<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 001-13459
AFFILIATED MANAGERS GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 04-3218510
(State or other jurisdiction (IRS Employer
of incorporation or Identification
organization) Number)
</TABLE>
TWO INTERNATIONAL PLACE, BOSTON, MASSACHUSETTS, 02110
(Address of principal executive offices)
(617) 747-3300
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
- - ----------------------------------- -----------------------------
<S> <C>
Common Stock ($.01 par value)...... New York Stock Exchange
</TABLE>
Securities registered pursuant to Section 12(g) of the Act: None
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 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 registrant's 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. [ ]
Aggregate market value of the voting and non-voting Common Stock held by
non-affiliates of the Registrant, based upon the closing price of $24.625 on
March 26, 1999 on the New York Stock Exchange was $493,458,405. Calculation of
holdings by non-affiliates is based upon the assumption, for these purposes
only, that executive officers, directors, and persons holding 10% or more of the
Registrant's Common Stock (including the Registrant's Common Stock and Class B
Non-Voting Common Stock as if they were a single class) are affiliates. Number
of shares of the Registrant's Common Stock outstanding at March 26, 1999:
23,282,559 including 1,492,079 shares of Class B Non-Voting Common Stock. Unless
otherwise specified, the term Common Stock includes both Common Stock and Class
B Non-Voting Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III of this report on Form 10-K is
incorporated by reference from certain portions of the Proxy Statement of the
Registrant to be filed pursuant to Regulation 14A and sent to stockholders in
connection with the Annual Meeting of Stockholders to be held on May 25, 1999.
Such Proxy Statement, except for the parts therein which have been specifically
incorporated herein by reference, shall not be deemed "filed" as part of this
report on Form 10-K.
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<PAGE>
FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
PART I..................................................................................................... 3
ITEM 1. BUSINESS........................................................................................ 3
ITEM 2. PROPERTIES...................................................................................... 20
ITEM 3. LEGAL PROCEEDINGS............................................................................... 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................. 20
PART II.................................................................................................... 21
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................... 21
ITEM 6. SELECTED HISTORICAL FINANCIAL DATA.............................................................. 22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION............ 23
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................................... 33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................................................... 34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............ 54
PART III................................................................................................... 55
INCORPORATED BY REFERENCE FROM THE COMPANY'S PROXY STATEMENT
FOR THE ANNUAL MEETING OF SHAREHOLDERS CURRENTLY SCHEDULED
TO BE HELD ON MAY 25, 1999, TO BE FILED PURSUANT TO REGULATION 14A
PART IV.................................................................................................... 55
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K................................. 55
</TABLE>
2
<PAGE>
PART I
ITEM 1. BUSINESS
OVERVIEW
We buy and hold equity interests in mid-sized investment management firms
and currently derive all of our revenues from those firms. We refer to firms in
which we have purchased less than 100%, typically less than 80%, as our
"affiliates". We hold investments in 13 affiliates that managed $62.1 billion in
assets at December 31, 1998. Our most recent affiliate investments were in Essex
Investment Management Company, LLC (March 1998); Davis Hamilton Jackson &
Associates, L.P. (December 1998) and Rorer Asset Management, LLC (January 1999).
On January 29, 1999, we also entered into a definitive agreement to acquire
substantially all of the partnership interests in The Managers Funds, L.P.,
which serves as the adviser to a family of ten equity and fixed income no-load
mutual funds. These mutual funds had a total of $1.8 billion in assets under
management at December 31, 1998.
We were founded in 1993 to address the succession and ownership transition
issues facing the founders and principal owners of many mid-sized investment
management firms. We did this because we believed that many of them wanted a new
alternative for shifting ownership to the next generation of management. We
developed an innovative transaction structure to serve as a succession planning
alternative for these firms.
The key component of our transaction structure is our purchase of majority
interests in these firms. Within this structure, we allow ongoing managers to
keep a significant ownership interest in their firms which they may sell to us
in the future, we give management autonomy over the day-to-day operations of
their firm, and we allow management to decide how to spend a fixed portion of
revenues on salaries, bonuses and other operating expenses.
We implement our structure through a revenue sharing arrangement with each
of our affiliates. This arrangement allocates a specified percentage of
revenues, typically 50-70%, for use by the affiliate's management in paying the
salaries, bonuses and other operating expenses (the "Operating Allocation") of
the affiliate. The remaining portion of revenues, typically 30-50% (the "Owners'
Allocation"), is allocated to the owners of that affiliate, including us,
generally in proportion to ownership of the affiliate. We believe that our
structure is particularly appealing to managers of firms which anticipate strong
future growth, because it gives them the opportunity to profit from an
affiliate's growth through this revenue sharing arrangement.
The table below depicts the pro forma change in our assets under management
(assuming all 13 of our affiliates were included for the entire periods
presented).
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
(IN MILLIONS)
<S> <C> <C>
Assets under management--beginning........................ $ 35,324 $ 54,961
Net new sales............................................. 12,339 2,001
Market appreciation....................................... 7,298 5,169
--------- ---------
Assets under management--ending........................... $ 54,961 $ 62,131
--------- ---------
--------- ---------
</TABLE>
We generally seek to acquire interests in investment management firms with
$500 million to $10 billion of assets under management. The growth in the
investment management industry has resulted in a significant increase in the
number of firms in this size range. We have identified over 1,300 of these firms
in the United States, Canada and the United Kingdom. We believe that, in the
coming years, a substantial number of investment opportunities will arise as
founders of these firms approach retirement age and begin to plan for
succession. We also anticipate significant additional investment opportunities
in firms
3
<PAGE>
that are currently wholly-owned by larger entities. We believe that we can take
advantage of these investment opportunities because our management team has
substantial industry experience and expertise in structuring and negotiating
transactions, as well as a highly organized process for identifying and
contacting investment prospects.
HOLDING COMPANY OPERATIONS
Our management performs two primary functions:
- implementing our strategy of growth through acquisitions of interests
in prospective affiliates; and
- supporting, enhancing, and monitoring the activities of our existing
affiliates.
ACQUISITION OF INTERESTS IN PROSPECTIVE AFFILIATES
The acquisition of interests in new affiliates is a primary element of our
growth strategy. Our management takes responsibility for each step in this
process, including identification and contact of potential affiliates, and the
valuation, structuring and negotiation of transactions. In general, we try to
initiate our discussions with potential affiliates on an exclusive basis. We do
not actively seek to participate in competitive auction processes or employ
investment bankers or finders. However, we have been competitive in cases where
investment bankers have been involved. Of our 13 affiliates, five were
represented by investment bankers while the remaining eight were transactions
initiated by our management.
Our management identifies and develops relationships with promising
potential affiliates based on a thorough understanding of the universe of
mid-sized investment management firms derived from our proprietary database made
up of data from third party vendors, public and industry sources and our own
research. We use this database to screen and prioritize investment prospects. We
also use the database to monitor the level and frequency of interaction with
potential affiliates. This database and our related contact management system
help us to identify promising potential affiliates and to develop and maintain
relationships with these firms.
We try to increase awareness of our approach to investing by actively
participating in conferences and seminars related to succession planning for
investment management firms. These activities lead to a substantial number of
unsolicited calls from firms considering succession planning issues. In
addition, our management maintains an active calling program in order to develop
relationships with prospective affiliates. In the past three years, our
management has visited over 440 firms. We believe we have established ongoing
relationships with a substantial number of firms which will be considering
succession planning alternatives in the future.
Once discussions with a target firm lead to transaction negotiations, our
management team performs all of the functions related to the valuation,
structuring and negotiation of the transaction. Our management team includes
professionals with substantial experience in mergers and acquisitions of
investment management firms.
