784  
Interest expense
    (8 )     (317 )     (961 )     (799 )     (612 )
Interest and other income, net
    490       896       687       236       351  
                                         
Income (loss) before income tax expense
    (8,156 )     (7,975 )     (1,773 )     (3,602 )     6,523  
Income tax expense
    12       8       31       12       834  
                                         
Net income (loss)
    (8,168 )     (7,983 )     (1,804 )     (3,614 )     5,689  
Less: Preferred stock dividend
    697       930             2,362       1,082  
                                         
Net income (loss) attributable to holders of common stock
  $ (8,865 )   $ (8,913 )   $ (1,804 )   $ (5,976 )   $ 4,607  
                                         
Net income (loss) per share attributable to holders of common stock:
                                       
Basic
  $ (1.06 )   $ (1.00 )   $ (0.19 )   $ (0.61 )   $ 0.46  
Diluted
  $ (1.06 )   $ (1.00 )   $ (0.19 )   $ (0.61 )   $ 0.13  
Shares used to compute net income (loss) per share attributable to holders of common stock:
                                       
Basic
    8,340       8,879       9,427       9,767       10,106  
Diluted
    8,340       8,879       9,427       9,767       34,866  
Pro forma net income per share (unaudited):
                                       
Basic (1)
                                  $ 0.17  
Diluted (1)
                                  $ 0.16  
Shares used to compute pro forma net income per share (unaudited):
                                       
Basic(1)
                                    33,005  
Diluted(1)
                                    35,401  
                                         
Non-GAAP Financial Data:
                                       
Adjusted EBITDA(2)
  $ (3,855 )   $ (856 )   $ 8,333     $ 8,409     $ 19,553  
Adjusted net income (loss)(3)
    (7,253 )     (5,024 )     2,612       3,006       11,592  


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(1) See Note 2 to our consolidated financial statements for an explanation of the method used to calculate basic and diluted net income per share and the unaudited pro forma basic and diluted net income per share for the year ended December 31, 2009. All shares to be issued in the offering were excluded from the unaudited pro forma basic and diluted net income per share calculation since the proceeds will be used for general corporate purposes.
 
(2) The table below sets forth a reconciliation of net income (loss) to adjusted EBITDA based on our historical results:
 
                                         
    Year Ended December 31,  
    2005     2006     2007     2008     2009  
    (In thousands, unaudited)  
 
Net income (loss)
  $ (8,168 )   $ (7,983 )   $ (1,804 )   $ (3,614 )   $ 5,689  
Interest (income) expense, net
    (477 )     (580 )     352       563       605  
Income tax expense
    12       8       31       12       834  
Depreciation
    1,219       1,388       1,284       1,641       1,729  
Withdrawn offering expense
                      3,031        
Amortization of internal use software
    1,756       2,488       3,020       2,196       2,711  
Amortization of direct response advertising
                            64  
Amortization of deferred sales commissions
    888       864       1,034       991       1,153  
Stock-based compensation expense
    915       2,959       4,416       3,589       6,768  
                                         
Adjusted EBITDA
  $ (3,855 )   $ (856 )   $ 8,333     $ 8,409     $ 19,553  
                                         
 
(3) The table below sets forth a reconciliation of net income (loss) to adjusted net income (loss) based on our historical results:
 
                                         
    Year Ended December 31,  
    2005     2006     2007     2008     2009  
    (In thousands, unaudited)  
 
Net income (loss)
  $ (8,168 )   $ (7,983 )   $ (1,804 )   $ (3,614 )   $ 5,689  
Stock-based compensation expense, net of tax (1)
    915       2,959       4,416       3,589       5,903  
Withdrawn offering expense
                      3,031        
                                         
Adjusted net income (loss)
  $ (7,253 )   $ (5,024 )   $ 2,612     $ 3,006     $ 11,592  
                                         
 
 
 
  (1)  In 2009, we adjusted stock-based compensation at our effective tax rate of 12.8%. In 2005, 2006, 2007 and 2008, we did not adjust stock-based compensation as income taxes were minimal for each of these periods.
 
                                         
    As of December 31,
   
2005
 
2006
 
2007
 
2008
 
2009
    (In thousands)
 
Balance Sheet Data:
                                       
Cash and cash equivalents
  $  11,156     $  18,196     $  15,015     $  14,857     $ 20,713  
Working capital
    5,715       13,268       16,390       2,490       16,562  
Total assets
    28,697       36,755       42,108       42,302       58,352  
Bank borrowings and note payable
          10,000       10,000       13,500       8,055  
Total liabilities
    16,951       28,988       30,594       31,033       34,086  
Total stockholders’ equity
    11,746       7,767       11,514       11,269       24,266  


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including but not limited to, those set forth under “Risk Factors” and elsewhere in this prospectus.
 
Overview
 
We are a leading provider of independent, technology-enabled portfolio management, investment advice and retirement help to participants in employer-sponsored defined contribution retirement plans, such as 401(k) plans. We use our proprietary advice technology platform to provide our services to millions of retirement plan participants on a cost-efficient basis. Our business model is based on workplace delivery of our services. We target three key constituencies in the retirement plan market: plan participants, plan sponsors and plan providers.
 
We deliver our services to plan sponsors and plan participants primarily through existing connections with eight retirement plan providers. We target large plan sponsors across a wide range of industries, and, as of December 31, 2009, had signed contracts to make our services available through 116 Fortune 500 companies and eight Fortune 20 companies. As of December 31, 2009, we were under contract to provide either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only, through more than 760 plan sponsors with approximately 7.4 million plan participants whose retirement savings represented more than $500 billion in assets. Within this group, we provide our full suite of services to 354 plan sponsors representing approximately 3.9 million participants and approximately $269 billion in Assets Under Contract, or AUC. As of December 31, 2009, we had approximately $25.7 billion in Assets Under Management, or AUM, and managed the accounts of approximately 391,000 members who have delegated investment decision-making authority to us.
 
Financial Engines was co-founded in 1996 by Professor William F. Sharpe, a recipient of the 1990 Nobel Prize in Economic Sciences for his pioneering work on the theory of financial economics, including how prices of financial assets are determined and the link between risk and return, Professor Joseph A. Grundfest, a former SEC commissioner and a professor of law at Stanford Law School, and the late Craig Johnson, then Chairman of the Venture Law Group. The company was founded to address the need for independent investment advice. Traditionally, high quality, personalized investment advice had been available only to large institutions and the affluent. Professor Sharpe’s vision was to leverage technology to make high quality independent advice available to millions regardless of their wealth or investment expertise.
 
A pioneer in our market, we introduced our Online Advice service in 1998. Following the introduction of Online Advice, we focused on expanding our service offerings to provide investors with advice on multiple tax-deferred accounts and taxable investments. Over the next five years, we made significant investments in technology and usability of our platform that allowed us to expand and enhance our service offerings, including our Retirement Evaluation, a personalized printed retirement assessment. In 2004, we launched our Professional Management service to provide personalized and professional portfolio management to retirement plan participants.
 
As part of our growth strategy, we plan to:
 
  •  increase penetration within our current plan sponsors that provide our Professional Management service by increasing enrollment in managed accounts and converting plans from Active Enrollment to Passive Enrollment;


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  •  use our existing technology, expertise and plan provider relationships to enhance and extend our services to include assisting individual investors with IRA accounts and those who are retired and draw income from their investments;
 
  •  expand the number of retirement plan sponsors through our existing relationships with plan providers; and
 
  •  offer our Professional Management service to plan sponsors that currently only provide our Online Advice service.
 
We benefit from a number of attributes of our business model, such as:
 
  •  Subscription-Based Revenue.  The majority of our revenue base in a given year consists of recurring revenue earned from contracts in place prior to the beginning of that year. Revenue from contracts in place as of December 31, 2008 accounted for approximately 99% of our total revenue for the year ended December 31, 2009. Our contracts with plan providers generally have initial terms ranging from three to five years, and have successive automatic renewal terms of one year unless terminated in accordance with prior notice requirements. Some of our plan provider agreements are in, or will soon be in, renewal periods. In addition, our contracts with plan sponsors typically have initial terms of three years and evergreen clauses that extend the initial term until terminated by either party after a specified notice period. At any time during the initial term or thereafter, a plan sponsor can cancel a contract for fiduciary reasons or breach of contract. A plan sponsor can generally terminate a contract after the initial term upon 90 days notice. Since the launch of our Professional Management service in 2004, we have retained over 96% of our plan sponsors each year.
 
  •  Favorable Cost Structure.  We provide our services from a proprietary advice technology platform. In addition, once we establish a relationship with a plan provider, our ongoing costs to manage existing member accounts are significantly lower and we are able to add new plan sponsors and plan participants with less than pro rata incremental expenses.
 
In evaluating our results, we focus on several key operating metrics and financial data including AUC, enrollment rate, AUM, GAAP net income, adjusted EBITDA and adjusted net income. Given our business model, we believe AUC and enrollment rate are indicators of our growth potential.
 
Revenue
 
We generate revenue primarily from management fees on AUM as well as from platform fees by providing portfolio management services, investment advice and retirement help to plan participants of employer-sponsored retirement plans.
 
Professional Management.  We derive Professional Management revenue from management fees paid by plan participants for our Professional Management service. Our Professional Management service is a discretionary investment management service, which includes a Retirement Plan analyzing investments, contribution rate and projected retirement income, and a Retirement Checkup designed to help plan participants to develop a strategy for closing the gap, if any, between the participant’s retirement goal and current retirement income forecast. The services are generally made available to plan participants in a 401(k) plan by written agreements between Financial Engines and the plan provider, plan sponsor and the plan participant.
 
The arrangement generally provides for management fees based on the value of assets we manage for plan participants, and is generally payable quarterly in arrears. Our Professional Management revenue is generally the product of managed accounts fee rates and the value of AUM at the end of each quarter.
 
The following section discusses the factors affecting our AUM, and as a consequence, our Professional Management revenue.


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Overview
 
Our AUM increases or decreases based on several factors, including new asset enrollment rates, asset cancellation rates due to members proactively terminating their membership, members rolling their assets out of the retirement plan and sponsors canceling the Professional Management service, as well as other factors, such as employee and employer contributions into their 401(k) accounts and market fluctuations. If any of these factors reduces our AUM, the amount of fees we would earn for managing those assets would decline, which in turn could negatively impact our revenue.
 
Unlike the clients of many other asset managers, our clients, the plan participants, typically retain the ability to effect certain transactions such as transfers out of their accounts, directly with the plan provider, since our services sit on top of an existing plan provider infrastructure of custodial and record keeping services. We provide our investment advisory and management services based on a summary or “snapshot” of account balances as of a specific moment in time, which we receive from the plan provider. The information we receive from plan providers does not separately identify certain transactions handled by the plan provider, such as the amounts or dates of employer and employee contributions, plan administrative fees other than Professional Management fees, withdrawals, loan withdrawals or repayments, into or from member accounts, or market movement. As a result, we do not have the ability to quantify whether changes in the balance of a particular member’s account are due to any of the foregoing factors or are due to market movement. Accordingly, we cannot quantify the impact of market movement or these other factors on our AUM as a whole.
 
We are, however, able to estimate the impact on our AUM due to AUM from new members, voluntary cancelled AUM and involuntary cancelled AUM. In addition, while we cannot quantify the impact on our AUM of any other single factor, including market movement, we can qualitatively observe how these factors as a whole may impact our AUM, as discussed below.
 
AUM from New Members
 
The enrollment of new members increases our AUM. We receive 401(k) account balances for each member at least weekly, including 401(k) account balances for any new members. Accordingly, we are able to capture the 401(k) account balance within a week of enrollment for any given new member.
 
Cancellations
 
Voluntary Cancelled AUM.  Members may cancel at any time without any requirement to provide advance notice. Our quarter-end AUM excludes the assets of any account cancelled by a member prior to the end of the last day of the quarter. We can quantify this amount for any period by retrieving the account value from the last file received during the week prior to cancellation.
 
Involuntary Cancelled AUM.  Plan sponsors may cancel their contract for the provision of Professional Management services to their plan participants upon specified notice or without notice for fiduciary reasons or breach of contract. If a plan sponsor has provided advance notice of cancellation of the plan sponsor contract, however, the AUM for members of that plan sponsor is included in our AUM until the effective date of cancellation, after which it is no longer part of our AUM. If a member’s account value falls to zero, either upon the effective date of a sponsor cancellation or the member transferring the entire account balance, we treat the account as an involuntary cancellation and quantify the amount for any period by retrieving the account value from the last file received with a positive balance. As of December 31, 2009, the AUM attributable to members in plans for which we had received notice of sponsor cancellation of the Professional Management service was approximately 0.3% of our AUM as of December 31, 2009. As of January 31, 2010, we have received cancellation notices from two plan sponsors covering members representing less than 1.0% of AUM as of December 31, 2009. These cancellations are expected to be effective on or before June 30, 2010.


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Market Movement, Contributions and Other Factors
 
As discussed above, the data files we receive from plan providers do not separately identify certain transactions handled by the plan provider. As a result, we do not have the ability to quantify whether changes in the amount of a particular holding in a member’s account are due to these transactions or are due to market movement. Generally, however, the impact of either rising or declining securities markets on our AUM will largely depend on which asset class or classes are rising or declining, and the relative proportion of that asset class held in aggregate in the portfolios we manage. For example, market gains and losses for fixed income securities and cash have historically been more moderate than market gains and losses for equity securities. Thus, we believe that market gains and losses for equity securities typically have a greater impact on our AUM. As of December 31, 2009, the percentages for the style exposures of the portfolios we managed, in aggregate, were approximately as follows:
 
           
 
Cash
      5 %
Bonds
      25 %
Domestic Equity
      50 %
International Equity
      20 %
Total
      100 %
 
We estimate the aggregate percentage of equity exposures have ranged from a low of approximately 56% to a high of approximately 78% since we began managing assets on a discretionary basis in September 2004. These percentages can be affected by the asset exposures of the overall market portfolio, the demographics of our member population, the number of members who have told us that they want to assume greater or lesser investment risk, and, to a lesser extent given the amount of assets we have under management, the proportion of our members for whom we have completed the transition from their initial portfolio.
 
Increases in our AUM due to employee contributions will depend on the proportion of members who are actively participating in their 401(k) plan and their respective contribution rates. Increases in our AUM due to employer contributions will depend on whether the plan sponsor offers an employer match, the amount of that match and the proportion of members who are active in their 401(k) plan. In most cases, participant contributions are capped by plan and IRS limits.
 
Changes in AUM since inception
 
The following table illustrates the inflows and outflows related to changes in our AUM from period to period:
 
                                                                               
                                                    2009  
In billions, except
                                                     
Professional Management
                                                  January 1 -
      October 1 -
 
revenue data in millions     2004       2005       2006       2007       2008       2009     September 30       December 31  
AUM, beginning of period
    $       $ 1.0       $ 3.3       $ 8.0       $ 16.3       $ 15.6     $ 15.6       $ 23.5  
AUM from New Members (1)
      1.1         2.5         4.4         8.8         7.7         7.3       5.3         2.0  
Voluntary Cancelled AUM (2)
      (0.1 )       (0.4 )       (0.7 )       (1.6 )       (2.8 )       (2.1 )     (1.6 )       (0.5 )
Involuntary Cancelled AUM (3)
                      (0.1 )       (0.4 )       (0.8 )       (1.2 )     (0.9 )       (0.3 )
Other (4)
              0.2         1.1         1.5         (4.8 )       6.1       5.1         1.0  
AUM, end of period
      1.0         3.3         8.0         16.3         15.6         25.7       23.5         25.7  
Professional Management Revenue*
      0.1         4.3         14.6         28.2         39.0         52.6       34.4         18.2  
                                                                               
 
 
 
* in millions
 
All data are shown as of December 31 of the applicable year, except where noted.
 
