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EX-32.2 - CERTIFICATION - ENVESTNET, INC.dex322.htm
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EX-10.12 - FORM OF EQUITY AWARD - ENVESTNET, INC.dex1012.htm
EX-21 - SUBSIDIARES OF THE REGISTRANT - ENVESTNET, INC.dex21.htm

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the year ended December 31, 2010

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-34835

 

 

Envestnet, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   20-1409613

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S Employer

Identification No.)

35 East Wacker Drive, Suite 2400, Chicago, IL   60601
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code:

(312) 827-2800

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class:  

Name of Each Exchange on Which Registered:

            NYSE

Common stock, par value $0.005 per share  

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ¨    No  x

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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      x    Smaller reporting company      ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

There was no public market for the registrant’s common stock on June 30, 2010.

As of March 16, 2011, 31,432,551 shares of the common stock with a par value of $0.005 per share were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our proxy statement for the 2011 Annual Meeting of Stockholders to be held May 19, 2011, are incorporated by reference into Parts II and III of this Form 10-K, to the extent indicated.


TABLE OF CONTENTS

 

        Page  
  PART I  

Forward-Looking Statements

    3   
Item 1.  

Business

    3   
Item 1A.  

Risk Factors

    20   
Item 1B.  

Unresolved Staff Comments

    35   
Item 2.  

Properties

    35   
Item 3.  

Legal Proceedings

    35   
Item 4.  

Removed and Reserved

    35   
  PART II  
Item 5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

    36   
Item 6.  

Selected Financial Data

    38   
Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

    39   
Item 7A.  

Quantitative and Qualitative Disclosures About Market Risk

    61   
Item 8.  

Financial Statements and Supplementary Data

    62   
Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    93   
Item 9A.  

Controls and Procedures

    93   
Item 9B.  

Other Information

    93   
  PART III  
Item 10.  

Directors, Executive Officers and Corporate Governance

    93   
Item 11.  

Executive Compensation

    94   
Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

    94   
Item 13.  

Certain Relationships and Related Transactions, and Director Independence

    94   
Item 14.  

Principal Accounting Fees and Services

    94   
  PART IV  
Item 15.  

Exhibits and Financial Statement Schedules

    95   
SIGNATURES     97   

 

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Forward-Looking Statements

This annual report on Form 10-K contains forward-looking statements regarding future events and our future results within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, in particular, statements about our plans, strategies and prospects under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements are based on our current expectations and projections about future events and are identified by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “expected,” “intend,” “will,” “may,” or “should” or the negative of those terms or other comparable terminology. Although we believe that our plans, intentions and expectations are reasonable, we may not achieve our plans, intentions or expectations.

These forward-looking statements involve risks and uncertainties. Important factors that could cause actual results to differ materially from the forward-looking statements we make in this annual report are set forth in Part I under “Risk Factors”; accordingly, investors should not place undue reliance upon our forward-looking statements. We undertake no obligation to update any of the forward-looking statements after the date of this annual report to conform those statements to reflect the occurrence of unanticipated events, except as required by applicable law.

You should read this annual report on Form 10-K completely and with the understanding that our actual future results, levels of activity, performance and achievements may be different from what we expect and that these differences may be material. We qualify all of our forward-looking statements by these cautionary statements.

The following discussion and analysis should also be read along with our consolidated financial statements and the related notes included elsewhere in this annual report. Except for the historical information contained herein, this discussion contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed below.

Item 1. Business

General

We are a leading independent provider of wealth management solutions to financial advisors and institutions. Through our wealth management offerings, including Envestnet Advisor Suite and Envestnet | PMC, our asset management arm, we deliver a Web-based gateway to expert, objective, integrated wealth management solutions. By integrating a wide range of investment solutions and services, our technology platform provides financial advisors with the flexibility to address their clients’ needs. We work with financial advisors who are independent, as well as those who are associated with small or mid-sized financial advisory firms and larger financial institutions, which we refer to as enterprise clients. We focus our technology development efforts and our sales and marketing approach on addressing financial advisors’ front-, middle- and back-office needs. We believe that our investment solutions and services allow financial advisors to be more efficient and effective in the activities critical to their businesses by facilitating client interactions, supporting and enhancing portfolio management and analysis, and enabling reliable account support and administration. In addition, we are not controlled by a financial institution, broker-dealer or other entity operating in the securities or wealth management industry, which we believe affords us a greater level of independence and impartiality.

Our centrally-hosted technology platform provides financial advisors with the flexibility to choose freely among a wide range of investment solutions, services, investment managers and custodians to identify those that are most appropriate for their clients. Given the flexibility of choice it provides, we refer to our technology platform as having “open architecture”. In addition, our technology platform allows us to add new or upgrade existing features and functionality as the industry and financial advisors’ needs evolve. For instance, in 2010 we added a “unified managed household” solution that empowers advisors to report and consult on clients’ accounts that are managed by other institutions or advisors.

 

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Our technology platform provides financial advisors with the following:

 

   

A series of integrated services to help them better serve their clients, including risk assessment and selection of investment strategies, asset allocation models, research and due diligence, portfolio construction, proposal generation and paperwork preparation, model management and account rebalancing, account monitoring, customized fee billing, overlay services covering asset allocation, tax management and socially responsible investing, aggregated multi-custodian performance reporting and communication tools, as well as access to a wide range of leading third-party asset custodians;

 

   

Web-based access to a wide range of technology-enabled investment solutions, including:

 

   

separately managed accounts, or SMAs, which allow advisors to offer their investor clients a customized, professionally managed portfolio of securities with a personalized tax basis;

 

   

unified managed accounts, or UMAs, which are similar to SMAs but allow the advisor to use different types of investment vehicles in one account;

 

   

advisor-directed portfolios, where advisors create, implement and maintain their own investment portfolio models to address specific client needs; and

 

   

mutual funds and portfolios of exchange-traded funds, or ETFs; and

 

   

Access to a broad range of investment managers and investment strategists, which allow advisors to use the research and recommendations of other investment experts, as well as to our internal investment management and portfolio consulting group, Portfolio Management Consultants, or PMC.

PMC primarily engages in consulting services aimed at providing financial advisors with additional support in addressing their clients’ needs, as well as the creation of proprietary investment solutions and products. PMC’s investment solutions and products include managed account and multi-manager portfolios, mutual fund portfolios and ETF portfolios.

While our technology platform is designed for financial advisors working at any size and type of financial services firm, we target our sales and marketing efforts towards:

 

   

Independent financial advisors that are part of small to mid-sized financial advisory firms; and

 

   

Enterprise clients. In some cases, enterprise clients establish relationships with more than one platform provider, allowing their financial advisors to choose the technology platform that best supports their needs. In these cases, we focus our sales efforts on the firm’s affiliated financial advisors to demonstrate the distinguishing features of our technology solutions and to work with them on transitioning their assets onto our technology platform. Other enterprise clients hire us to be their exclusive technology platform provider, and all financial advisors with that firm will transition their client accounts to our technology platform.

Our small to mid-sized customers include registered investment advisors, or RIAs, which are financial advisors registered with a state securities commissioner and/or the Securities and Exchange Commission, or SEC, and who typically receive fees based on a percentage of the client assets they manage, independent broker-dealers, or IBDs, which provide processing and oversight for their affiliated financial advisors who are registered with the Financial Industry Regulatory Authority, or FINRA, and dually registered advisors, which are financial advisors registered with both the SEC and FINRA.

We earn revenues primarily under two pricing models. First, a majority of our revenues are derived from fees charged as a percentage of the assets that are managed or administered on our technology platform by financial advisors. Our asset-based fees vary based on the types of investment solutions and services that financial advisors utilize. Asset-based fees accounted for approximately 78%, 73% and 77% of our total revenues for the years ended December 31, 2008, 2009 and 2010, respectively. As of December 31, 2010, approximately $64 billion of investment assets for which we receive asset-based fees were managed or administered utilizing our technology platform by approximately 13,800 financial advisors in approximately 307,000 investor accounts.

 

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Second, we generate revenues from recurring, contractual licensing fees for providing access to our technology platform, generally from a small number of enterprise clients. Licensing fees are generally fixed for the contract term and are based on the level and types of investment solutions and services provided, rather than on the amount of client assets on our technology platform. Generally, our licensing contracts range from two to five years and have annual renewal provisions. Licensing fees accounted for 19%, 24% and 20% of our total revenues for the years ended December 31, 2008, 2009 and 2010, respectively. Fees received in connection with professional services accounted for the remainder of our total revenues. As of December 31, 2010, approximately $76 billion of investment assets for which we receive licensing fees for utilizing our technology platform were serviced by approximately 7,700 financial advisors through approximately 604,000 investor accounts.

For over 85% of our asset-based fee arrangements, we bill customers at the beginning of each quarter based on the market value of customer assets on our technology platform as of the end of the prior quarter, providing for a high degree of visibility for the current quarter. Furthermore, our licensing fees are highly predictable because they are generally set in multi-year contracts providing longer term visibility regarding a portion of our total revenues.

The following table sets forth the assets that were managed or administered on our technology platform by financial advisors as of the end of the quarters indicated:

LOGO

 

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The following table sets forth the number of accounts with assets under assets under management or administration serviced through our technology platform as of the end of the quarters indicated:

LOGO

The following table sets forth as of the dates indicated the number of financial advisors that had client accounts on our technology platform:

LOGO

We were founded in 1999 and through organic growth and strategic transactions we have grown to become a leading independent provider of technology-enabled, Web-based investment solutions and services to financial advisors. Our headquarters are located in Chicago and we have offices in New York, Denver, Sunnyvale (CA), Boston, Charlotte (Landis, NC) and Trivandrum, India.

 

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Our Market Opportunity

The wealth management industry has experienced significant growth in terms of assets invested by retail investors in the past several years. According to the Federal Reserve, U.S. household and non-profit organization financial assets totaled $45.7 trillion as of September 30, 2010, up from $44.3 trillion in 2009 and $33.3 trillion in 2003. According to Cerulli Associates, an industry research firm, as of December 31, 2009, $9.5 trillion of assets were professionally managed for retail investors compared to $6.8 trillion as of December 31, 2003. In addition, according to Cerulli Associates, in 2009, there were approximately 334,000 financial advisors registered with FINRA or the SEC that were focused on retail investors.

In addition to experiencing significant growth in financial assets, the wealth management industry is characterized by a number of important trends, including those described below, which we believe create a significant market opportunity for technology-enabled investment solutions and services like ours.

Increased prevalence of independent financial advisors. Based on industry news reports, we believe that over the past several years an increasing percentage of financial advisors have elected to leave large financial institutions and start their own financial advisory practices or move to smaller, more independent firms. In 2010, according to the Investment News database called “Advisors on the Move,” $79 billion in assets shifted advisory channels. The independent channel was the only channel to realize asset gains (approximately $16 billion). Wirehouses, regional broker-dealers, insurance and bank broker-dealers all experience net asset outflows.

These independent firms include IBDs for FINRA-registered financial advisors, RIAs working as sole practitioners or as part of small firms with SEC registrations, and dually registered financial advisors. We believe, based on our industry experience, that this trend was accelerated in the past two to three years as a result of the reputational harm suffered by several of the largest financial institutions during the recent financial crisis. In particular, according to Cerulli Associates, an estimated 40% of financial advisors were considered independent in 2009, and 47% of financial advisors will be independent by the end of 2014, implying that the percentage of financial advisors employed by large financial institutions (wirehouse, regional, insurance and bank) will shrink from 60% in 2009 to 53% in 2014.

Moreover, according to projections by Cerulli Associates, the percentage of assets invested by retail clients with independent financial advisors is expected to rise from 30% in 2007 to 37% in 2012, while the wirehouse market share will shrink from 48% in 2007 to 33% in 2012.

Increased reliance on technology among independent financial advisors. In order to compete effectively in the marketplace, independent financial advisors are increasingly relying on technology service providers to help them provide comparable services cost effectively and efficiently, according to Cerulli Associates. In addition, IBDs and RIA firms have been incented to enhance the sophistication of their technology platforms in order to attract financial advisors from larger financial institutions, according to Cerulli Associates. In addition, we believe, based on a report from Cerulli Associates, that financial advisors generally favor technology solutions that enable them to spend more time on asset allocation, fund and manager selection and client interaction, rather than on administrative or technology-related activities. Based on a report from Cerulli Associates, we believe that advanced technological support is a key driver for growth in an independent financial advisor’s business. For example, an advanced technology platform with fully integrated tools helps reduce the need for the manual processing of data and the use of multiple incompatible technology applications, allowing financial advisors to spend more time interacting with their clients, while also potentially allowing the financial advisor to reduce technology-related costs.

Increased use of financial advisors. We believe, based on an analysis done by Cerulli Associates, that the recent significant volatility and increasing complexity in securities markets have resulted in increased investor interest in receiving professional financial advisory services. According to Cerulli Associates, 56% of households use one or more financial advisors. Following the market recession and amidst low confidence ratings for advisors, investors are increasingly implementing additional advisory relationships as a method to test drive

 

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advisors in order to compare performance and service. Independent financial advisors are well positioned to attract clients interested in managed account solutions over the next three years. According to Cerulli Associates, from December 31, 2002 to June 30, 2010, retail managed account assets with independent financial advisor accounts grew from 17% to 27% of total separate account assets. In addition, according to Cerulli Associates, financial advisors that serve as portfolio managers have had their assets under management grow at a compound annual growth rate of 25% from $62 billion in 2002 to $351 billion as of June 30, 2010.

Increased use of fee-based investment solutions. Retail investor assets in managed accounts exceeded $2 trillion in September 2010. Based on our industry experience, we believe that in order for financial advisors to effectively manage their clients’ assets, we believe they are utilizing account types that offer the flexibility to choose among the widest range of investment solutions. Financial advisors typically charge their clients fees for these types of flexible accounts based on a percentage of assets rather than on a commission or other basis. According to Cerulli Associates, the percentage of commission-only financial advisors declined from 18% in 2003 to 11% in 2010. In addition, according to information provided by the Securities Industry and Financial Markets Association, revenues from asset management fees (fee based revenue) increased at a compound annual growth rate of approximately 11% from 1990 to 2010, while revenues based on commissions increased at a compound annual growth rate of approximately 5% during the same period. Based on these trends, we believe that financial advisors will increasingly require a sophisticated technology platform to support their changing practice patterns and their ability to address their clients’ needs.

More stringent standards applicable to financial advisors. In light of the economic crisis and related securities market volatility in 2008 and 2009, we believe that there will be increased attention on investor consumer protection, whether as a result of regulatory changes, voluntary industry initiatives or competitive dynamics. Increased scrutiny of financial advisors to ensure compliance with current laws, coupled with the possibility of new laws focused on a fiduciary standard, may require changes to the way financial advisors offer advice. In order to adapt to these changes, we believe that financial advisors will benefit from utilizing a technology platform, such as ours, that allows them to address their clients’ wealth management needs, manage and memorialize decisions made throughout the process, and that assists them with recordkeeping and account monitoring.

Our Growth Strategy

We intend to increase our revenue and profitability by continuing to pursue the following strategies:

 

   

Increase the advisor base within our existing enterprise clients. Through the outreach and marketing activities of our regional sales and client service teams, we intend to continue the process of leveraging our existing enterprise client relationships to add new financial advisors to our technology platform. Generally, when we establish an enterprise client relationship, we are provided access to the client’s financial advisors and given the opportunity to move them to our technology platform. During the past five years, the number of financial advisors using our technology platform from existing enterprise clients has grown at a compound annual growth rate of 10%. Despite that growth, we have the opportunity to continue increasing the number of financial advisors we serve within our existing enterprise client relationships.

 

   

Extend the account base within a given advisor relationship. As our working relationships with our financial advisor customers develop over time, and through our sales and marketing efforts, we will seek to move more of their clients’ assets onto our technology platform. During the five year period ending December 31, 2010, the average number of AUM or AUA accounts per advisor on our technology platform has grown from approximately 11 to 22, an increase of 100%. As a result, total AUM or AUA accounts have grown at a compound annual growth rate of 45% from December 31, 2005 through December 31, 2010.

 

   

Expand the services we provide each advisor. In many cases, when we first enter into a client relationship with a financial advisor, the financial advisor utilizes some, but not all, of the investment solutions and services provided through our technology platform. Accordingly, through our sales and

 

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marketing efforts, we will continue to educate our financial advisor customers regarding our company in order to expand the scope of our investment solutions and services they employ.

 

   

Obtain new enterprise clients. New enterprise clients provide us with access to a large number of financial advisors that may be interested in utilizing our technology platform, as well as to the assets under management or administration that are managed by these financial advisors. In most cases, a new enterprise client will provide us with the opportunity to attract a large number of financial advisors to our technology platform over time. In other cases, new enterprise clients elect to convert all or a significant portion of the assets on their platform to our technology platform, with the financial advisors managing such assets migrating onto our platform at the time of the asset conversion. We believe that the current market opportunity for enterprise conversions is significant, particularly compared to recent historical levels. New enterprise clients also provide further opportunities to execute on the other strategies discussed above.

 

   

Continue to invest in our technology platform. To continue to attract and retain enterprise clients and financial advisors, and to deepen our relationships with them, we intend to continue to invest in our technology platform to provide financial advisors with access to investment solutions and services that address the widest range of the financial advisors’ front-, middle- and back-office needs. In the years ended December 31, 2008, December 31, 2009 and December 31, 2010, we had technology development expenditures totaling $4.9 million, $4.9 million and $5.6 million, respectively. We expect that we will have similar levels of technology development expenses in 2011. We will continue to invest to develop our technology platform to provide access to investment solutions and services from a wide range of leading third-party providers, while also continuing to enhance the investment solutions and services we offer through PMC.

 

   

Continue to pursue transactions and other relationships. Though we have no transactions planned currently, we intend to continue to selectively pursue acquisitions, investments and other relationships that we believe can significantly enhance the attractiveness of our technology platform or expand our client base. We characterize these acquisitions, investments and other relationships as either strategic or consolidating transactions. We pursue strategic transactions in order to add new functionality to our technology platform or to enhance our existing functionality. Consolidating transactions, such as our 2010 platform services agreement with FundQuest, present opportunities for us to utilize the operating efficiency that results from our significant scale of operations. We believe we have been successful historically in identifying and executing transactions that have complemented our business and allowed us to compete more effectively in our industry. Given our scale of operations and record of past transactions, we believe we are well positioned to engage in such transactions in the future.

Our Business Model

We believe that a number of attractive characteristics significantly contribute to the success of our business model, including:

 

   

Attractive business model with operating leverage. Because we have designed our systems architecture to accommodate growth in the number of advisors and accounts and to provide the flexibility to add new investment solutions and services, our technology platform and infrastructure allow us to grow our business efficiently, without the need for significant additional expenditures as assets grow and with low marginal costs required to add additional accounts and new investment solutions and services. Furthermore, once we have contracted with a financial advisor and transitioned the associated assets to our technology platform, we are able to add additional assets to our technology platform with minimal incremental costs. This enables us to generate substantial operating leverage during the course of our relationship with a financial advisor as the assets of the advisor’s clients grow, through the addition of advisors utilizing our technology platform and through the financial advisors’ use of additional investment solutions and services.

 

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Recurring and resilient revenue base. The substantial majority of our revenues is recurring and is derived either from asset-based fees, which are billed at the beginning of each quarter and from fixed fees under multi-year license agreements. For the year ended December 31, 2010, we derived 77% and 23% of our total revenues from asset-based fees and from licensing and professional services revenues, respectively.

 

   

Strong customer retention. We believe that the breadth of access to investment solutions and the multitude of services that we provide allow financial advisors to address a wide range of their clients’ needs and, as a result, financial advisors are less likely to move away from our technology platform. Because a technology platform is involved in nearly all of a financial advisor’s activities needed to serve their clients, once a financial advisor has moved clients and their assets onto our technology platform, significant time, costs and/or resources would be required for the financial advisor to shift to another technology platform.

 

   

Favorable industry trends. As an independent provider of technology services to financial advisors, we believe we are well positioned to take advantage of favorable secular trends in the wealth management industry, particularly the growth in investable assets, the movement toward independent financial advisors and fee-based pricing structures and increased use of technology.

