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EX-32.2 - Titanium Asset Management Corpv202398_ex32-2.htm
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EX-32.1 - Titanium Asset Management Corpv202398_ex32-1.htm
 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549  

 
Form 10-Q
 
(Mark One)
  þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
OR

  o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to
 
Commission file number: 000-53352
     
Titanium Asset Management Corp.
(Exact name of registrant as specified in its charter)
 
Delaware
(State or other jurisdiction of
incorporation or organization)
20-8444031
(I.R.S. Employer
Identification No.)
    
777 E. Wisconsin Avenue
Milwaukee, Wisconsin
(Address of principal executive offices)
53202-5310
(Zip Code)
 
(414) 765-1980
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ No  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ¨ No  ¨
 
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 ¨
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company þ
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨  No  þ
 
At November 6, 2010, there were 20,491,824 shares of the registrant’s common stock and 612,716 shares of restricted stock outstanding.
 


 
 

 
 
TABLE OF CONTENTS

   
Page
     
PART I. FINANCIAL INFORMATION
1
   
Item 1.
Financial Statements
1
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
28
     
Item 4T.
Controls and Procedures.
28
     
PART II. OTHER INFORMATION
29
   
Item 1.
Legal Proceedings
29
     
Item 1A.
Risk Factors.
29
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
29
     
Item 3.
Defaults Upon Senior Securities
29
     
Item 4.
(Removed and Reserved)
29
     
Item 5.
Other Information
29
     
Item 6.
Exhibits
29
 
 
i

 
PART I. 
FINANCIAL INFORMATION
   
Item 1. 
Financial Statements
 
Titanium Asset Management Corp.
Condensed Consolidated Balance Sheets

   
September 30,
2010
   
December 31,
2009
 
   
(unaudited)
       
Assets
           
Current assets
           
Cash and cash equivalents
  $ 1,599,000     $ 4,773,000  
Investments
    9,351,000       12,549,000  
Accounts receivable
    4,014,000       5,030,000  
Other current assets
    1,509,000       1,162,000  
Total current assets
    16,473,000       23,514,000  
                 
Investments in affiliates
    6,423,000       2,179,000  
Property and equipment, net
    488,000       427,000  
Goodwill
    23,047,000       28,147,000  
Intangible assets, net
    22,434,000       24,920,000  
Total assets
  $ 68,865,000     $ 79,187,000  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities
               
Accounts payable
  $ 64,000     $ 237,000  
Acquisition payments due
    -       1,746,000  
Other current liabilities
    3,004,000       3,504,000  
Total current liabilities
    3,068,000       5,487,000  
                 
Acquisition payments due
    960,000       960,000  
Total liabilities
    4,028,000       6,447,000  
Commitments and contingencies Stockholders’ equity
               
Common stock, $0.0001 par value; 54,000,000 shares authorized; 20,491,824 shares issued and outstanding at September 30, 2010 and 20,564,816 shares issued and outstanding at December 31, 2009
    2,000       2,000  
Restricted common stock, $0.0001 par value; 720,000 shares authorized; 612,716 issued and outstanding at September 30, 2010 and December 31, 2009
    -       -  
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued
    -       -  
Additional paid-in capital
    100,135,000       100,332,000  
Accumulated deficit
    (35,336,000 )     (27,766,000 )
Other comprehensive income
    36,000       172,000  
Total stockholders’ equity
    64,837,000       72,740,000  
Total liabilities and stockholders’ equity
  $ 68,865,000     $ 79,187,000  

See Notes to Condensed Consolidated Financial Statements contained herein and the Notes to Consolidated Financial Statements in the Titanium Asset Management Corp. Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”).

 
1

 
 
Titanium Asset Management Corp.
Condensed Consolidated Statements of Operations
(unaudited)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Operating revenues
  $ 5,822,000     $ 5,335,000     $ 17,064,000     $ 15,631,000  
                                 
Operating expenses:
                               
Administrative
    5,668,000       6,025,000       18,057,000       18,609,000  
Amortization of intangible assets
    828,000       1,020,000       2,486,000       3,059,000  
Impairment of goodwill
    5,100,000       4,847,000       5,100,000       4,847,000  
Total operating expenses
    11,596,000       11,892,000       25,643,000       26,515,000  
Operating loss
    (5,774,000 )     (6,557,000 )     (8,579,000 )     (10,884,000 )
                                 
Other income
                               
Interest income
    69,000       98,000       233,000       333,000  
Gain (loss) on investments
    54,000       28,000       181,000       (160,000 )
Income from equity investees
    167,000       -       611,000       -  
Interest expense
    -       (15,000 )     (16,000 )     (44,000 )
Loss before taxes
    (5,484,000 )     (6,446,000 )     (7,570,000 )     (10,755,000 )
                                 
Income tax benefit
    -       (249,000 )     -       (1,821,000 )
                                 
Net loss
  $ (5,484,000 )   $ (6,197,000 )   $ (7,570,000 )   $ (8,934,000 )
                                 
Earnings (loss) per share
                               
Basic
  $ (0.27 )   $ (0.30 )   $ (0.37 )   $ (0.43 )
Diluted
  $ (0.27 )   $ (0.30 )   $ (0.37 )   $ (0.43 )
                                 
Weighted average number of common shares outstanding:
                               
Basic
    20,683,824       20,546,490       20,691,303       20,546,490  
Diluted
    20,683,824       20,546,490       20,691,303       20,546,490  

See Notes to Condensed Consolidated Financial Statements contained herein and the Notes to Consolidated Financial Statements in the 2009 Form 10-K.
 
 
2

 
 
Titanium Asset Management Corp.
Condensed Consolidated Statements of Comprehensive Income
(unaudited)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net loss
  $ (5,484,000 )   $ (6,197,000 )   $ (7,570,000 )   $ (8,934,000 )
Unrealized gains (losses) on available-for-sale securities
    97,000       283,000       71,000       234,000  
Net (gains) losses reclassified from accumulated other comprehensive income to earnings
    (103,000 )     -       (207,000 )     294,000  
Income tax on other comprehensive income items
    -       (110,000 )     -       (202,000 )
Other comprehensive income items, net of tax
    (6,000 )     173,000       (136,000 )     326,000  
Comprehensive loss
  $ (5,490,000 )   $ (6,024,000 )   $ (7,706,000 )   $ (8,608,000 )

See Notes to Condensed Consolidated Financial Statements contained herein and the Notes to Consolidated Financial Statements in the 2009 Form 10-K.
 