(1) The aggregate amount of all assets under management, at the time of enrollment, of new members who enrolled in our Professional Management service within the given period.
 
(2) The aggregate amount of assets, at the time of cancellation, for voluntary cancellations occurring when a member terminates their membership in our Professional Management service within the given period.


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(3) The aggregate amount of assets, at the time of cancellation, for involuntary cancellations occurring when the member’s 401(k) plan account balance has been reduced to zero or cancellation of a plan sponsor contract for the Professional Management service has become effective within the given period.
 
(4) Other factors affecting assets under management cannot be separately quantified. These factors primarily consist of employer and employee contributions, plan administrative fees and market movement, and also include participant loans and hardship withdrawals.
 
Since the inception of our Professional Management service in 2004, our year-end AUM has increased in each year other than in 2008. Increases in AUM are primarily due to new members enrolling in the service, and to a lesser extent, employee and employer contributions to the 401(k) plan, and may also reflect rising securities markets. Decreases in AUM are typically due to voluntary and involuntary cancellations, and to a lesser extent, the deduction of plan administrative fees and Professional Management fees and participant loans and hardship withdrawals, and may also reflect declining securities markets.
 
Historically, member cancellations have had a lesser impact on our AUM relative to the positive impact of AUM from new members, in part due to the low historical rate of sponsor cancellations and that our voluntary cancellation rates tend to decrease after the first year of membership and have averaged approximately 1.0% per month during our history. Our voluntary member cancellation rate, measured as a percentage of AUM, was approximately 0.5% for the month of January 2010, as compared to approximately 1.0% for the month of January 2009. The involuntary member cancellation rate, measured as a percentage of AUM, was approximately 0.9% for the month of January 2010, as compared to approximately 0.8% for the month of January 2009. For the month of January 2010, voluntary cancelled AUM was approximately $127 million and involuntary cancelled AUM was approximately $229 million, as compared to approximately $158 million and approximately $118 million for the month of January 2009. Based solely on our historical cancellation rates, we believe that there may be a correlation between the improved condition of the financial markets and lower member cancellation rates generally; however, member satisfaction and other factors, as discussed above, may impact our cancellation rates.
 
While we cannot quantify the impact of market movement on our AUM, we believe the decrease in 2008 in the value of assets in member accounts was primarily due to the decline in the equity markets. Based on the magnitude of this decline, we also believe this decrease in value likely constituted a significant portion of the outflows included as “other.” However, outflows could have also included decreases in employer and employee contributions, loans and withdrawals. We cannot quantify the impact of these other factors as the information we receive from the plan providers does not separately identify these transactions.
 
In 2009, equity markets began to recover. We believe based on the magnitude of this recovery that an increase in the value of assets in member accounts due to the rising equity markets likely constituted the most significant portion of the “other” inflows. However, inflows also included contributions, and offsetting outflows such as loans and hardship withdrawals may have decreased. We believe that aggregate contribution rates in 2009 may reflect relatively lower employer contributions given that some employers suspended or reduced their matching contribution due to adverse economic conditions.
 
Platform.  We derive our platform revenue from recurring, annual subscription-based platform fees for access to either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only. Platform fees are paid by the plan sponsor, plan provider or the retirement plan itself, depending on the plan structure, and vary depending on the type of service provided. Our Online Advice service is a nondiscretionary Internet-based investment advisory service, which includes features such as recommendations among the investment alternatives available in the employer sponsored retirement plan, a summary of the current value of the plan account, a forecast of how much the plan account investments might be worth at retirement, whether a change is recommended to the contribution rate, risk and diversification and/or unrestricted employer stock holdings and a projection of how much the participant may be able to spend at retirement. Plan participants may use the service as frequently as they choose to monitor


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progress toward their financial goals, receive forecasts and investment recommendations and access educational content at our website.
 
Other Revenue.  Other revenue includes reimbursement for marketing and member materials from certain subadvisory relationships, reimbursement for providing personal statements to participants from a limited number of plan sponsors and plan implementation fees. A small portion of other revenue is derived from a defined benefit consulting business.
 
Costs and Expenses
 
Employee compensation and related expenses represent our largest expense. We allocate compensation and other related expenses, including stock-based compensation, to our cost of revenue, research and development, sales and marketing, general and administrative as well as amortization of internal use software expense categories. While we expect our headcount to increase over time, we believe that the economies of scale in our business model will allow us to grow our compensation and related expenses at a lower rate than revenue.
 
Other costs and expenses include the costs of marketing materials and postage, fees paid to plan providers for facilitating the exchange of plan and plan participant data as well as implementing our transaction instructions for member account and amortization and depreciation for hardware and software purchases.
 
The following summarizes our cost of revenue and certain significant operating expenses:
 
Cost of Revenue.  Cost of revenue excludes amortization of internal use software and includes expenses from portfolio management, operations, advisor call center operations, technical operations, including information technology, customer support, installation and set-up costs, data connectivity fees and printed materials costs for certain subadvisory relationships for which we are reimbursed. These expenses are shared across the different revenue categories and we are not able to meaningfully allocate such costs between separate categories of revenue. Consequently, all costs and expenses applicable to our revenue are included in the category cost of revenue in our statements of operations. Costs in this area are primarily related to employee compensation and related expenses, payments to third parties and purchased materials. Amortization of internal use software, a portion of which relates to our cost of revenue, is reflected as a separate line item in our statement of operations.
 
Research and Development.  Research and development expense includes costs associated with defining and specifying new features and ongoing enhancement to our Advice Engines and other aspects of our service offerings, financial research, quality assurance, related administration and other costs that do not qualify for capitalization. Costs in this area are primarily related to employee compensation for our investment research, product development and engineering personnel and related expenses and, to a lesser extent, related external consulting expenses.
 
Sales and Marketing.  Sales and marketing expense includes costs associated with plan provider and plan sponsor relationship management, marketing our services, plan provider and plan sponsor marketing, direct sales, printing of, and postage for marketing materials for, direct advisory relationships and amortization of direct response advertising. Costs in this area are primarily related to employee compensation for sales and marketing personnel and related expenses, which include commissions, printed materials and general marketing programs.
 
General and Administrative.  General and administrative expense includes costs for finance, legal, compliance and administration. Costs in this area include employee compensation and related expenses and fees for consulting and professional services. Following this offering, we expect that we will incur additional expenses as a result of becoming a public company for, among other things, SEC reporting and compliance, including compliance with the Sarbanes-Oxley Act of 2002, director fees, insurance, transfer agent fees and other similar expenses. General and administrative expenses are expected to continue to increase due to incremental headcount increases, the general growth of our business and the costs associated with being a public company.


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Amortization of Internal Use Software.  Amortization expense includes engineering costs associated with developing and enhancing our: (1) systems developed for our internal use for tracking member data, including AUM, member cancellations and other related member statistics and (2) enhancements to our advisory service platform. Associated direct development costs are capitalized and amortized using the straight-line method over the estimated lives of the underlying technology. Costs in this area include employee compensation and related expenses and fees for external consulting services.
 
Critical Accounting Policies and Significant Management Estimates
 
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.
 
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that there are several accounting policies that are critical to understanding our business and prospects for future performance, as these policies affect the reported amounts of revenue and other significant areas that involve management’s judgment and estimates.
 
These significant policies are:
 
  •  Revenue recognition;
 
  •  Deferred sales commissions;
 
  •  Direct response advertising;
 
  •  Valuation of long-lived assets;
 
  •  Income taxes; and
 
  •  Stock-based compensation.
 
These policies and our procedures related to these policies are described in detail below. In addition, please refer to the notes to consolidated financial statements for further discussion of our accounting policies.
 
Revenue Recognition.  We recognize revenue when all four of the following revenue recognition criteria have been met:
 
  •  persuasive evidence of an arrangement exists;
 
  •  the product has been delivered or the service has been performed;
 
  •  the fee is fixed or determinable; and
 
  •  collectibility is reasonably assured.
 
Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires the company to make judgments and estimates. Specifically, arrangements with multiple elements and nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting, including whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting. Other


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significant judgments include determining whether we are acting as the principal in a transaction and whether separate contracts are considered part of one arrangement.
 
Revenue recognition is also impacted by our judgment used in determining allowances for uncollectible receivables. We consider various factors, including a review of specific transactions, the credit-worthiness of the customers, historical experience and market and economic conditions when calculating these provisions and allowances. Estimates are evaluated each quarter to assess the adequacy of the amounts recorded.
 
We generate revenue through three primary sources: Professional Management revenue, platform revenue and other revenue.
 
We generate Professional Management revenue on the value of assets we manage for plan participants, which fees are generally payable quarterly in arrears. Each plan provider sends us a weekly file with the applicable asset values, on a specific day of the week agreed in advance with the plan provider, but which day varies by plan provider. At quarter-end, we use the most recently received file to derive our fees and recognize revenue. Pursuant to the contracts with our members, we calculate our fees based on the asset amounts in these files as received directly from the plan providers, with no judgment or estimates on our part. None of our fees are paid based on a performance or other incentive arrangement. Our fees are not based on a share of the capital gains or appreciation in a member’s account (except as such appreciation is reflected in aggregate AUM). Our fees are determined by the value of the assets in the member’s account at the specified date. Revenue derived from management fees for our Professional Management service is recognized as the services are performed. In certain instances, fees payable by members are deferred for a specified period, and are waived if the member cancels within the specified period. Effective January 1, 2009, we commenced recognizing revenue during certain of these fee deferral periods based on our estimate of the expected retention and cancellation rates determined by historical experience of similar arrangements. We currently only recognize revenue for fee deferral periods of approximately three months or less and where the member has actively enrolled in our Professional Management service. If we use different assumptions for expected retention and cancellation rates, or if actual retention and cancellation rates differ materially from our estimates, future revenue recognized may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and earnings (loss) per share. As a result of recognizing revenue during the fee deferral periods, our revenue during the year ended December 31, 2009 was higher by approximately $301,000 compared to the year ended December 31, 2008.
 
Platform revenue includes annual subscription-based platform fees for access to either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only, and to a lesser extent, setup fees. Platform fees are paid by the plan sponsor, plan provider or the retirement plan itself, depending on the plan structure, and vary depending on the type of service provided. Subscription fees for our Online Advice service are generally paid annually in advance and recognized ratably over the term of the subscription period beginning after the completion of customer setup and data connectivity. Setup fees are recognized ratably over the estimated customer life, which is usually three to five years. Other revenue is recognized as the related services are performed, in accordance with the specific terms of the contract with the customers.
 
Deferred revenue primarily consists of billings or payments received in advance of revenue recognition generated by subscription fees for our Online Advice service and setup fees described above. For these services, we generally invoice our customers in annual or quarterly installments payable in advance. Accordingly, the deferred revenue balance does notrepresent the total contract value of annual or multi-year, noncancelable subscription contracts. Setup fees are recognized ratably over the estimated customer life, which is usually three to five years.


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Deferred Sales Commissions.  We defer certain commission payments to our sales force. Deferred sales commissions consist of incremental costs paid to our direct sales force associated with the execution of noncancelable customer contracts. The deferred sales commission amounts are recoverable through future revenue streams under the noncancelable customer contracts. We believe this is the preferable method of accounting as the commission charges are so closely related to the revenue from the noncancelable customer contracts that they should be recorded as an asset and charged to expense over the life of the related noncancelable customer contracts, which is typically three years. Amortization of deferred sales commissions is included in sales and marketing expense in the accompanying consolidated statements of operations.
 
Direct Response Advertising.  Our advertising costs consist primarily of print materials associated with new customer solicitations. We account for our advertising costs in accordance with Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or Codification or ASC, 340-20, Capitalized Advertising Costs (previously American Institute of Certified Public Accountants Statement of Position (SOP) 93-7, Reporting on Advertising Costs). Advertising costs that do not qualify as direct response advertising are expensed to sales and marketing at the first time the advertisement takes place. Effective July 1, 2009, we commenced capitalization of advertising costs associated with Active Enrollment campaigns on a prospective basis as it was then determined that we had sufficient and verifiable historical patterns over a reasonable period to demonstrate probable future benefits of such campaigns.
 
ASC 340-20 requires the capitalization of direct response advertising only if the primary purpose of the advertising is to elicit sales to customers who could be shown to have responded specifically to the advertising and the direct-response advertising results in probable future benefits. The capitalized costs are amortized over the period over which the future benefits are expected to be received. Because of how we earn revenue from our Professional Management service, demonstrating that the direct-response advertising related to our direct advisory active choice campaigns results in probable future benefits requires us to make several assumptions about the gross revenues we will earn and costs we will incur as a result of each campaign.
 
We have developed forecasting methodologies that have a degree of reliability sufficient to reasonably estimate the future gross revenue stream associated with a given campaign. The significant estimates and judgments we use in our forecasting methodologies include average period of probable future benefits, market movement, AUM cancellation rates and net contribution rates. AUM cancellation rate is defined as the rate at which assets will cancel out of Professional Management program due to voluntary member terminations. A voluntary member termination is when a member contacts Financial Engines and terminates their membership in the Professional Management service. Involuntary cancellations (such as employee terminations, layoffs, etc.) are captured in the net contribution rate. Net contribution rate is defined as the net amount assets will increase as a result of new contributions in to the 401(k) plan less the amount assets will decrease as a result of disbursements from the 401(k) plan. We have estimated the average period of probable future benefits to be three years by analyzing our historical member retention rates and have estimated AUM cancellation rates by analyzing our historical AUM cancellation rates. In light of recent stock market volatility, we currently have assumed no market movement and a zero net contribution rate.
 
At December 31, 2009, $1.4 million of advertising costs associated with Active Enrollment campaigns were reported as assets. Advertising expense was $1.8 million, $2.6 million and $2.2 million for the years ended December 31, 2007, 2008 and 2009, respectively, of which direct advised Active Enrollment campaign expense was $1.6 million, $2.5 million and $2.0 million respectively.
 
The table below evaluates the sensitivity of two of our most significant estimates, namely average period of probable future benefits and assumed market movement, on the realizability of net capitalized direct response advertising costs as of December 31, 2009. This sensitivity analysis


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considered all campaigns that were eligible for capitalization under our current assumptions of a three-year average period of probable future benefits and 0% market movement per year. The sensitivity table indicates the additional impairment charges that would have been recorded as of December 31, 2009 if we had assumed different levels of market movement and/or assumed an estimated period of probable benefits other than 3 years.
 
Additional Expense (Impairments) to be Recognized
 
                                         
    Assumed Market Movement*
 
    (Per year)  
   
(40)%
   
(20)%
   
(10)%
   
0%
   
8%
 
    (In thousands)  
 
Average Period of Probable Future Benefits
                                       
1 year
  $  411     $  356     $  324     $  291     $  261  
2 years
    242       111       77       45       21  
3 years
    193       77       37              
4 years
    202       77       30              
5 years
    241       89       36              
 
* Any percentage change to market movement, net contribution rate and AUM cancellation rate would have the same relative impact on the sensitivity analysis as they all directly impact member AUM.
 
Valuation of Long-Lived Assets.  Long-lived assets, such as property, equipment and capitalized internal use software subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable such as: (a) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (b) a significant adverse change in legal factors or in the business climate that could affect its value, and (c) a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with its use.
 