Upon the negotiation and execution of definitive agreements, the target firm
contacts its clients to notify them and seek their consent to the transaction
(which constitutes an assignment of the firm's investment advisory contracts),
as required by the Investment Advisers Act of 1940, as amended. If the firm has
mutual fund clients, the firm seeks new contracts with those funds, as required
by the Investment Company Act of 1940, as amended. The new contracts must be
approved by the funds' shareholders through a proxy process.
4
<PAGE>
Descriptions of our most recently completed affiliate investments in Essex
Investment Management Company, LLC ("Essex"), Davis Hamilton Jackson &
Associates, L.P. ("DHJA") and Rorer Asset Management, LLC ("Rorer") are set
forth below.
ESSEX INVESTMENT MANAGEMENT COMPANY, LLC
Essex is a Boston-based investment adviser specializing in investing in
growth equities and fixed income securities employing a fundamental
research-driven approach. Founded in 1976, Essex is led by its founder, Chairman
and Chief Investment Officer, Joseph C. McNay, along with a management group led
by Stephen D. Cutler, President, and Stephen R. Clark, Executive Vice President.
Essex provides investment advisory services to defined benefit plans,
endowments, foundations, partnerships and private individuals and acts as a
subadviser to a mutual fund.
DAVIS HAMILTON JACKSON & ASSOCIATES, L.P.
DHJA is a Houston-based investment adviser which manages equity securities
employing a disciplined growth approach and fixed income instruments. Founded in
1988, the firm is led by its co-founders Robert C. Davis and Jack R. Hamilton,
along with a management group of other investment and client service
professionals, who serve a diversified client base including pension and profit
sharing plans for public and private entities, corporations and Taft-Hartley
accounts, as well as trusts, high net worth individuals and a sub-advised mutual
fund.
RORER ASSET MANAGEMENT, LLC
Rorer is a value-oriented equity and fixed income manager based in
Philadelphia which offers four types of investment management accounts:
large-capitalization equity, mid-capitalization equity, balanced and fixed
income. Founded in 1978, Rorer is led by its founder, Chairman and Chief
Investment Officer Edward C. Rorer, and a committee including James G. Hesser,
President, and Clifford B. Storms, Jr., Director of Research.
AFFILIATE SUPPORT
In addition to pursuing new investments, we seek to support and enhance the
growth and operations of our affiliates. We believe that the management of each
affiliate is in the best position to assess its firm's needs and opportunities,
and that the autonomy and culture of each affiliate should be preserved.
However, when requested by the management of an affiliate, we provide strategic,
marketing and operational assistance. We believe that our affiliates find these
support services attractive because the services otherwise may not be as
accessible or as affordable to mid-sized investment management firms.
In addition to the diverse industry experience and knowledge of our senior
management, we maintain relationships with many consultants whose specific
expertise enhances our ability to offer a wide range of assistance. Our
initiatives to support our affiliates have included:
- new product development,
- marketing material development,
- institutional sales assistance,
- recruiting,
- compensation evaluation,
- regulatory compliance audits, and
- client satisfaction surveys.
5
<PAGE>
We also work to obtain discounts on some of the products and services that
our affiliates need, such as:
- sales training seminars,
- public relations services,
- insurance, and
- retirement benefits.
One way that we seek to enhance the growth of our affiliates is by helping
them acquire smaller investment management firms or teams which are not suitable
as stand-alone investments for us. Mid-sized firms may have difficulty finding
and capitalizing on these opportunities on their own. As an example, in July
1998, we structured and financed the acquisition of Sound Capital Partners, LLC
by The Burridge Group LLC, one of our affiliates.
OUR STRUCTURE AND RELATIONSHIP WITH AFFILIATES
As part of our investment structure, each of our affiliates is organized as
a separate and largely autonomous limited liability company or partnership. Each
affiliate operates under its own organizational document, a limited liability
company agreement or partnership agreement. The organizational document includes
provisions regarding the use of the affiliate's revenues and the management of
the affiliate. The organizational document also generally gives management
owners the ability to realize the value of their retained equity interests in
the future. While the organizational document of each affiliate is agreed upon
at the time of our investment, from time to time we agree to amendments to
accommodate our business needs or those of our affiliates.
OPERATIONAL AUTONOMY OF AFFILIATES
We develop the management provisions in each organizational document jointly
with the affiliate's senior management at the time we make our investment. Each
organizational document has provisions that differ from the others. However, all
of them give the affiliate's management team the power and authority to carry on
the day-to-day operations and management of the affiliate, including matters
relating to:
- personnel,
- investment management,
- policies and fee structures,
- product development,
- client relationships, and
- employee compensation programs.
We retain, however, the authority to prevent specified types of actions
which we believe could adversely affect cash distributions to us. For example,
none of the affiliates may incur material indebtedness without our consent. We
do not directly engage in the business of providing investment advice and,
therefore, are not registered as an investment adviser.
REVENUE SHARING ARRANGEMENTS
When we make an investment in an affiliate, we negotiate a revenue sharing
arrangement with that affiliate, which we place in its organizational document.
The revenue sharing arrangement allocates a percentage of revenues (typically
50-70%) for use by management of that affiliate in paying operating
6
<PAGE>
expenses of the affiliate, including salaries and bonuses. We call this the
"Operating Allocation". We determine the percentage of revenues designated as
Operating Allocation for each affiliate in consultation with the managers of the
affiliate at the time of our investment based on the affiliate's historical and
projected operating margins. The organizational document of each affiliate
allocates the remaining portion of the affiliate's revenues (typically 30-50%)
to the owners of that affiliate (including us), generally in proportion to their
ownership of the affiliate. We call this the "Owners' Allocation" because it is
the portion of revenues which the affiliate's management is prohibited from
spending on operating expenses without our prior consent. Each affiliate
distributes its Owners' Allocation to its management owners and us in proportion
to their ownership interests in that affiliate.
Before agreeing to these allocations, we examine the revenue and expense
base of the firm. We only agree to a division of revenues if we believe that the
Operating Allocation will cover all operating expenses of the affiliate,
including in cases involving an increase in expenses, or a decrease in revenues
without a corresponding decrease in operating expenses.
While our management has significant experience in the asset management
industry, we cannot be certain that we will successfully anticipate changes in
the revenue and expense base of any firm. Therefore, we cannot be certain that
the agreed-upon Operating Allocation will be large enough to pay for all
operating expenses, including salaries and bonuses of the affiliate.
One of the purposes of our revenue sharing arrangements is to provide
ongoing incentives for the managers of the affiliates by allowing them:
- to participate in their firm's growth through their compensation from
the Operating Allocation,
- to receive a portion of the Owners' Allocation based on their ownership
interest in the affiliate, and
- to control operating expenses, thereby increasing the portion of the
Operating Allocation which is available for growth initiatives and
bonuses for management of the affiliate.
The managers of each affiliate, therefore, have an incentive to both
increase revenues (thereby increasing the Operating Allocation and their Owners'
Allocation) and to control expenses (thereby increasing the excess Operating
Allocation).
The revenue sharing arrangements allow us to participate in the revenue
growth of each affiliate because we receive a portion of the additional revenue
as our share of the Owners' Allocation. However, we participate in that growth
to a lesser extent than the managers of the affiliate, because we do not share
in the growth of the Operating Allocation.