 
3

 
 
Titanium Asset Management Corp.
Consolidated Statements of Changes in Stockholders’ Equity
For the Nine Months ended September 30, 2010 and 2009

   
Common Stock
   
Restricted Shares
                         
   
Shares
   
Shares
held by
TIP
   
Amount
   
Shares
   
Amount
   
Additional
Paid-in Capital
   
Retained
Earnings
(Deficit)
   
Other
Comprehensive
Income (Loss)
   
Total
Stockholders’
Equity
 
                                                       
Balances at December 31,  2008
    20,464,002       (97,011 )   $ 2,000       696,160     $ -     $ 99,462,000     $ (6,597,000 )   $ (163,000 )   $ 92,704,000  
Employee share grants
    45,500       55,322       -       -       -       -       -       -       -  
Equity compensation expense
    -       -       -       -       -       313,000       -       -       313,000  
Net loss and comprehensive income (loss)
    -       -       -       -       -       -       (8,934,000 )     326,000       (8,608,000 )
Balances at September 30, 2009
    20,509,502       (41,689 )   $ 2,000       612,716     $ -     $ 99,775,000     $ (15,531,000 )   $ 163,000     $ 84,409,000  
                                                                         
Balances at December 31, 2009
    20,689,478       (124,662 )   $ 2,000       612,716     $ -     $ 100,332,000     $ (27,766,000 )   $ 172,000     $ 72,740,000  
Equity compensation expense
    -       -       -       -       -       46,000       -       -       46,000  
Forfeitures of employee share grants
    -       (50,000 )     -       -       -       (185,000 )     -       -       (185,000 )
Redemption of common stock
    (22,991 )     -       -       -       -       (58,000 )     -       -       (58,000 )
Net loss and comprehensive loss
    -       -       -       -       -       -       (7,570,000 )     (136,000 )     (7,706,000 )
Balances at September 30, 2010
    20,666,486       (174,662 )   $ 2,000       612,716     $ -     $ 100,135,000     $ (35,336,000 )   $ 36,000     $ 64,837,000  

See Notes to Condensed Consolidated Financial Statements contained herein and the Notes to Consolidated Financial Statements in the 2009 Form 10-K.

 
4

 
 
Titanium Asset Management Corp.
Condensed Consolidated Statements of Cash Flows
(unaudited)
 
   
Nine Months Ended
September 30,
 
   
2010
   
2009
 
             
Cash flows from operating activities
           
Net loss
  $ (7,570,000 )   $ (8,934,000 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Amortization of intangible assets
    2,486,000       3,059,000  
Impairment of goodwill
    5,100,000       4,847,000  
Depreciation
    67,000       80,000  
Share compensation expense (credit)
    (139,000 )     313,000  
Loss (gain) on investments
    (181,000 )     160,000  
Income from equity investees
    (611,000 )     -  
Distributions from equity investees
    367,000       -  
Accretion of acquisition payments
    16,000       40,000  
Deferred income taxes
    -       (1,821,000 )
Changes in assets and liabilities:
               
Decrease in accounts receivable
    1,016,000       538,000  
Increase in other current assets
    (347,000 )     (440,000 )
Decrease in accounts payable
    (173,000 )     (398,000 )
Increase (decrease) in other current liabilities
    (576,000 )     876,000  
Net cash used in operating activities
    (545,000 )     (1,680,000 )
                 
Cash flows from investing activities
               
Purchases of investments
    (12,163,000 )     (16,340,000 )
Sales and redemptions of investments
    15,406,000       13,929,000  
Investments in equity investees
    (4,000,000 )     -  
Purchases of property and equipment
    (128,000 )     (128,000 )
Acquisitions of subsidiaries, net of cash acquired
    (1,744,000 )     (8,151,000 )
Net cash used in investing activities
    (2,629,000 )     (10,690,000 )
                 
Net decrease in cash and cash equivalents
    (3,174,000 )     (12,370,000 )
                 
Cash and cash equivalents:
               
Beginning
    4,773,000       18,753,000  
Ending
  $ 1,599,000     $ 6,383,000  

See Notes to Condensed Consolidated Financial Statements contained herein and the Notes to Consolidated Financial Statements in the 2009 Form 10-K.

 
5

 
 
Titanium Asset Management Corp.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 1 – General

Titanium Asset Management Corp. (the “Company”) was incorporated on February 2, 2007. The Company commenced operations as a special purpose acquisition company to acquire one or more operating companies engaged in the asset management business. On October 1, 2007, the Company acquired all of the voting common stock of Wood Asset Management, Inc. (“Wood”) and all of the membership interests of Sovereign Holdings, LLC (“Sovereign”), two asset management firms. On March 31, 2008, the Company acquired all of the outstanding capital stock of National Investment Services, Inc. (“NIS”), a third asset management firm. After such business combinations, the Company ceased to act as a special purpose acquisition vehicle. On December 31, 2008, the Company acquired all of the membership interests of Boyd Watterson Asset Management, LLC (“Boyd”), a fourth asset management firm. The Company’s strategy is to manage these operating companies as an integrated business.

The accompanying unaudited interim condensed consolidated financial statements have been prepared by the Company, in accordance with accounting principles generally accepted in the United States (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, in the opinion of management, include all adjustments (all of which were of a normal and recurring nature) necessary for a fair statement of the information for each period contained therein.
 
The preparation of consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. These estimates are based on information available as of the date of these consolidated financial statements. Actual results could differ materially from those estimates.

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and in the 2009 Form 10-K and the Consolidated Financial Statements and the Notes thereto included in the 2009 Form 10-K.

The cash flow activity for the nine months ended September 30, 2009 related to the payment of deferred acquisition obligations has been reclassified to be included within investing activities.

Note 2 – Adoption of New Accounting Standards

The Company’s significant accounting policies are discussed in the Notes to the Company’s Consolidated Financial Statements in the 2009 Form 10-K.

The following new accounting standards and amendments to standards first became effective for the fiscal year beginning January 1, 2010:

·
A standard, which was issued by the Financial Accounting Standards Board (“FASB”) in June 2009, that requires entities to provide more information regarding sales of securitized financial assets and similar transaction. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.
 
 
6

 

Note 2 – Adoption of New Accounting Standards (continued)

·
An amended standard, issued by the FASB in January 2010, that requires additional disclosures about significant transfers in and out of fair value measurement levels 1 and 2 and reasons for the transfers. In addition, the amended standard requires new disclosures relating to the reconciliation for fair value measurements using unobservable inputs (level 3) detailing information about purchases, issuances, and settlements on a gross basis. The adoption of these amended disclosure requirements did not have a significant impact on the Company’s consolidated financial statements.

Note 3 – Investments

The Company’s current portfolio of debt securities and its investment in a commingled stock fund that was originated in 2008 and liquidated in 2009 are accounted for as available-for-sale securities. The Company’s investments in affiliates are accounted for using the equity method of accounting because the Company has significant influence over the management of the funds.
 
Current portfolio of debt securities
 
   
Amortized cost
   
Unrealized gains
   
Unrealized
losses
   
Fair value
 
                         
September 30, 2010
  $ 9,230,000     $ 136,000     $ (15,000 )   $ 9,351,000  
December 31, 2009
  $ 12,292,000     $ 259,000     $ (2,000 )   $ 12,549,000  
  
Debt securities accounted for as available-for-sale and held at September 30, 2010 mature as flows:
 
   
Amortized cost
   
Fair value
 
Within one year
  $ 5,438,000     $ 5,496,000  
After one year, but within five years
  $ 3,792,000     $ 3,855,000  

The following is a summary of the realized gains and losses on the sale of investments from the Company’s portfolio of debt securities for the three and nine months ended September 30, 2010 and 2009. The specific identification method is used to determine the realized gain or loss.
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Realized gains
  $ 72,000     $ 55,000     $ 227,000     $ 263,000  
Realized losses
    (18,000 )     (27,000 )     (46,000 )     (42,000 )
Net realized gains
  $ 54,000     $ 28,000     $ 181,000     $ 221,000  
 
 
7

 

Note 3 – Investments (continued)

Commingled stock fund
 
The Company’s investment in a commingled stock fund consisted of its investment in the Plurima Titanium U.S. Stock Fund, a sub-fund of the Dublin-based Plurima Funds mutual funds complex, to which Wood served as investment advisor. In March 2009, the Company’s board of directors determined that additional investments from other parties into the Plurima Titanium U.S. Stock Fund were likely not to be forthcoming. As a result, the Company decided to liquidate its investment in the commingled stock fund. Based on this decision, the Company recognized a $381,000 impairment loss on this investment, including the previously unrecognized loss of $294,000 that was reclassified out of accumulated other comprehensive income into earnings. The Company subsequently liquidated its investment and received proceeds of $587,000 from Plurima in 2009.