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. An asset group is the lowest level at which cash flows can be identified that are largely independent of the cash flows of other asset groups. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. Management has determined that the entity level is the lowest level at which cash flows can be identified that are largely independent of the cash flows of other assets and liabilities as our revenue is interdependent on the revenue-producing activities and significant shared operating activities of all long-lived assets. In determining the undiscounted future cash flows expected to be generated at an entity level, we make estimates and judgments about the future cash flows and operating trends such as average member life, market movement, AUM cancellation rates and net contribution rates. We also consider other available information such as our total enterprise value determined for the purpose of estimating the fair value of our common stock, as further discussed below, in assessing the fair value of the entity level asset group.
 
Management evaluates the remaining useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to long-lived assets during the years ended December 31, 2007, 2008 and 2009.


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Income Taxes.  We are subject to income taxes in the U.S. Significant judgments are required in determining the consolidated provision for income taxes.
 
We use the asset and liability method to account for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance to reduce deferred tax assets to an amount whose realization is more likely than not. We recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense.
 
During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. These tax liabilities are recognized when, despite the belief that our tax return positions are supportable, we believe that certain positions may not be fully sustained upon review by tax authorities. We believe that our accruals for tax liabilities are adequate for all open audit years based on our assessment of many factors including past experience and interpretations of tax law. This assessment relies on estimates and assumptions and may involve a series of complex judgments about future events. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact income tax expense in the period in which such determination is made.
 
Management periodically evaluates if it is more likely than not that some or all of the deferred tax assets will be realized. In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. In order to support a conclusion that a valuation allowance is not needed, positive evidence of sufficient quantity and quality (objective compared to subjective) is necessary to overcome negative evidence. During the years ended December 31, 2007, 2008 and 2009, management determined there was significant negative evidence to conclude that it was more likely than not that the net deferred tax assets would not be realized and accordingly established a full valuation allowance. The lack of profitability prior to 2009 is a significant piece of negative evidence and generally precludes management’s estimate of forecasted future taxable income as positive evidence in its assessment. As a result, a valuation allowance is recognized for the net deferred tax assets as of December 31, 2009. In the event we become consistently more profitable in future periods and were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes in the period such determination was made.
 
As of December 31, 2009, we had net operating loss carryforwards for federal and state income tax purposes of approximately $134 million and $60 million, respectively, available to reduce future income subject to income taxes. The federal net operating loss carryforwards expire through 2029. The state net operating loss carryforwards expire through 2019.
 
As of December 31, 2009, approximately $6.3 million of the net operating losses will benefit additional paid in capital when realized. As of December 31, 2009, we also had research credit carryforwards for federal and California income tax purposes of approximately $1.8 million and $853,000, respectively, available to reduce future income taxes. The federal research credit carryforwards expire through 2029. The California research credit carries forward indefinitely.
 
We are currently under examination by the Internal Revenue Service for our domestic federal income tax returns for the years ended December 31, 2006 and 2007. We anticipate a decrease to our gross unrecognized tax benefits, including those associated with research credits, related to prior returns resulting from such examinations in the range of $0 to $3.8 million.


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Stock-Based Compensation.  Stock-based compensation for stock awards is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes option pricing model and is recognized as expense over the requisite service period. The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price and related volatility over the expected term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate, estimated forfeitures and expected dividends.
 
                         
    Year Ended
 
    December 31,  
    2007     2008     2009  
 
Expected life in years
    6.08       6.06       6.07  
Risk-free interest rate
    4.46 %     2.58 %     2.62 %
Volatility
    35       52       53  
Dividend yield
                 
 
Effective January 1, 2007, we use the “simplified” method in developing an estimate of expected term of stock options as we expect our employee exercise behavior to change resulting from our announced plans for an initial public offering. We base the risk-free interest rate on zero-coupon yields implied from U.S. Treasury issues with remaining terms similar to the expected term on the options. We estimate expected volatility based on a combination of the historical and implied volatility of comparable companies from a representative peer group based on industry and market capitalization data. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model. 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. If we use different assumptions for estimating stock-based compensation expense in future periods or if actual forfeitures differ materially from our estimated forfeitures, future stock-based compensation expense may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income (loss) and net income (loss) per share.
 
Given the absence of an active market for our common stock, our stock price at any given time is determined by our board of directors. Our board of directors considers numerous objective and subjective factors in determining the value of our common stock at each option grant date, including the following factors:
 
  •  prices for our preferred stock that we had sold to outside investors in arms-length transactions, and the rights, preferences and privileges of our preferred stock and our common stock;
 
  •  contemporaneous independent valuations performed at three to four month periodic intervals;
 
  •  secondary sales of shares of our common stock;
 
  •  our actual financial condition and results of operations relative to our operating plan during the relevant period;
 
  •  forecasts of our financial results and overall market conditions;
 
  •  the market value of the stock or other equity interests of similarly situated companies whose value can be readily determined through objective means;
 
  •  hiring of key personnel; and
 
  •  the likelihood of achieving a liquidity event for the shares of common stock underlying the options, such as an initial public offering or sale of the company, given prevailing market conditions at the time of grant.


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Our board of directors believe that the judgment required in such efforts necessarily involve an element of subjectivity.
 
Our contemporaneous valuations were performed in accordance with methods specified by the AICPA Practice Aid on “Valuation of Privately-Held Company Equity Securities Issued as Compensation.” These contemporaneous valuations of our common stock were performed as of December 31, 2006, June 30, 2007, December 31, 2007, March 31, 2008, June 30, 2008, October 31, 2008, January 31, 2009, April 30, 2009, July 31, 2009 and October 31, 2009. Our board of directors considered these valuations in determining the fair market value of our common stock during those periods. The valuations use the income approach method. The income approach involves applying appropriate risk-adjusted discount rates to estimated debt-free cash flows, based on forecasted revenues and costs. The discount rate applied to our cash flows was based on a weighted average cost of capital, which represents the blended, after-tax costs of debt and equity. The projections used in connection with this valuation were based on our expected operating performance over the forecast period. The valuations also considered the public company market multiple method to evaluate the reasonableness of the income approach. The public company market multiple method focuses on comparing our company to similar publicly traded entities. The valuations also considered differences between our preferred and common stock with respect to liquidation preferences, conversion rights, voting rights and other features. We also considered appropriate adjustments to recognize lack of marketability.
 
For empirical evidence on adjustments for lack of marketability, the contemporaneous evaluations relied upon studies based on restricted stocks of companies whose unrestricted shares are freely traded as a basis, and specifically on studies performed since 1991 and for which detailed data were available. Indications from studies of private transactions prior to initial public offerings were used as reasonableness checks against the concluded indications. The overall study discounts in the restricted stock studies used in the analysis ranged from 21.8% to 33.8%. Average marketability discount indications from restricted stock studies performed prior to 1991 and pre-IPO studies ranged from 20% to 59%.
 
Based on this analysis, a benchmark company-specific adjustment for lack of marketability was derived. To arrive at the concluded company-specific adjustment from the benchmark company-specific adjustment, additional factors not considered in the benchmark analysis were then analyzed. These factors included financial statement analysis, dividend policy and our history/nature, reputation and experience of our management, amount of control in transferred shares, transfer or sale restrictions, holding period and redemption policy. After analysis of each of these factors, it was concluded that these factors would not materially impact the adjustment except for our history/nature. Our performance is closely tied to the performance of the financial markets. Due to the high volatility in the financial markets and uncertainty of future financial market performances, we are assumed to be of higher risk than the benchmark transactions, thus this factor would increase the adjustment.
 
The following table summarizes the concluded company-specific adjustments for lack of marketability as of the valuation dates noted:
 
                 
    Concluded Company-
   
Valuation Date
  Specific Adjustment   Fair Value
 
As of January 30, 2009
    20 %   $ 5.79  
As of April 30, 2009
    20 %   $ 6.04  
As of July 31, 2009
    15 %   $ 6.95  
As of October 31, 2009
    15 %   $ 7.99  
 
No other discounts were applied to arrive at the fair value amount, other than the lack of marketability discount discussed above.


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In order to determine the value of our common stock, we utilized the total enterprise value in an option-based framework. Using this method, the common stock value is viewed as a claim on the enterprise’s liquidation or IPO proceeds after debt holders and preferred stockholders have been paid their principal and interest or liquidation preferences. This approach considers that the value associated with the common shares is based on our performance relative to the liquidation preferences of other share classes. There is inherent uncertainty in the estimates used in our valuations. If different discount rates, assumptions or weightings had been used, the valuations would have been different.
 
Results of Operations
 
Comparison of the Years Ended December 31, 2008 and 2009
 
                                 
    Year
       
    Ended
       
    December 31     Increase (Decrease)  
   
2008
   
2009
   
Amount
   
%
 
    (In thousands)  
 
Revenue:
                               
Professional Management
  $   38,963     $   52,579     $   13,616       35 %
Platform
    29,498       30,048       550       2  
Other
    2,810       2,355       (455 )     (16 )
                                 
Total revenue
    71,271       84,982       13,711       19  
                                 
Costs and expenses:
                               
Cost of revenue
    27,588       29,573       1,985       7  
Research and development
    13,663       15,618       1,955       14  
Sales and marketing
    21,157       22,515       1,358       6  
General and administrative
    6,613       7,679       1,066       16  
Withdrawn offering expense
    3,031             (3,031 )     n/a  
Amortization of internal use software
    2,258       2,813       555       25  
                                 
Total costs and expenses
    74,310       78,198       3,888       5  
                                 
Income (loss) from operations
    (3,039 )     6,784       9,823       n/a  
Interest expense
    (799 )     (612 )     187       (23 )
Interest and other income, net
    236       351       115       49  
                                 
Income (loss) before income tax expense
    (3,602 )     6,523       10,125       n/a  
Income tax expense
    12       834       822       n/a  
                                 
Net income (loss)
  $ (3,614 )   $ 5,689     $ 9,303       n/a  
                                 
 
Revenue
 
Total revenue increased 19% from $71.3 million in 2008 to $85.0 million in 2009. The increase was primarily due to growth in Professional Management revenue of $13.6 million. Professional Management revenue and platform revenue comprised 62% and 35%, respectively, of total revenue in 2009.
 
Professional Management Revenue
 
Professional Management revenue increased 35% from $39.0 million in 2008 to $52.6 million in 2009. This increase was primarily due to an increase in average AUM from $17.1 billion in 2008 to $21.2 billion in 2009. The increase in AUM was driven primarily by market appreciation, increased enrollment resulting from marketing campaigns and other ongoing member acquisitions.


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Platform Revenue
 
Platform revenue increased 2% from $29.5 million in 2008 to $30.0 million in 2009, due to an increased number of plan participants with respect to whom platform fees are paid, which was primarily due to an increase in the number of plan sponsors who use one or more of our services.
 
Other Revenue
 
Other revenue decreased 16% from $2.8 million in 2008 to $2.4 million in 2009. This decrease was primarily due to a reduction in revenue related to the reimbursement of personal evaluation expenses of $0.6 million, partially offset by an increase of $0.2 million in reimbursement for marketing materials from certain subadvisory relationships.
 
Cost of Revenue
 
Cost of revenue increased 7% from $27.6 million in 2008 to $29.6 million in 2009. This increase was primarily due to an increase of $2.7 million in the fees paid to plan providers for connectivity to plan and plan participant data and $0.9 million in bonus expense. These increases were partially offset by a decrease of $1.1 million in printing and postage of member materials and personal statements, and recruiting expense of $0.2 million. As a percentage of revenue, cost of revenue decreased from 39% in 2008 to 35% in 2009. The decrease as a percentage of revenue was primarily due to slower increases in payroll and employee-related expenses relative to the increase in revenue during the same period.
 
Research and Development
 
Research and development expense increased 14% from $13.7 million in 2008 to $15.6 million in 2009. This increase was primarily due to higher bonus expense of $1.7 million and stock-based compensation of $0.9 million, partially offset by increased capitalization of internal use software of $0.9 million. As a percentage of revenue, research and development expense decreased from 19% in 2008 to 18% in 2009.
 
Sales and Marketing
 
Sales and marketing expense increased 6% from $21.2 million in 2008 to $22.5 million in 2009. This increase was primarily due to higher bonus expense of $1.5 million, stock-based compensation of $0.8 million and participant communication expense of $0.8 million. This increase was partially offset by the capitalization of direct response advertising costs of $1.5 million in the second half of 2009 and a decrease of $0.3 million in consulting expense due to a rebranding effort in 2008. As a percentage of revenue, sales and marketing expense decreased from 30% in 2008 to 26% in 2009. The decrease as a percentage of revenue was primarily due to the capitalization of direct response advertising costs in the second half of 2009.
 
General and Administrative
 
General and administrative expense increased 16% from $6.6 million in 2008 to $7.7 million in 2009. This increase was primarily due to increased stock-based compensation expense of $0.8 million and bonus expense of $0.6 million, offset by a $0.2 million reduction in recruiting expense. As a percentage of revenue, general and administrative expense remained flat at 9% for 2008 and 2009.
 
Amortization of Internal Use Software
 
Amortization expense increased 25% from $2.3 million in the 2008 to $2.8 million in 2009. This increase was primarily due to increased capitalized development costs in late 2008. These costs include engineering costs associated with developing and enhancing our internally developed software.


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Interest Expense
 
Interest expense decreased 23% from $0.8 million in 2008 to $0.6 million in the 2009. This decrease was due to a $10.0 million term loan entered into in April 2009 with an effective interest rate lower than our previously outstanding $10.0 million promissory note.
 
Interest and Other Income, Net
 
Interest and other income increased 49% from $0.2 million in the 2008 to $0.4 million in 2009, as a result of other income of $0.2 million associated with the payoff of our previously outstanding $10.0 million note and $0.1 million adjustment to the fair value of a warrant, offset by lower money market rates.
 
Taxes and Net Loss
 
Taxes for 2008 were de minimis, as compared to $0.8 million for 2009. The income tax increase for 2009 was primarily a result of increased state taxes due to operating income in 2009 compared to a loss in 2008 and limitations on our use of net operating loss carryforwards in 2008.
 
Comparison of Years Ended December 31, 2007 and 2008
 
                                 
    Year Ended December 31,     Increase (Decrease)  
   
2007
   
2008
   
Amount
    %  
          (In thousands)              
 
Revenue:
                               
Professional Management
  $  28,226     $  38,963     $  10,737       38 %
Platform
    31,374       29,498       (1,876 )     (6 )
Other
    3,750       2,810       (940 )     (25 )
                                 
Total revenue
    63,350       71,271       7,921       13  
                                 
Costs and expenses:
                               
Cost of revenue
    20,602       27,588       6,986       34  
Research and development
    14,643       13,663       (980 )     (7 )
Sales and marketing
    19,871       21,157       1,286       6  
General and administrative
    6,663       6,613       (50 )     (1 )
Withdrawn offering expense
          3,031       3,031       n/a  
Amortization of internal use software
    3,070       2,258       (812 )     (26 )
                                 
Total costs and expenses
    64,849       74,310       9,461       15  
                                 
Loss from operations
    (1,499 )     (3,039 )     (1,540 )     103  
Interest expense
    (961 )     (799 )     162       (17 )
Interest and other income, net
    687       236       (451 )     (66 )
                                 
Loss before income tax expense
    (1,773 )     (3,602 )     (1,829 )     103  
Income tax expense
    31       12       (19 )     (61 )
                                 
Net loss
  $ (1,804 )   $ (3,614 )   $ (1,810 )     100  
                                 
 
Revenue
 
Total revenue increased 13% from $63.4 million in 2007 to $71.3 million in 2008. The increase was primarily due to growth in Professional Management revenue of $10.7 million. Professional Management revenue and platform revenue comprised 55% and 41%, respectively, of total revenue in 2008.