Under the organizational documents of the affiliates, the allocations and
distributions of cash to us generally take priority over the allocations and
distributions to the management owners of the affiliates. This further protects
us if there are any expenses in excess of the Operating Allocation of an
affiliate. Thus, if an affiliate's expenses exceed its Operating Allocation, the
excess expenses first reduce the portion of the Owners' Allocation allocated to
the affiliate's management owners until that portion is eliminated, and then
reduce the portion allocated to us.
OUR PURCHASE OF ADDITIONAL INTERESTS IN OUR EXISTING AFFILIATES
Under our transaction structure, the management team at each affiliate
retains an ownership interest in its own firm. We consider this a key way that
we provide management owners with incentives to grow their firms. In order to
provide as much incentive as we can, we include in the organizational documents
of each affiliate (other than Paradigm Asset Management Company, LLC) "put"
rights for its management owners. The put rights require us periodically to buy
part of the management owners' interests in the affiliate for cash, shares of
our Common Stock or a combination of both. In this way, the management
7
<PAGE>
owners can realize a portion of the equity value that they create in their firm.
In addition, the organizational documents of some of our affiliates provide us
with "call" rights that let us require the management owners to sell us portions
of their interests in the affiliate. Finally, the organizational documents of
each affiliate include provisions obligating each such owner to sell his or her
remaining interests at a point in the future, generally after the termination of
his or her employment with the affiliate. Underlying all of these provisions is
our basic philosophy that management owners of each affiliate should maintain an
ownership level in that affiliate within a range that offers them sufficient
incentives to grow and improve their business to create equity value for
themselves.
PUT RIGHTS
The put rights are designed to let the management owners sell portions of
their retained ownership interest for cash, shares of our Common Stock or a
combination of both, prior to their retirement. In addition, as an alternative
to simply purchasing all of a management owner's interest in the affiliate
following the termination of his or her employment, the put rights enable us to
purchase additional interests in the affiliates at a more gradual rate. We
believe that a more gradual purchase of interests in affiliates will make it
easier for us to keep our ownership of each affiliate within a desired range. We
can do this by transferring purchased interests in the affiliate to more junior
members of its management.
In most cases, the put rights do not become exercisable for a period of
several years from the date of our investment in an affiliate. Once exercisable,
the put rights generally are limited in the aggregate to a percentage of the
management owner's ownership interests. The most common formulation among all
the affiliates is that a management owner's put rights:
- do not commence for five years from the date of our investment (or, if
later, the date he or she purchased his or her interest in the
affiliate),
- are limited, in the aggregate, to fifty percent of the interests in the
affiliate, and
- are limited, in any twelve-month period, to ten percent of the greatest
interest he or she held in the affiliate. In addition, the
organizational documents of the affiliates generally contain a
limitation on the maximum total amount that management of any affiliate
may require us to purchase pursuant to their put rights in any given
twelve-month period.
The purchase price under the put rights is generally based on a multiple of
the affiliate's Owners' Allocation at the time the right is exercised, with the
multiple generally having been determined at the time we made our initial
investment.
CALL RIGHTS
The call rights are designed to assure us and the management members of some
of our affiliates that we can facilitate some transition within the senior
management team after an agreed-upon period of time. The call rights vary in
each specific instance, but in all cases the timing, mechanism and price are
agreed upon when we make our investment. The price is payable in cash, shares of
our Common Stock or a combination of both.
BUY-OUT RIGHTS
The organizational documents of each affiliate provide that the management
owners will realize the remaining equity value they have created generally
following the termination of their employment with the affiliate. In general,
upon a management owner's retirement after an agreed-upon number of years, or
upon his or her earlier death, permanent incapacity or termination without cause
(but with our consent), that management owner is required to sell to us (and we
are required to purchase from the management owner) his or her remaining
interests. The purchase price in these cases is payable either in cash, shares
of our Common Stock or a combination of both. The purchase price is generally
based on the same formulas
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that apply to put rights. In general, if a management owner quits early or is
terminated for cause, his or her interests will be purchased by us for cash at a
substantial discount to the price that he or she would otherwise be paid. Also,
if a management owner quits or is terminated for cause within the first several
years following our investment (or, if later, the date the management owner
purchased his or her interest in the affiliate), the management owner generally
receives nothing for his or her retained interest.
If an affiliate collects any key-man life insurance or lump-sum disability
insurance proceeds upon the death or permanent incapacity of a management owner,
the affiliate must use that money to purchase his or her interests. A purchase
by an affiliate would have the effect of ratably increasing our ownership
percentage as well as each of the remaining management owners. By contrast, the
purchase of interests by us only increases our ownership percentage. The
organizational documents of most of the affiliates provide for the purchase of
such insurance, to the extent we have requested it. The premium costs are
subtracted from the Owners' Allocation of the affiliate, so all of the
affiliate's owners (including AMG and management) bear this cost.
THE AFFILIATES
In general, our affiliates derive revenues by charging fees to their clients
that are typically based on the market value of assets under management. In some
instances, however, the affiliates may derive revenues from fees based on
investment performance.
Our affiliates are listed below in alphabetical order and include Rorer
Asset Management, LLC, in which we invested in January 1999. We own a majority
interest in each in our affiliates other than Paradigm.
<TABLE>
<CAPTION>
PRO FORMA
ASSETS UNDER
PRINCIPAL DATE OF MANAGEMENT AS OF
AFFILIATE LOCATION(S) INVESTMENT DECEMBER 31,1998
- - ---------------------------------------------------------- ----------------- -------------- -------------------
<S> <C> <C> <C>
(IN MILLIONS)
The Burridge Group LLC ("Burridge")....................... Chicago; Seattle December 1996 $ 1,594
Davis Hamilton Jackson & Associates, L.P. ("DHJA")........ Houston December 1998 3,468
Essex Investment Management Company, LLC ("Essex")........ Boston March 1998 5,558
First Quadrant, L.P.; First Quadrant Limited Pasadena, CA;
(collectively, "First Quadrant")........................ London March 1996 26,615(1)
GeoCapital, LLC ("GeoCapital")............................ New York September 1997 2,543
Gofen and Glossberg, L.L.C. ("Gofen and Glossberg")....... Chicago May 1997 4,280
J.M. Hartwell Limited Partnership ("Hartwell")............ New York May 1994 362
Paradigm Asset Management Company, L.L.C. ("Paradigm").... New York May 1995 2,898
Renaissance Investment Management ("Renaissance")......... Cincinnati November 1995 1,390
Rorer Asset Management, LLC ("Rorer")..................... Philadelphia January 1999 4,400
Skyline Asset Management, L.P. ("Skyline")................ Chicago August 1995 1,161
Systematic Financial Management, L.P. ("Systematic")...... Teaneck, NJ May 1995 1,221
Tweedy, Browne Company LLC ("Tweedy, Browne")............. New York; London October 1997 6,641
-------
Total................................................. $ 62,131
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-------
</TABLE>
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(1) Includes directly managed assets of $10.5 billion and $16.1 billion of
assets indirectly managed using overlay strategies which employ futures,
options or other derivative securities to achieve a particular investment
objective. These overlay strategies are intended to add incremental value to
the underlying portfolios, which may or may not be directly managed by First
Quadrant, and generate advisory fees which are generally at the lower end of
the range of those generated by First Quadrant's directly managed
portfolios.
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THE MANAGERS FUNDS, L.P.
On January 29, 1999, we signed a definitive agreement to purchase
substantially of all the partnership interests in The Managers Funds, L.P.