Investments in Affiliates
 
Investments in affiliates include the Company’s investment in the Titanium TALF Opportunity Fund (the “TALF Fund”), which it organized for its clients to invest in securities participating in the Term Asset-Backed Securities Loan Facility (“TALF”) of the Federal Reserve Bank of New York. The Company is the managing member of the TALF Fund and serves as the investment manager for the TALF Fund for which it receives management fees. As of September 30, 2010, the Company’s investment in the TALF Fund (including an additional investment of $2,000,000 made during the nine months ended September 30, 2010) represents approximately 11% of the total investments in the TALF Fund. Because the Company has an equity interest in the TALF Fund and has significant influence over the TALF Fund’s daily activities through its role as managing member and investment manager, the Company accounts for this investment using the equity method of accounting.
 
Investments in affiliates also include the Company’s $2,000,000 investment in the NIS Fixed Income Arbitrage Fund, LTD. (the “NIS ARB Fund”) made during the nine months ended September 30, 2010. The Company is the managing member of the NIS ARB Fund and serves as the investment manager for the NIS ARB Fund for which it receives management fees. As of September 30, 2010, the Company’s investment in the NIS ARB Fund represents approximately 15% of the total investments in the NIS ARB Fund. Because the Company has an equity interest in the NIS ARB Fund and has significant influence over the NIS ARB Fund’s daily activities through its role as managing member and investment manager, the Company accounts for this investment using the equity method of accounting.
 
The activity related to the Company’s investment in affiliates for the nine months ended September 30, 2010 is as follows:
 
Investment at December 31, 2009
  $ 2,179,000  
Additional investments
    4,000,000  
Distributions
    (367,000 )
Equity in income of affiliates
    611,000  
Investments in affiliates at September 30, 2010
  $ 6,423,000  
 
 
8

 
 
Note 4 – Goodwill

We perform goodwill impairment tests annually, or whenever events or changes in circumstances indicate that the carrying amount of goodwill might not be recoverable, using a two-step process with the first step being a test for potential impairment by comparing our reporting unit’s fair value with its carrying amount (including goodwill). If the carrying amount of the reporting unit exceeds its fair value, we complete the second step under which the fair value of the reporting unit is allocated to its assets and liabilities, including recognized and unrecognized intangibles. If the implied fair value of the reporting unit’s goodwill is lower than its carrying amount, goodwill is impaired and written down to its implied fair value. We complete our annual test for impairment during our fourth quarter.
 
For purposes of testing goodwill for impairment, the Company attributes all goodwill to a single reporting unit. We have aggregated all of our subsidiaries into a single reporting unit because they provide similar services to similar clients, operate in the same regulatory framework, and share similar economic characteristics. The Company’s shared sales force is organized to market the full range of the Company’s products and services.
 
We estimate fair value averaging fair value established using an income approach and fair value established using a market approach. The fair value from the income approach was weighted 75%, while the fair value from the market approach was weighted 25%. The weighting reflects that the market approach includes more mature asset management companies with greater scale than the Company. We use independent valuation specialists to assist us in our valuation process.
 
The income approach uses a discounted cash flow model that takes into account assumptions that marketplace participants would use in their estimates of fair value, current period actual results, and forecasted results for future periods that have been reviewed by senior management. In preparing our forecasts, we considered historical and projected growth rates, our business plans, prevailing business conditions and trends, anticipated needs for working capital and capital expenditures, and historical and expected levels and trends of operating profitability.

The market approach employs market multiples for comparable companies. Fair value estimates are established using multiples of assets under management and current and forward multiples of revenue and earnings before income taxes, depreciation and amortization (referred to as EBITDA).

Based on interim results through September 30, 2010, initial work in connection with preparing our 2011 budget, and some trading activity in our common stock, we determined that we should complete a goodwill impairment test as of September 30, 2010. For the current operating forecasts, our estimates for net inflows of assets under management and market returns resulted in estimated revenue growth rates of approximately 9% per annum, which are less than the estimated growth rates in the immediately prior valuation. Cash flows beyond the five year forecast period were projected at 4% per annum. We used a weighted average cost of capital of 14.5% determined using the capital asset pricing model, which is consistent with the rate used in the immediately prior valuation.
 
Upon completion of the goodwill impairment test as of September 30, 2010, we concluded that our recorded goodwill balance was impaired and recorded an impairment charge of $5,100,000 in the third quarter of 2010. In addition, we expect to settle the remaining acquisition obligation for Boyd in the fourth quarter for the full $8,000,000. This settlement would result in an additional $8,000,000 of goodwill. However, based on the current estimates, we expect that we will have to recognize an additional goodwill impairment charge for this entire amount in the fourth quarter of 2010.

During 2009, we incurred impairment charges of $8,489,000, of which $4,847,000 was recorded in the third quarter of 2009 and $3,642,000 was recorded in the fourth quarter of 2009.
 
 
9

 
 
Note 5 – Acquisition Obligations
 
In connection with the acquisitions of Wood, Sovereign, NIS and Boyd, the acquisition agreements provided for deferred fixed payments and contingent payments based on assets under management or revenues at specified future dates. The deferred fixed amounts due as of September 30, 2010 and December 31, 2009 are as follows:
 
   
September 30,
2010
   
December 31,
2009
 
Current amounts:
           
Sovereign acquisition obligation (a)
  $ -     $ 1,033,000  
NIS acquisition obligation (b)
    -       713,000  
Current acquisition payments due
  $ -     $ 1,746,000  
                 
Noncurrent amount:
               
Boyd acquisition obligation (c)
  $ 960,000     $ 960,000  
 
(a)
During the period ended March 31, 2010, as part of a settlement agreement with the previous majority owner of Sovereign, the Company agreed to pay $1,015,000 in full satisfaction of all amounts due, or that would become due, under the acquisition agreement. This amount was paid in April 2010.
 
(b)
The NIS acquisition obligation was paid in May 2010.
 
(c)
The Boyd acquisition obligation reflects a deferred stock grant of 192,000 shares of common stock valued at the acquisition date at $960,000, payable in 2011.
 
Under the terms of the acquisition agreement for Wood, the seller may receive additional payments should Wood achieve certain revenue and assets under management milestones through September 30, 2011. At September 30, 2010, the remaining maximum payments are $3,000,000, of which up to 50% is payable in Company common stock. Based on current estimates for assets under management and revenues, the Company estimates that approximately $825,000 will be due under the assets under management provision in 2011 and that no amount will be due under the revenue provision.
 
Under the terms of the acquisition agreement for Boyd, the sellers may receive an additional deferred payment up to $8,000,000 based on the revenue run rate as of December 31, 2010, payable in 2011. The current revenue run rate significantly exceeds the target for the maximum. We expect to amend the acquisition agreement, to accelerate the measurement date to November 30, 2010 and to make the payment in cash prior to December 31, 2010.
 