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Professional Management Revenue
 
Professional Management revenue increased 38% from $28.2 million in 2007 to $39.0 million in 2008. This increase was primarily due to an increase in average AUM from $12.6 billion in 2007 to $17.1 billion in 2008. The increase in AUM was driven primarily by increased enrollment arising from marketing campaigns and other ongoing member acquisitions.
 
Platform Revenue
 
Platform revenue decreased 6% from $31.4 million in 2007 to $29.5 million in 2008, due to reduced setup fees of $1.6 million primarily related to a one-time recognition of revenue from certain non-customary multiple element contracts including deliverables requiring the deferral of revenue recognition prior to the completion of final deliverables in 2007. A decreased number of plan participants at plan sponsors who use one or more of our services resulted in an additional $0.4 million reduction in platform revenue.
 
Other Revenue
 
Other revenue decreased 25% from $3.8 million in 2007 to $2.8 million in 2008. This decrease was due primarily to our decision to phase out a service directed to brokers and other investment professionals offered in 2007 but not offered in 2008, and which we do not currently expect to offer in subsequent years, as well as a reduction in revenue related to reimbursement of personal evaluation expenses of $0.4 million.
 
Cost of Revenue
 
Cost of revenue increased 34% from $20.6 million in 2007 to $27.6 million in 2008. This increase was primarily due to an increase of $3.0 million in fees paid to plan providers to facilitate the exchange of plan and plan participant data as well as implementing our transaction instructions for member accounts, $2.0 million in employee-related expense associated with an increase in the number of service delivery employees, $1.3 million in costs associated with the printing of, and postage for, member materials and $0.7 million in depreciation, maintenance and hosting fees associated with our data centers. As a percentage of revenue, cost of revenue increased from 33% in 2007 to 39% in 2008.
 
Research and Development
 
Research and development expense decreased 7% from $14.6 million in 2007 to $13.7 million in 2008. This decrease was primarily due to reduced bonus expense of $1.3 million, partially offset by increased capitalization of internal use software of $0.5 million. As a percentage of revenue, research and development expense decreased from 23% in 2007 to 19% in 2008.
 
Sales and Marketing
 
Sales and marketing expense increased 6% from $19.9 million in 2007 to $21.2 million in 2008. This increase was primarily due to additional marketing material expense of $0.9 million, selling and consulting expense of $0.8 million associated with a marketing rebranding effort in 2008 and $0.5 million in salary expense associated with increased headcount. These increases were partially offset by a reduction in bonus expense of $1.3 million. As a percentage of revenue, sales and marketing expense decreased from 31% in 2007 to 30% in 2008.
 
General and Administrative
 
General and administrative expense decreased 1% from $6.7 million in 2007 to $6.6 million in 2008. This decrease was primarily due to reduced stock-based compensation of $0.6 million, bonus expense of $0.5 million and bad debt expense of $0.3 million, partially offset by an increase of


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$0.4 million in salary expense associated with increased headcount and compensation, as well as increased legal and audit fees of $0.3 and $0.2 million, respectively. As a percentage of revenue, general and administrative expense decreased from 11% in 2007 to 9% in 2008.
 
Withdrawn Offering Expense
 
As of November 2008, we had incurred $3.0 million of costs directly attributable to a planned initial public offering. These costs were being deferred until the completion of the offering. In the quarter ended December 31, 2008, these costs were charged to expense as a result of our decision in November 2008 to cease efforts to pursue an initial public offering because of the disruption in the equity capital markets and general adverse economic conditions present at that time.
 
Amortization of Internal Use Software
 
Amortization expense decreased 26% from $3.1 million in 2007 to $2.3 million in 2008, primarily due to an increase in the average life of capitalized development costs subject to amortization. The increase in the average life was primarily driven by our newer projects having a longer expected life than our historical projects. These costs include engineering costs associated with developing and enhancing our internally developed software.
 
Interest Expense
 
Interest expense decreased from $1.0 million in 2007 to $0.8 million in 2008. This decrease was due to lower interest rates associated with a $10.0 million promissory note secured in September 2006 with a variable interest rate of three-month LIBOR plus 5% per annum and a maturity date of September 29, 2009.
 
Interest and Other Income, Net
 
Interest income decreased from $0.7 million in 2007 to $0.2 million in 2008 as a result of generally lower money market rates and cash balances.
 
Taxes and Net Loss
 
Taxes remained low as a result of net losses for the year in 2007 and 2008. We were subject to state minimum tax in both years as well as federal alternative minimum tax in 2007.


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Comparison of Years Ended December 31, 2006 and 2007
 
                                 
          Increase
 
    Year Ended December 31,     (Decrease)  
   
2006
   
2007
   
Amount
   
%
 
          (In thousands)              
 
Revenue:
                               
Professional Management
  $  14,597     $  28,226     $  13,629       93 %
Platform
    28,950       31,374       2,424       8  
Other
    4,686       3,750       (936 )     (20 )
                                 
Total revenue
    48,233       63,350       15,117       31  
                                 
Costs and expenses:
                               
Cost of revenue
    15,691       20,602       4,911       31  
Research and development
    14,233       14,643       410       3  
Sales and marketing
    18,807       19,871       1,064       6  
General and administrative
    5,557       6,663       1,106       20  
Amortization of internal use software
    2,499       3,070       571       23  
                                 
Total costs and expenses
    56,787       64,849       8,062       14  
                                 
Loss from operations
    (8,554 )     (1,499 )     7,055       (82 )
Interest expense
    (317 )     (961 )     (644 )     203  
Interest and other income, net
    896       687       (209 )     (23 )
                                 
Loss before income tax expense
    (7,975 )     (1,773 )     6,202       78  
Income tax expense
    8       31       23       288  
                                 
Net loss
  $ (7,983 )   $ (1,804 )   $ 6,179       77  
                                 
 
Revenue
 
Total revenue increased 31% from $48.2 million in 2006 to $63.4 million in 2007. The increase was primarily due to growth in Professional Management revenue of $13.6 million. Professional Management revenue and platform revenue comprised 45% and 50%, respectively, of total revenue in 2007.
 
Professional Management Revenue
 
Professional Management revenue increased 93% from $14.6 million in 2006 to $28.2 million in 2007. This increase was primarily due to an increase in average AUM from $5.7 billion in 2006 to $12.6 billion in 2007. The increase in AUM was driven primarily by increased enrollment arising from marketing campaigns and other ongoing member acquisitions.
 
Platform Revenue
 
Platform revenue increased 8% from $29.0 million in 2006 to $31.4 million in 2007, due primarily to an increased number of plan participants at plan sponsors who use one or more of our services.
 
Other Revenue
 
Other revenue decreased 20% from $4.7 million in 2006 to $3.8 million in 2007. This decrease was due primarily to our decision to phase out a service offered in 2007, but which we do not currently expect to offer in subsequent years, as well a decrease in consulting fees of $0.3 million, partially offset by an increase in revenue related to reimbursement for marketing and member materials of $1.0 million from certain subadvisory relationships.


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Cost of Revenue
 
Cost of revenue increased 31% from $15.7 million in 2006 to $20.6 million in 2007. This increase was primarily due to an increase of $2.0 million in costs associated with the printing of, and postage for, subadvisory marketing and member materials, $1.5 million in increased payroll-related expense, including $0.3 million in stock-based compensation associated with an increase in the number of service delivery employees and $1.1 million in fees paid to plan providers to facilitate the exchange of plan and plan participant data, as well as implementing our transaction instructions for member accounts. As a percentage of revenue, cost of revenue remained flat at 33% for both 2006 and 2007.
 
Research and Development
 
Research and development expense increased 3% from $14.2 million in 2006 to $14.6 million in 2007. This increase was primarily due to increased payroll and employee-related expenses of $1.1 million, including stock-based compensation expense of $0.2 million, offset by increased capitalization of website development costs of $0.8 million. As a percentage of revenue, research and development expense decreased from 30% in 2006 to 23% in 2007.
 
Sales and Marketing
 
Sales and marketing expense increased 6% from $18.8 million in 2006 to $19.9 million in 2007. This increase was primarily due to increased payroll and employee-related expense of $0.9 million and increased marketing materials for direct advisory relationships of $0.7 million. As a percentage of revenue, sales and marketing expense decreased from 39% in 2006 to 31% in 2007.
 
General and Administrative
 
General and administrative expense increased 20% from $5.6 million in 2006 to $6.7 million in 2007. This increase was primarily due to increased payroll and employee-related expenses of $1.4 million, including stock-based compensation expense of $1.0 million. As a percentage of revenue, general and administrative expense decreased from 12% in 2006 to 11% in 2007.
 
Amortization of Internal Use Software
 
Amortization expense increased 23% from $2.5 million in 2006 to $3.1 million in 2007. This increase was primarily due to an increase of capitalized development costs subject to amortization. These costs include engineering costs associated with developing and enhancing our internally developed software.
 
Interest Expense
 
Interest expense increased from $0.3 million in 2006 to $1.0 million in 2007. This increase was due to a higher effective interest rate on our $10.0 million promissory note in 2007 as compared to 2006.
 
Interest and Other Income, Net
 
Interest income decreased from $0.9 million in 2006 to $0.7 million in 2007 largely as a result of generally lower cash balances and money market rates.
 
Taxes and Net Loss
 
Taxes remained low as a result of net losses for the year in 2006 and 2007. We were subject to state minimum tax in both years as well as federal alternative minimum tax in 2007.
 
Quarterly Results of Operations
 
The following table sets forth our unaudited quarterly condensed consolidated statements of operations data for each of the eight quarters ended December 31, 2009. The data have been


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prepared on the same basis as the audited consolidated financial statements and related notes included in this prospectus and you should read the following tables together with such financial statements. The quarterly results of operations include all necessary adjustments, consisting only of normal recurring adjustments that we consider necessary for a fair presentation of this data. Results of interim periods are not necessarily indicative of results for the entire year and are not necessarily indicative of future results.
 
Our Professional Management revenue generally increased sequentially in each of the quarters presented as a result of AUM growth driven primarily by new rollouts and annual campaigns. Professional Management revenue decreased in the first quarter of 2009 compared to the prior quarter, primarily due to the fee structure with one of our plan providers under which we recognize the difference between earned revenue and minimum contractual revenue in the fourth quarter. Platform revenue has generally increased quarter over quarter as a result of new business, partially offset by the phase-out of services related to investment guidance.
 
Total costs and expenses have fluctuated both in absolute dollars and percentage of revenue from quarter to quarter due primarily to stock-based compensation, amortization of internal use software, costs related to marketing campaigns and costs associated with headcount across all functions. Cost of revenue generally increased in absolute dollars each quarter presented as a result of higher data connectivity fees and member materials incurred to support the increase in revenue. Cost of revenue decreased in the fourth quarter of 2008 and the first quarter of 2009 due to a decrease in revenue resulting from the decline in equity markets in the fourth quarter of 2008.
 
                                                                 
    Three Months Ended  
    Mar. 31,
    June 30,
    Sept. 30,
    Dec. 31,
    Mar. 31,
    June 30,
    Sept. 30,
    Dec. 31,
 
Condensed Consolidated Statements of Operations Data:  
2008
   
2008
   
2008
   
2008
   
2009
   
2009
   
2009
   
2009
 
    (In thousands, except per share data, unaudited)  
 
Revenue:
                                                               
Professional Management
  $ 8,964     $ 9,018     $ 9,913     $ 11,068     $ 9,593     $ 11,137     $ 13,646     $ 18,203  
Platform
    7,351       7,343       7,498       7,306       7,220       7,704       7,602       7,522  
Other
    519       886       772       633       595       588       762       410  
                                                                 
Total revenue
    16,834       17,247       18,183       19,007       17,408       19,429       22,010       26,135  
                                                                 
Costs and expenses:
                                                               
Cost of revenue (exclusive of amortization of internal use software)
    5,983       7,087       7,441       7,077       6,601       6,910       7,546       8,516  
Research and development
    3,464       3,529       3,303       3,367       3,688       3,711       3,967       4,252  
Sales and marketing
    4,370       6,245       5,444       5,098       5,360       6,001       5,328       5,826  
General and administrative
    1,855       1,530       1,542       1,686       1,842       1,773       1,744       2,320  
Withdrawn offering expense
                      3,031                          
Amortization of internal use software
    685       536       459       578       638       673       815       687  
                                                                 
Total costs and expenses
    16,357       18,927       18,189       20,837       18,129       19,068       19,400       21,601  
                                                                 
Income (loss) from operations
    477       (1,680 )     (6 )     (1,830 )     (721 )     361       2,610       4,534  
Interest expense
    (213 )     (162 )     (178 )     (246 )     (184 )     (171 )     (159 )     (98 )
Interest and other income, net
    114       73       43       6       27       232       45       47  
                                                                 
Income (loss) before income tax expense
    378       (1,769 )     (141 )     (2,070 )     (878 )     422       2,496       4,483  
Income tax expense (benefit)
    3       3       3       3       (162 )     79       442       475  
                                                                 
Net income (loss)
    375       (1,772 )     (144 )     (2,073 )     (716 )     343       2,054       4,008  
Less: Preferred stock dividend
                      2,362                         1,082  
                                                                 
Net income (loss) attributable to holders of common stock
  $ 375     $ (1,772 )   $ (144 )   $ (4,435 )   $ (716 )   $ 343     $ 2,054       2,926  
                                                                 
Basic net income (loss) per share
  $ 0.04     $ (0.18 )   $ (0.01 )   $ (0.45 )   $ (0.07 )   $ 0.03     $ 0.20     $ 0.29  
Diluted net income (loss) per share
  $ 0.01     $ (0.18 )   $ (0.01 )   $ (0.45 )   $ (0.07 )   $ 0.01     $ 0.06     $ 0.08  


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Liquidity and Capital Resources
 
Sources of Liquidity
 
Over the next 12 months, and in the longer term, we expect that our cash and liquidity needs will be met by existing resources and cash generated by our ongoing operations. We have a $7.0 million revolving credit facility with an interest rate of prime plus 0.75% that will expire as of April 19, 2010, and that we do not expect to draw upon in the next 12 months. In April 2009, we entered into a three-year, $10.0 million term loan with a maturity date of May 1, 2012. Under the term loan, we can receive prime rate loans or LIBOR rate loans. The interest rate for a prime rate loan is 1.50% above prime rate, with a minimum prime rate of 4.00% per annum, resulting in a minimum interest rate of 5.50% per annum. The interest rate for a LIBOR rate loan is 4.00% above the three-month LIBOR measured on a 360-day basis, with a minimum LIBOR rate of 1.50% per annum, resulting in a minimum interest rate of 5.50% per annum. As of December 31, 2009, the amount outstanding under our term loan was $8.1 million. The interest rate currently applicable to this term loan is equal to 1.50% above prime rate, with a minimum prime rate of 4.00% per annum, resulting in a minimum interest rate of 5.50% per annum. We were in compliance with all debt covenants as of December 31, 2009, and expect to comply with all debt covenants in the future through the maturity date. The term loan will become immediately due and payable in the event of default, if not cured, for non-payment of principal or interest as such amounts become due, misrepresentation, breach of covenants, insolvency proceedings, bankruptcy filing, judgments, cross-defaults, dissolution or liquidation and cessation of the enforceability of any material provision of the term loan. Additional information regarding our term loan can be found under “Description of Certain Indebtedness.”
 