("Managers") which is being reorganized as The Managers Funds LLC as part of the
transaction. Managers employs an innovative business model whereby it selects
subadvisers for its mutual fund products from a universe of over a thousand
investment managers. The mutual funds advised by Managers are distributed to
retail and institutional clients directly and through intermediaries including
independent investment advisers, 401(k) plan sponsors and alliances, broker-
dealers, major fund marketplaces, and bank trust departments. We believe that
the acquisition of Managers will provide some of our affiliates that have
traditionally focused on institutional clients with an opportunity to reach new
clients through Managers' mutual fund distribution channels. In the transaction,
we will purchase ninety-five percent of the outstanding partnership interests
and become the manager-member of The Managers Funds LLC, while a five percent
interest will remain in the hands of the senior management team. Following the
transaction, the firm will continue to employ its subadviser strategy and will
continue to be operated from its offices in Norwalk, Connecticut. The closing of
this transaction is subject to customary conditions.
The following table provides the pro forma composition of our assets under
management and relative EBITDA Contribution of our affiliates for the year ended
December 31, 1998. All amounts below are pro forma for the inclusion of the
Essex, DHJA and Rorer investments and financing transactions as if such
transactions occurred on January 1, 1998. Except as otherwise indicated, none of
the financial or other information contained in this Form 10-K reflects our
planned acquisition of Managers.
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PRO FORMA
ASSETS UNDER MANAGEMENT AND EBITDA CONTRIBUTION(1)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
---------------------------------------------------------
ASSETS UNDER PERCENTAGE EBITDA PERCENTAGE
MANAGEMENT OF TOTAL CONTRIBUTION OF TOTAL
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
(IN (IN
MILLIONS) THOUSANDS)
CLIENT TYPE:
Institutional............................................... $ 47,461 76% $ 48,852 50%
Mutual fund................................................. 4,317 7 24,187 25
High net worth.............................................. 9,255 15 18,008 19
Other....................................................... 1,098 2 5,879 6
------------ --- ------------- ---
Total................................................... $ 62,131 100% $ 96,926 100%
------------ --- ------------- ---
------------ --- ------------- ---
ASSET CLASS:
Equity...................................................... $ 41,578 67% $ 87,264 90%
Fixed income................................................ 4,391 7 5,689 6
Tactical asset allocation................................... 16,162 26 3,973 4
------------ --- ------------- ---
Total................................................... $ 62,131 100% $ 96,926 100%
------------ --- ------------- ---
------------ --- ------------- ---
GEOGRAPHY:
Domestic investments........................................ $ 39,833 64% $ 72,940 75%
Global investments.......................................... 22,298 36 23,986 25
------------ --- ------------- ---
Total................................................... $ 62,131 100% $ 96,926 100%
------------ --- ------------- ---
------------ --- ------------- ---
</TABLE>
<TABLE>
<CAPTION>
OTHER PRO FORMA FINANCIAL DATA:
<S> <C>
RECONCILIATION OF EBITDA CONTRIBUTION TO EBITDA:
Total EBITDA Contribution (as above)................................................................ $ 96,926
Less holding company expenses....................................................................... (7,648)
----------
EBITDA(2)........................................................................................... $ 89,278
----------
EBITDA as adjusted(3)................................................................................. $ 52,724
- - ------------------------------------------------------------------------------------------------------------------
OTHER HISTORICAL CASH FLOW DATA:
Cash flow from operating activities................................................................. $ 45,424
Cash flow used in investing activities.............................................................. (72,665)
Cash flow from financing activities................................................................. 28,163
EBITDA(2)........................................................................................... 76,312
EBITDA as adjusted(3)............................................................................... 45,675
</TABLE>
- - ------------------------
(1) EBITDA Contribution represents the portion of an affiliate's revenues that
is allocated to us, after amounts retained by the affiliate for compensation
and day-to-day operating and overhead expenses, but before the interest,
tax, depreciation and amortization expenses of the affiliate. EBITDA
Contribution does not include holding company expenses. We believe that
EBITDA Contribution may be useful to investors as an indicator of each
affiliate's contribution to our ability to service debt, to make new
investments and to meet working capital requirements. EBITDA Contribution is
not a measure of financial performance under generally accepted accounting
principles and should not be considered an alternative to net income as a
measure of operating performance or to cash flows from operating activities
as a measure of liquidity. EBITDA Contribution and EBITDA, as calculated by
us, may not be consistent with comparable computations by other companies.
(2) EBITDA represents earnings before interest expense, income taxes,
depreciation, amortization and extraordinary items. We believe EBITDA may be
useful to investors as an indicator of our ability to service debt, to make
new investments and to meet working capital requirements. EBITDA, as
calculated by us, may not be consistent with computations of EBITDA by other
companies. EBITDA is not a measure of financial performance under generally
accepted accounting principles and should not be considered an alternative
to net income as a measure of operating performance or to cash flows from
operating activities as a measure of liquidity.
(3) EBITDA as adjusted represents earnings after interest expense and income
taxes but before depreciation and amortization and extraordinary items. We
believe that this measure may be useful to investors as another indicator of
funds available to the Company, which may be used to make new investments,
repay debt obligations, repurchase shares of Common Stock or pay dividends
on Common Stock. EBITDA as adjusted, as calculated by us, may not be
consistent with computations of EBITDA as adjusted by other companies EBITDA
as adjusted is not a measure of financial performance under generally
accepted accounting principles and should not be considered an alternative
to net income as a measure of operating performance or to cash flows from
operating activities as a measure of liquidity.
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INDUSTRY
ASSETS UNDER MANAGEMENT
The investment management sector is one of the fastest growing sectors in
the financial services industry. According to U.S. Federal Reserve "Flow of
Funds Account" data, from 1991-1997, mutual fund assets under management
(excluding money market funds) grew at a compound annual growth rate of
approximately 24.3%, while the aggregate assets managed on behalf of pension
funds increased at a compound annual growth rate of approximately 11.5%. These
assets, which totaled over $9.5 trillion in 1997, represent only a portion of
the funds available for investment management. In addition, substantial assets
are managed on behalf of individuals in separate accounts, for foundations and
endowments, as a portion of certain insurance contracts such as variable annuity
plans and on behalf of corporations and other financial intermediaries. We
believe that demographic trends and the ongoing disintermediation of bank
deposits and life insurance reserves will result in continued growth of the
investment management industry.
INVESTMENT ADVISERS
The growth in industry assets under management has resulted in a significant
increase in the number of investment management firms within our principal
targeted size range of $500 million to $10 billion of assets under management.
Within this size range, we have identified over 1,300 investment management
firms in the United States, Canada and the United Kingdom. We believe that, in
the coming years, a substantial number of investment opportunities will arise as
founders of such firms approach retirement age and begin to plan for succession.
We also anticipate that there will be significant additional investment
opportunities among firms which are currently wholly-owned by larger entities.
We believe that we are well positioned to take advantage of these investment
opportunities because we have a management team with substantial industry
experience and expertise in structuring and negotiating transactions, as well as
a highly organized process for identifying and contacting investment prospects.
COMPETITION
We operate as an asset management holding company organized to invest in
mid-sized investment management firms. We are aware of several other holding
companies that have been organized to invest in or acquire investment management
firms and we view these firms as among our competitors. We believe that the
market for investments in asset management companies is and will continue to
remain highly competitive. We compete with many purchasers of investment
management firms, including other investment management holding companies,
insurance companies, broker-dealers, banks and private equity firms. Many of
these companies, both privately and publicly held, have longer operating
histories and greater resources than we do, which may make them more attractive
to the owners of firms in which we are considering an investment and may enable
them to offer greater consideration to such owners. Certain of our principal
stockholders also pursue investments in, and acquisitions of, investment
management firms, and we may, from time to time, encounter competition from such
principal stockholders with respect to certain investments. We believe that
important factors affecting our ability to compete for future investments are
(i) the degree to which target firms view our investment structure as
preferable, financially and operationally, to acquisition or investment
arrangements offered by other potential purchasers, and (ii) the reputation and
performance of the existing and future affiliates, by which target firms will
judge us and our future prospects.