Our Technology Platform

Our proprietary Web-based technology platform provides financial advisors with access to investment solutions and services that address, in one integrated, centrally-hosted platform, what we believe, based on our knowledge of the industry, is the widest range of front-, middle- and back-office needs in our industry. The “open architecture” design of our technology platform provides financial advisors with flexibility in terms of the investment solutions and services they access, and configurability in the manner in which the financial advisors utilize particular investment solutions and services. The multitenant architecture of the platform ensures that this level of flexibility and customization is achieved without requiring us to create unique application “instances” for each client, thereby reducing the need for additional technology personnel and associated expenses. In addition, though our technology platform is designed to deliver a breadth of functions, financial advisors are able to select from the various investment solutions and services we offer, without being required to subscribe to or purchase more than what they believe is necessary.

 

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The following provides a description of the investment solutions and services that financial advisors may access through our technology platform:

Broad Technology Service Offering with Multiple Access Points

LOGO

Financial Planning and Risk Profiling. Our technology platform integrates with a number of financial planning tools such as Monte Carlo simulations, portfolio diagnostics and estate and retirement planning that enables financial advisors to create and implement a financial plan that is tailored to each client’s investment goals, risk tolerance and assets. For example, financial advisors can create a time-segmented distribution portfolio based on a client’s retirement goals. Each segment is constructed as an individual portfolio, with its own criteria for risk tolerance and investment objectives. Once created, the financial advisor can run goals-based reports to track the progress of the retirement investments.

Portfolio Analysis. Our technology platform provides financial advisors with a customizable risk tolerance questionnaire to complete with clients. The questionnaire assists financial advisors in understanding the investment objectives and preferences of their clients. Questionnaire content may be customized to reflect the client’s particular circumstances. The questionnaire also helps the financial advisor comply with applicable

 

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regulatory requirements regarding the suitability of investments and fiduciary obligations. Once the investment policy is established and implemented, financial advisors can receive risk and style drift alerts, enabling them to adjust their clients’ portfolios to ensure that the portfolios remain in compliance with their clients’ stated investment objectives and risk tolerance levels.

Asset Allocation Tools. Our technology platform provides financial advisors with significant flexibility in determining the appropriate asset allocation strategy for their clients at either the account or household level. The financial advisor may utilize asset allocation recommendations designed by the financial advisor, the financial advisor’s employer or affiliated financial institution, an outside third-party asset manager or recommendations that are provided through our technology platform. As further described below, through our technology platform’s overlay services, our PMC group can provide ongoing review and monitoring of asset allocation decisions in order to make adjustments that may be necessary to respond to changing market conditions or client circumstances.

Research and Due Diligence. Our technology platform provides financial advisors with extensive resources to research and review information relating to third-party asset managers, investment solutions and other related services that the financial advisor may elect to recommend to clients. Through our technology platform, the financial advisor may utilize research and due diligence capabilities that are provided by the advisor’s firm, third-party service providers or PMC. The information obtained through research and due diligence activities may be organized and presented in highly customizable formats depending on the needs of the financial advisor’s clients. Examples of such information include in-depth manager profiles, side-by-side manager comparison of performance and other portfolio statistics and product profiles highlighting performance versus the appropriate benchmark.

Portfolio Construction. Once investment objectives, risk tolerance and asset allocation have been determined, and the financial advisor has completed any necessary research and due diligence, our technology platform allows the financial advisor to select investment solutions using a wide range of portfolio construction tools. The portfolio construction process is highly flexible, allowing the financial advisor to select the investment solutions, including through the creation of model portfolios, or to engage outside investment managers to assist in, or completely undertake, portfolio construction.

Investment Program Selection. Once the investment solutions have been selected, our technology platform, through relationships we have established with a variety of investment managers, allows the financial advisor to access and choose from a wide range of investment programs, including separately managed accounts, unified managed accounts, third-party strategist programs, mutual fund and exchange-traded fund programs, and others, depending on the financial advisor’s assessment of the client’s needs. Because our technology platform supports nearly every investment program type that is currently available, financial advisors are able to keep more of a client’s assets on one technology platform, thereby simplifying the operation of their business, saving time and lowering costs.

PMC, Envestnet’s Portfolio Consulting Group. Our PMC group provides consulting services aimed at providing financial advisors with additional support in addressing their clients’ needs, including asset allocation modeling, asset manager and mutual fund due diligence, selection and ongoing monitoring, investment portfolio construction and overlay services, principally relating to ongoing portfolio management and asset allocation rebalancing. Our PMC group also creates proprietary investment solutions and products, including separate account strategies, multi-manager portfolios, mutual funds, mutual fund wrap and ETF asset allocation strategies.

Proposal Generation and Fee Calculation. Our technology platform provides financial advisors with a flexible proposal and presentation tool that is capable of creating highly customized documents. Presentations and proposals may be prepared utilizing the financial advisor’s personalized branding and content, while also integrating the client’s particular investment account information. In addition, extensive fee-related information may be prepared and included in such presentations or proposals.

 

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Account Opening and Servicing. Once the financial advisor has entered the information necessary for generating account documents, the forms needed to open the account can be generated with information pre-populated, such as the client’s name and address, making the account-opening process less onerous for the end client. The forms are automatically generated with the investment proposal and are ready for the client’s signature. Once the documents are signed, the documents will be processed according to agreed-upon workflow procedures.

Custodial and Trading Interface. Our technology platform provides financial advisors with access to 14 third-party custodians, real-time data and Web-based service tools. In addition, the open architecture design of our technology platform allows us to respond to financial advisors’ needs that may not be currently addressed by our technology platform, including, for example, establishing relationships with additional custodians or third-party asset managers. Our technology platform also supports financial advisors through the management of account paperwork and by facilitating communications with any third-party asset managers that the financial advisor may have engaged.

Portfolio Overlay and Rebalancing. Once a financial advisor has created a client account and selected investment solutions and programs, our technology platform provides access to ongoing account management services, PMC portfolio managers review all PMC models and proprietary portfolios to determine when to rebalance across asset classes. Emphasis is placed on strict adherence to the paramaters set for each portfolio. In addition, we offer overlay services that can help enhance an advisor’s ability to carry out his or her fiduciary responsibility. These services include ongoing review of investment portfolios for compliance with asset allocation criteria, with rebalancing recommendations made as necessary, assistance with investment portfolio tax management and review of investment accounts to ensure that investment decisions are consistent with the client’s investment objectives. We also offer a socially responsible overlay (the Sustainability Platform) which the financial advisor may use to assist with maintain compliance with clients’ investment restrictions. These may include securities issued by specific companies or from issuers in certain industries that clients want to exclude from their investment accounts.

Reporting Solutions. Our technology platform is capable of producing highly configurable aggregated reports showing holdings, investment performance, capital gains and losses and other information for financial advisors to provide to their clients that can be downloaded, viewed on-line or printed. In addition, through our India operations, our technology platform provides financial advisors with access to client account data reconciled daily with records maintained by multiple custodians. Accordingly, when securities markets open each day, financial advisors have the most up-to-date account data available.

Billing and Account Administration. Our technology platform supports a wide range of fee and billing structures. These include breakpoint pricing, where lower fee rates are applied as asset levels meet or exceed pre-established thresholds, fees based on aggregated client funds across several accounts held by family members, fees tailored to different investment programs and investment solution types and other customized fee and billing arrangements. Account administration includes account set-up, asset manager set-up, account funding and back-office administration.

Compliance and Fiduciary Notes. Envestnet has created industry leading technology to help advisors and home offices track and maintain their own proprietary fiduciary process. Our technology platform includes configurable Fiduciary Oversight Notes (FONs) that help advisors understand implications of the decisions they make via educational text boxes, and then memorialize those decisions for client service and reporting. The FONs may be searched and reviewed by home offices or the advisors themselves.

Communication and Education. Based on our discussions with financial advisors, we believe that for financial advisors who operate within large financial institutions, the ability to communicate quickly and effectively with supervisors or firm management is important. Our technology platform provides supervisors or firm management with the ability to distribute to financial advisors notifications and announcements regarding changes to manager portfolios, platform maintenance, account activity and other related information. Resources are also available to assist financial advisors with practice management and education.

 

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Portfolio Management Consultants

Our PMC group primarily engages in two sets of activities:

 

   

Consulting services aimed at providing financial advisors with additional support in addressing their clients’ needs. The consulting services are focused on asset allocation modeling, asset manager and mutual fund due diligence, selection and ongoing monitoring, investment portfolio construction and overlay services, principally relating to ongoing portfolio management and asset allocation rebalancing.

 

   

Creation of proprietary investment solutions and products, including separate account strategies, multi-manager portfolios, mutual funds, mutual fund wrap and ETF portfolios. PMC’s investment solutions and products are discussed below.

PMC’s Investment Solutions and Products

PMC provides a wide range of investment solutions and products aimed at addressing different investor objectives and risk profiles. PMC’s investment solutions and products include:

 

   

Managed Account and Multi-Manager Portfolios. PMC provides financial advisors with access to SMAs, which allow advisors to offer their investor clients a customized, professionally-managed portfolio of securities with a personalized tax basis, manager blend portfolios, which utilize several asset managers to provide clients with diversification across multiple investment styles and asset classes within a single investment account, and multi-manager accounts, which provide clients, within a single investment account, with access to multiple separate account managers and mutual fund products in order to obtain diversification across asset classes, investment styles and investment products. PMC also conducts research and due diligence on a number of the separate asset managers to which it provides access.

 

   

Mutual Fund Portfolios. PMC offers a range of packaged mutual fund portfolios aimed at helping financial advisors address different client needs. These mutual fund portfolios include a series of products marketed under the “SIGMA Mutual Fund Solutions” brand, which provide for different allocations of a variety of equity- and fixed income-focused mutual funds tailored to address investors’ differing investment time horizons, portfolios of mutual funds marketed under the “PMC Select Portfolios” brand, which are tailored to be more attractive to smaller account sizes because they feature a full range of asset allocation targets built to meet various investment and risk levels in a single investment vehicle, portfolios of mutual funds marketed under the “PMC Enhanced Portfolio Strategies” brand, which offer asset class diversification strategies in a traditional mutual fund structure, and portfolios of mutual funds marketed under the “PMC Ultra Short Term Fixed Income” brand, which offer a fixed income portfolio aimed at providing investors with an attractive alternative to money market fund yields.

 

   

ETF Portfolios. PMC also offers pre-packaged portfolios of ETFs, ranging from products that simply track movements in a specified securities index to tailored products that are designed to outperform broad market indexes by focusing on expected increases in the value of securities issued by certain companies or issuers in specified industries.

Our Customers

Independent financial advisors that are working alone or as part of small to mid-sized financial advisory firms. Our principal value proposition aimed at independent financial advisors working alone or as part of small to mid-sized firms is that our technology platform allows them to compete effectively with financial advisors employed by large financial institutions. We provide independent financial advisors with access to as many or more of the investment solutions and services that are typically available to financial advisors working at the larger firms. An example of one our smaller independent financial advisor clients is Commonwealth.

 

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Enterprise clients. We provide enterprise clients with a customized, private-labeled technology platform that enables them to support their affiliated financial advisors with a broad range of investment solutions and services. Our contracts with enterprise clients establish the applicable terms and conditions, including pricing terms, service level agreements and basic platform configurations. For the years ended December 31, 2008, 2009 and 2010, revenues associated with our relationship with our single largest enterprise client, FMR LLC, an affiliate of FMR Corp., or Fidelity, accounted for 27%, 31% and 31%, respectively, of our total revenues. Though a loss of this client could have a material adverse effect on our results of operations, financial condition and business, in such event, we would evaluate the need to reduce costs and take other steps to attempt to mitigate the effects of the loss of such client. Such other steps may include, if necessary and appropriate, reduction of our operating expenses, including a reduction of our workforce. In the event that we were to lose Fidelity as a customer, though we would continue our ongoing efforts to attract new customers, we can provide no assurances that we would be successful in obtaining new customers that would replace all or any part of the revenues represented by our relationship with Fidelity. No other client accounted for more than 10% of our total revenues. Examples of our other enterprise clients include Northwestern Mutual, National Financial Partners, National Planning Holdings and Russell Investments.

Sales and Marketing

Our sales and marketing staff is divided into three teams. The Enterprise Sales team, made up of 11 employees, focuses on entering into agreements with enterprise clients. The Advisory Sales team has 8 regions, 27 employees and is focused on selling to the individual financial advisors of IBDs and entering into agreements with RIA firms pursuant to which the financial advisors agree to convert some or all of their clients onto our technology platform. Our third sales and marketing team has 8 employees from our PMC group. This team is focused on assisting financial advisors with constructing client portfolios and provides information regarding PMC’s proprietary investment solutions and products.

The principal aim of our marketing efforts is to create greater visibility of our company and provide thought leadership to the wealth management industry. Our marketing efforts are focused on our core markets: financial advisors and enterprise clients. We use advertising and public relations to communicate our message to these target markets. Examples of these marketing efforts include:

 

   

quotes in wealth management industry publications regarding our views on financial advisor trends and challenges;

 

   

advertising and other marketing materials promoting our investment solutions and services;

 

   

frequent participation in industry conferences and tradeshows, including events sponsored by our custodian partners, by making presentations and speaking on panels;

 

   

hosting conferences on wealth management solutions;

 

   

providing insights on industry trends through internal research and sponsoring and writing industry white papers; and

 

   

creating marketing tools for financial advisors to better communicate with their current and prospective clients.

To implement our marketing efforts, we generally employ paid print and online advertisements in a variety of industry publications, as well as promotions that include e-blast campaigns and sponsored webinars. We also partner with IBDs on direct mail campaigns targeting such firms’ financial advisors to describe the investment solutions and services that we offer, produce brochures and presentations for financial advisors to use with their clients and we create Internet pages or sites to promote our investment solutions and services.

Competition

We generally compete on the basis of several factors, including the breadth and quality of investment solutions and services to which we provide access through our technology platform, the number of custodians

 

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that are connected through our technology platform, the price of our investment solutions and services, the ease of use of our technology platform and the nature and scope of investment solutions and services that each client believes are necessary to address their needs. Our competitors offer a variety of products and services that compete with one or more of the investment solutions and services provided through our technology platform, although, based on our industry experience, we believe that none offer the same comprehensive set of products and services that we do. Our principal competitors include:

 

   

Custodians. A number of leading asset custodians, such as Pershing (a subsidiary of BNY Mellon Corporation) and The Charles Schwab Corporation, have expanded beyond their custodial businesses to also offer advisor trading tools that compete with our financial advisor-directed solutions.

 

   

Turnkey Asset Management Platform Providers. Providers of turnkey asset management platforms, including SEI Investments Company, Genworth Financial Inc. and Lockwood Advisors (a subsidiary of BNY Mellon Corporation), typically provide financial advisors with one or more types of products and services but generally offer fewer choices in terms of custodians, asset managers, technology features and functionality.

 

   

Providers of Specific Service Applications. A number of our competitors provide financial advisors with a product or service designed to address one specific issue or need, such as financial planning or performance reporting. While our technology platform also provides access to these investment solutions or services, financial advisors may elect to utilize a single application rather than a fully integrated platform.

Technology

Our technology platform features a three-tier architecture integrating a Web-based user interface, an application tier that houses the Java-based business logic for all of the platform’s functionality and a SQL Server database. The application tier resides behind load balancers which distribute the workload demands across our servers. We believe our technology design allows for significant scalability.

We devote significant resources to ensuring sufficient platform capacity and system uptime. In 2010, our actual uptime was 99.8%. We have achieved Type I and Type II SAS70 compliance with our platform and we maintain multiple redundancies, back up our databases and safeguard technologies and proprietary information consistent with industry best practices. We also maintain a comprehensive business continuity plan and company-wide risk assessment program that is consistent with industry best practices and that complies with applicable regulatory requirements.

We have historically made significant investments in platform development in order to enhance and expand our technology platform and expect to continue to make significant investments in the future. In the years ended December 31, 2008, December 31, 2009 and December 31, 2010, we incurred technology development expenditures totaling approximately $4.9 million, $4.9 million and $5.6 million, respectively. Of these expenditures, we capitalized approximately $1.7 million, $1.3 million and $1.3 million, respectively, as internally developed software. We expect to continue focusing our technology development efforts principally on adding strategic features to increase our market competitiveness, enhancements to improve operating efficiency and reduce risk and client-driven requests for new capabilities.

Intellectual Property and Proprietary Rights

We rely on a combination of trademark, copyright and trade secret protection laws to protect our proprietary technology and our intellectual property. We seek to control access to and distribution of our proprietary information. We enter into confidentiality agreements with our employees, consultants, customers and vendors that generally provide that any confidential or proprietary information developed by us or on our behalf be kept confidential. In the normal course of business, we provide our intellectual property to third parties through licensing or restricted use agreements. We have proprietary know-how in algorithms, implementation

 

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and business on-boarding functions, along with a wide variety of applications software. We have registered the mark “ENVESTNET” with the U.S. Patent and Trademark Office. We also pursue the registration of certain of our other trademarks and service marks in the United States. In addition, we have registered our domain name, www.envestnet.com and www.fidurciaryopportunity.com with Register.com, Inc. and maintain several additional websites, such as www.envestnetpmc.com, investpmc.com and envestnetadvisor.com (registered with Network Solutions, LLC). We have established a system of security measures to protect our computer systems from security breaches and computer viruses. We have employed various technology and process-based methods, such as clustered and multi-level firewalls, intrusion detection mechanisms, vulnerability assessments, content filtering, antivirus software and access control mechanisms. We also use encryption techniques for data transmissions. We control and limit access to confidential and proprietary information on a “need to know” basis.

Regulation

Overview

The financial services industry is among the most extensively regulated industries in the United States. We operate investment advisory, broker-dealer and mutual fund businesses, each of which is subject to a specific regulatory scheme, including regulation at the Federal and state level, as well as regulation by self-regulatory organizations and non-U.S. regulatory authorities. In addition, we are subject to numerous laws and regulations of general application.

Our wholly-owned subsidiaries, Envestnet Asset Management, Inc., Portfolio Management Consultants, Inc. and Oberon Financial Technology, Inc. operate investment advisory businesses. These subsidiaries are registered with the SEC as “investment advisers” under the Advisers Act, and are regulated thereunder. As described further below, many of our investment advisory programs are conducted pursuant to the non-exclusive safe harbor from the definition of an “investment company” provided for under Rule 3a-4 under the Investment Company Act. If Rule 3a-4 were to cease to be available, or if the SEC were to modify the rule or its interpretation of how the rule is applied, it could have a substantial effect on our business. Envestnet Asset Management, Inc. serves as the investment adviser to four mutual funds. Mutual funds are registered as “investment companies” under the Investment Company Act. The Advisers Act and the Investment Company Act, together with related regulations and interpretations of the SEC, impose numerous obligations and restrictions on investment advisers and mutual funds, including recordkeeping requirements, limitations on advertising, disclosure and reporting obligations, prohibitions on fraudulent activities, and detailed operating requirements, including restrictions on transactions between an adviser and its clients, and between a mutual fund and its advisers and affiliates. The fiduciary obligations of investment advisers to their clients require advisers to, among other things, consider the suitability of the investment products and advice they provide, seek “best execution” for their clients’ securities transactions, conduct due diligence on third-party products offered to clients, consider the appropriateness of the adviser’s fees, and provide extensive and ongoing disclosure to clients. The application of these requirements to wrap fee programs is particularly complex and the SEC has in the past scrutinized firms’ compliance with these requirements. The SEC is authorized to institute proceedings and impose fines and sanctions for violations of the Advisers Act and the Investment Company Act and has the power to restrict or prohibit an investment adviser from carrying on its business in the event that it fails to comply with applicable laws and regulations. Though we believe we are in compliance in all material respects with the requirements of the Advisers Act and the Investment Company Act and the rules and interpretations promulgated thereunder, our failure to comply with such laws, rules and interpretations could have a material adverse effect on us.

Portfolio Brokerage Services, Inc., or PBS, our broker-dealer subsidiary, is registered as a broker-dealer with the SEC under the Securities Exchange Act of 1934, or the Exchange Act, in all 50 states and the District of Columbia. In addition, PBS is a member of FINRA, the securities industry self-regulatory organization that supervises and regulates the conduct and activities of broker-dealers. Broker-dealers are subject to regulations that cover all aspects of their business, including sales practices, market making and trading among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure, record-keeping and the conduct

 

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of directors, officers, employees, representatives and associated persons. FINRA and the SEC conduct periodic examinations of the operations of its members, including PBS. Violation of applicable regulations can result in the suspension or revocation of a broker-dealer’s registration, the imposition of censures or fines and the suspension or expulsion of the broker-dealer from FINRA. PBS is subject to minimum net capital requirements under the Exchange Act, SEC and FINRA rules and conducts its business pursuant to the exemption from the SEC’s customer protection rule provided by Rule 15c3-3(k)(2)(i) under the Exchange Act. As of December 31, 2010, PBS was required to maintain a minimum of $100,000 in net capital and its actual net capital was $714,000.