Since inception, our operations have been financed through cash flows from operations, private sales of our capital stock and our bank borrowings. Through December 31, 2009, we had received net cash proceeds of $166.5 million through equity financings and from the exercise of options to purchase our common stock. At December 31, 2009, we had total cash and cash equivalents of $20.7 million, compared to $14.9 million at December 31, 2008.
 
Cash Flows
 
The following table presents information regarding our cash flows, cash and cash equivalents for the years ended December 31, 2007, 2008 and 2009:
 
                         
    Year Ended December 31,  
   
2007
   
2008
   
2009
 
    (In thousands)  
 
Net cash provided by operating activities
  $ 770     $ 3,188     $ 17,057  
Net cash used in investing activities
    (4,986 )     (6,548 )     (5,849 )
Net cash provided by (used in) financing activities
    1,035       3,202       (5,352 )
Net increase (decrease) in cash and cash equivalents
    (3,181 )     (158 )     5,856  
Cash and cash equivalents, end of year
  $  15,015     $  14,857     $  20,713  
 
Operating Activities
 
Net cash provided by operating activities for the year ended December 31, 2009 was $17.1 million compared to net cash provided by operating activities of $3.2 million for the year ended December 31, 2008. Net cash provided by operating activities was a result of a net income of $5.7 million for the year ended December 31, 2009, compared to a $3.6 million net loss for the year ended December 31, 2008, plus adjustments for non-cash expenses. These non-cash adjustments include $6.8 million in amortization of stock-based compensation expense, $2.7 million in amortization of internal use software, $1.7 million of depreciation expense, $1.2 million in amortization of deferred commissions, a $6.8 million increase in accrued compensation primarily due to a higher anticipated bonus accrual for 2009, resulting from improved financial results and a $1.0 million increase in accounts payable and offset by a $5.2 million increase in accounts receivable primarily due to growth in Professional Management fees, a $2.5 million


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increase in other assets primarily due to capitalization of direct response advertising costs effective July 1, 2009 and an increase in deferred commission capitalization, a $0.3 million increase in prepaid expenses and a $0.5 million decrease in deferred revenue. Net cash provided by operating activities for the year ended December 31, 2008 included approximately $2.9 million of offering costs. The offering costs were expensed during the quarter ended December 31, 2008, as a result of our decision in November 2008 to cease efforts to pursue an initial public offering.
 
Net cash provided by operating activities in 2008 was $3.2 million compared to net cash provided by operating activities of $0.8 million in 2007. Net cash provided by operating activities was a result of a net loss of $3.6 million in 2008, compared to a net loss of $1.8 million in 2007, plus adjustments for non-cash expenses. These adjustments include $3.6 million for amortization of stock-based compensation expense, a $2.8 million decrease in accounts receivable primarily due to an improvement in days sales outstanding, particularly for subadvised relationships, $2.2 million of amortization of internal use software and $1.6 million of depreciation expense, offset by a $4.5 million decrease in accrued compensation due to payment of 2007 bonuses as well as lower bonus accruals in 2008 primarily resulting from negatively impacted market conditions and a $1.5 million increase in other assets primarily due to an increase in capitalized commissions.
 
Net cash provided by operating activities in 2007 was $0.8 million compared to net cash used by operating activities of $1.7 million in 2006. The difference in net cash provided by operating activities was a result of a lower net loss of $1.8 million in 2007, compared to a net loss of $8.0 million in 2006, plus adjustments for non-cash expenses. These adjustments include $4.4 million for amortization of stock-based compensation expense, $3.0 million of amortization of internal use software and $1.3 million of depreciation expense, partially offset by an $8.3 million increase in accounts receivable primarily due to significant growth in our Professional Management revenue, which we bill quarterly in arrears, as well as an increase in our days sales outstanding due to increasing revenue generated by plan providers where we act as a subadvisor and a $0.9 million increase in other assets primarily due to an increase in capitalized commissions.
 
Investing Activities
 
Net cash used in investing activities was $5.8 million for the year ended December 31, 2009 compared to $6.5 million for the year ended December 31, 2008. For the year ended December 31, 2009, we capitalized $4.7 million of internal use software costs, compared to $4.1 million in the year ended December 31, 2008. For the year ended December 31, 2009, we used $1.2 million for the purchase of property and equipment, compared to $2.5 million for the year ended December 31, 2008.
 
Net cash used in investing activities was $6.5 million in 2008 compared to $5.0 million used in 2007. In 2008, we capitalized $4.1 million of internal use software costs, compared to $3.6 million in 2007. In 2008, we used $2.5 million for the purchase of property and equipment costs, compared to $1.4 million in 2007.
 
Net cash used in investing activities was $5.0 million in 2007 compared to $2.3 million used in 2006. In 2007, we capitalized $3.6 million of internal use software costs, compared to $2.8 million in 2006. In 2007, we used $1.4 million for the purchase of property and equipment costs, compared to $1.2 million in 2006.
 
Financing Activities
 
Net cash used in financing activities was $5.4 million for the year ended December 31, 2009. Net cash provided by financing activities was $3.2 million and $1.0 million during 2008 and 2007, respectively. In 2009, we repaid the outstanding balance under both our $3.5 million revolving credit facility and our $10.0 million promissory note, and also began paying down the $10.0 million term


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loan. In 2008, we borrowed $3.5 million against our revolving credit facility. In 2007, we generated net cash proceeds of $0.9 million from the exercise of options to purchase common stock.
 
Contractual Obligations
 
The following table describes our contractual obligations as of December 31, 2009:
 
                                         
    Payments Due by Period  
          Less than
    Years
    Years
    More than
 
   
Total
   
1 Year
   
1-3
   
4-5
   
5 Years
 
                (In thousands)              
 
Long-term debt obligations (1)
  $ 8,055     $  3,333     $  4,722     $     $  
Estimated interest payments on debt obligations(2)
    561       364       197              
Operating and capital leases (3)
    7,661       2,006       3,757       1,745       153  
                                         
Total
  $  16,277     $ 5,703     $ 8,676     $  1,745     $  153  
                                         
 
(1) Term loan: $10.0 million term loan executed in April 2009 with a stated interest rate of prime rate plus 1.50% per annum, with a minimum prime rate of 4.00% per annum, resulting in a minimum rate of 5.50% per annum, and a maturity date of May 1, 2012.
 
(2) Estimated interest payments assume the minimum rate of 5.5% per annum based on current terms.
 
(3) We lease facilities under noncancelable operating leases expiring at various dates through 2015.
 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements.
 
Recent Accounting Pronouncements
 
In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-13 — Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force (ASU 2009-13). ASU 2009-13 addresses how to measure and allocate arrangement consideration to one or more units of accounting within a multiple-deliverable arrangement. ASU 2009-13 modifies the requirements for determining whether a deliverable can be treated as a separate unit of accounting by removing the criteria that objective evidence of fair value exists for the undelivered elements in order to account for those undelivered elements as a single unit of accounting. ASU 2009-13 is effective for the Company prospectively for revenue arrangements entered into or materially modified beginning January 1, 2011. Early adoption is permitted. We are currently evaluating the impact the adoption of ASC 2009-13 will have on our financial condition and results of operations.


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Quantitative and Qualitative Disclosure about Market Risk
 
Market Risk.  Our exposure to market risk is directly related to our role as an investment advisor for the professionally managed accounts for which we provide portfolio management services. 62% of our revenue for the year ended December 31, 2009, was derived from fees based on the market value of AUM. We expect this percentage to increase over time. A decrease in the aggregate value of AUM may cause our revenue and income to decline.
 
Interest Rate Risk.  Interest payable on the $10.0 million term loan we entered into as of April 2009 is variable. We may borrow up to $10.0 million under our term loan as either a prime rate loan or a LIBOR rate loan. The interest rate with respect to a prime rate loan is equal to 1.50% above prime rate, with a minimum prime rate of 4.00% per annum, resulting in a minimum interest rate of 5.50% per annum. The interest rate with respect to a LIBOR loan is 4.00% above the three-month LIBOR measured on a 360-day basis, with a minimum LIBOR rate of 1.50% per annum, resulting in a minimum interest rate of 5.50% per annum. Interest rate changes will therefore affect the amount of our interest payments, future earnings and cash flows.


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BUSINESS
 
Retirement Industry Overview
 
The United States retirement savings industry is large and growing. Although Social Security is perhaps the best-known source of retirement assets, there are significant sources of retirement assets beyond Social Security. According to Cerulli Associates 2009 Retirement Markets Update, non-Social Security retirement assets grew from approximately $11.6 trillion in 2003 to approximately $16.5 trillion in 2007 before falling to approximately $13.0 trillion in 2008, representing a compound annual growth rate of 2.4%, and are anticipated to be approximately $20.4 trillion by 2014. Retirement assets fall primarily into two categories: defined benefit plans and defined contribution plans. In defined benefit plans, such as corporate or government pension plans, participants receive specified monetary distributions upon retirement. In most cases, professional asset managers, rather than individual investors, make investment decisions for defined benefit plans. In defined contribution plans, such as 401(k), 403(b) and 457 plans, which we collectively refer to as 401(k) plans, participants contribute a specified dollar amount into the plan on a regular basis by means of payroll deductions and, upon retirement, can draw from the amount of money resulting from these contributions and, in some cases, company matching contributions and the investment return of the contributions and company match. Unlike defined benefit plans, individual investors, rather than professional asset managers, are generally responsible for making investment decisions in defined contribution plans. Individual Retirement Accounts, or IRAs, are personal savings accounts that are typically directed by the individual and are not sponsored by a corporate or governmental employer.
 
Cerulli Associates estimates that private defined contribution assets, excluding IRAs, were approximately $2.6 trillion and constituted more than 20% of total retirement assets in the United States, excluding Social Security, in 2008, with approximately 58 million active 401(k) plan participants as of December 31, 2008. Cerulli Associates also estimates a compound annual growth rate of 7.1% for 401(k) assets from 2009 to 2014. This compares to an estimated 6.6% compound annual growth rate for total retirement assets over the same time period.
 
Actual and Estimated Retirement Market Assets by Segment 2003 — 2014E
 
(BAR CHART)
 
 
Source:  Cerulli Associates 2009 Retirement Markets Update. Excludes Social Security.


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Retirement Industry Trends
 
Shifting Demographics Drive a Growing Need for Retirement Assistance.  The ongoing growth in retirement assets, especially 401(k) assets, is driven in part by individuals seeking to supplement retirement funds they expect to receive from Social Security and corporate defined benefit plans. Defined contribution assets, including 401(k) assets, are not evenly distributed by age. According to data contained in the Federal Reserve Board’s Survey of Consumer Finances for 2007, households headed by individuals age 45 through 64 represented 45% of all retirement account holders but account for 56% of the assets in retirement accounts. Members of the Baby Boomer generation, which refers to individuals born between 1946 and 1964, will start to reach traditional retirement age in 2011. However, studies suggest that many Baby Boomers are not financially prepared to support themselves in retirement. The Employee Benefits Research Institute, or EBRI, 2009 Retirement Confidence Survey indicates that approximately 36% of the workers age 45 through 54, and approximately 30% of workers age 55 or older, report total savings and investments, excluding the value of their primary residence and any defined benefit plans, of less than $10,000. A study published in October 2009 by EBRI and the Investment Company Institute estimated that the median 401(k) balance was approximately $12,655 at year-end 2008.
 
Despite the increased reliance on defined contribution plans, we believe many investors are not equipped to adequately formulate an investment strategy for their retirement assets. As a result, we believe investors face significant risk and potentially inappropriate market exposure and asset allocations. According to research by the Investment Company Institute and EBRI, the average 401(k) account lost 24.3% in value over the course of 2008. As a result, we believe individuals across all age groups need assistance with investing their 401(k) assets and making other adjustments to their retirement plans to help them retire with sufficient income.
 
Growing Reliance on Defined Contribution Plans.  As employer-sponsored retirement plans continue to shift from defined benefit plans to defined contribution plans, the responsibility for making retirement investment decisions shifts from professional pension fund managers to individual investors. According to Cerulli Associates, the number of corporate defined benefit plans has declined from 56,400 in 1998 to an estimated 48,000 in 2008, with 190 additional defined benefit plans in Fortune 1000 companies being terminated or frozen during 2009. When a defined benefit plan is frozen to all employees or closed to new employees, the benefit level will no longer rise based on future service or salary increases, or new employees do not participate in these plans at all. Of the workers surveyed in EBRI’s 2009 Retirement Confidence Survey, 42% estimate that a major source of their retirement funds will come from employer-sponsored retirement savings plans. The 2009 Retirement Confidence Survey suggests that workers between the ages of 25 and 34 are even less likely than older workers to rely on income from Social Security. As a result, we believe that these workers will need to accumulate greater savings amounts outside of defined benefit plans for retirement.
 
Changing Legal and Regulatory Framework.  As the burden of retirement investing shifts to the individual, we believe that there is an increasing need for assistance and guidance on how to manage retirement wealth. However, according to a 2009 survey by Hewitt Associates, the primary reason cited by plan sponsors for not making investment advice available to employees has been the fear of increased fiduciary or legal risk. We believe the Pension Protection Act of 2006 and subsequent Department of Labor regulations can reduce these concerns. In addition to providing specific guidelines for plan sponsors to automatically enroll employees into qualified plans and accelerate contributions on an annual basis, the Pension Protection Act of 2006 further supports the existing foundation for professional asset management of 401(k) accounts. Adherence to these guidelines provides specific safeguards to plan sponsors from fiduciary and legal risk. As a result, we anticipate that the Pension Protection Act will continue to accelerate demand for advisory services.
 
The Pension Protection Act of 2006 also mandated that the Department of Labor define what are known as Qualified Default Investment Alternatives, or QDIAs. QDIAs are default investment


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options to which a plan sponsor can direct participants’ ongoing contributions when automatically enrolling employees into 401(k) plans. The Department of Labor defines three qualified default investment options as QDIAs: professionally managed accounts, balanced funds and lifecycle funds. A plan sponsor that elects to automatically default plan participant contributions into a QDIA in accordance with the regulation receives a fiduciary safe harbor protecting the plan sponsor from potential liability that arises from adoption of automatic enrollment. We believe that the designation of managed accounts, such as our Professional Management service, as a QDIA will continue to increase demand for managed accounts.
 
Automatic 401(k).  As a result of the Pension Protection Act of 2006 and Department of Labor guidelines, more plan sponsors are now actively seeking automatic retirement savings solutions for their employees. According to a 2009 401(k) plan survey conducted by Hewitt Associates, the percentage of employers that automatically enroll new participants increased from 19% in 2005 to 58% in 2009. Similarly, automatic contribution escalation, where employees’ contribution rates are automatically increased over time unless the employee affirmatively elects otherwise, increased from 9% in 2005 to 44% in 2009. A 2006 report by the Retirement Security Project estimates that the automatic 401(k) could increase net national saving by about 0.34% of gross domestic product per year, or approximately $44 billion per year. A growing trend within the automatic 401(k) is changing the default investment option to a target-date fund or managed account and re-enrolling existing plan participants into the new default investment option.
 