Note 6 – Stockholders’ Equity

The Company’s authorized capital consists of 54,000,000 shares of common stock with a $0.0001 par value, 720,000 shares of restricted common stock with a $0.0001 par value, and 1,000,000 shares of preferred stock with a $0.0001 par value. The restricted common stock shares carry voting rights and no rights to dividends except in the case of liquidation of the Company. The restricted common stock shares convert on a one-for-one basis to shares of common stock if at any time within five years of their issue the ten-day average share price of the common stock exceeds $6.90 or if there is a change in control (as defined in the Company’s certificate of incorporation). No preferred stock had been issued at September 30, 2010.

At December 31, 2009, the Company had outstanding compensatory stock grants for 55,322 shares of common stock held by Titanium Incentive Plan, LLC (“TIP”), a wholly-owned subsidiary. During April 2010, an award for 50,000 shares was forfeited resulting in the reversal of $185,000 of previously recognized compensation expense. The remaining grants vested on June 21, 2010. At September 30, 2010, the Company had no further compensatory awards outstanding.

 
10

 
 
Note 6 – Stockholders’ Equity (continued)

In connection with the Company’s 2007 private placement, the Company issued 20,000,000 warrants that entitle the holder to purchase one share of common stock at $4.00 per share. The warrants expire in June 2011 unless earlier redeemed by the Company. At September 30, 2010, all 20,000,000 warrants were outstanding.
 
As part of the private placement, the Company granted an option to Sunrise Securities Corp. to acquire 2 million units at a price of $6.60 (each unit consists of one share of common stock and one warrant to acquire one share of common stock at $4.00 per share). At September 30, 2010, all of these options were outstanding.

Note 7 Income Taxes

At December 31, 2009, the Company had deferred tax assets of $10,273,000 including deferred tax benefits related to federal net operating loss carryforwards of approximately $10,636,000 that expire in 2028 and 2029 and state net operating loss carryforwards totaling approximately $10,233,000 that expire between 2023 and 2029.
 
In assessing the realizability of the Company’s deferred tax assets, we consider all relevant positive and negative evidence in determining whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of the gross deferred tax assets depends on several factors, including the generation of sufficient taxable income prior to the expiration of the net operating loss carryforwards. Pursuant to FASB guidance, a cumulative loss in recent years is a significant piece of negative evidence to be considered in evaluating the need for a valuation allowance that is difficult to overcome. Based on the pretax losses in 2008 and 2009, we determined that it was no longer appropriate to consider expected future income as the primary factor in determining the realizability of our deferred tax assets. As a result, the Company recognized a valuation allowance of $10,273,000 against the full value of deferred tax assets as of December 31, 2009.
 
Based on the continuation of cumulative losses, the Company continued to fully offset any additional deferred tax assets with additional valuation allowances during the nine months ended September 30, 2010.
 
 
11

 
 
Note 8 Earnings per Share

Basic earnings per share (“EPS”) is computed by dividing net income (loss) by the weighted average shares of common stock outstanding. In addition, in periods following the acquisition of Boyd, basic weighted average shares include 192,000 shares of common stock to be issued to the sellers of Boyd in 2011, except under certain circumstances described in the Boyd acquisition agreement. Diluted EPS gives effect to all dilutive potential shares of common stock outstanding during the period. Dilutive potential shares of common stock include the incremental shares of common stock issued under the compensatory common stock grants computed using the treasury stock method. No incremental shares of common stock have been included for the 20,000,000 outstanding warrants as their effect would have been antidilutive under the treasury stock method. The 612,716 shares of restricted common stock have been excluded from the computation of diluted weighted average shares because their conversion terms require the ten-day average share price of the common stock to exceed $6.90 per share. In addition, the option to acquire 2,000,000 units is excluded from the computation of diluted weighted average shares because the effect would have been antidilutive.
 
The computation of basic and diluted EPS is as follows:
 
   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Basic EPS:
                       
Net loss
  $ (5,484,000 )   $ (6,197,000 )   $ (7,570,000 )   $ (8,934,000 )
                                 
Weighted average shares of common stock outstanding
    20,491,824       20,354,490       20,499,303       20,354,490  
Shares of common stock to be issued in Boyd acquisition
    192,000       192,000       192,000       192,000  
Basic weighted average shares of common stock outstanding
    20,683,824       20,546,490       20,691,303       20,546,490  
                                 
Basic EPS
  $ (0.27 )   $ (0.30 )   $ (0.37 )   $ (0.43 )
                                 
Diluted EPS:
                               
Net loss
  $ (5,484,000 )   $ (6,197,000 )   $ (7,570,000 )   $ (8,934,000 )
                                 
Basic weighted average shares of common stock outstanding
    20,683,824       20,546,490       20,691,303       20,546,490  
Shares of common stock under compensatory common stock grants
    -       41,995       14,474       63,137  
Diluted weighted average shares of common stock outstanding
    20,683,824       20,588,485       20,705,777       20,609,627  
                                 
Diluted EPS
  $ (0.27 )   $ (0.30 )   $ (0.37 )   $ (0.43 )

The diluted weighted average shares amount for the three and nine month periods ended September 30, 2010 and 2009 are provided for informational purposes, as the net loss for these periods causes basic earnings per share to be the most dilutive.
 
 
12

 
 
 Note 9 – Fair Value Disclosures
 
Under the FASB’s fair value requirements, the fair values for assets and liabilities are to be disclosed based on three levels of input: Level 1 – quoted prices in active markets for identical assets or liabilities; Level 2 – observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or Level 3 – unobservable inputs that are supported by little or no market activity and that are significant to the fair value of assets or liabilities. Level 3 assets and liabilities include financial instruments the value of which is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.
 
The Company measures the following assets at fair values on a recurring basis:
 
   
Category used for Fair Values
 
   
Level 1
   
Level 2
   
Level 3
 
                   
Assets at September 30, 2010
                 
Cash and cash equivalents
  $ 1,599,000     $ -     $ -  
Current securities available for sale – Debt securities
    -       9,351,000       -  
     $ 1,599,000     $ 9,351,000     $ -  
                         
Assets at December 31, 2009
                       
Cash and cash equivalents
  $ 4,773,000     $ -     $ -  
Current securities available for sale – Debt securities
    -       12,549,000       -  
    $ 4,773,000     $ 12,549,000     $ -  
 
 
13

 
 
Note 10 Contingencies

On February 10, 2010, a former client filed suit in the United States District Court for the Northern District of Illinois (the “US District Court”) against the Company and its subsidiary Sovereign Holdings, LLC, alleging fraudulent conduct and breach of fiduciary duty on the part of Sovereign in investing the former client’s assets in auction-rate securities. The claim alleged, among other things, that Sovereign failed to conduct adequate due diligence into the auction rate securities purchased for the former client’s account, and that the investment in the auction rate securities was outside the investment policy of the former client. The former client’s suit sought $4,704,000 in damages. On October 26, 2010, the US District Court granted our motion to dismiss the suit with prejudice. At this time, we cannot predict what further actions (if any) the former client may attempt to pursue in regards to its claims. In any event, we believe the claims are without merit, and will vigorously defend against them.

The Company's subsidiary, Sovereign, received a letter dated July 16, 2010 from a former client demanding that Sovereign compensate it for losses relating to allegedly unsuitable investments in approximately $30 million of various auction rate securities purchased on its behalf by Sovereign.  The former client has filed a claim against the underwriters for the purchased securities, but has not to this point brought a claim against Sovereign. Management is in the process of evaluating this demand and the former client's allegations to determine whether there is any merit to them.  In the interim, we have entered into a tolling agreement with the former client. At this preliminary stage, the Company cannot determine the potential liability of the Company or the likelihood of an unfavorable outcome.  In any event, management believes the claim would be covered by insurance (up to $20 million), subject to the payment of deductible amounts by the Company.