Our affiliates compete with a large number of domestic and foreign
investment management firms, including public companies, subsidiaries of
commercial banks, and insurance companies. Many of these firms have greater
resources and assets under management than any of our affiliates, and offer a
broader array of investment products and services than any of our affiliates.
From time to time, our affiliates may also compete with each other for clients.
In addition, there are relatively few barriers to entry by new
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investment management firms, especially in the institutional managed accounts
business. We believe that the most important factors affecting our affiliates'
ability to compete for clients are (i) the products offered, (ii) the abilities,
performance records and reputation of the particular affiliate and its
management team, (iii) the management fees charged, (iv) the level of client
service offered, and (v) the development of new investment strategies and
marketing. The importance of these factors can vary depending on the type of
investment management service involved. Each affiliate's ability to retain and
increase assets under management would be adversely affected if client accounts
underperform in comparison to relevant benchmarks, or if key management or
employees leave the affiliate. The ability of each affiliate to compete with
other investment management firms is also dependent, in part, on the relative
attractiveness of its investment philosophies and methods under then prevailing
market conditions.
GOVERNMENT REGULATION
Our affiliates' businesses are highly regulated, primarily by U.S. federal
authorities and to a lesser extent by other authorities including non-U.S.
authorities. The failure of our affiliates to comply with laws or regulations
could result in fines, suspensions of individual employees or other sanctions,
including revocation of an affiliate's registration as an investment adviser,
commodity trading advisor or broker/ dealer. Each of our affiliates (other than
First Quadrant Limited) is registered as an investment adviser with the
Securities and Exchange Commission under the Investment Advisers Act of 1940, as
amended (the "Investment Advisers Act"), and is subject to the provisions of the
Investment Advisers Act and related regulations. The Investment Advisers Act
requires registered investment advisers to comply with numerous obligations,
including record keeping requirements, operational procedures and disclosure
obligations. Each of our affiliates (other than First Quadrant Limited) is also
subject to regulation under the securities laws and fiduciary laws of several
states. Moreover, some of our affiliates, including Tweedy, Browne and Skyline,
act as advisers or subadvisers to mutual funds which are registered with the
Securities and Exchange Commission pursuant to the Investment Company Act of
1940, as amended (the "1940 Act"). As an adviser or subadviser to a registered
investment company, each of these affiliates must comply with the requirements
of the 1940 Act and related regulations. In addition, an adviser or subadviser
to a registered investment company generally has obligations with respect to the
qualification of the registered investment company under the Internal Revenue
Code of 1986, as amended.
Our affiliates are also subject to the Employee Retirement Income Security
Act of 1974 ("ERISA"), and related regulations, to the extent they are
"fiduciaries" under ERISA with respect to some of their clients. ERISA and
related provisions of the Internal Revenue Code of 1986, as amended, impose
duties on persons who are fiduciaries under ERISA, and prohibit some
transactions involving the assets of each ERISA plan which is a client of an
affiliate, as well as some transactions by the fiduciaries (and several other
related parties) to such plans. Two of our affiliates, First Quadrant and
Renaissance, are also registered with the Commodity Futures Trading Commission
as Commodity Trading Advisors and are members of the National Futures
Association. Finally, Tweedy, Browne is registered under the Exchange Act as a
broker/dealer and, therefore, is subject to extensive regulation relating to
sales methods, trading practices, the use and safekeeping of customers' funds
and securities, capital structure, record keeping and the conduct of directors,
officers and employees.
Furthermore, the Investment Advisers Act and the 1940 Act provide that each
investment management contract under which our affiliates manage assets for
other parties either terminates automatically if assigned, or must state that it
is not assignable without consent. In general, the term "assignment" includes
not only direct assignments, but also indirect assignments which may be deemed
to occur upon the direct or indirect transfer of a "controlling block" of our
voting securities or the voting securities of one of our affiliates. The 1940
Act provides that all investment contracts with mutual fund clients may be
terminated by such clients, without penalty, upon no later than 60 days' notice.
Several of our affiliates are also subject to the laws of non-U.S.
jurisdictions and non-U.S. regulatory agencies. For example, First Quadrant
Limited, located in London, is a member of the Investment
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Management Regulatory Organisation of the United Kingdom, and some of our other
affiliates are investment advisers to funds which are organized under non-U.S.
jurisdictions, including Luxembourg (where the funds are regulated by the
Institute Monetaire Luxembourgeois) and Bermuda (where the funds are regulated
by the Bermuda Monetary Authority).
We anticipate that, subject to a fulfillment of certain conditions, we will
complete our acquisition of The Managers Funds LLC in April 1999. The Managers
Funds LLC will serve as an investment adviser to a family of mutual funds and
also be registered as a broker-dealer, and, as such, will be subject to the
investment adviser, investment company and broker-dealer regulations described
above.
The foregoing laws and regulations generally grant supervisory agencies and
bodies broad administrative powers, including the power to limit or restrict any
of the affiliates from conducting their business in the event that they fail to
comply with such laws and regulations. Possible sanctions that may be imposed in
the event of such noncompliance include the suspension of individual employees,
limitations on the affiliate's business activities for specified periods of
time, revocation of the affiliate's registration as an investment adviser,
commodity trading adviser and/or other registrations, and other censures and
fines. Changes in these laws or regulations could have a material adverse impact
on our profitability and mode of operations.
Our officers, directors and employees and the officers and employees of each
of the affiliates may own securities that are also owned by one or more of the
affiliates' clients. We and each affiliate have internal policies with respect
to individual investments and require reports of securities transactions and
restrict certain transactions so as to minimize possible conflicts of interest.
EMPLOYEES
As of December 31, 1998, we had 17 employees and our affiliates employed
approximately 412 persons, approximately 410 of which were full-time employees.
Neither we nor any of our affiliates is subject to any collective bargaining
agreements and we believe that our labor relations are good.
CORPORATE LIABILITY AND INSURANCE
Our affiliates' operations entail the inherent risk of liability related to
litigation from clients and actions taken by regulatory agencies. In addition,
we face liability both directly as a control person of our affiliates, and
indirectly as a direct or indirect general partner of certain of our affiliates.
To protect our overall operations from such liability, we maintain errors and
omissions and general liability insurance in amounts which we and our affiliates
consider appropriate. There can be no assurance, however, that a claim or claims
will not exceed the limits of available insurance coverage, that any insurer
will remain solvent and will meet its obligations to provide coverage, or that
such coverage will continue to be available with sufficient limits or at a
reasonable cost. A judgment against one of our affiliates in excess of available
coverage could have a material adverse effect on us.
CAUTIONARY STATEMENTS
Our growth strategy includes acquiring ownership interests in mid-sized
investment management firms. To date, we have invested in 13 such firms. We
intend to continue this investment program in the future, assuming that we can
find suitable firms to invest in and that we can negotiate agreements on
acceptable terms. We cannot be certain that we will be successful in finding or
investing in such firms or that they will have favorable operating results.
We have been in operation for five years and had net losses in the first
four years. To date, our growth has come mostly from making new investments.
However, the performance of our existing affiliates is becoming increasingly
important to our growth. We may not be successful in making new investments and
the firms we invest in may fail to carry out their growth or management
succession plans. As we continue
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to execute our business strategy, we may experience net losses in the future,
which could have an adverse effect on our financial condition and prospects.