Automatic 401(k) Enrollment 1997-2009E
 
(LINE GRAPH)
 
 
Note: Percentage of employers who automatically enrolled new employees into 401(k) plans.
Source: Hewitt Associates Survey Findings: Trends and Experience in 401(k) Plans 2009.


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Greater Use of Managed Accounts Among Near-Retirees.  A 2009 study by EBRI, based on 2007 data, reported that workers under the age of 30, with lower incomes, less time on the job and with few assets are significantly more likely to have assets invested in target-date funds than are older workers. The study found that almost 44% of participants under 30 had assets in a target-date fund, compared with 27% of those 60 or older. Target-date funds and managed accounts can complement each other within 401(k) plans because they can appeal to different participants with different needs. We believe that younger workers are more likely to utilize target-date funds and near-retirees, who generally hold outside assets and are looking for more retirement planning help, are more likely to use managed accounts.
 
Our Company
 
We are a leading provider of independent, technology-enabled portfolio management services, investment advice and retirement help to participants in employer-sponsored defined contribution plans, such as 401(k) plans. We help investors plan for retirement by offering personalized plans for saving and investing, as well as by providing assessments of retirement income needs and readiness, regardless of personal wealth or investment account size. We use our proprietary advice technology platform to provide our services to millions of retirement plan participants on a cost-efficient basis. We believe that our services have significantly lowered the cost and increased the accessibility to plan participants of independent, personalized portfolio management services, investment advice and retirement help.
 
Our business model is based on workplace delivery of our services. We target three key constituencies in the retirement plan market: plan participants (employees of companies offering 401(k) plans), plan sponsors (employers offering 401(k) plans to their employees) and plan providers (companies providing administrative services to plan sponsors). We provide the following benefits for each of these constituencies:
 
  •  For retirement plan participants, we provide personalized, unconflicted advice and management services unique to each individual’s specific investment needs and goals, using the investment options available through their employer-provided plan. We offer three principal services:
 
  •  Professional Management is a discretionary managed account service designed for plan participants who want affordable, personalized and professional portfolio management services, investment advice and retirement help from an independent investment advisor without the conflicts of interest that can arise when an advisor offers proprietary products. Our investment recommendations are limited to the investment alternatives available in a 401(k) plan as determined and approved by a plan fiduciary other than us, although we do take into account other identified holdings of the plan sponsor or the plan participant when offering investment advice. With the exception of employer stock, if any, included as an investment alternative, we do not provide advice on or manage single-company securities. We do not consult with, or make recommendations to, the plan sponsor regarding which investment alternatives to make available in a participant plan. With this service, individuals delegate investment decision-making and trading authority to us, which is referred to as discretionary authority. The Professional Management service is our fastest growing service, with Assets Under Management, or AUM, growing at a compound annual growth rate of approximately 90% since December 31, 2004 to approximately $25.7 billion as of December 31, 2009. Plan sponsors choosing to make our Professional Management service available typically also make available our Online Advice service. In some cases, we provide this service by acting as a subadvisor to a plan provider acting as the investment manager to plan participants.
 
  •  Online Advice is a nondiscretionary Internet-based service designed for plan participants who wish to take a more active role in personally managing their portfolios and offers personalized advice for retirement portfolios. With this service, plan participants may elect to follow the online advice without delegating investment decision-making and trading authority to us, making this a nondiscretionary service. In some


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  cases, we provide this service by acting as a subadvisor to a plan provider acting as the investment advisor to plan participants.
 
  •  Retirement Evaluation is a retirement readiness assessment provided to plan participants upon rollout and generally annually thereafter, together with a Professional Management enrollment form. Retirement Evaluations highlight specific risks in a plan participant’s retirement account and assess the likelihood of achieving the plan participant’s retirement income goals. The assessment also provides guidance on how to reduce these highlighted risks and introduces our services as a means of obtaining help in addressing these issues.
 
  •  For retirement plan sponsors, our services are designed to improve employee satisfaction and reduce fiduciary and business risk by evaluating, disclosing and addressing poor investment and savings decisions by plan participants.
 
  •  For retirement plan providers, our services represent a cost-effective method of providing personalized, independent investment advice that is an attractive and increasingly necessary service for the largest plan sponsors. Providing these services helps plan providers compete more effectively in the large plan market.
 
We deliver our services to plan sponsors and plan participants primarily through connections to eight retirement plan providers. In addition, we have connectivity with Charles Schwab to support one full suite plan sponsor. We target large plan sponsors across a wide range of industries. As of December 31, 2009, we had signed contracts to make our services available through 116 Fortune 500 companies and eight Fortune 20 companies. As of December 31, 2009, we were under contract to provide either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only, through more than 760 plan sponsors with approximately 7.4 million plan participants whose retirement savings represented more than $500 billion in assets. Within this group, we provide our full suite of services to 354 plan sponsors representing approximately 3.9 million participants and approximately $269 billion in AUC. As of December 31, 2009, we had approximately $25.7 billion in AUM, and managed the accounts of approximately 391,000 members who have delegated investment decision-making authority to us. Our AUC does not include assets in plans where we have signed contracts, but for which we have not yet rolled out our Professional Management service. Assets count for AUM once plan participants actively or passively enroll in Professional Management. The assets underlying our Online Advice only service are not included in AUC. Retirement evaluation services are part of our Professional Management service. We do not derive revenue based on AUC. We believe however that AUC is both a useful indication of the additional plan assets available for enrollment efforts that, if successful, result in these assets becoming AUM, and also indicates the benefit of increasing our enrollment rates since this will lead to additional AUM. As of December 31, 2009, we had 25 plan sponsors, representing approximately 540,000 plan participants, with which we had signed contracts but for which we had not yet rolled out our Professional Management service.
 
Our business model is characterized by subscription-based, recurring revenue. Our contracts with plan sponsors typically have initial terms of three years and evergreen clauses that extend the initial term until terminated by either party after a specified notice period. Our revenue is derived from both management fees and platform fees. The management fees we earn are based on the value of the assets that we manage for plan participants who have delegated investment decision-making authority to us or to a plan provider for which we act as a subadvisor. None of our fees are paid based on a performance or other incentive arrangement. Our fees are not based on a share of the capital gains or appreciation in a member’s account. Our fees are determined by the value of the assets in the member’s account at the specified date. The platform fees we earn are derived through annual subscriptions paid by the plan sponsor, plan provider or the retirement plan itself, depending on the plan structure, and are based on the number of eligible employees in the plan. We generated Professional Management revenue of $52.6 million for 2009, an increase of 35% from $39.0 million for


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2008. We generated platform revenue of $30.0 million for 2009, an increase of 2% from $29.5 million for 2008.
 
The key steps associated with delivering our Professional Management service are as follows:
 
  •  Contract with Plan Sponsor.  First, we sign a contract to provide our Professional Management service to a plan sponsor’s employees.
 
  •  Plan Rollout.  Second, we obtain plan and plan participant data, set up the plan on our systems and make services available to plan participants. Upon completion of rollout, our services are available to all eligible participants of that plan. As of December 31, 2009, we had approximately $269 billion in AUC.
 
  •  Encourage Enrollment in Our Professional Management Service.  Once the plan has been rolled out, we deliver to plan participants retirement evaluations and enrollment materials, either through the plan provider or directly to plan participants, and with the support of plan sponsors. As of December 31, 2009, our asset enrollment rate for plans actively rolled out at least 14 months was approximately 10.8% and our participant enrollment rate for plans actively rolled out at least 14 months was approximately 11.4%.
 
  •  Manage Assets.  Once a plan participant enrolls in our Professional Management service, the retirement assets of that plan participant count toward our AUM. As of December 31, 2009, we had approximately $25.7 billion of AUM. At this point, the plan participant’s 401(k) assets are allocated pursuant to the participant’s investment objectives and investment options available.
 
We launched our Professional Management service in September 2004. From December 31, 2004 to December 31, 2009, we had a compound annual growth rate, or CAGR, of 90% for AUM and 92% for membership. As of December 31, 2009, we had AUM of approximately $25.7 billion and approximately 391,000 members, compared to AUM of approximately $15.6 billion and approximately 322,000 members at December 31, 2008. Our total revenue in 2009 was $85.0 million, compared to $71.3 million in 2008, an increase of 19%. Of these amounts, Professional Management revenue represented 62% in 2009 and 55% in 2008.
 
The following tables illustrate the increase in our AUM and membership, and the corresponding CAGR, from December 31, 2004 to December 31, 2009.
 
     
     Assets Under Management
         Total Members
(BAR CHART)   (BAR CHART)
 
All data are shown as of December 31 of the applicable year.


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The following table illustrates the number of plan sponsors where Professional Management is available, and the corresponding CAGR. The data below includes plan sponsors where no members had yet enrolled.
 
     Total Plan Sponsors
 
(BAR CHART)
 
All data are shown as of December 31 of the applicable year.
 
Company History
 
Financial Engines was co-founded in 1996 by Professor William F. Sharpe, a recipient of the 1990 Nobel Prize in Economic Sciences for his pioneering work on the theory of financial economics, including how prices of financial assets are determined and the link between risk and return, Professor Joseph A. Grundfest, a former SEC commissioner and a professor of law at Stanford Law School, and the late Craig Johnson, then Chairman of the Venture Law Group. The company was founded to address the need for independent investment advice. Traditionally, high quality, personalized investment advice had been available only to large institutions and the affluent. Professor Sharpe’s vision was to leverage technology to make high quality independent advice available to millions regardless of their wealth or investment expertise.
 
A pioneer in our market, we introduced our Online Advice service in 1998. Following the introduction of Online Advice, we focused on expanding our service offerings to provide investors with advice on multiple tax-deferred accounts and taxable investments. Over the next five years, we made significant investments in technology and usability of our platform that allowed us to expand and enhance our service offerings, including our Retirement Evaluation, a personalized printed retirement assessment. In 2004, we launched our Professional Management service to provide personalized and professional portfolio management to retirement plan participants.
 
Our Market Opportunity
 
We believe shifting retirement industry trends present us with an opportunity to help plan sponsors provide independent portfolio management services, investment advice and retirement help to plan participants while working within the parameters of ERISA, the Pension Protection Act and recent Department of Labor regulations. Furthermore, the market downturn in 2008 has highlighted the need for providing employees with retirement help. We have the capability to provide portfolio management services, investment advice and retirement help to plan participants who previously did not have access to these services, and we believe we can leverage our advice technology platform to cost-effectively serve the fragmented plan participant market.
 
Our Competitive Strengths
 
We believe that our leading market position results from the following key competitive strengths:
 
Independent and Unconflicted Advice.  We believe that many plan participants value an investment advisor that is independent and free from potential conflicts of interests. We also believe that many plan fiduciaries value making independent and unconflicted advice available to their plan


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participants. We do not receive differential compensation based on the investments we recommend. We offer no proprietary investment products and are free from the conflicts or the perception of conflicts of interest that can arise for competitors who offer such products. We do not hold assets in custody or execute trades. Our investment recommendations are limited to the investment alternatives available in a 401(k) plan as determined and approved by a plan fiduciary other than us, although we do take into account other identified holdings of the plan sponsor or the plan participant when offering investment advice. With the exception of employer stock, if any, included as an investment alternative, we do not provide advice on or manage single-company securities. We do not consult with, or make recommendations to, the plan sponsors regarding which investment alternatives to make available in a particular plan. We are not associated with or controlled by any broker-dealer, registered investment company, insurance company or financial services organization. We believe our independence ensures that our recommendations are based only on the best interests of individual plan participants. We base our investment advice on quantitative criteria applied through a computerized model that is consistently applied through plan participants, plan sponsors, plan providers and investment choices.
 
Proprietary Investment Advice Technology.  Our technology-based investment process is based on a number of methodologies pioneered by our co-founder and Nobel Laureate, Professor William F. Sharpe, that are used by large institutional investors, including pension funds and endowments. We have applied and extended this core methodology to service the needs of a wide range of individual investors while achieving economies of scale.
 
Our technology-based investment approach incorporates the following:
 
  •  Our Optimization Engine allows us to make personalized investment recommendations chosen from the investment options available within each plan, with consideration of the plan participant’s individual circumstances including investment horizon, existing investment allocations and characteristics of his or her 401(k) plan, as well as any anticipated benefits from other employer plans, such as cash balance or defined benefit plans. Our Optimization Engine also considers other assets in a plan participant’s household portfolio, allowing the advice provided to adjust for the risks and correlations of other financial assets, as well as the participant’s risk tolerance. In addition, we provide personalized savings recommendations to help participants reach their retirement objectives.
 
  •  Our Simulation Engine allows us to model the characteristics of more than 30,000 securities, including retail mutual funds, stocks, employee stock options, institutional funds, guaranteed investment contracts and stable value funds, exchange-traded funds and fixed-income securities, taking into consideration factors such as asset class exposures, expenses, turnover, manager performance, active management risk, stock specific risk and the security’s tax-efficiency. This allows our Advice Engines to generate high quality recommendations over almost any investment universe.
 
  •  Our Advice Engines’ ability to manage a plan participant’s employer stock holdings is an attractive feature to plan sponsors seeking to reduce the risk of fiduciary liability that can arise when employer stock is included in a 401(k) plan. The advice produced by our Advice Engines also generally reduces plan participants’ undiversified exposure to the equity risk that results from holding an overly-high concentration in employer stock. Managed accounts are the only QDIA under the recent Department of Labor regulations that provide a fiduciary safe harbor for plan sponsors that include employer stock in their plans.
 
  •  Our Advice Engines are able to provide advice that takes into consideration the impact of personal tax rates, unrealized gains and losses, asset placement across taxable and tax-deferred accounts and the tax efficiency of specific investments.
 
Scalable Technology Platform.  Historically, providing high quality investment advice to low balance investors had been cost-prohibitive. We believe that our advice technology platform allows us to cost-


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effectively service the needs of individual investors with low asset balances and provide sophisticated, personalized investment advice that addresses the needs of millions of individual investors, many of whom are underserved by the financial services industry. Traditional advisors and asset managers have typically focused on investors with financial assets of several hundred thousand dollars or more. According to a July 2009 article by Registered Rep. Magazine, the top 100 independent registered investment advisors in America had an average AUM of $2.5 billion and serviced an average of 2,300 accounts, implying an average client balance of approximately $1.0 million. As of December 31, 2009, approximately 45% of our Professional Management members had less than $20,000 of retirement assets in their accounts. The ability to serve these low balance plan participants cost-effectively is a key advantage of our business model.
 
Significant Invested Capital.  Our services are based on our proprietary technology, which we developed over a number of years and in which we have invested significant financial and personnel resources. We believe that any potential competitor will face significant challenges in terms of the human capital, time, money and technology required to develop a competitive offering. Furthermore, the technology interfaces that we have established with our retirement plan providers and plan sponsors are complex and would be time-consuming and costly for our plan providers and plan sponsors to replicate.
 
Established Relationships and Data Connections with Retirement Plan Providers.  Effectively managing plan participant accounts requires relationships and a data connection with the recordkeeping systems of those retirement plans. We have built data transfer and retrieval, transaction processing and fee deduction interfaces with a number of retirement plan providers, including these eight primarily: ACS, Fidelity, Hewitt, ING, JPMorgan, Mercer, T. Rowe Price and Vanguard. Based on information from Pensions and Investments, as of March 31, 2009, and from one of the plan providers, we estimate that these eight plan providers collectively service plan sponsors representing more than $1.5 trillion in plan assets, or more than 80% of the assets contained in plans with more than 10,000 participants. In addition, we have connectivity with Charles Schwab to support one full suite plan sponsor. Building these connections are major technical projects that we believe provide us with a significant advantage over companies wishing to provide retirement plan managed accounts. In addition, our connections and arrangements with plan providers allow for direct deduction of our fees from plan participant accounts, with the approval of the plan sponsor.
 