Our regulated subsidiaries are subject to various federal and state laws and regulations that grant supervisory agencies, including the SEC, broad administrative powers. In the event of a failure to comply with these laws and regulations, the possible sanctions that may be imposed include the suspension of individual employees, limitations on the permissibility of our regulated subsidiaries and our other subsidiaries to engage in business for specified periods of time, censures, fines, and the revocation of registration as a broker-dealer or investment adviser, as applicable. Additionally, the securities laws applicable to us and our subsidiaries provide for certain private rights of action that could give rise to civil litigation. Any litigation could have significant financial and non-financial consequences including monetary judgments and the requirement to take action or limit activities that could ultimately affect our business.

Additional legislation and regulations, including those relating to the activities of investment advisers and broker-dealers, changes in rules imposed by the SEC or other regulatory authorities and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules may adversely affect our business and profitability. Our businesses may be materially affected not only by regulations applicable to it as an investment adviser or broker-dealer, but also by regulations that apply to companies generally.

Investment Advisory Program, Conducted Under Rule 3a-4

Under the Investment Company Act, an issuer that is engaged in the business of investing, reinvesting or trading in securities may be deemed an “investment company,” in which case the issuer may be subject to registration requirements and regulation as an investment company under the Investment Company Act. In order to provide assurance that certain discretionary investment advisory programs would not be considered investment companies, the Securities and Exchange Commission adopted Rule 3a-4 under the Investment Company Act, which provides a non-exclusive safe harbor from the definition of an investment company for programs that meet the requirements of the rule. We conduct the following programs pursuant to the Rule 3a-4 safe harbor:

 

   

Separately managed accounts;

 

   

Unified managed accounts portfolios;

 

   

Mutual fund portfolios and exchange-traded funds’ portfolios; and

 

   

Advisor directed portfolios.

We believe that, to the extent we exercise discretion over accounts in any of these programs, these programs qualify for the safe-harbor because all of the programs have the following characteristics, which are generally required in order for a program to be eligible for the Rule 3a-4 safe harbor:

 

   

Each client account is managed on the basis of the client’s financial situation, investment objectives and reasonable client-imposed investment restrictions;

 

   

At the opening of the account, the client’s financial advisor obtains information from the client and provides us with the client’s financial situation, investment objectives and reasonable restrictions;

 

   

On no less than an annual basis, the client’s financial advisor periodically contacts the client to determine whether there have been any changes in the client’s financial situation or investment objectives, and whether the client wishes to impose any reasonable restrictions on the management of

 

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the account or reasonably modify existing restrictions. This information is communicated to us and reflected in our management of client accounts;

 

   

On a quarterly basis, we or another designated person (in most cases this will be the client’s financial advisor) notify the client to contact us or another designated person if there have been any changes to the client’s financial position or investment objectives or if the client wishes to impose any reasonable restrictions on the management of the account;

 

   

We, the client’s financial advisor and the manager of the client’s account, all of whom are knowledgeable about the account and its management, are reasonably available to the client for consultation;

 

   

All of the programs allow each client to impose reasonable restrictions on the management of his or her account;

 

   

On at least a quarterly basis, the client is provided with a statement containing a description of all activity in the client’s account during the preceding period, including all transactions made on behalf of the account, all contributions and withdrawals made by the client, all fees and expenses charged to the account, and the value of the account at the beginning and end of the period; and

 

   

For all of the programs, each client retains, with respect to all securities and funds in the client’s account, the right to withdraw securities or cash, vote securities, or delegate the authority to vote securities to another person, receive written confirmation or other notification of each securities transaction by the client’s independent custodian, and proceed directly as a security holder against the issuer of any security in the client’s account without the obligation to include us or any other client of the program in any such action as a condition precedent to initiating such proceeding.

Employees

As of December 31, 2010, we had 457 employees, including 88 in sales and marketing, 121 in engineering and systems, 196 in operations, 12 in investment management and research, and 40 in executive and corporate functions. Of these 457 employees, 185 were located in India. None of our employees is represented by a labor union. We have never experienced a work stoppage and believe our relationship with our employees is satisfactory.

Executive Officers of the Registrant

The following table summarizes information about each one of our executive officers.

 

Name

   Age     

Position(s)

Judson Bergman

     54       Chairman, Chief Executive Officer, Director

William Crager

     47       President

Peter D’Arrigo

     43       Chief Financial Officer

Scott Grinis

     49       Chief Technology Officer

Shelly O’Brien

     45       General Counsel

Charles Tennant

     46       Chief Operating Officer

Brandon Thomas

     47       Chief Investment Officer

Judson Bergman, Age 54. Mr. Bergman is the founder of our company and has served as our Chairman, Chief Executive Officer and a director since 1999. Prior to founding our company, Mr. Bergman was Managing Director at Nuveen Investments, Inc., or Nuveen, a diversified investment manager. Mr. Bergman serves as a trustee of RS Investment Trust and RS Variable Products Trust, registered investment companies. Mr. Bergman received an MBA in finance and accounting from Columbia University and a BA in English from Wheaton College. Mr. Bergman’s qualifications to serve on our Board of Directors are primarily based on his experience as the founder of our company, his familiarity with the financial services industry acquired through his experience at Nuveen and his education in finance and accounting.

 

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William Crager, Age 47. Mr. Crager has served as our President since 2002. Prior to joining us, Mr. Crager served as Managing Director of Marketing and Client Services at Rittenhouse Financial Services, Inc., an investment management firm affiliated with Nuveen. Mr. Crager received an MA from Boston University and a BA from Fairfield University, with a dual major in economics and English.

Peter D’Arrigo, Age 43. Mr. D’Arrigo has served as our Chief Financial Officer since 2008. Prior to joining us, Mr. D’Arrigo worked at Nuveen where he served as Treasurer since 1999, as well as holding a variety of other titles after joining them in 1990. Mr. D’Arrigo received an MBA from the Northwestern University Kellogg Graduate School of Management and an undergraduate degree in applied mathematics from Yale University.

Scott Grinis, Age 49. Mr. Grinis has served as our Chief Technology Officer since 2004. Prior to joining us, Mr. Grinis co-founded Oberon Financial Technology, Inc., our subsidiary, prior to its acquisition by us. Mr. Grinis received a BS and an MS degree in electrical engineering from Stanford University.

Shelly O’Brien, Age 45. Ms. O’Brien has served as our General Counsel and Corporate Secretary since 2002. Prior to joining us, Ms. O’Brien was General Counsel and Director of Legal and Compliance for ING (U.S.) Securities, Futures & Options Inc., a broker-dealer, and futures commission merchant. Ms. O’Brien received a degree in political science from Northwestern University, a JD from Hamline University School of Law, and an LLM in taxation from John Marshall Law School.

Charles Tennant, Age 46. Mr. Tennant has served as our Chief Operating Officer since 2007. Prior to joining us, Mr. Tennant was the Chief Operating Officer of Ameriprise Financial’s brokerage clearing services group from 2003 to 2007. Mr. Tennant received a degree in management information systems from the University of South Florida.

Brandon Thomas, Age 47. Mr. Thomas is a Co-Founder of our company and has served as Chief Investment Officer and Managing Director of Portfolio Management Consultants, our internal investment management and portfolio consulting group, since 1999. Prior to joining us, Mr. Thomas was Director of Equity Funds for Nuveen. Mr. Thomas received an MBA from the University of Chicago, a JD from DePaul University and is a graduate of Brown University.

 

Item 1A. Risk Factors

Investment in our securities involves risk. An investor or potential investor should consider the risks summarized in this section when making investment decisions regarding our securities. These risks and uncertainties include, but are not limited to, the risk factors set forth below. The risks and uncertainties described in this section are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs on our business, financial condition and results of operations could be materially adversely affected.

Risks Related to Our Business

We have experienced rapid revenue growth over the past several years, which may be difficult to sustain and which may place significant demands on our administrative, operational and financial resources and any inability to maintain or manage our growth could have a material adverse effect on our results of operations, financial condition or business.

Our revenues during the five years ended December 31, 2010 have grown at a compound annual growth rate of 20%. We expect our growth to continue, which could place additional demands on our resources and increase our expenses. Our future growth will depend on, among other things, our ability to successfully grow our total assets under management and administration and add additional clients. If we are unable to implement

 

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our growth strategy, develop new investment solutions and services and gain new clients, our results of operations, financial condition or business may be materially adversely affected.

Sustaining growth will also require us to commit additional management, operational and financial resources and to maintain appropriate operational and financial systems. In addition, continued growth increases the challenges involved in:

 

   

Recruiting, training and retaining sufficiently skilled technical, marketing, sale and management personnel;

 

   

Preserving our culture, values and entrepreneurial environment;

 

   

Successfully expanding the range of investment solutions and services offered to our clients;

 

   

developing and improving our internal administrative infrastructure, particularly our financial, operational, compliance, record-keeping, communications and other internal systems; and

 

   

maintaining high levels of satisfaction with our investment solutions and services among clients.

There can be no assurance that we will be able to maintain or accelerate our growth, and any failure to do so could adversely affect our results of operations, financial condition or business.

Our revenue can fluctuate from period to period, which could cause our share price to fluctuate.

Our revenue 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 events, 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 under management and administration and therefore our revenues and cash flows;

 

   

negative public perception and reputation of the financial services industry, which would reduce demand for our investment solutions and services;

 

   

unanticipated changes to economic terms in contracts with clients, including renegotiations;

 

   

downward pressure on fees we charge our clients, which would therefore reduce our revenue;

 

   

changes in laws or regulations that could impact our ability to offer investment solutions and services;

 

   

failure to obtain new clients;

 

   

cancellation or non-renewal of existing contracts with clients;

 

   

failure to protect our proprietary technology and intellectual property rights;

 

   

unanticipated delays in connection with the conversion of client assets onto our technology platform;

 

   

reduction in the suite of investment solutions and services provided to existing clients; or

 

   

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 operations for any quarterly or annual period may differ materially from the results of operations for any prior or future quarterly or annual period and should not be relied upon as indications of our future performance.

We operate in a highly competitive industry, with many firms competing for business from financial advisors on the basis of a number of factors, including the quality and breadth of investment solutions and services, ability to innovate, reputation and the prices of services and this competition could hurt our financial performance.

We compete with many different types of companies that vary in size and scope, including Pershing LLC (a subsidiary of BNY Mellon Corporation), The Charles Schwab Corporation, SEI Investments Company,

 

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Genworth Financial Inc. and Lockwood Advisors (a subsidiary of BNY Mellon Corporation) and which are discussed in greater detail under “Business—Competition” included in this Form 10-K. In addition, some of our clients have developed or may develop the in-house capability to provide the technology and/or investment advisory services they have retained us to perform. These clients may also offer internally developed services to their financial advisors, obviating the need to hire us, and they may offer these services to third-party financial advisors or financial institutions, thereby competing directly with us for that business.

Many of our competitors have significantly greater resources than we do. These resources may allow our competitors to respond more quickly to changes in demand for investment solutions and services, to devote greater resources to developing and promoting their services and to make more attractive offers to potential clients and strategic partners, which could hurt our financial performance.

We may lose clients as a result of the sale or merger of a client, a change in a client’s senior management, competition from other financial advisors and financial institutions and for other reasons. We also face increased competition due to the current trend of industry consolidation. If large financial institutions that are not our clients are able to attract assets from our clients, our ability to generate future growth in revenues and earnings may be adversely affected.

Our failure to successfully compete in any of the above-mentioned areas could have a material adverse effect on our results of operations, financial condition or business. Competition could also affect the revenue mix of services we provide, resulting in decreased revenues in lines of business with higher profit margins.

We derive nearly all of our revenues from the delivery of investment solutions and services to clients in the financial advisory industry and our revenue could suffer if that industry experiences a downturn.

We derive nearly all of our revenues from the delivery of investment solutions and services to clients in the financial advisory industry and we are therefore subject to the risks affecting that industry. A decline or lack of growth in demand for financial advisory services would adversely affect our clients and, in turn, our results of operations, financial condition and business. For example, the availability of free or low-cost investment information and resources, including research and information relating to publicly traded companies and mutual funds available on the Internet or on company websites, could lead to lower demand by investors for the services provided by financial advisors. In addition, demand for our investment solutions and services among financial advisors could decline for many reasons. Consolidation or limited growth in the financial advisory industry could reduce the number of our clients and potential clients. Events that adversely affect our clients’ businesses, rates of growth or the numbers of customers they serve, including decreased demand for our clients’ products and services, adverse conditions in our clients’ markets or adverse economic conditions generally, could decrease demand for our investment solutions and services and thereby decrease our revenues. Any of the foregoing could have a material adverse effect on our results of operations, financial condition or business.

A limited number of clients account for a material portion of our revenue. Termination of our contracts with any of these clients could have a material adverse effect on our results of operations, financial condition or business.

For the years ended December 31, 2008, 2009 and 2010, revenues associated with our relationship with our single largest client, FMR LLC, an affiliate of FMR Corp., or Fidelity, accounted for 27%, 31% and 31% respectively, of our total revenues and our ten largest clients accounted for 63%, 66% and 62% respectively, of our total revenues. Our license agreements with large financial institutions are generally multi-year contracts that may be terminated upon the expiration of the contract term or prior to such time for cause, which may include breach of contract, bankruptcy, insolvency and other reasons. Our license agreement with Fidelity does not have a specified term, but the license fee payments made to us by Fidelity under the license agreement cease on December 31, 2011. At such time, we will still receive ongoing platform services fees through the Fidelity relationship based upon usage, which include fees for ongoing technology services and software updates. A majority of our agreements with financial advisors generally provide for termination at any time. If our

 

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contractual relationship with Fidelity were to terminate, or if a significant number of our most important clients were to terminate their contracts with us and we were unable to obtain a significant number of new clients, our results of operations, financial condition or business could be materially adversely affected.

Our clients that pay us an asset-based fee may seek to negotiate a lower fee percentage or may cease using our services, which could limit the growth of, or decrease, our revenues.

A significant portion of our revenues are derived from asset-based fees. Our clients may, for a number of reasons, seek to negotiate a lower asset-based fee percentage. For example, an increase in the use of index-linked investment products by the clients of our financial advisor clients may result in lower fees being paid to our clients, and our clients may in turn seek to negotiate lower asset-based fee percentages for our services. In addition, as competition among our clients increases, they may be required to lower the fees they charge to their clients, which could cause them to seek to decrease our fees accordingly. Any of these factors could result in fluctuation or a decline in our asset-based fees, which would have a material adverse effect on our results of operations, financial condition or business.

Changes in market and economic conditions could lower the value of assets on which we earn revenues and could decrease the demand for our investment solutions and services.

Asset-based fees make up a significant portion of our revenues and several of our largest clients pay us on this basis. Asset-based fees represented 78%, 73% and 77% of our total revenues for the years ended December 31, 2008, 2009 and 2010, respectively. In addition, as a result of the current trend of increased use of financial advisors by individual investors, we expect that asset-based fees will account for an increasing percentage of our total revenues in the future. Significant fluctuations in securities prices may materially affect the value of the assets managed by our clients and may also influence financial advisor and investor decisions regarding whether to invest in, or maintain an investment in, a mutual fund or other investment solution. If such market fluctuation led to less investment in the securities markets, our revenues and earnings derived from asset-based fees could be materially adversely affected.

We provide our investment solutions and services to the financial services industry. The financial markets, and in turn the financial services industry, are affected by many factors, such as U.S. and foreign economic conditions and general trends in business and finance that are beyond our control. In the event that the U.S. or international financial markets suffer a severe or prolonged downturn, investors may choose to withdraw assets from financial advisors and transfer them to investments that are perceived to be more secure, such as bank deposits and Treasury securities. For example, in late 2007 and through the first quarter of 2009, the financial markets experienced a broad and prolonged downturn, our redemption rates were higher than our historical average, and our results of operations, financial condition and business were materially adversely affected. Any prolonged downturn in financial markets, or increased levels of asset withdrawals could have a material adverse effect on our results of operations, financial condition or business.

Investors’ decisions regarding their investment assets are affected by many factors and investors may redeem or withdraw their investment assets generally at any time. Significant changes in investing patterns or large-scale withdrawal of investment funds could have a material adverse effect on our results of operations, financial condition or business.

The clients of our financial advisors are generally free to change financial advisors, forgo the advice and other services provided by financial advisors or withdraw the funds they have invested with financial advisors. These clients of financial advisors may elect to change their investment strategies, including by moving their assets away from equity securities to fixed income or other investment options, or by withdrawing all or a portion of their assets from their accounts to avoid all securities markets-related risks. These actions by investors are outside of our control and could materially adversely affect the market value of the investment assets that our clients manage, which could materially adversely affect the asset-based fees we receive from our clients.

 

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We are subject to liability for losses that result from a breach of our fiduciary duties.

Our investment advisory services involve fiduciary obligations that require us to act in the best interests of our clients, and we may be sued and face liabilities for actual or claimed breaches of our fiduciary duties. Because we provide investment advisory services, both directly and indirectly, with respect to substantial assets we could face substantial liability to our clients if it is determined that we have breached our fiduciary duties. In certain circumstances, which generally depend on the types of investment solutions and services we are providing, we may enter into client agreements jointly with advisors and retain third-party investment money managers on behalf of clients. As a result, we may be included as a defendant in lawsuits against financial advisors and third-party investment money managers that involve claims of breaches of the duties of such persons, and we may face liabilities for the improper actions and/or omissions of such advisors and third-party investment money managers. In addition, we may face claims based on the results of our investment advisory recommendations, even in the absence of a breach of our fiduciary duty. Such claims and liabilities could therefore have a material adverse effect on our results of operations, financial condition or business.

We are subject to liability for losses that result from potential, perceived or actual conflicts of interest.

Potential, perceived and actual conflicts of interest are inherent in our existing and future business activities and could give rise to client dissatisfaction, litigation or regulatory enforcement actions. In particular, we pay varying fees to third-party asset managers and custodians and our financial advisor customers, or their clients, could accuse us of directing them toward those asset managers or custodians that charge us the lowest fees. In addition, we offer proprietary mutual funds and portfolios of mutual funds through our internal investment management and portfolio consulting group, and financial advisors or their clients could conclude that we favor our proprietary investment products because of their belief that we earn higher fees when our proprietary investment products are used. Adequately addressing conflicts of interest is complex and difficult and if we fail, or appear to fail, to adequately address potential, perceived or actual conflicts of interest, the resulting negative public perception and reputational harm could materially adversely affect our client relations or ability to enter into contracts with new clients and, consequently, our results of operations, financial condition and business.

If our reputation is harmed, our results of operations, financial condition or business could be materially adversely affected.

Our reputation, which depends on earning and maintaining the trust and confidence of our clients, 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 our clients, 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 solutions and services 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 clients, which would materially adversely affect our results of operations, financial condition and business.

If our investment solutions and services fail to perform properly due to undetected errors or similar problems, our results of operations, financial condition and business could be materially adversely affected.

Investment solutions and services we develop or license may contain undetected errors or defects despite testing. Such errors can exist at any point in the life cycle of our investment solutions or services, but are frequently found after introduction of new investment solutions and services or enhancements to existing investment solutions or services. We continually introduce new investment solutions and services and new versions of our investment solutions and services. Despite internal testing and testing by current and potential clients, our current and future investment solutions and services may contain serious defects or malfunctions. If

 

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we detect any errors before release, we might be required to delay the release of the investment solution or service for an extended period of time while we address the problem. We might not discover errors that affect our new or current investment solutions, services or enhancements until after they are deployed, and we may need to provide enhancements to correct such errors. Errors may occur that could have a material adverse effect on our results of operations, financial condition or business and could result in harm to our reputation, lost sales, delays in commercial release, third-party claims, contractual disputes, contract terminations or renegotiations, or unexpected expenses and diversion of management and other resources to remedy errors. In addition, negative public perception and reputational damage caused by such claims would adversely affect our client relationships and our ability to enter into new contracts. Any of these problems could have a material adverse effect on our results of operations, financial condition and business.