During 2008, the Company received an invoice for $670,000 from the lawyers who worked on the placement of the Company’s shares of common stock on AIM in June 2007. The Company is disputing this invoice and at the current time believes there is no liability. Accordingly, no provision has been made in these condensed consolidated financial statements for the invoice. In the event that the Company must pay all or a portion of this amount, the Company’s consolidated results of operations will be unaffected and the Company does not expect its consolidated financial position to materially change.
 
The Company is from time to time involved in legal matters incidental to the conduct of its business and such matters can involve current and former employees and vendors. Management does not expect these matters would have a material effect on the Company’s consolidated financial position or results of operations.

 
14

 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q, including particularly the Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a “safe harbor” for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by and information currently available to the management of Titanium Asset Management Corp., a Delaware corporation (referred to as “we,” “our” or the “Company,” and, unless the context indicates otherwise, includes our wholly owned asset management subsidiaries, Wood Asset Management, Inc. (“Wood”), Sovereign Holdings LLC (“Sovereign”), National Investment Services, Inc. (“NIS”), and Boyd Watterson Asset Management, LLC (“Boyd”). We refer to Wood, Sovereign, NIS and Boyd collectively as our subsidiaries. The outcome of the events described in these forward-looking statements is subject to risks and uncertainties. Actual results and the outcome or timing of certain events may differ significantly from those projected in these forward-looking statements due to market fluctuations that alter our assets under management; termination of investment advisory agreements; loss of key personnel; loss of third-party distribution services; impairment of goodwill and other intangible assets; our inability to compete; market pressure on investment advisory fees; problems experienced in the acquisition or integration of target businesses; changes in law, regulation or tax rates; ineffective management of risk; inadequacy of insurance; changes in interest rates, equity prices, liquidity of global markets and international and regional political conditions; terrorism; changes in monetary and fiscal policy, investor sentiment and availability and cost of capital; technological changes and events; outcome of legal proceedings; changes in currency values, inflation and credit ratings; failure of our systems to properly operate; or actions taken by Clal Finance Ltd., (“Clal”), as our significant stockholder; factors listed under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”); and other factors listed in this Quarterly Report on Form 10-Q and from time to time in our other filings with the Securities and Exchange Commission (“SEC”). For this purpose, statements relating to integrating the operational, administrative and sales activities of our subsidiaries, earning of incentive fees, amount of future assets under management, acquisitions of additional asset management firms and payment therefor, payment of deferred consideration for the purchase of our subsidiaries and anticipated levels of future revenues, expenses or earnings, among other things; any statements using the terms “aim,” “anticipate,” “appear,” “based on,” “believe,” “can,” “continue,” “could,” “are emerging,” “estimate,” “expect,” “expectation,” “intend,” “may,” “ongoing,” “plan,” “possible” “potential, “predict,” “project,” “should” and “would” or similar words or phrases, or the negatives of those words or phrases; or discussions of strategy, plans, objectives or goals, may identify forward-looking statements that involve risks, uncertainties and other factors that could cause our actual results, financial condition and the outcome and timing of certain events to differ materially from those projected or management’s current expectations. By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.
 
The following discussion is designed to provide a better understanding of significant trends related to our consolidated financial condition and consolidated results of operations. The discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q, as well as the Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included in our 2009 Form 10-K.
 
General
 
Our principal business is providing investment advisory services to institutional and retail clients. Our core strategy is to develop a broad array of investment management expertise to enable us to offer a full range of investment strategies to our clients. Although we manage and distribute a range of products and services, we operate in one business segment, namely as an investment advisor to institutional and retail clients.
 
Through four acquisitions, we have assembled a group of investment managers with solid long-term track records to serve as our core asset management business. Through these investment managers, we have expertise in both fixed-income and equity investment strategies and have a client base that extends from individuals to a range of institutional investors, as well as solid sub-advisory and referral arrangements with a variety of broker-dealers. During 2009, we extended our business to include real estate investment advisory services through the hiring of two experienced real estate investment managers. As of September 30, 2010, we had $8.5 billion of assets under management and an additional $1.0 billion of assets, on which we earn referral fees.
 
 
15

 
 
Our asset management services are typically delivered pursuant to investment advisory agreements entered into between each subsidiary and its clients. Investment advisory fees are generally received quarterly, based on the value of assets under management on a particular date, such as the first or last day of a quarter. Our institutional business is generally billed in arrears, whereas the retail business is generally billed in advance. The majority of our investment advisory contracts are generally terminable at any time or on notice of 30 days or less. The nature of these agreements, the notice periods and the billing cycles vary depending on the nature and the source of each client relationship.
 
Most of our investment advisory services are provided through the management of separate accounts. However, an increasing percentage of our services are provided through private funds, which allow us to provide our investment strategies to our institutional clients in a more cost efficient manner. We earn incentive fees on two of the funds, which are organized to invest in preferred stocks.
 
We also have a referral arrangement with a hedge fund manager through which were earn fees for referring clients to its investment vehicles.
 
Our operating revenues are substantially influenced by the changes to our assets under management and shifts in the distribution of assets under management among types of securities and investment strategies. Our assets under management fluctuate based primarily on our investment performance (both absolutely and relative to other investment advisors) and the success of our sales and marketing efforts. A material portion of our results will be influenced by fluctuations in world financial markets. Because they comprise the largest part of our assets under management, the performance of U.S. fixed-income securities should have the greatest influence on our results.
 
A significant portion of our expenses, including employee compensation and occupancy, do not vary directly with operating revenues. As a result, our efforts to improve our cost structure have focused on integrating the operational and administrative functions of the acquired subsidiaries, including accounting, information technology, human resources, and risk management activities. During 2009, we completed the staffing and reorganization of our sales staff to better position us to sell the full range of our strategies to our existing customer base and to prospective clients. In addition, we completed the integration of our accounting operations.
 
On February 8, 2010, our Board of Directors announced that it had accepted the resignation of Nigel Wightman as Chairman and Chief Executive Officer and had named Mr. Robert Brooks as Chief Executive Officer. In addition to these changes, the Board of Directors also announced the appointments of Mr. Brian Gevry as Chief Operating Officer and Mr. Jonathan Hoenecke as Chief Financial Officer. Further, on April 9, 2010, Mr. John Fisher resigned his positions as a Managing Director and President and Chief Executive Officer of Wood and Sovereign. These changes have centralized our management team, enhanced our efforts to integrate our operations, and reduced our ongoing cost structure. Since completion of the Boyd acquisition on December 31, 2008, we have reduced our headcount from 97 to 82. Principally as a result of these reductions, we have reduced our annualized administrative expenses from approximately $25.1 million at March 31, 2009 to $22.7 million at September 30, 2010.
 
Market Developments
 
The fixed income market performance during the three months ended September 30, 2010 was solid with the Barclay’s Aggregate Index increasing 2.5% while the equity markets recovered, with the S&P 500 Index increasing by 11.3%. For the twelve months ended September 30, 2010, the Barclay’s Aggregate Index gained 10.2% while the S&P 500 Index gained 8.2%. As a result of the strong market returns, our assets under management increased by $227.0 million, or 3%, since September 30, 2009. The resultant increase in average assets under management further resulted in a 9% increase in investment advisory fees for the three months ended September 30, 2010 and a 9% increase for the nine months ended September 30, 2010 compared to the prior year comparable periods.
 