A large part of the purchase price we pay for the firms in which we invest
usually consists of cash. We believe that our existing cash resources and cash
flow from operations will be sufficient to meet our working capital needs for
normal operations for the foreseeable future. However, we expect that these
sources of capital will not be sufficient to fund anticipated investments in
firms. Therefore, we will need to raise capital by making additional long-term
or short-term borrowings or by selling shares of our stock, either publicly or
privately, in order to complete further investments. This could increase our
interest expense, decrease our net income or dilute the interests of our
existing shareholders. Moreover, we may not be able to obtain financing for
future investments on acceptable terms, if at all.
On March 3, 1999 we completed our second public offering of Common Stock
which generated $102.3 million of net proceeds which was used to repay
indebtedness. After the application of these proceeds we had $156.2 million of
outstanding debt and $173.8 million available to borrow under our credit
facility. We can use borrowings under our credit facility for future investments
and for our working capital needs only if we continue to meet the financial
tests under the terms of our credit facility. We may also expand our credit
facility by an additional $70 million with the consent of our lenders. We
anticipate that we will borrow more in the future when we invest in investment
management firms. This will subject us to the risks normally associated with
debt financing.
Our credit facility contains provisions for the benefit of our lenders which
could operate in ways that restrict the manner in which we can conduct our
business or may have an adverse impact on the interests of our stockholders. For
example:
- Our borrowings under the credit facility are collateralized by pledges of
all of our interests in our affiliates (including all interests indirectly
held through wholly-owned subsidiaries).
- Our credit facility contains, and future debt instruments may contain,
restrictive covenants that could limit our ability to obtain additional
debt financing and could adversely affect our ability to make future
investments in investment management firms.
- Our credit facility prohibits us from paying dividends and other
distributions to our stockholders and restricts us, our affiliates and any
other subsidiaries we may have from incurring indebtedness, incurring
liens, disposing of assets and engaging in extraordinary transactions. We
are also required to comply with the credit facility's financial covenants
on an ongoing basis.
- We cannot borrow under our credit facility unless we comply with its
requirements.
Because indebtedness under our credit facility bears interest at variable
rates, interest rate increases will increase our interest expense, which could
adversely affect our cash flow and ability to meet our debt service obligations.
Although we have entered into interest rate "hedging" contracts designed to
offset a portion of our exposure to interest rate fluctuations above specified
levels, we cannot be certain that this strategy will be effective. If prevailing
interest rates drop below levels set in our hedging contracts, we may have to
pay higher interest rates under the hedging contracts than would otherwise apply
under the actual indebtedness.
At December 31, 1998, our total assets were $605.3 million, of which $490.5
million were intangible assets consisting of acquired client relationships and
goodwill. We cannot be certain that we will ever realize the value of such
intangible assets. We are amortizing (writing off) these intangible assets on a
straight-line basis over periods ranging from nine to 28 years in the case of
acquired client relationships and 15 to 35 years in the case of goodwill. Pro
forma for all investments in our affiliates to date, amortization of intangible
assets, including goodwill, would have resulted in a charge to operations of
$21.3 million for the year ended December 31, 1998.
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We evaluate each investment and establish appropriate amortization periods
based on a number of factors including:
- the firm's historical and potential future operating performance and rate
of attrition among clients,
- the stability and longevity of existing client relationships,
- the firm's recent, as well as long-term, investment performance,
- the characteristics of the firm's products and investment styles,
- the stability and depth of the firm's management team, and
- the firm's history and perceived franchise or brand value.
After making each investment, we reevaluate these and other factors on a
regular basis to determine if the related intangible assets continue to be
realizable and if the amortization period continues to be appropriate. In 1995
and 1996, our reevaluations resulted in the write-off of approximately $2.5
million and $4.6 million of unamortized goodwill, respectively.
Any future determination requiring the write-off of a significant portion of
unamortized intangible assets could adversely affect our results of operations
and financial position. In addition, we intend to invest in additional
investment management firms in the future. While these firms may contribute
additional revenue to us, they will also result in the recognition of additional
intangible assets which will cause further increases in amortization expense.
The Financial Accounting Standards Board ("FASB") is currently considering a
new approach for all companies that would require all purchased goodwill to be
amortized on a straight-line basis over its useful life, not to exceed 20 years.
The FASB is also considering an approach in which the useful life of goodwill
would be presumed to be 10 years or less, unless sufficient evidence supports a
longer life, not to exceed 20 years. It is not certain whether the FASB's new
approach would apply only to newly purchased goodwill or whether it would apply
to both previously recorded and newly purchased goodwill, however, the FASB
voted to grandfather the accounting for goodwill recorded prior to the effective
date of the final statement in the first quarter of 1999. The final statement on
this issue, which is expected to be issued in the fourth quarter of 2000, may
present a different approach.
We currently amortize goodwill purchased in our 13 investments on a straight
line basis ranging from 15 to 35 years. Any changes in generally accepted
accounting principles ("GAAP") that reduce the period over which we may amortize
goodwill may have an adverse effect on our acquisition strategy and our
financial results. A shorter goodwill amortization period would increase annual
amortization expense and reduce our net income over the amortization period.
We depend on the efforts of William J. Nutt, our President and Chief
Executive Officer, Sean M. Healey, our Executive Vice President, and our other
officers. Messrs. Nutt and Healey, in particular, play an important role in
identifying suitable investment opportunities for us. Messrs. Nutt and Healey do
not have employment agreements with us, although each of them has a significant
equity interest in us (including options subject to vesting provisions).
In addition, Tweedy, Browne, our largest affiliate based on revenue, depends
heavily on the services of Christopher H. Browne, William H. Browne and John D.
Spears. These individuals have managed Tweedy, Browne for over 20 years and are
primarily responsible for all of that firm's investment decisions. Although each
of these individuals has entered into an employment agreement with Tweedy,
Browne providing for continued employment until October 2007, these employment
agreements are not a guarantee that these individuals will remain with Tweedy,
Browne until that date.
Our loss of key management personnel or our inability to attract, retain and
motivate sufficient numbers of qualified management personnel may adversely
affect our business. The market for investment
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managers is extremely competitive and is increasingly characterized by frequent
movement by investment managers among different firms. In addition, because
individual investment managers at our affiliates often maintain a strong,
personal relationship with their clients based on the clients' trust in
individual managers, the loss of a key investment manager at an affiliate could
jeopardize the affiliate's relationships with its clients and lead to the loss
of client accounts. Losing client accounts in these circumstances could have a
material adverse effect on the results of our operations and our financial
condition and that of our affiliates. Although we use a combination of economic
incentives, vesting provisions, and, in some instances, non-solicitation
agreements and employment agreements in an attempt to retain key management
personnel, we cannot guarantee that key managers will remain with us.
Because our affiliates offer a broad range of investment management services
and utilize a number of distribution channels, changing conditions in the
financial and securities markets directly affect our performance.
The financial markets and the investment management industry in general have
experienced both record performance and record growth in recent years. For
example, between January 1, 1995 and December 31, 1998, the S&P 500 Index
appreciated at a compound annual rate of approximately 30.5% and the aggregate
assets under management of mutual and pension funds grew at a compound annual
rate of 20.7% during 1995-1997, according to the Federal Reserve Board and the
Investment Company Institute. Domestic and foreign economic conditions and
general trends in business and finance, among other factors, affect the
financial markets and businesses operating in the securities industry. We cannot
guarantee that broader market performance will be favorable in the future. Any
decline in the financial markets or a lack of sustained growth may result in a
corresponding decline in our affiliates' performance and may cause our
affiliates to experience declining assets under management and/or fees, which
would reduce cash flow distributable to us.