We could face liability or incur costs to remediate operational errors or to address possible customer dissatisfaction.

Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions and inadequacies or breaches in our internal control processes. We operate in diverse markets and are reliant on the ability of our employees and systems to process large volumes of transactions often within short time frames. In the event of a breakdown or improper operation of systems, human error or improper action by employees, we could suffer financial loss, regulatory sanctions or damage to our reputation.

In addition, there may be circumstances when our customers are dissatisfied with our investment solutions and services, even in the absence of an operational error. In such circumstances, we may elect to make payments or otherwise incur increased costs or lower revenues in order to maintain a strong customer relationship. In any of the forgoing circumstances, our results of operations, financial condition or business could be materially adversely affected.

We may become subject to liability based on the use of our investment solutions and services by our clients.

Our investment solutions and services support the investment processes of our clients, which, in the aggregate, manage billions of dollars of assets. Our client agreements have provisions designed to limit our exposure to potential liability claims brought by our clients or third parties based on the use of our investment solutions and services. However, these provisions have certain exceptions and could be invalidated by unfavorable judicial decisions or by federal, state, foreign or local laws. Use of our products as part of the investment process creates the risk that clients, or the parties whose assets are managed by our clients, may pursue claims against us for very significant dollar amounts. Any such claim, even if the outcome were to be ultimately favorable to us, would involve a significant commitment of our management, personnel, financial and other resources and could have a negative impact on our reputation. Such claims and lawsuits could therefore have a material adverse effect on our results of operations, financial condition or business.

Furthermore, our clients may use our investment solutions and services together with software, data or products from other companies. As a result, when problems occur, it might be difficult to identify the source of the problem. Even when our investment solutions and services do not cause these problems, the existence of these errors might cause us to incur significant costs and divert the attention of our management and technical personnel, any of which could materially adversely affect our results of operations, financial condition or business.

Our business relies heavily on computer equipment, electronic delivery systems and the Internet. Any failures or disruptions in such technologies could result in reduced revenues, increased costs and the loss of customers.

Our business relies heavily on our computer equipment (including our servers), electronic delivery systems and the Internet, but these technologies are vulnerable to disruptions, failures or slowdowns caused by fire,

 

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earthquake, power loss, telecommunications failure, terrorist attacks, wars, Internet failures, computer viruses and other events beyond our control. Furthermore, we rely on agreements with our suppliers, such as our current data hosting and service provider, to provide us with access to certain computer equipment, electric delivery systems and the Internet. We are unable to predict whether a future contractual dispute may arise with one of our suppliers that could cause a disruption in service, or whether our agreements with our suppliers can be obtained or renewed on acceptable terms, or at all. An unanticipated disruption, failure or slowdown affecting our key technologies or facilities may have significant ramifications, such as data-loss, data corruption, damaged software codes or inaccurate processing of transactions. We maintain off-site back-up facilities for our electronic information and computer equipment, but these facilities could be subject to the same interruptions that may affect our primary facilities. Any significant disruptions, failures, slowdowns, data-loss or data corruption could have a material adverse effect on our results of operations, financial condition or business and result in the loss of customers.

We could face liability related to disclosure or theft of the personal information we store on our technology platform.

Clients may maintain personal investment and financial information on our technology platform and we could be subject to liability if we were to inappropriately disclose any user’s personal information, inadvertently or otherwise, or if third parties were able to penetrate our network security or otherwise gain access to any user’s name, address, portfolio holdings or other financial information. Any such event could subject us to claims for misuses of personal information, such as unauthorized marketing or unauthorized access to personal portfolio information could therefore have a material adverse effect on our results of operations, financial condition or business.

We could incur significant costs protecting the personal information we store on our technology platform.

Users of our investment solutions and services are located in the United States and around the world. As a result, we collect and store the personal information of individuals who live in many different countries. Privacy regulators in some of those countries have publicly stated that foreign entities (including entities based in the United States) may render themselves subject to those countries’ privacy laws and the jurisdiction of such regulators by collecting or storing the personal data of those countries’ residents, even if such entities have no physical or legal presence there. Consequently, we may be obligated to comply with the privacy and data security laws of such foreign countries. Our exposure to foreign countries’ privacy and data security laws impacts our ability to collect and use personal information, increases our legal compliance costs and may expose us to liability.

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 could require us to modify our operations and incur significant additional expense, which could have a material adverse effect on our results of operations, financial condition or business.

We could face liability for certain information we provide, including information based on data we obtain from other parties.

We may be subject to claims for securities law violations, negligence, breach of fiduciary duties or other claims relating to the information we provide. For example, individuals may take legal action against us if they rely on information we have provided and it contains an error. In addition, we could be subject to claims based upon the content that is accessible from our website through links to other websites. Moreover, we could face liability based on inaccurate information provided to us by others. Defending any such claims could be expensive and time-consuming, and any such claim could materially adversely affect our results of operations, financial condition or business.

 

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We depend on our senior management team and other key personnel and the loss of their services could have a material adverse effect on our results of operations, financial condition or business.

We depend on the efforts, relationships and reputations of our senior management team and other key personnel, including Judson Bergman, our Chief Executive Officer, William Crager, our President, and Scott Grinis, our Chief Technology Officer, in order to successfully manage our business. We believe that success in our business will continue to be based upon the strength of our intellectual capital. The loss of the services of any member of our senior management team or of other key personnel could have a material adverse effect on our results of operations, financial condition or business.

Our operations are subject to extensive government regulation, and compliance failures or regulatory action against us could adversely affect our results of operations, financial condition or business.

The financial services industry is among the most extensively regulated industries in the United States. We operate investment advisory, broker-dealer and mutual fund businesses, each of which is subject to a specific and extensive regulatory scheme. In addition, we are subject to numerous laws and regulations of general application. It is very difficult to predict the future impact of the legislative and regulatory requirements affecting our business and our clients’ businesses.

Certain of our subsidiaries are registered as “investment advisers” with the SEC under the Investment Advisers Act of 1940 and are regulated thereunder. In addition, many of our investment advisory services are conducted pursuant to the non-exclusive safe harbor from the definition of an “investment company” provided under Rule 3a-4 under the Investment Company Act of 1940. If Rule 3a-4 were to cease to be available, or if the Securities and Exchange Commission were to modify the rule or its interpretation of how the rule is applied, our business could be adversely affected. Certain of our registered investment adviser subsidiaries provide advice to mutual fund clients. Mutual funds are registered as “investment companies” under the Investment Company Act of 1940. The Investment Advisers Act of 1940 and the Investment Company Act of 1940, together with related regulations and interpretations of the Securities and Exchange Commission, impose numerous obligations and restrictions on investment advisers and mutual funds, including requirements relating to the safekeeping of client funds and securities, limitations on advertising, disclosure and reporting obligations, prohibitions on fraudulent activities, restrictions on transactions between an adviser and its clients, and between a mutual fund and its advisers and affiliates, and other detailed operating requirements, as well as general fiduciary obligations.

In addition, PBS, our broker-dealer subsidiary, is registered as a broker-dealer with the Securities and Exchange Commission and with all 50 states and the District of Columbia, and is a member of the Financial Industry Regulatory Authority, a securities industry self-regulatory organization that supervises and regulates the conduct and activities of its members. Broker-dealers are subject to regulations that cover all aspects of their business, including sales practices, market making and trading among broker-dealers, use and safekeeping of customer funds and securities, capital structure, recordkeeping and the conduct of directors, officers, employees, representatives and associated persons. The Financial Industry Regulatory Authority conducts periodic examinations of the operations of its members, including Portfolio Brokerage Services, Inc. As a broker-dealer, PBS is also subject to certain minimum net capital requirements under SEC and FINRA rules. Compliance with the net capital rules may limit our ability to withdraw capital from Portfolio Brokerage Services, Inc.

All of the foregoing laws and regulations are complex and we are required to expend significant resources in order to maintain our compliance with such laws and regulations. Any failure on our part to comply with these and other applicable laws and regulations could result in regulatory fines, suspensions of personnel or other sanctions, including revocation of our registration or that of our subsidiaries as an investment adviser or broker-dealer, as the case may be, which could, among other things, require changes to our business practices and scope of operations or harm our reputation, which, in turn could have a material adverse effect on our results of operations, financial condition or business.

 

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Changes to the laws or regulations applicable to us or to our financial advisor clients could adversely affect our results of operations, financial condition or business.

We may be adversely affected as a result of new or revised legislation or regulations imposed by the Securities and Exchange Commission or other U.S. or foreign governmental regulatory authorities or self-regulatory organizations that supervise the financial markets around the world. In addition, we may be adversely affected by changes in the interpretation or enforcement 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 current proposals will become law, and it is difficult to predict how any changes or potential changes could affect our business. Changes to laws or regulations could increase our potential liability in connection with the investment solutions and services that we provide. The introduction of any new laws or regulations could make our ability to comply with applicable laws and regulations more difficult and expensive. Any of the foregoing could have a material adverse effect on our results of operations, financial condition or business.

The offering of shares of our common stock in our initial public filing may be deemed a change of control of our company and the method by which the company obtained the consent of its clients to the change of control could be challenged, which could adversely affect our results of operations, financial condition or business.

Under the Investment Advisers Act of 1940, the investment advisory agreements entered into by our investment adviser subsidiaries may not be assigned without the client’s consent. Under the Investment Company Act of 1940, advisory agreements with registered funds terminate automatically upon assignment and, if an assignment of an advisory agreement occurs, the board of directors and the shareholders of the registered fund must approve a new agreement. Under the Investment Advisers Act of 1940 and the Investment Company Act of 1940, such an assignment may be deemed to occur upon a change of control of the Company. A change of control could be deemed to occur if we, or one of our investment adviser subsidiaries, were to gain or lose a controlling person, or in other situations that may depend significantly on facts and circumstances.

In case the offering of our common stock in our initial public offering could have been deemed to result in a change in control, we sought and obtained the consent of our financial advisor clients, as well as the clients of financial advisors receiving advisory services. However, it is possible that the method by which we obtained consents could be challenged at a later time. If such a challenge were to be successful it could have a material adverse effect on our results of operations, financial condition or business.

We rely on exemptions from certain laws and if for any reason these exemptions were to become unavailable to us, we could become subject to regulatory action or third-party claims and our business could be materially and adversely affected.

We regularly rely on exemptions from various requirements of the Securities Exchange Act of 1934, the Investment Company Act of 1940 and the Employment Retirement Income Security Act in conducting our activities. These exemptions are sometimes highly complex and may in certain circumstances depend on compliance by third parties whom we do not control. If for any reason these exemptions were to become unavailable to us, we could become subject to regulatory action or third-party claims and our business could be materially and adversely affected.

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. Such laws and regulations may cover sales, practices, taxes, user privacy, data protection, pricing, content, copyrights, distribution, electronic

 

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contracts, consumer protection, broadband residential Internet access and the characteristics and quality of services. Moreover, it is not clear how existing laws governing these matters apply to the Internet. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, we may be required to incur additional expenses or alter our business model, either of which could have a material adverse effect on our results of operations, financial condition or business.

We are substantially dependent on our intellectual property rights, and a failure to protect these rights could adversely affect our results of operations, financial condition or business.

We have made substantial investments in software and other intellectual property on which our business is highly dependent. We rely on trade secret, trademark and copyright laws, confidentiality and nondisclosure agreements and other contractual and technical security measures to protect our proprietary technology. Any loss of our intellectual property rights, or any significant claim of infringement or indemnity for violation of the intellectual property rights of others, could have a material adverse effect on our results of operations, financial condition or business.

None of our technologies, investment solutions or services is covered by any copyright registration, issued patent or patent application. We are the owner of six registered trademarks in the United States, including “ENVESTNET”, and we claim common law rights in other trademarks that are not registered. We cannot guarantee that:

 

   

our intellectual property rights will provide competitive advantages to us;

 

   

our ability to assert our intellectual property rights against potential competitors or to settle current or future disputes will not be limited by our agreements with third parties;

 

   

our intellectual property rights will be enforced in jurisdictions where competition may be intense or where legal protection may be weak;

 

   

any of the trademarks, copyrights, trade secrets or other intellectual property rights that we presently employ in our business will not lapse or be invalidated, circumvented, challenged or abandoned;

 

   

our trademark applications will lead to registered trademarks; or

 

   

competitors will not design around our intellectual property rights or develop similar technologies, investment solutions or products; or that we will not lose the ability to assert our intellectual property rights against others.

We are also a party to a number of third-party intellectual property license agreements. Some of these license agreements require us to make one-time payments or ongoing subscription payments. We cannot guarantee that the third-party intellectual property we license will not be licensed to our competitors or others in our industry. In the future, we may need to obtain additional licenses or renew existing license agreements. We are unable to predict whether these license agreements can be obtained or renewed on acceptable terms, or at all. In addition, we have granted our customers certain rights to use our intellectual property in the ordinary course of our business. Some of our customer agreements restrict our ability to license or develop certain customized technology or services within certain markets or to certain competitors of our customers. For example, our agreement with Fidelity restricts our ability to develop an enterprise-level integration or combination of products and services substantially similar to the technology platform we have developed for Fidelity. Some of our customer agreements grant our customers ownership rights with respect to the portion of the intellectual property we have developed or customized for our customers. In addition, some of our customer agreements require us to deposit the source code to the customized technology and investment solutions with a source code escrow agent, which source code may be released in the event we enter into bankruptcy or are unable to provide support and maintenance of the technology or investment solutions we have licensed to our customers. These provisions in our agreements may limit our ability to grow our business in the future.

 

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Third parties may sue us for intellectual property infringement or misappropriation which, if successful, could require us to pay significant damages or make changes to the investment solutions or services that we offer.

We cannot be certain that our internally developed or acquired technologies, investment solutions or services do not and will not infringe the intellectual property rights of others. In addition, we license content, software and other intellectual property rights from third parties and may be subject to claims of infringement if such parties do not possess the necessary intellectual property rights to the products they license to us. The risk of infringement claims against us will increase if more of our competitors are able to obtain patents for investment solutions or services or business processes. In addition, we face additional risk of infringement or misappropriation claims if we hire an employee who possesses third party proprietary information who decides to use such information in connection with our investment solutions, services or business processes without such third party’s authorization. We have in the past been and may in the future be subject to legal proceedings and claims that we have infringed or misappropriated the intellectual property rights of a third party. These claims sometimes involve patent holding companies who have no relevant product revenues and against whom our own proprietary technology may therefore provide little or no deterrence. In addition, third parties may in the future assert intellectual property infringement claims against our customers, which, in certain circumstances, we have agreed to indemnify. Any intellectual property related infringement or misappropriation claims, whether or not meritorious, could result in costly litigation and could divert management resources and attention. Moreover, should we be found liable for infringement or misappropriation, we may be required to enter into licensing agreements, if available on acceptable terms or at all, pay substantial damages or make changes to the investment solutions and services that we offer. Any of the foregoing could prevent us from competing effectively, result in substantial costs to us, divert management’s attention and our resources away from our operations and otherwise harm our reputation.

If our intellectual property and proprietary 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 intellectual property rights. The steps we have taken to protect our intellectual property rights may be inadequate to prevent the misappropriation of our proprietary technology. There can be no assurance that others will not develop or patent similar or superior technologies, investment solutions or services. Unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our intellectual property rights 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 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. If we are unable to protect our intellectual property rights or if third parties independently develop or gain access to our or similar technologies, investment solutions or services, our results of operations, financial condition and business could be materially adversely affected.

The use of “open source code” in investment solutions may expose us to additional risks and harm our intellectual property rights.

To a limited extent, we rely on open source code to develop our investment solutions and support our internal systems and infrastructure. While we monitor our use of open source code to attempt to avoid subjecting our investment solutions to conditions we do not intend, such use could inadvertently occur. Additionally, if a third-party software provider has incorporated certain types of open source code into software we license from such third party for our investment solutions, we could, under certain circumstances, be required to disclose the source code for our investment solutions. This could harm our intellectual property position and have a material adverse effect on our results of operations, financial condition and business.

 

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Confidentiality agreements with employees, consultants and others may not adequately prevent disclosure of trade secrets and other proprietary information.

We have devoted substantial resources to the development of our proprietary technologies, investment solutions and services. In order to protect our proprietary rights, we enter into confidentiality agreements with our employees, consultants and independent contractors. These agreements may not effectively prevent unauthorized disclosure of confidential information or unauthorized parties from copying aspects of our technologies, investment solutions or products or obtaining and using information that we regard as proprietary. Moreover, these agreements may not provide an adequate remedy in the event of such unauthorized disclosures of confidential information and we cannot assure you that our rights under such agreements will be enforceable. In addition, others may independently discover trade secrets and proprietary information, and in such cases we could not assert any trade secret rights against such parties. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could reduce any competitive advantage we have developed and cause us to lose customers or otherwise harm our business.

Our failure to successfully integrate acquisitions could strain our resources. In addition, there are significant risks associated with growth through acquisitions, which may materially adversely affect our results of operations, financial condition or business.

We expect to grow our business by, among other things, making acquisitions. Acquisitions involve a number of risks. They can be time-consuming and may divert management’s attention from day-to-day operations. Financing an acquisition could result in dilution from issuing equity securities or a weaker balance sheet from using cash or incurring debt. Acquisitions might also result in losing key employees. In addition, we may fail to successfully complete any acquisitions. We may also fail to generate enough revenues or profits from an acquisition to earn a return on the associated purchase price.

To the extent we grow our business through acquisitions, any such future acquisitions could present a number of other risks, including:

 

   

incorrect assumptions regarding the future results of acquired operations or assets or expected cost reductions or other synergies expected to be realized as a result of acquiring operations or assets;

 

   

failure to integrate the operations or management of any acquired operations or assets successfully and on a timely and cost effective basis;

 

   

insufficient knowledge of the operations and markets of acquired businesses;

 

   

loss of key personnel;

 

   

diversion of management’s attention from existing operations or other priorities;

 

   

increased costs or liabilities as a result of undetected or undisclosed legal, regulatory or financial issues related to acquired operations or assets; and

 

   

inability to secure, on terms we find acceptable, sufficient financing that may be required for any such acquisition or investment.

In addition, if we are unsuccessful in completing acquisitions of other businesses, operations or assets or if such opportunities for expansion do not arise, our results of operations, financial condition or business could be materially adversely affected.

Our failure to successfully execute the conversion of our clients’ assets from their technology platform to our platform in a timely and accurate manner could have a material adverse effect on our results of operations, financial condition or business.

When we begin working with a new client, or acquire new client assets through an acquisition or other transaction, such as our agreement with FundQuest Incorporated, we are required to convert the new assets from

 

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the clients’ technology platform to our technology platform. These conversions present significant technological and operational challenges, can be time-consuming and may divert management’s attention from other operational challenges. If we fail to successfully complete our conversions in a timely and accurate manner, we may be required to expend more time and resources than anticipated, which could erode the profitability of the client relationship. In addition, any such failure may harm our reputation and may make it less likely that prospective clients will commit to working with us. Any of these risks could materially adversely affect our results of operations, financial condition or business.

Our business will suffer if we do not keep up with rapid technological change, evolving industry standards or changing requirements of clients.

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 technology professionals;

 

   

enhance our current investment solutions and services;

 

   

develop new investment solutions and services that meet changing client needs;

 

   

advertise and market our investment solutions and services;

 

   

protect our proprietary technology and intellectual property rights; or

 

   

influence and respond to emerging industry standards and other technological changes.

We must accomplish these tasks in a timely and cost-effective manner and our failure to do so could materially adversely affect our results of operations, financial condition or business.

We must continue to introduce new investment solutions and services and investment solution and service enhancements to address our clients’ changing needs, market changes and technological developments and failure to do so could have a material adverse effect on our results of operations, financial condition or business.

The market for our investment solutions and services is characterized by shifting client demands, evolving market practices and, for some of our investment solutions and services, rapid technological change. Changing client demands, new market practices or new technologies can render existing investment solutions and services obsolete and unmarketable. As a result, our future success will continue to depend upon our ability to develop new investment solutions and services and investment solution and service enhancements that address the future needs of our target markets and respond to technological and market changes. We incurred technology development expenditures of $4.9 million, $4.9 million and $5.6 million in the years ended December, 31, 2008, 2009 and 2010, respectively. We expect that our technology development expenditures will continue at this level or they may increase in the future. We may not be able to accurately estimate the impact of new investment solutions and services on our business or how their benefits will be perceived by our clients. Further, we may not be successful in developing, introducing, marketing and licensing our new investment solutions or services or investment solution or service enhancements on a timely and cost effective basis, or at all, and our new investment solutions and services and enhancements may not adequately meet the requirements of the marketplace or achieve market acceptance. In addition, clients may delay purchases in anticipation of new investment solutions or services or enhancements. Any of these factors could materially adversely affect our results of operations, financial condition or business.