Large, Industry-Leading Retirement Plan Sponsor Clients.  As of December 31, 2009, we were under contract to provide either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only, through more than 760 plan sponsors with approximately 7.4 million plan participants whose retirement savings represented more than $500 billion in assets. Within this group, we were under contract to make available our full suite of services to more than 354 plan sponsors representing approximately 3.9 million participants and approximately $269 billion in AUC as of December 31, 2009. We believe our brand recognition and experience serving plan sponsors from a wide variety of industries provide us with a competitive advantage. Our strategy of serving large plan sponsors with complex plans has led us to develop a set of product features, processes and organizational knowledge that is attractive to other large plan sponsors that have similar plan complexities. Of the approximately 490,000 401(k) plans and $2.3 trillion in 401(k) assets in 2008, companies with more than 5,000 employees accounted for 0.4% of all plans, 45% of all plan participants and 52% of all assets, according to Cerulli Associates. We believe that among discretionary managed account providers, we have the largest installed base of plan sponsors that have more than 10,000 participants. As of December 31, 2009, we had signed contracts to make our services available through 116 Fortune 500 and eight Fortune 20 companies. We believe the quality and quantity of our plan sponsor customer base further enhances our position as an acknowledged leader in our markets. Furthermore, we believe that many plan sponsors that contemplate switching plan providers consider the availability of our services on alternative plan provider platforms in making their decisions. We believe that this in turn provides incentives to plan providers to maintain ongoing relationships with Financial Engines.


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Our Business Model
 
Recurring and Resilient Revenue Base.  We believe our business model has structural advantages that allow us to demonstrate resiliency in difficult environments. We currently serve investors with 401(k) accounts that, unlike non-retirement investment accounts, generally receive consistent automatic contributions from participants and have adverse tax treatment on early withdrawals. We create portfolios with a diversified mix of equity and fixed income exposure designed to reduce volatility. Our investment methodology also avoids market timing biases that can increase volatility for investors. In addition, our contracts with plan sponsors typically have initial terms of three years and evergreen clauses that extend the initial term until terminated by either party after a specified notice period. Our technological connectivity with plan providers and plan sponsors results in low sponsor turnover and high switching costs should a competitor try to win these accounts. In a given year, our Professional Management revenue consists of recurring revenue earned from contracts in place prior to the beginning of that year. Revenue from contracts in place as of December 31, 2008 accounted for approximately 99% of our total revenue for the year ended December 31, 2009.
 
While market declines may affect the value of our AUM, we believe our business model may mitigate the effects of market declines. From December 31, 2007 to December 31, 2008, our AUM declined approximately 4%. This was a challenging time for the equity markets, as shown by a decline in the S&P 500 of approximately 38% over the same period. We believe the effect on our AUM during this period was mitigated as a result of new business, ongoing participant contributions and less volatile investment performance among other factors. From December 31, 2008 to December 31, 2009, our AUM increased 65%.
 
The table below illustrates the level of the S&P 500 and our AUM, measured as of the last day of the quarter in each of the past five quarters. Changes in AUM reflect ongoing enrollment from new members and ongoing contributions into member accounts. Factors that may cause our AUM to fluctuate include, but are not limited to, the performance of financial markets globally, new enrollments and participant contributions or cancellations. This table does not reflect our prediction or belief as to how our AUM will perform in relation to the S&P 500 in future periods or on future dates.
 
                                         
              Percentage
              Percentage
 
              Change from
      AUM*
      Increase from
 
Quarter     S&P 500*       Prior Quarter       (in billions)       Prior Quarter  
Q4 2008
      903         (23 )%     $ 15.6            
Q1 2009
      798         (12 )%     $ 16.1         3 %
Q2 2009
      919         15 %     $ 19.5         21 %
Q3 2009
      1057         15 %     $ 23.5         21 %
Q4 2009
      1115         5 %     $ 25.7         9 %
                                         
 
* Measured as of the last day of the applicable quarter.
 
Attractive Economic Model.  We believe the scalability of our technology platform results in attractive per-member economics. We incur significant up-front expenses to establish connectivity with plan provider and plan sponsor platforms. After establishing connectivity, we are able to add new plan sponsors and new members with less than pro rata incremental expenses. However, we do also incur one-time new member acquisition costs, which include costs of the personnel associated with marketing to prospective members and costs related to printing and postage of enrollment materials. These acquisition costs are significantly higher than our ongoing servicing costs to manage existing member accounts in subsequent years. We experience relatively high contribution margins in the years following the acquisition of a new member. In 2009, we averaged approximately $145 in revenue per member and approximately $42 in ongoing variable servicing costs per member. Ongoing variable servicing costs include data connectivity fees to plan providers, retirement updates and other member materials, as well as the expense associated with our advisor center, operations and portfolio


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management teams. Our fixed costs and other variable costs, such as any other portions of our service delivery and investment management teams, as well as technology, sales and marketing, and general and administrative teams which may also be involved with member servicing, are not included as these teams are primarily dedicated to activities other than member servicing and any incremental costs which may be associated with member servicing have generally been insignificant. Accordingly, it is difficult to estimate the actual total ongoing variable servicing costs per member and these costs are likely to vary in the future.
 
Sole Access and Customer Retention.  Our business model enjoys a number of structural advantages that result in sole access to plan participants and high plan sponsor retention levels. The 354 plan sponsors representing approximately $269 billion in AUC who make available our Professional Management service have each made us the sole provider of these services to their plans. We believe this reflects the desire of plan sponsors to avoid inconsistent methodologies, to simplify choices for plan participants and to avoid building new data connections with multiple investment advice vendors.
 
Since the launch of our Professional Management service in September 2004, we have retained over 96% of our plan sponsor clients each year. We believe this reflects the desire of plan sponsors to maintain continuous and consistent provision of investment advisory services for their employees. In addition, we have been largely unaffected if a plan sponsor changes its underlying recordkeeping platform or the investment alternatives available to its employees because of the breadth of our data connections and our independent investment methodology.
 
Significant Growth Opportunity Within Our Existing Customer Base.  We believe our business has a significant opportunity for growth from our existing customer base. As of December 31, 2009, we had approximately $25.7 billion in AUM and approximately 391,000 members, while our Professional Management services were available to employees representing approximately $269 billion in AUC and approximately 3.9 million potential members. This implies a participant enrollment rate, or the percentage of plan participants who use our Professional Management service, across all plans where Professional Management is available, including plans where enrollment campaigns are not concluded or have not yet been commenced, of approximately 10.0%. The growth from ongoing contributions, market returns and AUM penetration of existing sponsors will provide us with the ability to increase our revenue and net income. With our scalable technology, we will be able to use our existing infrastructure to serve additional members without significantly increasing servicing costs. We believe we can increase our revenue and net income by increasing our participant enrollment rate within our existing client base.
 
Our Growth Strategy
 
Increase Penetration Within Our Existing Professional Management Plan Sponsors.  We believe we have a significant opportunity for growth within our existing plan sponsor base that offers our Professional Management service to plan participants by increasing enrollment rates for our Professional Management service. Our focus is to encourage enrollment in our Professional Management service in order to help employees reach their retirement goals and plan sponsors execute their duties as prudent plan fiduciaries. As of December 31, 2009, we managed approximately 10.8% of plan assets in plans to which our Professional Management service has been actively rolled out for at least 14 months. We plan to increase enrollment by both continuing to promote our services to participants in Active Enrollment campaigns and encouraging plan sponsors to initiate Passive Enrollment campaigns. Active Enrollment campaigns require that plan participants proactively sign up for our services. Passive Enrollment campaigns automatically enroll some or all of a plan sponsor’s plan participants into our Professional Management service unless the individual participant declines or “opts-out” of the service.
 
Over time, we believe that we can increase our enrollment rate in Active Enrollment campaign plans through annual enrollment campaigns, direct marketing to plan participants and other


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promotional activities. Our past experience has shown that in cases where a plan sponsor used Passive Enrollment, the enrollment rate of plan assets was higher and achieved at lower acquisition cost per member than in cases where a plan sponsor used Active Enrollment. We believe Passive Enrollment is attractive to plan sponsors due to the lower fees payable by plan participants who are passively enrolled, the fiduciary protection afforded to plan sponsors by participants having to affirmatively elect not to receive professional advice and the relatively higher number of participants likely to be enrolled and receiving professional management upon rollout. We believe that the adoption of Passive Enrollment among more plan sponsors will likely increase our AUM as a result of the higher enrollment rates that these campaigns historically generate. Depending on the proportion of the plan’s participants who are passively enrolled, we eliminate or reduce our platform fees, as well as reducing the fees payable by plan participants.
 
We measure enrollment in our Professional Management service by members as a percentage of plan participants, and by AUM as a percentage of AUC, in each case across all plans where Professional Management is available, including plans where enrollment campaigns are not yet concluded or have not been commenced. In addition to measuring enrollment in all plans that have been rolled out, we measure enrollment in plans that have been actively rolled out for at least 14 months and in plans that have been actively rolled out for at least 26 months. We consider a plan to be actively rolled out upon mailing of initial enrollment materials. We measure enrollment in plans that have been rolled out for at least 14 months and at least 26 months because we generally seek to commence annual campaigns 12 months after the start of the prior campaign, and each campaign typically lasts 45-60 days.
 
                     
      Members as a
    AUM as a
      Percentage of
    Percentage of
As of December 31, 2009     Eligible Participants     AUC
All plans rolled out
      10.0 %       9.5 %
All plans actively rolled out 14 months or more
      11.4 %       10.8 %
All plans actively rolled out 26 months or more
      12.3 %       11.4 %
                     
 
Enhance and Extend Our Services as Baby Boomers Enter Retirement.  While the financial services industry has largely focused on helping Baby Boomers accumulate assets for retirement, we believe there is a growing need for services to help convert their accumulated retirement assets into stable lifetime income. According to data contained in the Federal Reserve Board’s Survey of Consumer Finances for 2007, households headed by individuals age 45 through 64 represented 45% of all retirement account holders but account for 56% of the assets in retirement accounts. While accumulating enough assets for retirement is challenging for the average investor, the calculation of how to spend retirement assets is even more intimidating as individuals bear the risk of outliving their assets. A McKinsey & Company report, “Redefining Defined Contribution” (2007), indicated that 85% of the consumers concerned or extremely concerned about not having a sufficient income for retirement are interested in seeking advice on how to guarantee sufficient income for retirement.
 
We have plans to extend our services to help investors turn those retirement assets into stable lifetime income. With many Baby Boomers now reaching traditional retirement age, we believe there is an opportunity for us to expand our services to offer cost-effective, objective and convenient solutions to help retirees safely convert their accumulated assets into stable lifetime income. We believe our established investment methodology, technology, communications and access to our Investment Advisor Representatives can form the basis of an attractive service for individuals who need payouts from their retirement accounts. We believe our existing relationships with retirement plan providers, plan sponsors and plan participants provide us with an opportunity to extend our services to help manage the complex challenge of turning retirement investments into retirement income. Approximately 42% of our current Professional Management members are over the age of 50 and represent 62% of assets in our Professional Management program as of December 31, 2009.


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Address IRA Rollover Market.  We also intend to expand our services to help members of our Professional Management program who roll over their 401(k) into an IRA account available through the plan provider. We believe that our pre-existing relationships with many 401(k) participants will provide an advantage as we expand into the IRA rollover market. We also plan to help other individual IRA investors manage and draw down income from their IRAs. We believe that the existing technology, distribution relationships and operational scale we have developed will be directly applicable to serving millions of IRA investors cost-effectively. According to Cerulli Associates, the IRA market, with more than $3.6 trillion in assets as of December 31, 2008, and a historical five-year compound annual growth rate approaching 3.8% per year, is estimated to grow faster than any other part of the retirement market, due largely to retirees rolling their assets from a 401(k) plan to an IRA.
 
Increase Defined Contribution Market Penetration.  We also plan to expand our services to more fully serve the defined contribution market. We currently focus our sales and marketing efforts on large, corporate defined contribution plans, or 401(k) plans, and have little penetration into public defined contribution plans such as 403(b) and 457 plans. We believe that the existing technology, distribution relationships and operational scale we have developed will be directly applicable to serving millions of 403(b) and 457 investors cost-effectively, as well as participants at employers with fewer employees.
 
Expand Number of Retirement Plan Sponsors.  We deliver our services to plan sponsors and plan participants primarily through existing connections with eight retirement plan providers. Based on information from Pensions and Investments, as of March 31, 2009, and from one of the plan providers, we estimate that these eight plan providers collectively service plan sponsors representing more than $1.5 trillion in plan assets, or more than 80% of the assets contained in plans with more than 10,000 participants. As of December 31, 2009, we had approximately $269 billion in AUC. We intend to sell our services to other plan sponsors that are not current clients but are serviced by plan providers with whom we have relationships. We also plan to create data connections with additional plan providers to access defined contribution plans of educational institutions as well as non-profit organizations and government entities.
 
Offer Professional Management Service to “Online Only” Plan Sponsors.  As of December 31, 2009, we provided our Online Advice service to more than 380 of our plan sponsor customers, but do not offer our Professional Management service to them. We plan to pursue growth by seeking to convert a number of the largest of these plan sponsors to our full suite of services, including Professional Management, Online Advice and Retirement Evaluation. As of December 31, 2009, we were under contract to provide our full suite of services through more than 760 plan sponsors with approximately 7.4 million plan participants whose retirement savings represented more than $500 billion in assets. More than one million participants have accepted our online services agreement. We believe that successfully converting a portion of the 401(k) assets in our online-services-only plans into AUC, and then into AUM, will likely increase future revenue because we would earn fees based on AUM as well as the flat fee paid by the plan sponsor.
 
Products and Services
 
We provide individuals with personalized portfolio management services, investment advice and retirement help to plan participants through plan providers. Our services address some of the most important questions and concerns faced by plan participants as they prepare for retirement, including:
 
  •  “How much will I need when I retire”?
 
  •  “Will I have enough money to retire”?
 
  •  “How should I invest my money”?
 
  •  “When can I retire and how much can I spend when I do”?


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Professional Management.  Our Professional Management service, a discretionary managed account service launched in 2004, is designed for 401(k) participants who want affordable, personalized and professional portfolio management, investment advice and retirement help from an independent investment advisor with no conflicts of interest. With this service, plan participants delegate investment decision-making and trading authority to us, which is referred to as discretionary authority. We developed our Professional Management service to reach a large number of plan participants on a cost-effective basis and assist them on the path to a secure retirement. When plan participants enroll in our Professional Management service, we use our Advice Engines to create personalized, diversified portfolios and provide ongoing Professional Management.
 
Members enrolled in the Professional Management service receive a Retirement Plan, which analyzes their investments, contribution rate and projected retirement income. The Retirement Plan provides advice on their annual contribution amount, shows how we propose to allocate their investments and forecasts their retirement income relative to a retirement goal. Members are encouraged to provide their desired retirement age, risk preference, employer stock holding preference and information regarding certain other assets that they hold outside of their 401(k) account. Any personal information provided is used to customize a new portfolio allocation that is reflected in a revised Retirement Plan. Each member portfolio is reviewed every three months and transactions are executed, if necessary, to reallocate the investments. The member also receives a quarterly Retirement Update that shows how they are progressing towards their retirement goals and describes any changes that we have made to their investment allocations.
 