Our investment in Tweedy, Browne represents our single largest investment to
date, with a purchase price of $300 million. Tweedy, Browne's revenues
represented 28% of our pro forma revenues for 1998. Poor financial performance
by Tweedy, Browne would have an adverse effect on our consolidated results of
operations and financial condition.
Our affiliates derive almost all of their revenues from investment
management contracts. These contracts are typically terminable without penalty
upon 60 days' notice in the case of mutual fund clients or upon 30 days' notice
in the case of individual and institutional clients. As a result, our
affiliates' clients may withdraw funds from accounts managed by the affiliates
at their election. In addition, these contracts generally provide for payment
based on the market value of assets under management, although a portion also
provide for payment based on investment performance. Because most of these
contracts provide for payments based on market values of securities,
fluctuations in securities prices will directly affect our consolidated results
of operations and financial condition. Changes in our clients' investment
patterns will also affect the total assets under management. Moreover, some of
our affiliates' fees are higher than those of other investment managers for
similar types of investment services. The ability of each of our affiliates to
maintain its fee levels in a competitive environment depends on its ability to
provide clients with investment returns and services which are satisfactory to
its clients. We cannot be certain that our affiliates will be able to retain
their existing clients or to attract new clients at their current fee levels.
Because we are a holding company, we receive all of our cash from
distributions made to us by our affiliates. All of our affiliates have entered
into agreements with us pursuant to which they have agreed to pay to us a
specified percentage of their gross revenues on a quarterly basis. In our
agreements with our affiliates, the distributions made to us by our affiliates
represent only a portion of our affiliates' gross revenues. Our affiliates use
the portion of their revenues not required to be distributed to us to pay their
operating expenses and distributions to their management teams. The payment of
distributions to us by our affiliates may be subject to the claims of our
affiliates' creditors and to limitations applicable to our affiliates under
state laws governing corporations, partnerships and limited liability companies,
state and
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federal regulatory requirements for the securities industry and bankruptcy and
insolvency laws. As a result, we cannot guarantee that our affiliates will
always make these distributions. See "Business--Our Structure and Relationship
with Affiliates--Revenue Sharing Arrangements".
When we made our original investments in our affiliates, we agreed to
purchase the additional ownership interests in each affiliate from the owners of
these interests on pre-negotiated terms which are subject to several conditions
and limitations. Consequently, we may have to purchase some of these interests
from time to time for cash (which we may have to borrow) or in exchange for
newly issued shares of our Common Stock. These purchases may result in us having
more interest expense and less net income or in our existing stockholders
experiencing a dilution of their ownership of us. In addition, these purchases
may result in our ownership of larger portions of our affiliates, which may have
an adverse effect on our cash flow and liquidity. See "Business--Our Structure
and Relationship with Affiliates--Our Purchase of Additional Interests in Our
Existing Affiliates".
Although our agreements with our affiliates give us the authority to control
some types of business activities undertaken by them and we have voting rights
with respect to significant decisions, our affiliates manage and control their
own day-to-day operations, including all investment management policies and fee
levels, product development, client relationships, compensation programs and
compliance activities. As a result, we may not become aware, for example, of one
of our affiliates' non-compliance with a regulatory requirement as quickly as if
we were involved in the day-to-day business of the affiliate or we may not
become aware of such non-compliance. In situations such as the preceding
example, our financial condition and results of operations may be adversely
affected by problems stemming from the day-to-day operations of our affiliates.
See "Business--Government Regulation". In addition, because our affiliates
conduct their own marketing and client relations, they may from time to time
compete with each other for clients. See "Business--Our Structure and
Relationship with Affiliates".
Some of our existing affiliates are partnerships of which we are the general
partner. Consequently, to the extent any of these affiliates incurs liabilities
or expenses which exceed its ability to pay for them, we are liable for their
payment. In addition, with respect to all of our affiliates we may be held
liable in some circumstances as a control person for their acts as well as those
of their employees. We and our affiliates maintain errors and omissions and
general liability insurance in amounts which we and they believe to be adequate
to cover any potential liabilities. We cannot be certain, however, that we will
not have claims which exceed the limits of our available insurance coverage,
that our insurers will remain solvent and will meet their obligations to provide
coverage, or that insurance coverage will continue to be available to us with
sufficient limits or at a reasonable cost. A judgment against us or any of our
affiliates in excess of our available coverage could have a material adverse
effect on us.
We are an asset management holding company which invests in mid-sized
investment management firms. The market for partial or total acquisitions of
interests in investment management firms is highly competitive. We have several
competitors which are also set up as holding companies and invest in or buy
investment management firms. In addition, many other public and private
companies, including commercial and investment banks, insurance companies and
investment management firms, most of which have longer operating histories and
significantly greater resources than us, invest in or buy investment management
firms. Moreover, some of our principal stockholders also invest in or buy
investment management firms and may compete with us as we pursue additional
investments. We cannot guarantee that we will be able to compete effectively
with such competitors, that new competitors will not enter the market or that
such competition will not make it more difficult or impracticable for us to make
new investments in investment management firms.
The investment management business is also highly competitive. Our
affiliates compete with a broad range of investment managers, including public
and private investment advisers as well as firms associated with securities
broker-dealers, banks, insurance companies and other entities. From time to
time, our affiliates may also compete with each other for clients. Many of our
affiliates' competitors have greater
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resources than do we and our affiliates. In addition to competing directly for
clients, competition may reduce the fees that our affiliates can obtain for
their services. We believe that each of our affiliate's ability to compete
effectively with other firms is dependent upon the affiliate's products, level
of investment performance and client service, as well as the marketing and
distribution of its investment products. We cannot be certain that our
affiliates will be able to achieve favorable investment performance and retain
their existing clients.
Some of our affiliates operate or advise clients outside of the United
States. Furthermore, in the future we may invest in other investment management
firms which operate or advise clients outside of the United States and our
existing affiliates may expand their non-U.S. operations. Our affiliates take
risks inherent in doing business internationally, such as changes in applicable
laws and regulatory requirements, difficulties in staffing and managing foreign
operations, longer payment cycles, difficulties in collecting investment
advisory fees receivable, political instability, fluctuations in currency
exchange rates, expatriation controls and potential adverse tax consequences. We
cannot be certain that one or more of these risks will not have an adverse
effect on our affiliates, including investment management firms in which we may
invest in the future, and, consequently, on our consolidated business, financial
condition and results of operations.
Many aspects of our affiliates' businesses are subject to extensive
regulation by varying U.S. federal regulatory authorities, certain state
regulatory authorities, and non-U.S. regulatory authorities. There is no
assurance that our affiliates will fulfill all applicable regulatory
requirements. The failure of any affiliate to meet regulatory requirements could
subject such affiliate to sanctions which might materially impact the
affiliate's business and our business. For further information concerning the
regulations to which we and our Affiliates are subject, see
"Business--Government Regulation".
The "Year 2000" poses a concern to our business as a result of the fact that
computer applications have historically used the last two digits, rather than
all four digits, to store year data. If left unmodified, these applications
would misinterpret the year 2000 for the year 1900 and would in many cases be
unable to function properly in the Year 2000 and beyond. We cannot be certain
that we or our affiliates will not encounter unforeseen delays or costs in
completing preparations for the Year 2000. For further information concerning
the Year 2000, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Year 2000".
Several provisions of our Amended and Restated Certificate of Incorporation,
our Amended and Restated By-laws and Delaware law may, together or separately,
prevent a transaction which is beneficial to our stockholders from occurring.