 
16

 
 
Assets Under Management
 
Our asset management services are delivered pursuant to investment advisory agreements with fees generally determined on a quarterly basis as a percentage (or range of percentages) of either beginning or ending market value of assets under management. Our investment advisory fees vary, among other things, by investment strategy and by client type. Our average fee rates for equity investment strategies generally are higher than those for fixed income strategies. In general, our clients may terminate our services at any time with limited notice.
 
We manage a portion of our assets under management through private funds that generally are organized as limited liability companies. We believe the use of these funds allows us to provide our investment strategies to our institutional clients in a cost effective manner. We earn incentive fees on two of the funds, which are organized to invest in preferred stocks.
 
Assets under management of $8.5 billion at September 30, 2010 were 5% higher than the $8.2 billion reported at December 31, 2009 and 3% higher than the $8.3 billion reported at September 30, 2009. The following table presents summary activity for the three and nine months ended September 30, 2010 and 2009.
 
   
Three Months Ended
   
2010
   
Nine Months Ended
   
2010
 
   
September 30,
   
vs.
   
September 30,
   
vs.
 
(in millions)
 
2010
   
2009
   
2009
   
2010
   
2009
   
2009
 
                                     
Period Activity:
                                   
Beginning balance
  $ 8,415.8     $ 7,614.9       10 %   $ 8,151.4     $ 7,573.2       8 %
                                                 
Inflows
    324.2       779.1       -58 %     1,157.9       1,725.6       -33 %
Outflows(1)
    (492.4 )     (446.5 )     10 %     (1,284.1 )     (1,531.0 )     -16 %
Net flows
    (168.2 )     332.6    
NM
      (126.2 )     194.6    
NM
 
                                                 
Market value change
    315.2       372.6       -15 %     537.6       552.3       -3 %
                                                 
Ending balance
  $ 8,562.8     $ 8,320.1       3 %   $ 8,562.8     $ 8,320.1       3 %
                                                 
Average Assets Under Management (2)
  $ 8,489.3     $ 7,967.5       6 %   $ 8,492.2     $ 7,764.3       9 %
Average Fee Rate (basis points)
    25       24       4 %     24       24    
NC
 

(1)
Outflows for the nine month period ended September 30, 2010 include the elimination of approximately $100 million of advisory-only accounts whose fees are not asset-based.
 
(2)
Average assets under management are calculated based on the quarter end balances and include amounts acquired in acquisitions in the first quarter following the acquisition.
 
NM: Not meaningful
NC: No change
 
The principle factors affecting our net flows during the periods ended September 30, 2010 and 2009 include the following:

 
·
We generated approximately $700 million of new assets in the quarter ended September 30, 2009 through our participation in the Term Asset-Backed Securities Loan Facility (TALF”) of the Federal Reserve Bank of New York. These new assets under management were added through new separate client accounts and our Titanium TALF Opportunity Fund (“TALF Fund”). The securities purchased under the TALF program are beginning to mature and as a result we may begin to experience some downward pressure on assets under management over the next year.

 
17

 
 
 
·
Our real estate investment advisory services began adding clients during the third quarter of 2009. During the quarter ended September 30, 2010, we added approximately $90 million of new assets compared to approximately $20 million of new assets in the comparable prior year period. During the nine months ended September 30, 2010, we added approximately $170 million of new assets compared to $20 million of new assets in the comparable prior year period. We earn higher average fees on the real estate assets, and the growth in these assets resulted in the marginal improvement to our overall average fee rate for the quarter ended September 30, 2010.

 
·
During 2009 and 2010, we experienced higher asset withdrawals by multiemployer pension clients of NIS due to their asset rebalancing activities and general economic conditions. During the quarter ended September 30, 2010, these withdrawals were approximately $110 million compared to approximately $80 million in the comparable prior year period. During the nine months ended September 30, 2010, these withdrawals were approximately $300 million compared to approximately $340 million for the comparable prior year period. We would expect these withdrawals to moderate with improved equity market returns and with improved economic conditions.

 
·
During the second half of 2009, we lost approximately $500 million of client accounts at Sovereign due to the loss of one broker-dealer platform and its underlying retail accounts and several large institutional accounts. We made several management changes at Sovereign to address the underlying reasons for these client losses and the Sovereign activity has stabilized in 2010. These asset losses were approximately $195 million during the quarter ended September 30, 2009 and approximately $280 million during the nine months ended September 30, 2009.

 
·
The lack of individual investor confidence in the equity markets has led to higher account closures and withdrawals of equity assets, particularly in our retail accounts. During the quarter ended September 30, 2010, the total outflows of equity assets were approximately $70 million compared to approximately $30 million in the comparable prior year period. During the nine months ended September 30, 2010, the total outflows of equity assets were approximately $140 million compared to $120 million in the comparable prior year period.

Market value changes reflect our investment performance for the respective periods. Fixed income assets comprise approximately 89% of our total assets under management at September 30, 2010. Fixed income returns as measured by the Barclay’s Aggregate Index were 2.5% for the quarter ended September 30, 2010 (3.7% for the comparable 2009 period) and 8.0% for the nine months ended September 30, 2010 (5.7% for the comparable 2009 period). For the nine months ended September 30, 2010, approximately 87% of our fixed income assets with defined performance benchmarks outperformed their respective benchmarks.

Equity assets comprise approximately 9% of total assets under management at September 30, 2010. Equity returns as measured by the S&P 500 Index were 11.3% for the quarter ended September 30, 2010 (15.6% for the comparable 2009 period) and 3.9% for the nine months ended September 30, 2010 (19.3% for the comparable 2009 period). Our equity assets generally underperformed their respective benchmarks for the nine months ended September 30, 2010.
 
 
18

 
 
The following table presents summary breakdowns for our assets under management at September 30, 2010 and 2009.
   
2010
   
2009
       
By investment strategy:
                 
Fixed income
  $ 7,607.5     $ 7,516.9       1 %
Equity
    749.0       780.0       -4 %
Real estate
    206.3       23.2    
NM
 
Total
  $ 8,562.8     $ 8,320.1       3 %
                         
By client type:
                       
Institutional
  $ 7,286.9     $ 6,634.3       10 %
Retail
    1,275.9       1,685.8       -24 %
Total
  $ 8,562.8     $ 8,320.1       3 %
                         
By investment vehicle:
                       
Separate accounts
  $ 7,630.2     $ 7,798.9       -2 %
Private funds
    932.6       521.2       79 %
Total
  $ 8,562.8     $ 8,320.1       3 %

Our mix of assets under management by investment strategy was relatively unchanged as fixed income assets comprised 89% of total assets under management in 2010 compared to 90% in 2009.
 
During 2010, our mix of assets under management with institutional clients increased to 85% compared to 78% in 2009, primarily due to the loss of retail accounts at Sovereign during the latter half of 2009. The modest change in mix did not result in a significant change in our average fee rate.
 
The increase in assets managed through private funds reflects our organization during the third quarter of 2009 of the TALF Fund. At September 30, 2010, we had approximately $314.3 million of assets under management in the TALF Fund.
 
Through October 31, 2010, our aggregate assets under management remained approximately the same at $8.5 billion.
 