Members can, at any time, call one of our registered Investment Advisor Representatives or log in to a website to check their progress or further tailor their portfolio to their personal circumstances. Our registered Investment Advisor Representatives, and certain call center personnel of the plan providers with whom we work, have access to the Financial Engines Professional Advisor, our proprietary client relationship management application, enabling the advisor to change or add to the personal information used to manage the member’s account and explain to the member the impact of any changes on the member’s projected future 401(k) balance. Registered Investment Advisor Representatives can modify member inputs but not Advice Engine outputs and recommendations. As members approach retirement, they are offered a Retirement Checkup, which is a phone-based consultation with an Investment Advisor Representative. During the Retirement Checkup, the Investment Retirement Representative confirms the participant’s retirement goal, reviews the participant’s retirement income forecast and helps the participant close the gap, if any, by exploring alternatives, such as the impact of increasing savings or adjusting the participant’s retirement age. As of December 31, 2009, we had 17 Investment Advisor Representatives. We additionally rely on supervisors and other trained employees and personnel when call volumes are high. We expect to increase modestly the number of Investment Advisor Representatives to support Retirement Checkups and outbound calling initiatives.
 
Online Advice.  Our Online Advice service, launched in 1998, is a nondiscretionary Internet-based service designed for plan participants who wish to take a more active role in personally managing their portfolio. With this service, plan participants may elect to follow the online advice without delegating investment decision-making and trading authority to us, making this a nondiscretionary service. This Internet-based service includes interactive access to simulation and portfolio optimization technologies through our Advice Engines. Plan participants see a forecast that shows how likely they are to reach their desired retirement goals, get recommendations on which investments to buy or sell and simulate how their portfolios might perform under a wide variety of economic scenarios. They can also explore different levels of investment risk, savings amounts and retirement horizons, as well as get tax-efficient advice on accounts other than their 401(k). The Online Advice service is integrated with single sign-on to the plan provider’s 401(k) website, which enables data pre-population and, typically, the ability to initiate transactions directly from the Online Advice service. A version of the service is also available to retail investors directly through our website.


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Retirement Evaluation.  When our full suite of services is being offered in a plan, we send each eligible plan participant a Retirement Evaluation or similar retirement readiness assessment upon rollout and generally annually thereafter, together with a Professional Management enrollment form. Retirement Evaluations highlight specific risks in a plan participant’s retirement account, provide an assessment of the likelihood of achieving the plan participant’s retirement income goal, provide guidance on how to reduce those risks and introduce our services as a means of obtaining help in addressing these issues. Retirement Evaluations are based on data provided by the plan provider and include an evaluation of how well the plan participant is investing and saving in the retirement plan. Specifically, the evaluation considers the individual plan participant’s risk, diversification, employer stock concentration and 401(k) contribution rate.
 
Investment Process and Methodology
 
Our goal is to apply investment techniques traditionally available only to large, sophisticated investors to help small, individual investors achieve their retirement goals. Our advice services incorporate several of the methodologies developed by our co-founder and economics Nobel Laureate, Professor William F. Sharpe. We use Monte Carlo simulation and proprietary optimization techniques to provide plan participants with cost-effective, sophisticated, personalized and unconflicted advice. Monte Carlo simulation is widely used in investment management and is a statistical technique in which many simulations of an uncertain quantity are run to model the distribution of possible outcomes.
 
We model more than 30,000 securities, including retail mutual funds, stocks, employee stock options, institutional funds, guaranteed investment contracts and stable value funds, exchange-traded funds and fixed-income securities on an ongoing basis. When providing simulations and investment recommendations, our methodology evaluates a variety of factors that impact investment returns, including: fees, portfolio turnover, management performance, tax-efficiency, a fund’s investment style where we identify the underlying asset class exposures and active management risk associated with asset allocation changes by a fund manager in response to market conditions and decisions to weight specific security holdings differently than comparable indices. By modeling the characteristics of specific investment alternatives, we are able to provide quantitative estimates of possible future outcomes and make investment recommendations. We are able to model the complexities found in large retirement plans and to provide investment advice to plan participants that can be implemented within the limits of a given plan’s available options.
 
Unlike traditional advisory services, we do not rely on the subjective evaluation of each plan participant’s portfolio by a human investment advisor. Instead, our services rely on Advice Engines that accept inputs on available investment choices along with a variety of personal information including: risk tolerance, investment horizon, age, savings, outside personal assets, investor preferences and tax considerations. This approach results in a consistent, systematic and objective investment methodology in which the advice generation is distinct from the method of delivery, which may be online, via printed materials or through phone conversations with our registered Investment Advisor Representatives or the call center representatives of certain plan providers with whom we have relationships. The representatives who are available by phone to speak with Professional Management members have the ability to change or add to the personal information used to manage the member’s account and explain to the member the impact of any changes on the member’s projected future 401(k) balance. Registered Investment Advisor Representatives can modify member inputs but not Advice Engine outputs and recommendations. This process is designed to ensure that the advice is personalized and consistent regardless of the asset balance of the plan participant, or the channel through which the plan participant receives our advice. This process also ensures that the investment recommendations are consistent across plan providers, plan sponsors and plan participants. Finally, this approach enables a detailed audit trail of the recommendations provided to each plan participant over time to assist with regulatory responsibilities.


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To maintain the quality of our investment recommendations, our Advice Engines incorporate a wide variety of automated checks and validation procedures. These processes are overseen by multiple groups within our Investment Management and Service Delivery organizations. These processes help verify that the data inputs into our systems are timely and accurate, and that the resulting investment recommendations reflect the correct application of our investment methodology. We devote substantial ongoing product development to the maintenance and development of these data and advice validation procedures.
 
Our investment recommendations are limited to the investment alternatives available in a 401(k) plan as determined and approved by a plan fiduciary other than us, although we do take into account other identified holdings of the plan participant when offering investment advice. With the exception of employer stock, if any, included as an investment alternative, we do not provide advice on or manage single-company securities. We do not consult with, or make recommendations to, the plan sponsor regarding which investment alternatives to make available in a particular plan.
 
We offer no proprietary investment products. We are free of the conflicts of interest, or the perceptions of conflicts of interest, that can arise for competitors who offer such products. We do not receive differential compensation based on the investments we recommend. We do not hold assets in custody or execute trades.
 
We have a single investment methodology that is consistently applied across all member accounts. We create diversified portfolios for each member from the investment choices available in a plan with the goal of balancing potential returns consistent with the client’s investment horizon, other financial assets and risk preferences.
 
We maintain an ongoing research program to improve and extend our investment methodologies and our portfolio management and investment advisory services. We conduct research into the needs of retirees, publishing new findings in academic and practitioner journals. Recent research has included a behavioral finance study of the demand for annuities, efficient methods for addressing longevity risk and efficient methods for generating retirement income. This research can form the basis of extensions to our current investment methodology that can enable services that allow our Professional Management program to help participants generate stable retirement income from accumulated defined contribution assets. We believe that these extensions can expand the opportunity to manage assets for participants both within existing sponsored plans as well as in IRA rollover accounts.
 
Investment Performance
 
Historical investment performance is one factor that plan sponsors evaluate when deciding whether to offer our Professional Management service to their employees and when monitoring the investment manager selected. Because each of our Professional Management portfolios is personalized to the member’s specific financial circumstances, there is no one representative portfolio from which to calculate investment performance. Unlike a traditional investment fund, there is no single benchmark that would be appropriate to measure the relative performance of member portfolios. In order to provide investment performance and benchmarking information to plan sponsors, we have aggregated members into “cohort portfolios” corresponding to specific anticipated retirement dates. While the member allocations within these cohort portfolios differ according to the specific financial circumstances of each individual member, they share a common investment horizon and often have similar risk levels. This makes it possible to benchmark the cohort portfolios against the investment performance of similar strategies. For instance, the performance of cohort portfolios can be compared against the performance of target maturity funds with similar retirement horizons.
 
We believe the historical investment performance of cohort portfolios compares favorably to target-date fund benchmarks with similar time horizons and risk-return objectives. Our investment methodology emphasizes using market consensus expectations (i.e., no market timing), investing in lower cost funds and selecting managers with consistent performance over long time periods. We


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believe that this methodology can result in lower volatility and more predictable results for Professional Management members relative to the strategies employed by most target-date funds.
 
                               
      Financial Engines
    Target-Date Fund
    Performance
      Professional Management*
    Composite Benchmark
    Difference
      (Net of Fees)     (Net of Fees)     (Net of Fees)
Annualized Since Program Inception (June 30, 2005 through December 31, 2009)
                               
2010 Portfolio
      3.61 %       3.23 %       0.38 %
                               
2020 Portfolio
      3.01 %       2.77 %       0.24 %
                               
2030 Portfolio
      2.61 %       2.26 %       0.34 %
                               
 
* Includes management on an advised and subadvised basis.
 
The performance shown for the member cohort portfolios reflect asset weighted performance, net of all Professional Management fees, across all members in retirement plans that had the requisite data and were retiring in a specified target year, plus or minus one year. For example, the 2010 Portfolio includes members retiring in years 2009, 2010 and 2011. Cohort portfolios therefore do not include results of all program members in the reported plans. We net out fees on the basis of the maximum fee schedule applicable to any cohort member. The “requisite data” qualification is in regard to members who are through the transition period and who had account balances at some time during the measured time period. In a small number of cases, we excluded certain member accounts because they included investments in closed or private funds for which performance data is not available or is not able to be derived, based on asset class, or we may not include multiple accounts. For periods after January 1, 2010, the cohort portfolios will reflect performance across all members in plans that had such requisite data and were retiring in a specified target year, plus or minus two years, subject to a retired member cohort portfolio adjustment. A retired member cohort portfolio shall be established and consist of all members in plans that had such requisite data and were retiring, or retired, within one year from the then current calendar year. For example, in 2011, the retired member cohort portfolio shall consist of members targeted to retire in 2012 and all other previous periods. No cohort portfolios contain results of members who cancelled out of the program. Because daily participant contribution and withdrawal information is generally not available, we derive performance by attributing the performance of each investment held to plan accounts in the proportions held at the start of the period.
 
The target-date fund composite benchmark is an equally weighted average performance of the top five target-date funds by assets, currently the target-date funds of Fidelity, Vanguard, T. Rowe Price, Principal Investments and American Funds. Changes are made in the composite on a forward basis, and prior composites are available upon request. For some target years, a fund family did not offer a specific target horizon fund, and in those cases the return was interpolated using the returns of the existing target-date funds.
 
Historical performance, particularly short-term performance, is not a guarantee of future returns. The target-date fund composite is provided as a benchmark, but is not illustrative of any particular investment. An investment cannot be made in the benchmark as a single investment.
 
Investment Technology
 
We believe portfolio management services in the workplace should be offered to all eligible plan participants regardless of wealth. Achieving that objective requires significant scalability to achieve an affordable cost to the investment manager. The scalability of our technology has been tested and continues to deliver flexibility and results as our business has grown. As of December 31, 2009, we were managing approximately 391,000 separate portfolios with a total AUM value of approximately $25.7 billion. As of December 31, 2009, approximately 45% of our Professional Management


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members have less than $20,000 of retirement assets in their accounts. We believe this technology advice platform and delivery mechanism allows us to normally operate, on average, with a ratio of one registered Investment Advisor Representative for approximately every 10,000 members who are served by our advisors. We believe this is a more favorable ratio than that of the typical traditional broker or investment advisor.
 
Our Advice Engines consist of two main components: a Simulation Engine and an Optimization Engine. In the course of our development, we have received nine U.S. patents that apply to various parts of our Advice Engines.
 
Simulation Engine.  We have developed a Monte Carlo Simulation Engine that provides plan participants with a view of the potential range of future values of their retirement investments. The Simulation Engine helps plan participants reach informed decisions about the appropriate level of risk, savings and time horizon to improve the likelihood of achieving financial goals. Our Simulation Engine is capable of:
 
  •  modeling more than 30,000 securities, including retail mutual funds, stocks, employee stock options, institutional funds, guaranteed investment contracts and stable value funds, exchange-traded funds and fixed-income securities while considering tax implications, expenses, redemption fees, loads and distributions;
 
  •  considering security-specific characteristics such as investment style, expenses, turnover, manager performance, security-specific and industry risk;
 
  •  forecasting the total household portfolio, including tax-deferred and taxable accounts;
 
  •  incorporating social security, pension income and other retirement benefits; and
 
  •  presenting outcomes in terms of portfolio value or retirement income.
 
Optimization Engine.  We use our Optimization Engine to construct personalized portfolios. We do not rely on generic, model portfolios that are unable to accommodate many real-world complexities. As of January 5, 2010, approximately 74% of the portfolios generated by our Advice Engines for our members had investment allocations that were not identical to any other member’s portfolio in their plan. We believe individuals prefer personalized investment recommendations that consider their personal preferences and financial circumstances over model portfolios.
 
Our Optimization Engine takes into consideration the costs, quality and investment styles of the specific investment alternatives available to a plan participant. Specifically, our investment recommendations take into consideration for each fund the mix of asset class exposures, fund expenses, turnover, fund-specific risk due to active management, manager performance and consistency, user imposed constraints and tax efficiency, where applicable, to construct a personalized portfolio recommendation for each client. The calibration of this model is based on more than a decade of research into the factors that influence investment performance. Our approach does not rely on market timing or tactical asset allocation strategies. Our models are designed and calibrated on an ongoing basis to reflect the consensus market expectations built into the observed asset holdings of the market as a whole. We believe this approach increases the probability that our recommendations are consistent with current market conditions and are free from subjective or market timing biases that can arise from traditional optimization models. Our platform has been employed to provide portfolio management services, investment advice and retirement readiness assessments to millions of investors over the last 11 years.
 
When constructing a portfolio, our Optimization Engine:
 
  •  supports real-time, specific, product-level buy and sell recommendations for Online Advice, which can be readily executed, and automated transactions for Professional Management;
 
  •  creates recommended portfolios from the available investment alternatives, such as retail mutual funds, institutional funds and employer stock, in the case of a 401(k) plan, or from


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  either the entire universe of more than 15,000 retail mutual funds, or a subset thereof, in the case of taxable or other tax-deferred accounts;
 
  •  creates recommendations across multiple taxable and tax-deferred accounts;
 
  •  takes into consideration investor risk preferences, restricted positions, redemption fees, investor constraints and outside account information provided to us to create personalized investment recommendations;
 
  •  for assets held in taxable accounts, considers the impact of personal tax rates, unrealized capital gains and losses, the tax efficiency of specific investment options including the propensity to distribute capital gains and income distributions and the benefit of optimal asset placement to maximize after-tax investment returns; and
 
  •  enables real-time interaction with plan participants allowing them to partially override recommendations and immediately receive updated advice reflecting these constraints.
 
Our systems assess a plan participant’s portfolio through a variety of market conditions including variation in inflation, interest rates, dividends and the performance of 15 different asset classes. We are able to simulate an individual investment portfolio’s performance across a wide variety of scenarios in a fraction of a second, illustrating the possible outcomes for a given strategy. This technology underlies the interactive user experience available to users online or through call center sessions. The platform enables us to provide a financial forecast of a plan participant’s current or target portfolio, showing the impact of a wide variety of potential market scenarios on their investment performance.
 
Customers and Key Relationships
 
We provide personalized portfolio management services, investment advice and retirement help to plan participants and reach them through plan sponsors whose retirement plans are administered by plan providers.