 

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Risks Related to our Common Stock

Our share price may be volatile, and the value of an investment in our common stock may decline.

An active, liquid and orderly market for our common stock may not be sustained, which could depress the trading price of our common stock. The price of our common stock has been, and is likely to continue to be, volatile, which means that it could decline substantially within a short period of time. For example, since shares of our common stock were sold in our initial public offering in July 2010 at a price of $9.00 per share, our closing stock price has ranged from $9.90 to $17.09 in the period August 1, 2010 to December 31, 2010. 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. 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.

Our insiders who are significant stockholders may have interests that conflict with those of other stockholders.

Our directors and executive officers, together with members of their immediate families, as a group, beneficially own, in the aggregate, approximately 29% of our outstanding capital stock as of December 31, 2010. As a result, when acting together, this group has the ability to exercise significant influence over most matters requiring our stockholders’ approval, including the election and removal of directors and significant corporate transactions. The interests of our insider stockholders may not be aligned with the interests of our other stockholders and conflicts of interest may arise. In addition, the concentration of our shares may have the effect

 

33


of delaying, deterring or preventing significant corporate transactions which may otherwise adversely affect the market price of our shares.

The future sale of shares of our common stock may negatively impact our stock price.

If our stockholders sell substantial amounts of our common stock, the market price of our common stock could fall. A reduction in ownership by a large stockholder could cause the market price of our common stock to fall. In addition, the average daily trading volume in our stock is relatively low. The lack of trading activity in our stock may lead to greater fluctuations in our stock price. Low trading volume may also make it difficult for stockholder to make transactions in a timely fashion.

Certain provisions in our charter documents and agreements and Delaware law may inhibit potential acquisition bids for our company and prevent changes in our management.

Our certificate of incorporation and bylaws contains provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in management that our stockholders might deem advantageous. As a result of these provisions in our certificate of incorporation, the price investors may be willing to pay for shares of our common stock may be limited.

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which imposes certain restrictions on mergers and other business combinations between us and any holder of 15% or more of our common stock.

We do not currently intend to pay dividends on our common stock for the foreseeable future and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We do not anticipate paying any cash dividends to holders of our common stock in the foreseeable future. Consequently, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our common stock.

We have incurred and will continue to incur increased costs as a result of being a public company and our management has limited experience managing a public company.

Prior to our initial public offering effective July 28, 2010, we had never operated as a public company and since we have become a publicly traded company, we have incurred and will continue to 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 have devoted and will need to continue 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. Rules and regulations such as the Sarbanes-Oxley Act of 2002 have increased our legal and finance compliance costs and have made some activities more time-consuming and costly. We may need to hire additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company.

Compliance with the public company requirements set forth in the Securities Exchange Act of 1934, the Sarbanes-Oxley Act of 2002 and New York Stock Exchange rules have and will continue to increase our costs and make some activities more time consuming. For example, we have adopted and will continue to adopt certain new internal controls and procedures. In addition, we have incurred and will continue to incur additional expenses associated with our Securities and Exchange Commission reporting requirements. A number of those requirements have and will continue to require us to carry out activities we have not done previously. For example, under Section 404 of the Sarbanes-Oxley Act of 2002, for our annual report on Form 10-K for year ending December 31, 2011, we will need to document and test our internal control procedures, and our management will need to assess and report on our internal control over financial reporting. Furthermore, if we

 

34


identify any issues in complying with those requirements (for example, if we or our registered public accounting firm identify a material weakness or significant deficiency in our internal control over financial reporting), we could incur additional costs rectifying those issues, and the existence of those issues could adversely affect our results of operations, financial condition or business, our reputation or investor perceptions of us. We cannot predict or estimate the amount of additional costs we may incur as a result of such requirements or the timing of such costs, and any such costs could have a material adverse effect on our results of operations, financial condition or business.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

Our headquarters are located in Chicago, Illinois, and consist of approximately 30,000 square feet of leased space. We also lease office space in Denver, Colorado, New York, New York, Sunnyvale, California, Boston, Massachusetts, Landis, North Carolina and two locations in Trivandrum, India. We believe that our office facilities are adequate for our immediate needs and that additional or substitute space is available if needed to accommodate the foreseeable growth of our operations.

 

Item 3. Legal Proceedings

On November 23, 2009, we sued Fetter Logic, Inc., or Fetter Logic, and David Fetter, its chief executive officer, in the United States District Court for the Northern District of Illinois. Our complaint sought, among other things, unspecified damages for breaches of the investment agreement and operating agreement that we entered into with Fetter Logic, described below, and a declaratory judgment that we own certain rights in certain intellectual property. Fetter Logic asserted claims against us in a separate suit and in a counterclaim filed November 30, 2009, and subsequently moved to the United States District Court for the Northern District of Illinois, for breaches of the investment agreement and operating agreement, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, copyright infringement, misappropriation of trade secrets, an accounting, unjust enrichment and a declaratory judgment that Fetter Logic owns all rights in the contested intellectual property. Fetter Logic sought declaratory and injunctive relief, as well as unspecified compensatory and punitive damages. Both cases arose out of (1) an investment agreement, pursuant to which we purchased shares in Fetter Logic for approximately $5.7 million, and (2) an operating agreement, under which the parties agreed to integrate their respective software applications and develop and sell joint product offerings. Fetter Logic alleged that we did not comply with the terms of the operating agreement to develop joint product offerings, but instead misappropriated Fetter Logic’s intellectual property to develop products for our own benefit.

On July 8, 2010, the parties to the aforementioned litigation agreed to dismiss their respective lawsuits. In connection with this settlement, none of the parties are required to make any payments to any other party, we have relinquished our ownership interest in Fetter Logic, as well as operating receivables for services we provided during the term of the operating agreement and our rights under a promissory note issued to us in December 2009 in connection with our redemption of a portion of our ownership interest in Fetter Logic. In addition, we have the right to use any intellectual property developed or obtained by us in connection with the aforementioned operating agreement.

We are also involved in other litigation arising in the ordinary course of our business. We do not believe that the outcome of any of the aforementioned proceedings, individually or in the aggregate, would, if determined adversely to us, have a material adverse effect on our results of operations, financial condition or business.

 

Item 4. Removed and Reserved

This section intentionally left blank.

 

35


PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a) Market Information

Our common stock is listed on the New York Stock Exchange.

The following table sets forth, for the periods indicated, the high and low closing sale prices of our common stock as report in the consolidated reporting system for the New York Stock Exchange Composite Transactions. The Company was first listed on the New York Stock Exchange beginning July 29, 2010. Therefore, all periods prior to that date are not applicable.

 

     2010

Quarter ended March 31, 2010

   N/A

Quarter ended June 30, 2010

   N/A

Quarter ended September 30, 2010

   $12.05 to $9.90

Quarter ended December 31, 2010

   $17.09 to $11.10

(b) Holders

The approximate number of common stockholders was 140 as of March 16, 2011.

(c) Dividends

We have not paid dividends for the most recent two years.

Common Stock

As of December 31, 2009, we had 60,000,000 common shares authorized at a par value of $0.005, of which 12,910,676 shares were outstanding.

On August 3, 2010 the Company amended its certificate of incorporation which increased the amount of authorized common stock to 500,000,000 shares at a par value to $0.005 per share. There were 31,368,822 shares outstanding as of December 31, 2010.

Preferred Stock

As of December 31, 2009, we had 200,000 preferred shares authorized at a par value of $0.001, of which 76,643 shares were outstanding.

On August 3, 2010 the Company amended its certificate of incorporation which increased the amount of authorized preferred stock to 50,000,000 shares and increased the par value to $0.005 per share. There were no shares outstanding as of December 31, 2010.

(d) Annual Meeting of Shareholders

Our annual meeting of shareholders will be held on May 19, 2011, in Chicago, Illinois.

(e) Stock Performance Graph

The following graph compares the cumulative return to stockholders on our common stock relative to the cumulative total returns of the Russell® 2000 Index and The S&P North American Technology-Services IndexTM from the effective date of our initial public offering on July 28, 2010 through December 31, 2010. In calculating total annual stockholder return, reinvestment of dividends, if any, is assumed. The indices are included for comparative purposes only. This graph is not “soliciting material,” is not deemed filed with the SEC and is not to

 

36


be incorporated by reference in any of our filings under the Securities Act of 1933, as amended, or the Exchange Act, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

5 MONTH STOCK PERFORMANCE GRAPH

LOGO

 

     7/28/2010      12/31/2010  

Envestnet, Inc.

     $       100.00         $       189.56   

Russell® 2000 Index

     100.00         119.02   

S&P North American Technology-Services IndexTM

     100.00         112.38   

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

(f) Recent Sales of Unregistered Securities

None

(g) Issuer Purchases of Equity Securities

 

     Total number
of shares
purchased
    Average
price paid
per share
    Total number of
shares purchased
as part of publicaly
announced plans
or programs
    Maximum number (or
approximate dollar
value) of shares
that may yet be
purchased under the
plans or programs
 

October 1, 2010 through October 31, 2010

    62,500        $   11.69        -            $                              -   

November 1, 2010 through November 30, 2010

    -            -            -            -   

December 1, 2010 through December 31, 2010

    2,119        14.64        -            -   

(h) Securities Authorized for Issuance Under Equity Compensation Plan

For a description of securities authorized under our equity compensation plans, see note 16 to the notes to the consolidated financial statements in Part II, Item 8.

 

37


Item 6. Selected Financial Data

Consolidated Statements of Operations

 

    Year ended December 31,  
    2006     2007     2008     2009     2010  
    (Unaudited)                          
    (In thousands, except for share and per share information)  

Revenues:

         

Assets under management or administration

    $ 49,806        $ 71,442        $ 71,738        $ 56,857        $ 75,951   

Licensing and professional services

    9,245        10,027        20,104        21,067        22,101   
                                       

Total revenues

    59,051        81,469        91,842        77,924        98,052   
                                       

Operating expenses:

         

Cost of revenues

    25,221        34,541        34,604        24,624        31,444   

Compensation and benefits

    18,878        23,250        28,452        28,763        37,027   

General and administration (1)

    9,334        12,135        15,500        15,726        21,607   

Depreciation and amortization

    2,524        2,914        3,538        4,499        5,703   

Restructuring charges

    -            -            -            -            961   
                                       

Total operating expenses

    55,957        72,840        82,094        73,612        96,742   
                                       

Income from operations

    3,094        8,629        9,748        4,312        1,310   

Total other income (expense)

    584        1,159        115        (3,368     (403
                                       

Income before income tax provision (benefit)

    3,678        9,788        9,863        944        907   

Income tax provision (benefit) (2)

    14        (13,156     4,608        1,816        1,533   
                                       

Net income (loss)

    3,664        22,944        5,255        (872     (626

Less preferred stock dividends

    -            -            (203     (720     (422

Less net income allocated to participating convertible preferred stock

    (1,904     (10,886     (2,406     -            -       
                                       

Income (loss) attributable to common shareholders

    $ 1,760        $ 12,058        $ 2,646        $ (1,592     $ (1,048
                                       

Net income (loss) per share attributable to common stockholders

         

Basic

    $ 0.16        $ 0.91        $ 0.20        $ (0.12     $ (0.05
                                       

Diluted

    $ 0.16        $ 0.91        $ 0.19        $ (0.12     $ (0.05
                                       

Weighted average common shares outstanding:

         

Basic

      11,065,612          13,213,503          13,354,845          12,910,998          20,805,911   
                                       

Diluted

      11,065,612          13,213,503          13,354,845          12,910,998          20,805,911   
                                       

(1) Included in general and administration expenses for the years ended December 31, 2009 and 2010 is $385 and $2,668 of bad debt expense, respectively, and $601 and $1,933 of legal expenses related to the Fetter Logic litigation, respectively. See notes 5 and 18 to the notes to the audited consolidated financial statements.

(2) During the third quarter of 2010, we identified an approximate $994 error tax error related to preparing the year-end estimated federal net operating loss carryforward for 2007. Accordingly, we recorded a $994 decrease to the income tax benefit in 2007. The correction of this error does not impact the Consolidated Statements of Operations or Consolidated Statements of Cashflows for each of the years ended December 31, 2008, 2009 and 2010. See note 2 to the notes to the audited consolidated financial statements.

 

38


Consolidated Balance Sheet Data

 

     December 31,  
     2006      2007 (1)      2008 (1)      2009 (1)      2010  
     (Unaudited)                              
     (In thousands)  

Cash and cash equivalents

     $       13,369         $       25,255         $       28,445         $       31,525         $ 67,668   

Working capital

     5,657         15,168         21,405         27,262         62,979   

Goodwill and intangible assets

     12,320         5,402         4,331         3,261         3,361   

Total assets

     37,948         64,256         71,257         74,064         141,868   

Stockholders’ equity

     25,559         49,158         57,589         57,252               102,319   

(1) During the third quarter of 2010, the Company identified an approximate $994 error related to preparing the year-end estimated federal net operating loss carryforward for 2007. Accordingly, the 2007, 2008 and 2009 total assets and stockholder’s equity has been reduced by this amount. The correction of this error does not impact the Consolidated Statements of Operations or the Consolidated Statements of Cash Flows for the each of the three years ended December 31, 2008, 2009 and 2010. The correction of this error was not considered material to the 2007 Consolidated Statement of Operations. See note 2 to the notes to the consolidated financial statements.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a leading independent provider of wealth management solutions to financial advisors and institutions. Through our wealth management offerings, including Envestnet Advisor Suite and Envestnet PMC, our asset management arm, we deliver a Web-based gateway to expert, objective, integrated wealth management solutions. By integrating a wide range of investment solutions and services, our technology platform provides financial advisors with the flexibility to address their clients’ needs. We work with financial advisors who are independent, as well as those who are associated with small or mid-sized financial advisory firms and larger financial institutions, which we refer to as enterprise clients. We focus our technology development efforts and our sales and marketing approach on addressing financial advisors’ front-, middle- and back-office needs. We believe our investment solutions and services allow financial advisors to be more efficient and effective in the activities critical to their businesses by facilitating client interactions, supporting and enhancing portfolio management and analysis, and enabling reliable account support and administration. In addition, we are not controlled by a financial institution, broker-dealer or other entity operating in the securities or wealth management industry, which we believe affords us a greater level of independence and impartiality.

Our centrally-hosted technology platform provides financial advisors with the flexibility to choose freely among a wide range of investment solutions, services, investment managers and custodians to identify those that are most appropriate for their clients. Given the flexibility of choice it provides, we refer to our technology platform as having “open architecture”. In addition, our technology platform allows us to add new or upgrade existing features and functionality as the industry and financial advisors’ needs evolve. Our technology platform provides financial advisors with the following:

 

   

A series of integrated services to help them better serve their clients, including risk assessment and selection of investment strategies, asset allocation models, research and due diligence, portfolio construction, proposal generation and paperwork preparation, model management and account rebalancing, account monitoring, customized fee billing, overlay services covering asset allocation, tax management and socially responsible investing, aggregated multi-custodian performance reporting and communication tools, as well as access to a wide range of leading third-party asset custodians;

 

   

Web-based access to a wide range of technology-enabled investment solutions, including:

 

   

separately managed accounts, or SMAs, which allow advisors to offer their investor clients a customized, professionally managed portfolio of securities with a personalized tax basis;

 

   

unified managed accounts, or UMAs, which are similar to SMAs but allow the advisor to use different types of investment vehicles in one account;

 

39


   

advisor-directed portfolios, where advisors create, implement and maintain their own investment portfolio models to address specific client needs; and

 

   

mutual funds and portfolios of exchange-traded funds, or ETFs; and

 

   

Access to a broad range of investment managers and investment strategists, as well as to our internal investment management and portfolio consulting group, Portfolio Management Consultants, or PMC.

PMC primarily engages in consulting services aimed at providing financial advisors with additional support in addressing their clients’ needs, as well as the creation of proprietary investment solutions and products. PMC’s investment solutions and products include managed account and multi-manager portfolios, mutual fund portfolios and ETF portfolios.

Revenues

Overview

We earn revenues primarily under two pricing models. First, a majority of our revenues are derived from fees charged as a percentage of the assets that are managed or administered on our technology platform by financial advisors. These revenues are recorded under revenues from assets under management or administration. Our asset-based fees vary based on the types of investment solutions and services that financial advisors utilize. Asset-based fees accounted for approximately 78%, 73% and 77% of our total revenues for the years ended December 31, 2008, 2009 and 2010, respectively. The percentage of our total revenues represented by asset-based fees declined in the year ended December 31, 2009 principally due to the significant decline in the market value of the assets on our technology platform resulting from fluctuations in the securities markets, particularly from September 2007 to March 2009, and also due to our entering into a significant license agreement in 2008. U.S.-based equities appreciated significantly during the remainder of 2009 and throughout 2010 and contributed to an increase in our assets under management or administration, and our resulting revenues from asset-based fees. In future periods, the percentage of our total revenues attributable to asset-based fees is expected to vary based on fluctuations in securities markets, whether we enter into significant license agreements, the mix of assets under management, or AUM, and assets under administration, or AUA, and other factors. As of December 31, 2010, approximately $64 billion of investment assets subject to asset-based fees were managed or administered utilizing our technology platform by approximately 13,800 financial advisors in approximately 307,000 investor accounts.

Second, we generate revenues from recurring, contractual licensing fees for providing access to our technology platform, generally from a small number of enterprise clients. These revenues are recorded under revenues from licensing and professional services. Licensing fees are generally fixed in nature for the contract term and are based on the level of investment solutions and services provided, rather than on the amount of client assets on our technology platform. Licensing fees accounted for 19%, 24% and 20% of our total revenues for the years ended December 31, 2008, 2009 and 2010. Fees received in connection with professional services accounted for the remainder of our total revenues. As of December 31, 2010, approximately $76 billion of investment assets for which we receive licensing fees for utilizing our technology platform were serviced by approximately 7,700 financial advisors through approximately 604,000 investor accounts.

 

40


The following table provides information regarding the amount of assets utilizing our platform, financial advisors and investor accounts in the periods indicated.

 

     As of December 31,  
     2006      2007      2008      2009      2010  
     (in millions except accounts and advisors data)  

Platform Assets

              

Assets Under Management (AUM)

     $ 7,099         $ 10,048         $ 7,136         $ 9,660         $ 14,486   

Assets Under Administration (AUA)

     12,632         18,883         21,742         27,931         49,202   
                                            

Subtotal AUM/A

     19,731         28,931         28,878         37,591         63,688   

Licensing

     32,278         56,166         41,704         51,450         75,668   
                                            

Total Platform Assets

     $ 52,009         $ 85,097         $ 70,582         $ 89,041         $   139,356   
                                            

Platform Accounts

              

AUM

     23,557         35,588         37,345         48,541         65,663   

AUA

     49,466         77,713           121,645           126,634         241,162   
                                            

Subtotal AUM/A

     73,023           113,301         158,990         175,175         306,825   

Licensing

       327,328         485,011         547,283         510,865         603,950   
                                            

Total Platform Accounts

     400,351         598,312         706,273         686,040         910,775   
                                            

Advisors

              

AUM/A

     5,669         7,118         7,771         8,408         13,833   

Licensing

     3,747         4,651         5,299         5,542         7,746   
                                            

Total Advisors

     9,416         11,769         13,070         13,950         21,579   
                                            

Revenues from assets under management or administration

We generally charge our customers fees based on a higher percentage of the market value of AUM than the fees we charge on the market value of AUA, because we provide fiduciary oversight and/or act as the investment advisor in connection with assets we categorize as AUM. The level of fees varies based on the nature of the investment solutions and services we provide, as well as the specific investment manager, fund and/or custodian chosen by the financial advisor. A portion of our revenues from assets under management or administration include costs paid by us to third parties for sub-advisory, clearing, custody and brokerage services. These expenses are recorded under cost of revenues. We do not have fiduciary responsibility in connection with AUA and, therefore, charge lower fees on these assets. Our fees for AUA vary based on the nature of the investment solutions and services we provide.