 We have a referral arrangement with Attalus Capital (“Attalus”), whereby we refer investors to investment vehicles sponsored by Attalus and in turn receive a referral fee equal to a percentage of the fees received by Attalus from the new clients. The assets managed by Attalus under this arrangement increased slightly from $974.9 million at December 31, 2009 to $997.5 million at September 30, 2010. The activity related to these assets was as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(in millions)
 
2010
   
2009
   
2010
   
2009
 
                         
Annual Activity:
                       
Beginning balance
  $ 955.6     $ 860.4     $ 974.9     $ 806.2  
Inflows
    -       63.1       24.2       67.6  
Outflows
    -       -       -       -  
Market value change
    41.9       46.4       (1.6 )     96.1  
Ending balance
  $ 997.5     $ 969.9     $ 997.5     $ 969.9  
                                 
Average Assets Under Management
  $ 976.6     $ 915.2     $ 980.0     $ 864.7  
Average Referral Fee Rate (basis points)
    25       25       25       26  
 
 
19

 
 
Results of Operations
 
Consolidated Results of Operations
 
   
Three Months Ended
   
2010
   
Nine Months Ended
   
2010
 
   
September 30,
   
vs.
   
September 30,
   
vs.
 
   
2010
   
2009
   
2009
   
2010
   
2009
   
2009
 
Operating revenues
  $ 5,822,000     $ 5,335,000       9 %   $ 17,064,000     $ 15,631,000       9 %
Operating expenses:
                                               
Administrative
    5,668,000       6,025,000       -6 %     18,057,000       18,609,000       -3 %
Amortization of intangible assets
    828,000       1,020,000       -19 %     2,486,000       3,059,000       -19 %
Impairment of goodwill
    5,100,000       4,847,000       5 %     5,100,000       4,847,000       5 %
Total operating expenses
    11,596,000       11,892,000       -2 %     25,643,000       26,515,000       -3 %
Operating loss
    (5,774,000 )     (6,557,000 )     -12 %     (8,579,000 )     (10,884,000 )     -21 %
Other income and expense
    290,000       111,000       161 %     1,009,000       129,000       682 %
Loss before taxes
    (5,484,000 )     (6,446,000 )     -15 %     (7,570,000 )     (10,755,000 )     -30 %
Income tax benefit
    -       (249,000 )  
NM
      -       (1,821,000 )  
NM
 
Net loss
  $ (5,484,000 )   $ (6,197,000 )     -12 %   $ (7,570,000 )   $ (8,934,000 )     -15 %
Net loss per share
                                               
basic
  $ (0.27 )   $ (0.30 )           $ (0.37 )   $ (0.43 )        
diluted
  $ (0.27 )   $ (0.30 )           $ (0.37 )   $ (0.43 )        
 
NM: Not meaningful
 
The decrease in the net loss for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 is primarily attributable to the following:
 
 
·
An increase in revenue of $487,000, or 9%, reflecting both an increase in average assets under management and a modest increase in our average fee rate.
 
·
A decrease in administrative expenses of $357,000, primarily reflecting compensation reductions.
 
·
A decrease in amortization charges from $1,020,000 to $828,000, reflecting the write off of intangible assets during 2009.
 
·
An impairment charge for goodwill of $5,100,000 recognized in 2010 compared to a charge of $4,847,000 recognized in 2009.
 
·
An increase in other income of $179,000, primarily reflecting the income from two equity investees in 2010.
 
·
A $249,000 decrease in income tax benefits, reflecting the continued establishment of valuation allowances for all deferred tax assets.
 
 
20

 
 
The decrease in the net loss for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 is primarily attributable to the following:
 
 
·
An increase in revenue of $1,433,000, or 9%, reflecting an increase in average assets under management.
 
·
A decrease in administrative expenses of $552,000, despite incurring $813,000 of severance costs in the 2010 period, primarily reflecting compensation reductions.
 
·
A decrease in amortization charges from $3,059,000 to $2,486,000, reflecting the write off of intangible assets during 2009.
 
·
An impairment charge for goodwill of $5,100,000 recognized in 2010 compared to a charge of $4,847,000 recognized in 2009.
 
·
An increase in other income of $880,000, primarily reflecting income from two equity investees in the 2010 period compared to a $381,000 impairment loss on a commingled stock fund recognized in the 2009 period.
 
·
A $1,821,000 decrease in income tax benefits reflecting the continued establishment of valuation allowances for all deferred tax assets.

In evaluating operating performance, we consider operating income and net income, which are calculated in accordance with accounting principles generally accepted in the United States (“GAAP”), as well as Adjusted EBITDA, an internally derived non-GAAP performance measure. We define Adjusted EBITDA as operating income or loss before non-cash charges for amortization and impairment of intangible assets and goodwill, depreciation, and share compensation expense. We believe Adjusted EBITDA is useful as an indicator of our ongoing performance and our ability to service debt, make new investments, and meet working capital requirements. Adjusted EBITDA, as we calculate it, may not be consistent with computations made by other companies. We believe that many investors use this information when analyzing the operating performance, liquidity, and financial position of companies in the investment management industry. The following table provides a reconciliation of operating income to Adjusted EBITDA for the three and nine month periods ended September 30, 2010 and 2009.
 
   
Three Months Ended
   
2010
   
Nine Months Ended
   
2010
 
   
September 30,
   
vs.
   
September 30,
   
vs.
 
   
2010
   
2009
   
2009
   
2010
   
2009
   
2009
 
Operating loss
  $ (5,774,000 )   $ (6,557,000 )     -12 %   $ (8,579,000 )   $ (10,884,000 )     -21 %
Amortization of intangible assets
    828,000       1,020,000       -19 %     2,487,000       3,059,000       -19 %
Impairment of goodwill
    5,100,000       4,847,000       5 %     5,100,000       4,847,000       5 %
Depreciation expense
    20,000       26,000       -23 %     67,000       80,000       -16 %
Share compensation expense
    -       107,000    
NM
      (139,000 )     314,000    
NM
 
Adjusted EBITDA
  $ 174,000     $ (557,000 )  
NM
    $ (1,064,000 )   $ (2,584,000 )     -58 %
  
NM: Not meaningful
 
Adjusted EBITDA for the nine months ended September 30, 2010 includes severance costs of $813,000. Excluding severance costs, our Adjusted EBITDA deficit would have been $251,000.
 
21

 
 
Operating Revenues
 
Our operating revenues include investment advisory fees received for the management of assets within separate accounts and private funds. We also receive incentive fees on an annual basis from the management of two of the private funds that invest in preferred stocks. Our operating revenues also include referral fees earned in connection with NIS’s referral arrangement with Attalus. Operating revenues increased by $487,000, or 9%, in the three months ended September 30, 2010 and by $1,433,000, or 9%, for the nine months ended September 30, 2010 primarily due to the increase in average assets under management. The changes by revenue category are more fully described below.
 
   
Three Months Ended
   
2010
   
Nine Months Ended
   
2010
 
   
September 30,
   
vs.
   
September 30,
   
vs.
 
   
2010
   
2009
   
2009
   
2010
   
2009
   
2009
 
Investment advisory fees
  $ 5,220,000     $ 4,760,000       10 %   $ 15,240,000     $ 13,973,000       9 %
Referral fees
    602,000       575,000       5 %     1,824,000       1,658,000       10 %
Total operating revenues
  $ 5,822,000     $ 5,335,000       9 %   $ 17,064,000     $ 15,631,000       9 %

For the three month periods, investment advisory fees increased by $460,000, or 10%, in 2010 due to the increase in average assets under management from $8.0 billion in 2009 to $8.5 billion in 2010 and a modest increase in the average fee rate. The 6% increase in average assets under management was principally the result of strong fixed income returns and the new business generated from the TALF program. For the nine month periods, investment advisory fees increased by $1,267,000, or 9%, due to the increase in average assets under management from $7.8 billion in 2009 to $8.5 billion in 2010.