For over 85% of our revenues from assets under management or administration, we bill customers at the beginning of each quarter based on the market value of customer assets on our technology platform as of the end of the prior quarter. For example, revenues from assets under management or administration recognized during the fourth quarter of 2010 were based on the market value of assets as of September 30, 2010. Our revenues from assets under management or administration are generally recognized ratably throughout the quarter based on the number of days in the quarter.

As noted above, the most significant factor affecting our revenues from assets under management or administration is changes in the market values of securities held in client accounts due to fluctuations in the securities markets. Certain types of securities have historically experienced greater market price fluctuations, such as equity securities, than other securities, such as fixed income securities, though in any given period the nature of securities that experience the greatest fluctuations may vary. For example, from October 2007 to March 2009, the equity markets, as measured by the value of the S&P 500 index, declined in value by approximately 57%, which significantly contributed to the 37% decrease in our revenues from assets under management or administration between the fourth quarter of 2007 and the second quarter of 2009.

Our revenues from assets under management or administration are also affected by the amount of new assets that are added to existing and new client accounts, which we refer to as gross sales, and the amount of

 

41


assets that are withdrawn from client accounts, which we refer to as redemptions. We refer to the difference between asset in-flows and out-flows as net flows. Positive net flows indicate that the market value of assets added to client accounts exceeds the market value of assets that have been withdrawn from client accounts.

The following table provides information regarding the degree to which gross sales, redemptions, net flows and changes in the market values of assets contributed to changes in AUM or AUA in the periods indicated.

 

    Asset Rollforward - 2009  
    As of
12/31/08
    Gross
Sales
    Redemp-
tions
    Net
Flows
    Market
Impact
    As of
12/31/09
 
    (in millions except account data)  

Assets under Management (AUM)

    $ 7,136        $ 3,586        $ (2,799     $ 787        $   1,737        $ 9,660   

Assets under Administration (AUA)

    21,742        9,528        (6,494     3,034        3,155        27,931   
                                               

Subtotal AUM/A

    $ 28,878        $ 13,114        $ (9,293     $ 3,821        $   4,892        $ 37,591   
                                               

Fee-Based Accounts

    158,990        55,506        (39,321     16,185          175,175   
    Asset Rollforward - 2010  
    As of
12/31/09 *
    Gross
Sales
    Redemp-
tions
    Net
Flows
    Market
Impact
    As of
12/31/10
 
    (in millions except account data)  

Assets under Management (AUM)

    $ 10,269        $ 6,788        $ (3,541     $ 3,247        $ 970        $ 14,486   

Assets under Administration (AUA)

    27,322        30,957        (12,165     18,792        3,088        49,202   
                                               

Subtotal AUM/A

    $ 37,591        $ 37,745        $ (15,706     $ 22,039        $ 4,058        $ 63,688   
                                               

Fee-Based Accounts

    175,175        185,347        (53,697     131,650          306,825   

 

* 12/31/2009 historical data for AUM and AUA have been reclassified to conform to current presentation format.

The mix of assets under management and assets under administration was as follows for the periods indicated:

 

     December 31,  
     2008     2009     2010  

Assets under management (AUM)

                 25                 27                 23

Assets under administration (AUA)

     75     73     77
                        
     100     100     100
                        

We expect the percentage of AUM and AUA to fluctuate in future periods. The nature and type of services requested by our customers are the key drivers in determining whether customer assets are classified as AUM or AUA. Therefore, we do not have direct control over the mix of AUM and AUA.

Revenues from licensing and professional services fees

Our revenues received under license agreements are recognized over the contractual term. To a lesser degree we also receive revenues from professional services fees by providing customers with certain technology platform software development services. In the years ended December 31, 2008, 2009 and 2010, our revenues from professional services fees were $2.4 million, $2.4 million and $2.9 million respectively. These revenues are generally recognized under a proportional performance model utilizing an output based approach. Our contracts have fixed prices, and generally specify or quantify interim deliverables.

 

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We may enter into license agreements in future periods if requested by our customers and commercially attractive to us.

Expenses

The following is a description of our principal expense items.

Cost of revenues

Cost of revenues primarily include expenses related to our receipt of sub-advisory and clearing, custody and brokerage services from third parties. The largest component of cost of revenues, sub-advisory fees paid to third- party investment managers, relates only to AUM since a sub-advisor is not utilized in connection with AUA.

Clearing, custody and brokerage services are provided by third-party providers. All of these expenses are typically calculated based upon a contractual percentage of the market value of assets held in customer accounts measured as of the end of each fiscal quarter and are recognized ratably throughout the quarter based on the number of days in the quarter.

Compensation and benefits

Compensation and benefits expenses primarily relate to employee compensation, including salaries, commissions, non-cash stock-based compensation, profit sharing, benefits and employer-related taxes.

General and administration

General and administration expenses include occupancy costs and expenses relating to communications services, research and data services, website and system development, marketing, professional and legal services and travel and entertainment.

Depreciation and amortization

Depreciation and amortization expenses include depreciation related to:

 

   

fixed assets, including computer equipment and software, leasehold improvements, office furniture and fixtures and other office equipment;

 

   

internally developed software; and

 

   

intangible assets, primarily related to customer lists, the value of which was capitalized in connection with our prior acquisitions.

Furniture and equipment is depreciated using the straight-line method based on the estimated useful lives of the depreciable assets. Leasehold improvements are amortized using the straight-line method over their estimated economic useful lives or the remaining lease term, whichever is shorter. Improvements are capitalized, while repairs and maintenance costs are recorded as expenses in the period they are incurred. Assets are tested for recoverability whenever events or circumstances indicate that the carrying value of the assets may not be recoverable.

Internally developed software is amortized on a straight-line basis over its estimated useful life. We evaluate the useful lives of these assets on an annual basis and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.

Intangible assets are depreciated using the straight-line method over their estimated economic useful lives and are reviewed for possible impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.

 

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2010 Developments

FundQuest Agreement

In February 2010, we signed a seven-year platform services agreement with FundQuest. Pursuant to this agreement, we provide FundQuest and its clients our platform technology and support services, replacing FundQuest’s technology platform. FundQuest will continue to provide investment products to its clients.

In order to support the increase in assets under administration resulting from this agreement, we hired 20 staff from FundQuest to assist us with the ongoing administration of existing and new FundQuest customers. As a result, we expect total compensation and benefits expense, as a percentage of total revenues, to increase by approximately one percentage point.

In connection with this agreement, we have agreed to make various payments to FundQuest during the contract term. These payments include an up-front payment upon completion of the conversion of FundQuest’s clients’ assets to our technology platform, five annual payments and a payment after the fifth year of the agreement calculated based on the revenues we receive from the FundQuest assets during the first five years of the contract term. As of June 30, 2010 and December 31, 2010, our estimate of the present value of these payments was approximately $28.7 million and $30.4 million, respectively. The increase in the present value of these payments is a result of an increase in the estimated revenue we expect to receive from the FundQuest assets during the first five years of the contract term.

In addition, we also issued FundQuest a warrant to purchase shares of our common stock, with an exercise price to be calculated as 120% of our initial public offering price per share of our common stock with an estimated fair value of $2.9 million. As of the closing of our initial public offering, the number of shares of common stock issuable to FundQuest under the warrant was 1,388,888 shares at an exercise price of $10.80 per share. The present value of all payments and the fair value of the warrant is being accounted for as customer inducement costs and is being amortized as a reduction to our revenues from assets under management or administration on a straight-line basis over the contract term.

We anticipate that our annual net revenues will increase in proportion to the increase in assets under administration resulting from the agreement. The revenue we recognize under this agreement will be net of customer inducement amortization of approximately $4.8 million per year. Additionally, we expect to recognize approximately $0.8 million of interest expense annually during the first five years of the contract term. Revenues, customer inducement costs and interest expense may change over the contractual term based upon changes in the market value of customer assets and in the net flows relating to new and existing customer accounts.

In the year ended December 31, 2010, the company recognized customer inducement amortization of approximately $3.2 million and imputed interest expense of $0.5 million related to this agreement.

As a result of the reduction in our revenues due to the amortization of customer inducement costs, cash flows received under this agreement will exceed the recorded value of the revenues we recognize relating to the agreement for any given period during the term of the agreement.

Closure of Los Angeles Office

In January 2010, we announced that we would be closing our Los Angeles, CA office, effective March 31, 2010, in order to more appropriately align and manage our internal resources. The Los Angeles office was the headquarters of NetAssetManagement, Inc., or NAM, which we acquired in 2004. The office had three primary functional groups: our investment consulting group, Portfolio Management Consultants; operational processing; and technology operations support. In connection with the closing of the Los Angeles office, its investment consulting group functions were transferred to our Chicago headquarters, its operational processing functions were transferred to our Denver operations center and its technical operations support functions were transferred to our Sunnyvale office.

 

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In connection with the closure of the Los Angeles office, we have incurred pretax restructuring charges of approximately $961 in the year ended December 31, 2010 and future pre-tax restructuring charges related to the closure of the Los Angeles office will not be material in 2011. Restructuring charges include expenses related to vacating rental office space, relocation expenses and severance charges. The closure of this office and related actions are expected to result in decreased costs in future periods.

Factors Affecting Comparability

We expect our stock-based compensation expense to increase in future periods as a result of our award of approximately 1,834,000 stock options to our employees upon the closing of our initial public offering in July of 2010. In addition, we expect our compensation and benefits and general and administrative expenses to increase in future periods as a result of becoming an SEC-reporting company subject to the Sarbanes-Oxley Act and the other regulatory requirements applicable to public companies. Accordingly, our results of operations for future periods may not be comparable to our results of operations for the periods under review.

Critical Accounting Policies

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States, or U.S. GAAP. The accounting policies described below require management to apply significant judgment in connection with the preparation of our consolidated financial statements. In particular, judgment is applied to determine the appropriate assumptions to be used in calculating estimates that affect certain reported amounts in our consolidated financial statements. These estimates and assumptions are based on historical experience and on various other factors that we believe to be reasonable under the circumstances. If different estimates or assumptions were used, our results of operations, financial condition and cash flows could have been materially different than those reflected in our consolidated financial statements. For additional information regarding our critical accounting policies, see note 2 to the notes to the audited consolidated financial statements.

Revenue recognition

We recognize revenues when all four of the following 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

 

   

Collectability is reasonably assured.

Types of revenues

We generate revenues from assets under management or administration and from licensing and professional service fees. Revenues from assets under management or administration are generated from fees based on a contractual percentage of assets under management or administration valued at each quarter-end. These fees are generally collected at the beginning of a quarter in advance based upon the previous quarter-end values. In less than 15% of our contracts, fees are collected at the end of the quarter based upon the current quarter-end value. The contractual fee percentages vary based upon the level and type of services we provide to our customers. Pursuant to the contracts with our customers, we calculate our fees based on the asset values in the customer’s account, without making any judgment or estimates. None of our fees are earned pursuant to performance-based or other incentive-based arrangements.

We generate revenues from licensing fees pursuant to recurring contractual fixed-fee agreements, principally with a portion of our enterprise clients. Our licensing fees vary based on the type of services we provide. We generate revenues from professional service fees by providing customers with customized technology platform software development services. These revenues are received pursuant to contracts that detail the nature of the services to be provided by us, the estimated number of hours such work will require and the total contract fee amount.

 

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Recognition of revenues

Application of the applicable accounting principles of U.S. GAAP requires us to make judgments and estimates in connection with the measurement and recognition of revenues. Revenues are recognized in the period in which the related services are provided. In certain cases, management is required to determine whether revenues should be recognized in an amount equal to the gross fees we receive or as a net amount reflecting the payment of expenses to third-parties, such as sub-advisors and custodians, that provide services to us in connection with certain of our financial advisors’ client accounts. When fees are collected for sub-advisory, clearing, custody or brokerage services in circumstances where we do not have a direct contract with the third-party provider, the fees are recorded as revenue on a net basis. Fees we received in advance of the performance of services are recorded as deferred revenues on our consolidated balance sheets and are recognized as revenues when earned, generally over three months.

Revenues from licensing are recognized over the contractual term. Contracts with nonstandard terms and conditions may require contract interpretation to determine the appropriate revenue recognition policy to apply.

Revenues from professional services are recognized under a proportional performance model utilizing an output based approach. Our contracts have fixed prices, and generally specify or quantify interim deliverables.

Our revenue recognition is also affected by our judgment in determining appropriate allowances for uncollectible receivables. We consider customer-specific information related to delinquent accounts and past lost experience, as well as current economic conditions in establishing the amount of the allowance.

Customer inducements

In certain instances, we enter into platform service agreements which include inducement payments to the customer. In accordance with U.S. GAAP, inducement payments made to customers are capitalized and amortized against revenue on a straight-line basis over the term of the agreement. Customer inducement assets are reviewed for impairment whenever events or circumstances occur that may impact the fair value of these assets.

Internally developed software

Costs relating to internally developed software that are incurred in the preliminary stages of development are expensed as incurred. Management determines when projects have met the criteria of the application development stage. This typically occurs when the conceptual formulation and evaluation of software functionality are finalized.

Once work on a software application has passed the preliminary stages, internal and external costs, if direct and incremental, are capitalized until the software application is substantially complete and ready for its intended use. These costs include expenditures related to software design, technical specifications, coding, installation of hardware and parallel testing. We cease capitalizing these costs upon completion of all substantial testing of the software application.

We also capitalize costs related to specific upgrades and enhancements of our internally developed software when we conclude that it is probable that the expenditures will result in additional functionality. Our maintenance and training costs are expensed as incurred.

As of December 31, 2009 and 2010, we had net capitalized internally developed software of $3.9 million and $3.6 million, respectively. We capitalized $1.7, million, $1.3 million and $1.3 million in internally developed software during the years ended December 31, 2008, 2009 and 2010, respectively.

Internally developed software is amortized on a straight-line basis over its estimated useful life. We evaluate the useful lives of these assets on an annual basis and test for impairment whenever events or changes in

 

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circumstances occur that could impact the recoverability of these assets. There were no impairments to internally developed software during the years ended December 31, 2008, 2009 and 2010.

Non-cash stock-based compensation expense

Since our 2004 Stock Incentive Plan and 2010 Long-Term Incentive Plan were adopted and in the periods under review, stock options have been an important component of our compensation structure. We expect that this will continue to be the case in the future. Our board of directors is responsible for determining the timing and magnitude of all option grants. Prior to our initial public offering on July 28, 2010, our board of directors, were responsible for determining the fair value of our common stock on the date of each stock option grant. The board of directors had delegated certain of its responsibilities to the compensation committee of the board of directors and certain members of management. As required under our 2004 Stock Incentive Plan and our 2010 Long-Term Incentive Plan, all of our options are granted with exercise prices at or above the fair value of our common stock on the grant date.

The following table provides information regarding options granted since January 1, 2009 through December 31, 2010:

 

        Date        

   Shares        Stock Price          Exercise Price        Intrinsic Value
As of December 31, 2010
 

2/16/2009

     1,000         $           7.85         $               7.85         $                                  9.24   

4/8/2009

     8,230         7.85         7.85         9.24   

5/15/2009

     232,732         7.15         7.15         9.94   

7/6/2009

     10,000         7.15         7.15         9.94   

11/16/2009

     12,000         11.50         11.50         5.59   

2/22/2010

     71,000         13.45         13.45         3.64   

7/28/2010

     1,885,390         9.00         9.00         8.09   

9/1/2010

     2,000         10.25         10.25         6.84   

9/30/2010

     33,600         10.46         10.46         6.63   

As a private company, there was no market for our common stock and therefore no readily available price to reference when determining the fair value of our common stock in connection with the granting of stock options. The value of our common stock was dependent upon our company valuation and, as described below, we had periodically obtained independent valuations and performed internal valuations of our common stock. In each case, such valuations had been performed contemporaneously and we had determined the fair market value of our company in conformity with commonly accepted corporate valuation techniques and methodologies.

Prior to our initial public offering, we generally had obtained contemporaneous independent valuations at least annually and at the time of broad-based option grants, such as on May 15, 2009 and February 22, 2010. For our internal valuations, we applied the same approach and methodology used by the independent valuation firm. For any option grants made between quarterly valuations of our common stock, our board of directors assessed all available information in determining whether the stock price in effect at the time of the grant should otherwise be adjusted. As a private company, we had performed our quarterly valuations such that they were effective approximately 45 days following the end of each calendar quarter to approximate the date upon which, if we were a reporting company, we would be required to disclose to the public through filings with the Commission our financial performance and associated operating metrics, which include assets under management and administration. Until such date, any information about a given quarter’s financial performance, ending asset values, and other information that could be deemed material to investors, would not be known to the public even if we were a reporting company and therefore is not included in the valuation of our common stock during interim periods.

In the specific cases of option grants made after the dates of our quarterly valuations during the period under review, our board of directors concluded that no adjustment should have been made to the most recent valuation of our common stock based on its assessment that, had we been a reporting company, no new material information would have been available to the public since the date of the prior valuation of our common stock.

 

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As a private company, our company valuation, whether prepared by an independent valuation firm or performed internally, considered an income approach, also known as a discounted cash flow analysis, incorporating our historical and expected financial performance, the relevant market and industry and economic trends. Our valuation also considered a market approach, including recent capital transactions involving either our company or comparable companies, and comparable public-company valuations. The resulting calculation assigned a value for 100% of our company’s equity on a marketable equivalent, non-controlling interest basis. We considered, but did not include, an asset approach, as we did not believe the book value of our assets provides meaningful input into our expected revenue and earnings, or the value of our company.

We believe the value of our common stock had the potential to change each fiscal quarter in the normal course of our business, since the majority of our total revenues earned in a given quarter are calculated based on the value of AUM and AUA as of the end of the previous fiscal quarter. These revenues, and our historical resulting projections for earnings and cash flow, were inherently subject to fluctuations from quarter to quarter.

Accordingly, as a private company, we calculated the value of our common stock at least once each fiscal quarter. The historical quarterly valuations did at times fluctuate significantly as the market value of our assets under management or administration drives our near term financial results and longer term projections. The value of our common stock could also change if a material financing transaction or other significant event occurs within a given fiscal quarter. In such circumstances we performed an additional valuation of our common stock at the time of the transaction or event, using the same valuation methodology that is utilized in connection with our quarterly valuations.

After we determined a value for our company, we allocated the value to each class of our shares, including our common stock. Our value allocation methodology applies the principles set forth in the AICPA Practice Aid—Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Practice Aid. The Practice Aid defines appropriate methods to allocate enterprise value to common shares when multiple share classes exist. Based on various factors, including the stage of a company’s life and the timing and likelihood of various liquidity events, one method of allocation may be more appropriate than the others. We considered, but did not use, the probability-weighted expected return method due to the number of assumptions for each scenario that are difficult to estimate, and the fact that our most likely liquidation event was an initial public offering. Additionally, we did not apply the liquidation method because, as the Practice Aid indicates, it would be inappropriate for a later-stage company such as ours to use that method to allocate value to the various share classes. Furthermore, the more imminent a liquidity event becomes, the more aligned the liquidation model and option pricing model become in attributing value to each share class. Accordingly, we used the option pricing method, as defined in the Practice Aid, which treats each class of equity as having a “call option” on the enterprise value. The option pricing method considers the economic preferences and other rights attributable to each share class, resulting in a price for each of our share classes, including our common stock. Our valuations of our common stock also reflected a discount for lack of marketability, adjusted over time to reflect the expected likelihood and timing of a liquidity event subsequent to each valuation date. No other discounts were applied in determining the value of our common stock.

During 2009 and through the date our initial public offering on July 28, 2010, we performed the following contemporaneous valuations of our common stock:

 

        Date        

   Fair Value of
Common Stock
 

2/15/2009

   $               7.85   

5/15/2009

     7.15   

8/15/2009

     9.90   

11/15/2009

     11.50   

2/15/2010

     13.45   

As described above, the assets under management or administration on our technology platform at the end of a given quarter have a significant impact on our short- and long-term financial projections and resulting

 

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valuation. For example, the valuation conducted on May 15, 2009 incorporated financial projections based on assets under management or administration as of March 31, 2009. The value of those assets was 6% below the value of the assets as of December 31, 2008. This contributed to the decline in the estimated fair value of our common stock between periods. Conversely, assets under management or administration increased 16% between March 31, 2009 and June 30, 2009, contributing to an increase in the estimated fair value of our common stock between May 15, 2009 and August 15, 2009. In addition, assets under management or administration increased 15% between June 30, 2009 and September 30, 2009, which contributed to the increase in the fair value of our common stock between August 15, 2009 and November 15, 2009. A 4% increase in assets under management or administration between September 30, 2009 and December 31, 2009, as well as our new agreement with FundQuest (see “—2010 Developments”), contributed to the increase in the fair value of our common stock between November 15, 2009 and February 15, 2010. The decrease between the fair value of our common stock on November 15, 2009 and February 15, 2010 and the initial public offering price was principally attributable to volatility in the trading prices of the common stock of comparable companies and the difficult conditions in the market for initial public offerings at and immediately prior to our determination of the initial public offering price for this offering. Other factors, such as updated financial projections not related to changes in our assets under management or administration, as well as fluctuations in the value of comparable publicly-traded companies, also contributed to the differences in the estimated fair value of our common stock between periods.

Since our initial public offering on July 28, 2010, we have not performed internal valuations or obtained independent valuations in order to determine the Company’s stock price to reference when determining the fair value of our common stock in connection with the granting of stock options.

Non-cash stock-based compensation expense for stock option grants is estimated at the grant date based on each grant’s fair value, calculated using the Black-Scholes option pricing model. Compensation and benefits expenses are recognized over the vesting period for each grant. The fair value of our stock options and the resulting expenses are based on various assumptions, including the expected volatility of our stock price, the expected term of the stock options, estimated forfeiture rates and the risk-free interest rate. The use of different assumptions would result in different fair values and compensation and benefits expenses for our option grants.

Income taxes

We are subject to income taxes in the United States and India. Significant judgment is required in evaluating our tax positions and determining our 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 for 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 under income tax provision in the period that includes the enactment date. We record a valuation allowance to reduce deferred tax assets to an amount that we determine is more-likely-than-not to be realized in the future.

In our ordinary course of business, we may enter into transactions for which the ultimate tax determination is uncertain. In such cases, we establish reserves for tax-related uncertainties based on our estimates of whether, and the extent to which, additional taxes will be due. The reserves are established when we believe that certain positions are likely to be challenged and may not be fully sustained on review by tax authorities. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or refinement of an estimate. Although we believe our reserves are reasonable, no assurance can be given that the final outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will be reflected in our provision for income taxes. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.

 

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Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.

Our effective tax rates differ from the statutory rates primarily due to adjustments in valuation allowances, state income taxes and changes in rates. Our provision for income taxes varies based on, among other things, changes in the valuation of our deferred tax assets and liabilities, the tax effects of non-cash stock-based compensation or changes in applicable tax laws, regulations and accounting principles or interpretations thereof.

As of December 31, 2010, we had net operating loss carry-forwards for federal and state income tax purposes of $36.0 million and $35.0 million, respectively, available to reduce future income subject to income taxes. The federal and state net operating loss carryforwards expire through 2026.

We are subject to examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities. We assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these examinations will not have a material adverse effect on our results of operations, financial condition and cash flows.

Results of Operations

Year ended December 31, 2010 compared to year ended December 31, 2009

 

     Year Ended December 31,     Increase (Decrease)  
     2009     2010     Amount         %      
     (In thousands)        

Revenues:

        

Assets under management or administration

     $         56,857        $         75,951        $         19,094        34

Licensing and professional services

     21,067        22,101        1,034        5
                          

Total revenues

     77,924        98,052        20,128        26
                          

Operating expenses:

        

Cost of revenues

     24,624        31,444        6,820        28

Compensation and benefits

     28,763        37,027        8,264        29

General and administration

     15,726        21,607        5,881        37

Depreciation and amortization

     4,499        5,703        1,204        27

Restructuring charges

     -            961        961        *   
                          

Total operating expenses

     73,612        96,742        23,130        31
                          

Income from operations

     4,312        1,310        (3,002     -70
                          

Other income (expense):

        

Interest income

     221        149        (72     -33

Interest expense

     -            (564     (564     *   

Unrealized gain (loss) on investments

     19        12        (7     -37

Impairment of investments

     (3,608     -            3,608        *   
                          

Total other (expense)

     (3,368     (403     2,965        -88
                          

Income before income tax provision

     944        907        (37     -4

Income tax provision

     1,816        1,533        (283     -16
                          

Net loss

     $ (872     $ (626     $ 246        -28
                          

 

* Not meaningful.

 

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Revenues

Total revenues increased 26% from $77.9 million in 2009 to $98.1 million in 2010. The increase was primarily due to an increase in revenues from assets under management or administration of $19.1 million. Revenues from assets under management or administration comprised 73% and 77% of total revenue in 2009 and 2010, respectively.

Assets under management or administration

Revenues earned from assets under management or administration increased 34% from $56.9 million in 2009 to $76.0 million in 2010. This increase was primarily due to an increase in asset values applicable to our quarterly billing cycles in 2010, relative to those used in 2009. Our 2010 revenues were positively affected by new account growth and positive net flows of AUM and AUA during the fourth quarter of 2009 through September 30, 2010, as well as an increase in market value of AUM and AUA from the fourth quarter of 2009 to September 30, 2010.

New account growth and positive net flows of AUM and AUA resulted from continued efforts to increase the number of financial advisors and accounts on our technology platform and the implementation of the FundQuest assets on our technology platform. The number of financial advisors with AUM or AUA that had client accounts on our technology platform increased from 8,408 as of December 31, 2009 to 13,833 as of December 31, 2010 and the number of AUM or AUA client accounts increased from approximately 175,000 as of December 31, 2009 to approximately 307,000 as of December 31, 2010.

Licensing and professional services

Licensing and professional services revenues increased 5% from $21.1 million in 2009 to $22.1million in 2010, primarily due to an increase in licensing revenue of $0.6 million and an increase in professional services revenue of $0.5 million.

Cost of revenues

Cost of revenues increased 28% from $24.6 million in 2009 to $31.4 million in 2010, primarily due to an increase in revenues from assets under management or administration. As a percentage of total revenues, cost of revenues remained flat at 32% in both periods.

Compensation and benefits

Compensation and benefits increased 29% from $28.8 million in 2009 to $37.0 million in 2010, primarily due to an increase in salaries and commissions of $5.3 million related to an increase in headcount, an increase in non-cash stock-based compensation expense of $1.0 million primarily due to the grant of stock options effective the date of our initial public offering, an increase in benefits and payroll taxes of $0.7 million, an increase in profit sharing expense of $0.8 million and an increase in severance of $0.6 million. Headcount increased from an average of 408 in 2009 to an average of 437 in 2010 primarily due to the hiring of former FundQuest and B-Ready Outsourcing Solutions, Inc. employees (see note 3 to the notes to the audited financial statements) in the second quarter of 2010. As a percentage of total revenues, compensation and benefits increased from 37% in 2009 to 38% in 2010.

General and administration

General and administration expenses increased 37% from $15.7 million in 2009 to $21.6 million in 2010, primarily due to an increase in bad debt expense of $2.7 million in 2010 related to the uncollectible portion of accounts and notes receivable from Fetter Logic (see note 5 to the notes to the audited consolidated financial statements) and increased legal fees related to the Fetter Logic litigation of $1.9 million (see note 18 to the notes to the audited consolidated financial statements). As a percentage of total revenues, general and administration

 

51


expenses increased from 20% in 2009 to 22% in 2010. Excluding bad debt expense of $2.7 million and legal fees of $1.9 million related to the Fetter Logic litigation, general and administration expenses as a percentage of total revenues would have been 17% in 2010.

Depreciation and amortization

Depreciation and amortization expense increased 27% from $4.5 million in 2009 to $5.7 million in 2010, primarily due to an increase in fixed asset depreciation and amortization of $1.1 million. The increase in depreciation and amortization expense was primarily due to increases in capitalized computer equipment and software to support the growth of our operations. As a percentage of total revenues, depreciation and amortization remained flat at 6% in both periods.

Restructuring charges

Effective March 31, 2010, we closed our Los Angeles office in order to more appropriately align and manage our resources and incurred restructuring charges of approximately $1.0 million in 2010. These expenses related to vacating rental office space, relocation expenses and severance charges. We expect our 2011 expenses relating to the closure of our Los Angeles office will not be significant.

Interest expense

Interest expense increased from $0.0 million in 2009 to $0.6 million in 2010, primarily due to imputed interest on the payments due to FundQuest. See note 4 to the notes to the audited consolidated financial statements.

Impairment of investments

Impairment of investments decreased from $3.6 million in 2009 to $0.0 million in 2010. In the fourth quarter of 2009, we evaluated the fair value of an investment in Fetter Logic and we recognized a $3.3 million impairment charge. See note 5 to the notes to the audited consolidated financial statements.

Income tax provision

 

     Year Ended December 31,  
     2009      2010  
     (in thousands)  

Income tax provision

     $             1,816         $             1,533   

Effective tax rate

     *         *   

 

* Not meaningful.

Our 2009 and 2010 effective tax rates differ from the statutory rate primarily as a result of changes in our estimates of our state income tax obligations for prior years and changes in state tax rates. The changes in state tax rates were primarily related to changes in state tax laws regarding the sourcing of state taxable income.

Our 2009 and 2010 effective tax rates also differ from the statutory rate primarily as a result of an increase in our tax valuation allowance we recorded in 2009 and 2010. In 2009 and 2010, our management determined that newly generated deferred tax assets related to capital losses from investments and bad debts were not expected to be utilized and correspondingly, we increased our tax valuation allowance.

 

52


Year ended December 31, 2009 compared to year ended December 31, 2008

 

     Year Ended December 31,     Increase (Decrease)  
         2008             2009         Amount         %      
     (In thousands)        

Revenues:

        

Assets under management or administration

     $         71,738        $         56,857        $         (14,881     -21

Licensing and professional services

     20,104        21,067        963        5
                          

Total revenues

     91,842        77,924        (13,918     -15
                          

Operating expenses:

        

Cost of revenues

     34,604        24,624        (9,980     -29

Compensation and benefits

     28,452        28,763        311        1

General and administration

     15,500        15,726        226        1

Depreciation and amortization

     3,538        4,499        961        27
                          

Total operating expenses

     82,094        73,612        (8,482     -10
                          

Income from operations

     9,748        4,312        (5,436     -56
                          

Other income (expense):

        

Interest income

     816        221        (595     -73

Unrealized gain (loss) on investments

     (21     19        40        *   

Impairment of investments

     (680     (3,608     (2,928     431
                          

Total other income (expense)

     115        (3,368     (3,483     *   
                          

Income before income tax provision

     9,863        944        (8,919     -90

Income tax provision

     4,608        1,816        (2,792     -61
                          

Net income (loss)

     $ 5,255        $ (872     $ (6,127     -117
                          

 

* Not meaningful.

Revenues

Total revenues decreased 15% from $91.8 million in 2008 to $77.9 million in 2009. The decrease was primarily due to a decrease in revenues from assets under management or administration of $14.9 million. Revenues from assets under management or administration comprised 78% and 73% of total revenue in 2008 and 2009, respectively.

Assets under management or administration

Revenues earned from assets under management or administration decreased 21% from $71.7 million in 2008 to $56.9 million in 2009. This decrease was primarily due to a decline in asset values applicable to our quarterly billing cycles for 2009, relative to those used in 2008. In 2008, revenues were relatively unaffected by the significant market decline that occurred during the fourth quarter of 2008. Our fourth quarter 2008 revenues were driven primarily by the value of AUM and AUA as of September 30, 2008. In addition, the decline in market values in the fourth quarter of 2008 and first quarter of 2009 negatively impacted revenues in 2009.

The recovery in the equity markets in the second quarter of 2009 through the end of 2009 modestly affected our revenues from assets under management or administration in the second half of 2009, as market values at the end of a quarter primarily impact our revenues in the subsequent quarter.

The overall decline in revenues from assets under management or administration was partially offset by revenues from new account growth and positive net flows of AUM or AUA during 2009. New account growth and positive net flows of AUM or AUA resulted from our continued efforts to increase the number of financial

 

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advisors on our technology platform. The number of financial advisors with AUM or AUA that had client accounts on our technology platform increased from 7,771 as of December 31, 2008 to 8,408 as of December 31, 2009 and the number of AUM or AUA client accounts increased from approximately 159,000 as of December 31, 2008 to approximately 175,000 as of December 31, 2009.

Licensing and professional services

Licensing and professional services revenues increased 5% from $20.1 million in 2008 to $21.1 million in 2009, primarily due to increased fees on existing license agreements, including an increase in revenues from the Fidelity license agreement.

Cost of revenues

Cost of revenues decreased 29% from $34.6 million in 2008 to $24.6 million in 2009, primarily due to the decrease in the quarter-end market values of AUM and AUA, as well as a relative increase in AUA, for which we incur lower direct costs. As a percentage of total revenues, cost of revenues decreased from 38% in 2008 to 32% in 2009 due to the decrease in market values, as well as a relative increase in licensing revenues, for which we incur no direct costs.

Compensation and benefits

Compensation and benefits increased 1% from $28.5 million in 2008 to $28.8 million in 2009, primarily due to an increase in non-cash stock-based compensation expense of $0.4 million and an increase in profit sharing of $0.4 million, which was partially offset by a decrease in severance of $0.3 million. As a percentage of total revenues, compensation and benefits increased from 31% in 2008 to 37% in 2009, due to the decline in revenue between periods.

General and administration

General and administration expenses increased 1% from $15.5 million in 2008 to $15.7 million in 2009, primarily driven by increases in occupancy-related costs of $0.6 million as a result of new lease agreements related to the Chicago and Denver offices, communications expenses of $0.3 million, research and data costs of $0.3 million related to increased account activity and bad debt expense of $0.4 million related to uncollectible portion of accounts receivable from a private company (see note 5 to the notes to the audited consolidated financial statements), offset by lower professional services of $0.6 million, travel-related expenses of $0.4 million and marketing expenses of $0.3 million, primarily due to efforts to reduce expenses. As a percentage of total revenues, general and administration expenses increased from 17% in 2008 to 20% in 2009. This increase was primarily due to the decrease in revenues in 2009.

Depreciation and amortization

Depreciation and amortization increased 27% from $3.5 million in 2008 to $4.5 million in 2009. This increase was driven by an increase in fixed asset and internally developed software depreciation and amortization of $0.7 million and $0.3 million, respectively. The increase in depreciation and amortization expense was primarily due to increased levels of capitalized leasehold improvements of $2.8 million, as well as increased levels of capitalized hardware and outside software costs of $1.9 million needed to support the growth of our operations. As a percentage of total revenues, depreciation and amortization increased from 4% in 2008 to 6% in 2009. This increase was primarily due to the decrease in revenues in 2009.

Interest income

Interest income decreased 73% from $0.8 million in 2008 to $0.2 million in 2009, primarily due to lower effective interest rates earned on our cash and cash equivalent balances in 2009 compared to 2008.

 

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Impairment of investments

Impairment of investments increased $2.9 million from $0.7 million in 2008 to $3.6 million in 2009. In the fourth quarter of 2009, we evaluated the fair value of an investment in a private company and we recognized a $3.3 million impairment charge. See note 5 to the notes to the audited consolidated financial statements.

Income tax provision

 

     Year Ended December 31,  
             2008                      2009          
     (in thousands)  

Income tax provision

     $         4,608         $         1,816   

Effective tax rate

     46.7%         *   

 

* Not meaningful.

Our 2008 and 2009 effective tax rate differs from the statutory rate primarily as a result of changes in our estimates of our state income tax obligations for prior years and changes in state tax rates. The changes in state tax rates were primarily related to changes in state tax laws regarding the sourcing of state taxable income.

Our 2009 effective tax rate also differs from the statutory rate primarily as a result of an increase in our tax valuation allowance we recorded in 2009. In 2009, our management determined that newly generated deferred tax assets related to capital losses from investments were not expected to be utilized and correspondingly, we increased our tax valuation allowance.

Non-U.S. GAAP Financial Measures

 

     Year Ended December 31,  
         2008              2009              2010      
     (in thousands, unaudited)  

Adjusted EBITDA

     $         13,744         $         10,595         $         18,115   

Adjusted operating income

     10,505         6,096         12,412   

Adjusted net income

     6,088         2,449         7,629   

Adjusted net income per share

     0.23         0.06         0.24   

“Adjusted EBITDA” represents net income (loss) before interest income, interest expense, income tax provision (benefit), depreciation and amortization, non-cash stock-based compensation expense, unrealized gain (loss) on investments, impairment of investments, restructuring charges, severance, bad debt expense, customer inducement costs and litigation related expense.

“Adjusted operating income” represents income (loss) from operations before non-cash stock-based compensation expense, restructuring charges, severance, bad debt expense, customer inducement costs and litigation related expense.

“Adjusted net income” represents net income (loss) before non-cash stock-based compensation expense, impairment of investments, restructuring expense, severance, bad debt expense, customer inducement costs, imputed interest expense and litigation related expense. Reconciling items are tax effected using the income tax rates in effect on the applicable date.

“Adjusted net income per share” represents adjusted net income attributable to common stockholders divided by the diluted number of weighted-average shares outstanding.

Our Compensation Committee of the Board of Directors and our management use adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share:

 

   

As measures of operating performance;

 

   

For planning purposes, including the preparation of annual budgets;

 

55


   

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.

Our Compensation Committee and our management may also consider adjusted EBITDA, among other factors, when determining management’s incentive compensation.

We also present adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share as supplemental performance measures because we believe that they provide our Board of Directors, management and investors with additional information to assess 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 internally developed software, amortization of customer inducement costs, impairment of investments, impairment of goodwill, litigation-related expense, bad debt expense, severance, unrealized income (loss) on investments, and changes in interest expense and interest income that are influenced by capital structure decisions and capital market conditions. Our management also believes it is useful to exclude non-cash stock-based compensation expense from adjusted EBITDA, adjusted operating income and adjusted net income 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, adjusted operating income, adjusted net income and adjusted net income per share are useful to investors in evaluating our operating performance because securities analysts use adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share as supplemental measures to evaluate the overall performance of companies, and we anticipate that our investor and analyst presentations will include adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share.

Adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share are not measurements of our financial performance under U.S. GAAP and should not be considered as an alternative to net income, operating income 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, adjusted operating income, adjusted net income and adjusted net income per share are frequently used by securities analysts and others in their evaluation of companies, these measures 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, adjusted operating income, adjusted net income and adjusted net income per share do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;

 

   

Adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share do not reflect changes in, or cash requirements for, our working capital needs;

 

   

Adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share do not reflect non-cash components 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 2009 and 2010 we had cash income tax payments of $0.2 million and $0.2 million in the year ended December 31, 2009 and 2010, respectively. Income tax payments will be higher if we continue to generate taxable income and our existing net operating loss carryforwards for federal and state income taxes have been fully utilized or have expired; and

 

56


   

Other companies in our industry may calculate adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share differently than we do, limiting their usefulness as a comparative measure.

Management compensates for the inherent limitations associated with using adjusted EBITDA, adjusted operating income, adjusted net income and adjusted net income per share through disclosure of such limitations, presentation of our financial statements in accordance with U.S. GAAP and reconciliation of adjusted EBITDA, adjusted net income and adjusted net income per share to net income and net income per share, the most directly comparable U.S. GAAP measure, and adjusted operating income to income from operations, the most directly comparable U.S. GAAP measure. Further, our management also reviews U.S. GAAP measures and evaluates individual measures that are not included in some or all of our non-U.S. GAAP financial measures, such as our level of capital expenditures and interest income, among other measures.