The $27,000 increase in referral fees for the three month period and the $166,000 increase for the nine month period primarily reflect the increase in average assets under management with Attalus under NIS’s referral arrangement.
 
We also earn annual incentive fees from two private preferred stock funds managed by NIS. These fees are based on a calendar year performance period and we recognize the fees at the conclusion of the performance period. In 2009, we earned incentive fees of $1,256,000, which were recognized in December 2009. While preferred stock returns are volatile, based on performance through September 30, 2010, we expect to earn incentive fees of approximately $600,000.
 
 
22

 
 
Administrative Expenses
 
Administrative expenses for the three month period ended September 30, 2010 decreased by $357,000 compared to the 2009 period. The decrease primarily reflects a $368,000 reduction in ongoing cash compensation costs. Administrative expenses for the nine month period ended September 30, 2010 decreased by $552,000 compared to the 2009 period, despite incurring $813,000 of severance costs during the 2010 period. The decrease primarily reflects a $1,140,000 reduction in cash compensation costs. Other changes by expense category are more fully described below.

   
Three Months Ended
   
2010
   
Nine Months Ended
   
2010
 
   
September 30,
   
vs.
   
September 30,
   
vs.
 
   
2010
   
2009
   
2009
   
2010
   
2009
   
2009
 
Employee compensation:
                                   
Cash compensation
  $ 3,368,000     $ 3,736,000       -10 %   $ 11,081,000     $ 11,408,000       -3 %
Share-based compensation
    -       107,000    
NM
      (139,000 )     314,000    
NM
 
Total compensation
    3,368,000       3,843,000       -12 %     10,942,000       11,722,000       -7 %
Third party distribution expense
    291,000       212,000       38 %     902,000       627,000       44 %
Investment management expense
    521,000       440,000       18 %     1,479,000       1,213,000       22 %
Legal, audit, and other professional services
    357,000       443,000       -19 %     1,347,000       1,614,000       -17 %
Occupancy
    311,000       330,000    
NC
      969,000       989,000    
NC
 
Other administrative expenses
    820,000       757,000       8 %     2,418,000       2,444,000       -1 %
Total administrative expenses
  $ 5,668,000     $ 6,025,000       -6 %   $ 18,057,000     $ 18,609,000       -3 %

NM: Not meaningful
NC: No change

Cash compensation includes salaries and wages, sales incentives and other cash bonuses, and other payroll related taxes and benefits. For the three month period ended September 30, 2010, cash compensation decreased by $368,000, or 10%, compared to the 2009 period, primarily due to reduced headcount. For the nine month period ended September 30, 2010, cash compensation decreased by $327,000 compared to the 2009 period despite $813,000 of severance costs. Excluding severance, our cash compensation for the nine month periods decreased by $1,140,000, or 10%. Overall, we reduced headcount from 90 at September 30, 2009 to 82 at September 30, 2010.
 
The credit for share-based compensation in the nine months ended September 30, 2010 reflects the forfeiture of a share grant in the second quarter and the reversal of previously recognized compensation expense. At September 30, 2010 there were no outstanding stock awards.
 
Third party distribution expense represents payments made to broker-dealer networks and other outside sales commissions. The increases in 2010 reflect increased levels of business conducted through an outside sales agent and a broker dealer network.
 
Investment management expense includes pricing, trading, compliance, and other investment management service costs and subadvisory service fees for outside assistance in the management of a certain asset class. The increase in investment management expense primarily reflects increased subadvisory service fees resulting from growth in that class of assets.
 
 
23

 
 
The $267,000 decrease in legal, audit and other professional services expense for the nine months ended September 30, 2010 primarily reflects reduced legal and accounting services. During the first quarter of 2009, we incurred significant legal and accounting costs in connection with the completion of our initial Form 10-K.
 
Other administrative expenses principally include travel and other marketing related expenses, insurance expense, and other operating expenses.
 
Goodwill Impairment
 
We perform goodwill impairment tests annually, or whenever events or changes in circumstances indicate that the carrying amount of goodwill might not be recoverable, using a two-step process with the first step being a test for potential impairment by comparing our reporting unit’s fair value with its carrying amount (including goodwill). If the carrying amount of the reporting unit exceeds its fair value, we complete the second step under which the fair value of the reporting unit is allocated to its assets and liabilities, including recognized and unrecognized intangibles. If the implied fair value of the reporting unit’s goodwill is lower than its carrying amount, goodwill is impaired and written down to its implied fair value. We complete our annual test for impairment during our fourth quarter.
 
For purposes of testing goodwill for impairment, the Company attributes all goodwill to a single reporting unit. We have aggregated all of our subsidiaries into a single reporting unit because they provide similar services to similar clients, operate in the same regulatory framework, and share similar economic characteristics. The Company’s shared sales force is organized to market the full range of the Company’s products and services.
 
We estimate fair value averaging fair value established using an income approach and fair value established using a market approach. The fair value from the income approach was weighted 75%, while the fair value from the market approach was weighted 25%. The weighting reflects that the market approach includes more mature asset management companies with greater scale than the Company. We use independent valuation specialists to assist us in our valuation process.
 
The income approach uses a discounted cash flow model that takes into account assumptions that marketplace participants would use in their estimates of fair value, current period actual results, and forecasted results for future periods that have been reviewed by senior management. In preparing our forecasts, we considered historical and projected growth rates, our business plans, prevailing business conditions and trends, anticipated needs for working capital and capital expenditures, and historical and expected levels and trends of operating profitability.

The market approach employs market multiples for comparable companies. Fair value estimates are established using multiples of assets under management and current and forward multiples of revenue and earnings before income taxes, depreciation and amortization (referred to as EBITDA).

Based on interim results through September 30, 2010, initial work in connection with preparing our 2011 budget, and some trading activity in our common stock, we determined that we should complete a goodwill impairment test as of September 30, 2010. For the current operating forecasts, our estimates for net inflows of assets under management and market returns resulted in estimated revenue growth rates of approximately 9% per annum, which are less than the estimated growth rates in the immediately prior valuation. Cash flows beyond the five year forecast period were projected at 4% per annum. We used a weighted average cost of capital of 14.5% determined using the capital asset pricing model, which is consistent with the rate used in the immediately prior valuation.
 
Upon completion of the goodwill impairment test as of September 30, 2010, we concluded that our recorded goodwill balance was impaired and recorded an impairment charge of $5,100,000 in the third quarter of 2010. In addition, we expect to settle the remaining acquisition obligation for Boyd in the fourth quarter for the full $8,000,000. This settlement would result in an additional $8,000,000 of goodwill. However, based on the current estimates, we expect that we will have to recognize an additional goodwill impairment charge for this entire amount in the fourth quarter of 2010.

 
24

 
 
During 2009, we incurred impairment charges of $8,489,000, of which $4,847,000 was recorded in the third quarter of 2009 and $3,642,000 was recorded in the fourth quarter of 2009.
 
Other Income and Expense
 
Other income and expense includes investment income from the investment of excess cash balances offset by interest expense that represents accretion of discounted acquisition obligations.