The following table sets forth a reconciliation of net income (loss) to adjusted EBITDA based on our historical results:

 

     Year Ended December 31,  
     2008     2009     2010  
     (in thousands, unaudited)  

Net income (loss)

     $         5,255        $ (872     $ (626

Add (deduct):

      

Interest income

     (816     (221     (149

Interest expense

     -            -            564   

Income tax provision

     4,608        1,816        1,533   

Depreciation and amortization

     3,538        4,499        5,703   

Stock-based compensation expense

     458        780        1,731   

Unrealized (gain) loss on investments

     21        (19     (12

Impairment of investments

     680        3,608        -       

Restructuring charges (excluding severance)

     -            -            864   

Severance

     -            -            667   

Bad debt expense

     -            385        2,668   

Customer inducement costs

     -            18        3,239   

Litigation related expense

     -            601        1,933   
                        

Adjusted EBITDA

     $ 13,744        $     10,595        $     18,115   
                        

The following table sets forth the reconciliation of income from operations to adjusted operating income based on our historical results:

 

     Year Ended December 31,  
     2008      2009      2010  
     (in thousands, unaudited)  

Income from operations

     $ 9,748         $       4,312         $ 1,310   

Add:

        

Stock-based compensation expense

     458         780         1,731   

Restructuring charges (excluding severance)

     -             -             864   

Severance

     299         -             667   

Bad debt expense

     -             385         2,668   

Customer inducement costs

     -             18         3,239   

Litigation related expense

     -             601         1,933   
                          

Adjusted operating income

     $     10,505         $ 6,096         $     12,412   
                          

 

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The following table sets forth the reconciliation of net income (loss) to adjusted net income and adjusted net income per share based on our historical results:

 

     Year Ended December 31,  
     2008 *     2009 *     2010 *  
     (in thousands, unaudited)  

Net income (loss)

     $ 5,255        $ (872     $ (626

Add:

      

Stock-based compensation expense

     266        480        1,077   

Impairment of investments

     394        2,223        -       

Restructuring charges (excluding severance)

     -            -            538   

Severance

     173        -            415   

Bad debt expense

     -            237        2,668   

Customer inducement costs

     -            11        2,015   

Imputed interest expense

     -            -            340   

Litigation related expense

     -            370        1,202   
                        

Adjusted net income

     6,088        2,449        7,629   

Less: Preferred stock dividends

     (203     (720     (422

Less: Net income allocated to particpating preferred stock

     (2,803     (857     (1,887
                        

Adjusted net income attributable to common stockholders

     $ 3,082        $ 872        $ 5,320   
                        

Basic number of weighted-average shares outstanding

       13,354,845          12,910,998          20,805,911   

Effect of dilutive shares:

      

Options to purchase commons stock

     197,071        416,291        992,753   

Commons warrants

     123,097        284,562        154,364   
                        

Diluted number of weighted-average shares outstanding

     13,675,013        13,611,851        21,953,028   
                        

Adjusted net income per share

     $ 0.23        $ 0.06        $ 0.24   
                        

 

* Adjustments, excluding bad debt expense, are tax effected using income tax rates as follows: for 2008—42.0%; for 2009—38.4%; for 2010—37.8%.

Liquidity and Capital Resources

Since our inception, our operations have been financed through cash flows from operations, private sales of our capital stock and from an initial public offering of common stock in July of 2010. As of December 31, 2010, we had received net cash proceeds of approximately $114 million through equity financings and from the exercise of options to purchase our common stock. As of December 31, 2010, we had total cash and cash equivalents of $67.7 million, compared to $31.5 million as of December 31, 2009.

In connection with our initial public offering of common stock (including the exercise of the underwriter’s overallotment option), we received net proceeds of approximately $42.1 million, after deducting underwriting discounts and commissions and offering costs, which is included in the $114 million noted above.

 

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Cash Flows

The following table presents information regarding our cash flows and cash and cash equivalents for the periods indicated:

 

     Year Ended December 31,  
     2008     2009     2010  
     (In thousands)  

Net cash provided by operating activities

     $         13,178        $         8,365        $         1,467   

Net cash used in investing activities

     (12,706     (5,040     (5,501

Net cash provided by (used in) financing activities

     2,718        (245     40,177   

Net increase in cash and cash equivalents

     3,190        3,080        36,143   

Cash and cash equivalents, end of period

     28,445        31,525        67,668   

Operating Activities

Net cash provided by operating activities in 2010 decreased by $6.9 million compared to 2009, primarily due to an upfront payment of $10.3 million to FundQuest in 2010 (see note 4 to the notes to the consolidated financial statements), primarily offset by an increase in non-cash bad debt expense of $2.7 million in 2010 related to the uncollectible portion of accounts and notes receivable from Fetter Logic (see note 5 to the notes to the consolidated financial statements).

Net cash provided by operating activities in 2009 decreased by $4.8 million compared to 2008, primarily due to lower net income resulting from the overall decline in our operating results due to the decline in the equity markets from September 2007 through the first quarter of 2009.

Investing Activities

Net cash used in investing activities in 2010 increased by $0.5 million compared to 2009. Cash disbursements in 2010 and 2009 totaled $5.5 million and $4.4 million, respectively, for purchases of property and equipment and capitalization of internally developed software. Additionally, the Company acquired the assets of B-Ready Outsourcing Solutions, Inc. and Metamorphosis Money Management, LLC (see note 3 to the notes to the audited consolidated financial statements) for cash totaling $0.9 million offset by proceeds from the repayment of notes receivable of $1.0 million.

Net cash used in investing activities in 2009 decreased by $7.7 million compared to 2008. Cash disbursements in 2009 and 2008 totaled $4.4 million and $5.0 million, respectively, for purchases of property and equipment and capitalization of internally developed software. Cash disbursements in 2008 also included $7.7 million used to purchase non-marketable securities, including $5.7 million relating to an investment in Fetter Logic. See note 7 to the notes to the audited consolidated financial statements.

Financing Activities

Net cash provided by (used in) financing activities in 2010 increased by $40.4 million compared to the same period in 2009, primarily due to the receipt of net proceeds of $42.1 from our initial public offering after deducting underwriting discounts and offering costs, net proceeds of $1.5 million for the exercise of warrants and net proceeds of $1.9 million from the exercise of stock options, partially offset by $4.0 million used in purchases of our common stock in 2010 and payments of preferred stock dividends of $1.3 million. In 2009, we purchased $0.2 million of our common stock.

Net cash provided by (used in) financing activities in 2009 decreased by $3.0 million compared to 2008, primarily due to the receipt of net proceeds of $8.8 million from the issuance of our series C preferred stock in 2008, partially offset by $6.1 million used in purchases of our common stock in 2008. In 2009, we purchased $0.2 million of our common stock.

 

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Commitments

The following table sets forth information regarding our contractual obligations as of December 31, 2010:

 

     Payments Due by Period  
     Total      Less than
1 year
     1-3 years      3-5 years      More than
5 years
 
     (In thousands)  

Operating leases (1)

     $     35,080         $     2,699         $ 6,577         $ 7,134         $ 18,670   

Customer inducement payments

     23,273         1,000         2,000         2,000         18,273   

Note payable

     300         150         150         -             -       
                                            

Total

     $ 58,653         $ 3,849         $     8,727         $     9,134         $     36,943   
                                            

 

(1) We lease facilities under non-cancelable operating leases expiring at various dates through 2022.

The table above does not reflect the following:

 

   

Amounts estimated for uncertain tax positions since the timing and likelihood of such payments cannot be reasonably estimated.

 

   

Voluntary employer matching contributions to our defined contribution benefit plans since the amount cannot be reasonably estimated. For the years ended December 31, 2008, 2009 and 2010, we made voluntary employer matching contributions of $0.4 million, $0.4 million and $0.4 million, respectively.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Recent Accounting Pronouncements

In October 2009, the FASB issued authoritative guidance that enables vendors to account for products or services sold to customers (deliverables) separately rather than as a combined unit, as was generally required by past guidance. The revised guidance provides for two significant changes to the existing multiple element revenue arrangement guidance. The first change relates to the determination of when individual deliverables included in a multiple element arrangement may be treated as separate units of accounting. The second change modifies the manner in which the transaction consideration is allocated across the separately identified deliverables. This guidance also significantly expands the disclosures required for multiple-element revenue arrangements. The guidance is required to be adopted in fiscal years beginning on or after June 15, 2010, but early adoption is permitted. We do not anticipate the adoption of this guidance will have a material impact on our consolidated financial statements.

In October 2009, the FASB issued authoritative guidance that changes the accounting model for revenue arrangements that include both tangible products and software elements so that tangible products containing software components and nonsoftware components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance in Accounting Standards Codification (“ASC”) Subtopic 985-605. In addition, this guidance requires hardware components of a tangible product containing software components always be excluded from the software revenue guidance. The guidance is required to be adopted in fiscal years beginning on or after June 15, 2010, but early adoption is permitted. We do not anticipate the impact of the adoption of this guidance will have a material impact on our consolidated financial statements.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risk

Our exposure to market risk is directly related to revenues from asset management or administration services earned based upon a contractual percentage of AUM or AUA. In the years ended December 31, 2008, 2009 and 2010, 78%, 73% and 77% of our revenues, respectively, were derived from revenues based on the market value of AUM or AUA. We expect this percentage to vary over time. A decrease in the aggregate value of AUM or AUA may cause our revenue and income to decline.

Foreign currency risk

The expenses of our India subsidiary, which primarily consist of expenditures related to compensation and benefits, are paid using the Indian Rupee. We are directly exposed to changes in foreign currency exchange rates through the translation of these monthly expenditures into U.S. dollars. As of December 31, 2010, we estimate that a hypothetical 10% increase in the value of the Indian Rupee to the U.S. dollar would result in a decrease of $0.4 million to pre-tax earnings and a hypothetical 10% decrease in the value of the Indian Rupee to the U.S. dollar would result in a $0.3 million increase to pre-tax earnings.

Interest rate risk

We have no floating interest rate debt and therefore we are not directly exposed to interest rate risk.

 

61


Item 8. Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

Envestnet, Inc.

We have audited the accompanying consolidated balance sheets of Envestnet, Inc. (the “Company”) as of December 31, 2009 and 2010, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Out audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2009 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.

/s/ McGladrey & Pullen, LLP

Chicago, Illinois

March 18, 2011

 

62


Envestnet, Inc.

Consolidated Balance Sheets

(In thousands, except share information)

 

    December 31,  
    2009     2010  

Assets

   

Current assets:

   

Cash and cash equivalents

  $ 31,525      $ 67,668   

Fees receivable, net of allowance for doubtful accounts of $76 and $0, respectively

    5,800        9,135   

Deferred tax assets - current, net

    134        107   

Notes receivable including affiliate - current, net of allowance of $103 and $0, respectively

    714        -       

Prepaid expenses and other current assets

    1,427        2,026   
               

Total current assets

    39,600        78,936   
               

Notes receivable including affiliate and officer, net of allowance of $206 and $0, respectively

    2,322        -       

Property and equipment, net

    8,560        9,713   

Internally developed software, net

    3,887        3,621   

Intangible assets, net

    2,238        1,330   

Goodwill

    1,023        2,031   

Deferred tax assets, net

    13,998        13,649   

Customer inducements

    282        30,400   

Other non-current assets

    2,154        2,188   
               

Total assets

    $ 74,064        $ 141,868   
               

Liabilities and Stockholders’ Equity

   

Current liabilities:

   

Accrued expenses

  $ 10,272      $ 12,859   

Accounts payable

    1,892        1,707   

Customer inducements payable - current

    150        1,000   

Note payable - current

    -            159   

Deferred revenue

    24        232   
               

Total current liabilities

    12,338        15,957   
               

Deferred rent and lease incentive liability

    3,999        4,015   

Customer inducements payable

    -            18,806   

Note payable

    -            159   

Other non-current liabilities

    475        612   
               

Total liabilities

    16,812        39,549   
               

Commitments and contingencies (Note 18)

   

Stockholders’ equity

   

Preferred stock (total liquidation preference of $81,779 and $0 as of December 31, 2009 and 2010, respectively)

    -            -       

Common stock, par value $0.005, 60,000,000 and 500,000,000 shares authorized as of December 31, 2009 and 2010, respectively; 13,524,276 and 43,068,371 shares issued as of December 31, 2009 and 2010, respectively; 12,910,676 and 31,368,822 shares outstanding as of December 31, 2009 and 2010, respectively

    68        215   

Additional paid-in capital

    106,893        157,778   

Accumulated deficit

    (43,375     (45,347

Treasury stock at cost, 613,600 shares and 11,699,549 shares as of December 31, 2009 and 2010, respectively

    (6,334     (10,327
               

Total stockholders’ equity

    57,252        102,319   
               

Total liabilities and stockholders’ equity

    $ 74,064        $ 141,868   
               

See accompanying notes to Consolidated Financial Statements.

 

63


Envestnet, Inc.

Consolidated Statements of Operations

(In thousands, except share and per share information)

 

     Year ended December 31,  
     2008     2009     2010  

Revenues:

      

Assets under management or administration

     $ 71,738        $ 56,857        $ 75,951   

Licensing and professional services

     20,104        21,067        22,101   
                        

Total revenues

     91,842        77,924        98,052   
                        

Operating expenses:

      

Cost of revenues

     34,604        24,624        31,444   

Compensation and benefits

     28,452        28,763        37,027   

General and administration (see Notes 5 and 18)

     15,500        15,726        21,607   

Depreciation and amortization

     3,538        4,499        5,703   

Restructuring charges

     -            -            961   
                        

Total operating expenses

     82,094        73,612        96,742   
                        

Income from operations

     9,748        4,312        1,310   
                        

Other income (expense):

      

Interest income

     816        221        149   

Interest expense

     -            -            (564

Unrealized gain (loss) on investments

     (21     19        12   

Impairment of investments

     (680     (3,608     -       
                        

Total other income (expense)

     115        (3,368     (403
                        

Income before income tax provision

     9,863        944        907   
                        

Income tax provision

     4,608        1,816        1,533   
                        

Net income (loss)

     5,255        (872     (626

Less preferred stock dividends

     (203     (720     (422

Less net income allocated to participating preferred stock

     (2,406     -            -       
                        

Net income (loss) attributable to common stockholders

     $ 2,646        $ (1,592     $ (1,048
                        

Net income (loss) per share attributable to common stockholders:

      

Basic

     $ 0.20        $ (0.12     $ (0.05
                        

Diluted

     $ 0.19        $ (0.12     $ (0.05
                        

Weighted average common shares outstanding:

      

Basic

       13,354,845          12,910,998          20,805,911   
                        

Diluted

     13,675,013        12,910,998        20,805,911   
                        

See accompanying notes to Consolidated Financial Statements.

 

64


Envestnet, Inc.

Consolidated Statements of Stockholders’ Equity

(In thousands, except share information)

 

    Preferred Stock     Common Stock     Treasury Stock     Additional
Paid-in
Capital
    Accumulated
Deficit
    Total
Stockholders’
Equity
 
    Shares     Amount     Shares     Amount     Common
Shares
    Preferred
Shares
    Amount        

Balance, December 31, 2007 (1)

    72,779        -            13,506,976        68        -            -            -            96,848        (47,758     49,158   

Issuance of Series C, less legal expenses incurred of $213

    3,864        -            -            -            -            -            -            8,787        -            8,787   

Exercise of stock options

    -            -            14,300        -            -            -            -            17        -            17   

Stock-based compensation

    -            -            -            -            -            -            -            458        -            458   

Purchase of treasury stock (at cost)

    -            -            -            -            (588,000     -            (6,086     -            -            (6,086

Net income

    -            -            -            -            -            -            -            -            5,255        5,255   
                                                                               

Balance, December 31, 2008

    76,643        -            13,521,276        68        (588,000     -            (6,086     106,110        (42,503     57,589   

Exercise of stock options

    -            -            3,000        -            -            -            -            3        -            3   

Stock-based compensation

    -            -            -            -            -            -            -            780        -            780   

Purchase of treasury stock (at cost)

    -            -            -              (25,600     -            (248     -        -            (248

Net loss

    -            -            -            -            -            -            -            -        (872     (872
                                                                               

Balance, December 31, 2009

    76,643      $ -            13,524,276      $ 68        (613,600     -          $ (6,334   $ 106,893      $ (43,375   $ 57,252   

Exercise of Series B warrants

    1,497        -            -            -            -            -            -            1,497        -            1,497   

Conversion of preferred stock to common stock effective upon initial public offering

    (45,890     -            7,842,034        39        -            -            -            (39     -            -       

Merger transactions between EnvestNet Group, Inc. and Envestnet, Inc.: Issuance of Envestnet, Inc. common stock to EnvestNet Group, Inc. shareholders

    -            -            10,680,000        54        -            -            -            (54     -            -       

Conversion of Envestnet, Inc. preferred and common stock held by EnvestNet Group, Inc., into treasury stock (common equivalents)

    (32,250     -            5,160,000        26        (10,680,000     -            -            (26     -            -       

Net operating loss tax benefit recognized from EnvestNet Group, Inc. merger

    -            -            -            -            -            -            -            839        -            839   

Initial public offering of common stock, net of offering costs

        5,411,325        27        -            -            -            42,039        -            42,066   

Issuance of warrant to FundQuest, Inc.

    -            -            -            -            -            -            -            2,946        -            2,946   

Exercise of common warrants

    -            -            154,548        -            -            -            -            28        -            28   

Exercise of stock options

    -            -            296,188        1        -            -            -            1,924        -            1,925   

Stock-based compensation

    -            -            -            -            -            -            -            1,731        -            1,731   

Purchase of treasury stock (at cost)

    -            -            -            -            (381,480     (122     (3,993     -            -            (3,993

Conversion of preferred stock in treasury to common stock

    -            -            -            -            (24,469     122        -            -            -            -       

Preferred stock dividends

    -            -            -            -            -            -            -            -            (1,346     (1,346

Net loss

    -            -            -            -            -            -            -            -            (626     (626
                                                                               

Balance, December 31, 2010

    -            $     -            43,068,371        $     215        (11,699,549     -            $     (10,327)        $     157,778        $     (45,347)        $     102,319   
                                                                               

(1) The opening balance of Accumulated Deficit was adjusted by $994 for an immaterial correction. Refer to Note 2, “Summary of Significant Accounting Policies” for additional information.

See accompanying notes to Consolidated Financial Statements.

 

65


Envestnet, Inc.

Consolidated Statements of Cash Flows

(In thousands)

 

    Year ended December 31,  
    2008     2009     2010  

OPERATING ACTIVITIES:

     

Net income (loss)

    $ 5,255        $ (872     $ (626

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

     

Depreciation and amortization

    3,538        4,499        5,703   

Amortization of customer inducements

    -            18        3,238   

Amortization of deferred rent and lease incentive

    143        544        58   

Provision for doubtful accounts

    -            385        2,668   

Unrealized (gain) loss on investments

    21        (19     (12

Impairment of investments

    680        3,608        -       

Deferred income taxes

    3,679        1,572        1,215   

Stock-based compensation

    458        780        1,731   

Interest expense

    -            -            564   

Changes in operating assets and liabilities:

     

Fees receivable

    (796     (1,338     (3,718

Prepaid expenses and other current assets

    (552     (148     (599

Other non-current assets

    2,403        42        (52

Customer inducements, net

    -            (150     (11,300

Accrued expenses

    (2,014     38        2,437   

Accounts payable

    151        (475     (185

Deferred revenue

    33        (187     208   

Other non-current liabilities

    179        68        137   
                       

Net cash provided by operating activities

    13,178        8,365        1,467   
                       

INVESTING ACTIVITIES:

     

Purchase of property and equipment

    (3,336     (3,078     (4,169

Capitalization of internally developed software

    (1,652     (1,306     (1,340

Proceeds from repayment of notes receivable

    -            -            985   

Increase in notes receivable

    (64     (54     (90

Investments in non-marketable securities

    (7,654     (812     -       

Proceeds from investments

    -            210        30   

Acquisition of businesses, net

    -            -            (917
                       

Net cash (used in) investing activities

    (12,706     (5,040     (5,501
                       

FINANCING ACTIVITIES:

     

Proceeds from exercise of stock options

    17        3        1,925   

Proceeds from exercise of warrants

    -            -            1,525   

Net proceeds from issuance of common stock

    -            -            42,066   

Purchase of treasury stock

    (6,086     (248     (3,993

Net proceeds from issuance of preferred stock

    8,787        -            -       

Preferred stock dividends

    -            -            (1,346
                       

Net cash provided by (used in) financing activities

    2,718        (245     40,177   
                       

INCREASE IN CASH AND CASH EQUIVALENTS

    3,190        3,080        36,143   
                       

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

    25,255        28,445        31,525   
                       

CASH AND CASH EQUIVALENTS, END OF PERIOD

    $     28,445        $     31,525        $     67,668   
                       

Supplemental disclosure of cash flow information - cash paid during the period for:

     

Income taxes

    $ 1,125        $ 240        $ 171   

Supplemental disclosure of non-cash investing and financing activities:

     

Leasehold improvements funded by lease incentive

    74        3,156        119   

Purchase of non-marketable securities

    -            275        -       

Exercise of redemption rights into note receivable

    -            2,450        -       

Issuance of warrant for customer inducement