These provisions may discourage potential purchasers from presenting acquisition
proposals, delay or prevent potential purchasers from acquiring a controlling
interest in us, block the removal of incumbent directors or limit the price that
potential purchasers might be willing to pay in the future for shares of our
Common Stock. These provisions include the issuance, without further stockholder
approval, of preferred stock with rights and privileges which could be senior to
the Common Stock. We are also subject to Section 203 of the Delaware General
Corporation Law which, subject to a few exceptions, prohibits a Delaware
corporation from engaging in any of a broad range of business combinations with
any "interested stockholder" for a period of three years following the date that
such stockholder became an interested stockholder.
We have never declared or paid a cash dividend on our Common Stock. We
intend to retain earnings to repay debt and to finance the growth and
development of our business and do not anticipate paying cash dividends on our
Common Stock in the foreseeable future. Any declaration of cash dividends in the
future will depend, among other things, upon our results of operations,
financial condition and capital requirements as well as general business
conditions. Our credit facility also contains restrictions which prohibit us
from making dividend payments to our stockholders. See "Market for Registrant's
Common Equity and Related Stockholder Matters".
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The market price of our Common Stock has historically experienced and may
continue to experience high volatility. Our quarterly operating results, changes
in general conditions in the economy or the financial markets and other
developments affecting us or our competitors could cause the market price of our
Common Stock to fluctuate substantially. In addition, in recent years, the stock
market has experienced significant price and volume fluctuations. This
volatility has affected the market prices of securities issued by many companies
for reasons unrelated to their operating performance and may adversely affect
the price of our Common Stock.
If our stockholders sell substantial amounts of our Common Stock (including
shares issued upon the exercise of outstanding options) in the public market,
the market price of our Common Stock could fall. Such sales may also make it
more difficult for us to sell equity or equity-related securities in the public
market in the future at a time and at a price that we deem appropriate.
In addition, we have registered for resale the 1,750,000 shares of our
Common Stock reserved for issuance under our stock plans. As of December 31,
1998, options to purchase 1,171,750 shares of our Common Stock were outstanding
and will be eligible for sale in the public market from time to time subject to
vesting and, in the case of some stock options, the expiration of lock-up
agreements. The possible sale of a significant number of the shares may cause
the price of our Common Stock to fall.
In addition, the holders of certain shares of our Common Stock have the
right in some circumstances to require us to register their shares under the
Securities Act of 1933, as amended (the "Securities Act") for resale to the
public, while those holders as well as others have the right to include their
shares in any registration statement filed by us.
In addition, some of the managers of our affiliates have the right under
some circumstances to exchange portions of their interests in our affiliates for
shares of our Common Stock. Some of these managers also have the right to
include these shares in a registration statement filed by us under the
Securities Act. By exercising their registration rights and causing a large
number of shares to be sold in the public market, these holders may cause the
price of our Common Stock to fall. In addition, any demand to include shares in
our registration statements could have an adverse effect on our ability to raise
needed capital.
ITEM 2. PROPERTIES
Our executive offices are located at Two International Place, 23rd Floor,
Boston, Massachusetts 02110. In Boston, we occupy 8,047 square feet under a
lease that expires in March 2003. Each of our affiliates also leases office
space in the city or cities in which it conducts business.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we and our affiliates may be parties to various claims,
suits and complaints. Currently, there are no such claims, suits or complaints
that, in our opinion, would have a material adverse effect on our financial
position, liquidity or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth
quarter of the year covered by this Annual Report on Form 10-K.
20
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is traded on the New York Stock Exchange (symbol: AMG). The
following table sets forth the high and low closing prices as reported on the
New York Stock Exchange composite tape since our initial public offering on
November 21, 1997.
<TABLE>
<CAPTION>
HIGH LOW
-------- ---------
<S> <C> <C>
1998
First Quarter.......................................................... $37 3/16 $27 1/4
Second Quarter......................................................... 39 3/16 34 1/16
Third Quarter.......................................................... 37 7/16 13 11/16
Fourth Quarter......................................................... 30 3/4 13 11/16
1997
Fourth Quarter (since November 21, 1997)............................... $29 7/8 $24
</TABLE>
The closing price for the shares on the New York Stock Exchange on March 26,
1999 was $24 5/8.
As of December 31, 1998 there were 95 stockholders of record. As of March
26, there were 119 stockholders of record.
We have not declared a dividend with respect to the periods presented. We
intend to retain earnings to repay debt and to finance the growth and
development of our business and do not anticipate paying cash dividends on our
Common Stock in the foreseeable future. Our credit facility also prohibits us
from making dividend payments to our stockholders. See "Management's Discussion
and Analysis of Financial Condition and Results of Operation--Liquidity and
Capital Resources".
21
<PAGE>
ITEM 6. SELECTED HISTORICAL FINANCIAL DATA
Set forth below are selected financial data for the five years since
inception, December 29, 1993. This data should be read in conjunction with, and
is qualified in its entirety by reference to, the financial statements and
accompanying notes included elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ----------
(DOLLARS IN THOUSANDS, EXCEPT AS INDICATED AND PER
SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues............................. $ 5,374 $ 14,182 $ 50,384 $ 95,287 $ 238,494
Operating expenses:
Compensation and related
expenses........................... 3,591 6,018 21,113 41,619 87,669
Amortization of intangible
assets............................. 774 4,174 8,053 6,643 17,417
Depreciation and other
amortization....................... 19 133 932 1,915 2,707
Other operating expenses........... 1,000 2,567 13,115 22,549 37,921
--------- --------- --------- --------- ----------
Total operating expenses......... 5,384 12,892 43,213 72,726 145,714
--------- --------- --------- --------- ----------
Operating income (loss).............. (10) 1,290 7,171 22,561 92,780
Non-operating (income) and expenses:
Investment and other income........ (966) (265) (337) (1,174) (2,251)
Interest expense................... 158 1,244 2,747 8,479 13,603
--------- --------- --------- --------- ----------
(808) 979 2,410 7,305 11,352
--------- --------- --------- --------- ----------
Income before minority interest,
income taxes and extraordinary
item............................... 798 311 4,761 15,256 81,428
Minority interest(1)................. (305) (2,541) (5,969) (12,249) (38,843)
--------- --------- --------- --------- ----------
Income (loss) before income taxes and
extraordinary item................. 493 (2,230) (1,208) 3,007 42,585
Income taxes......................... 699 706 181 1,364 17,034
--------- --------- --------- --------- ----------
Income (loss) before extraordinary
item............................... (206) (2,936) (1,389) 1,643 25,551
--------- --------- --------- --------- ----------
Extraordinary item................... -- -- (983) (10,011) --
--------- --------- --------- --------- ----------
Net income (loss).................... $ (206) $ (2,936) $ (2,372) $ (8,368) $ 25,551
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Net income (loss) per share--basic... $ (0.07) $ (2.95) $ (5.49) $ (3.69) $ 1.45
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Net income (loss) per
share--diluted..................... $ (0.07) $ (2.95) $ (5.49) $ (1.02) $ 1.33
--------- --------- --------- --------- ----------
Average shares outstanding--basic.... 3,030,548 996,144 431,908 2,270,684 17,582,900
Average shares
outstanding--diluted............... 3,030,548 996,144 431,908 8,235,529 19,222,831
OTHER FINANCIAL DATA
Assets under management (at period
end, in millions).................. $ 755 $ 4,615 $ 19,051 $ 45,673 $ 57,731
EBITDA(2)............................ 1,444 3,321 10,524 20,044 76,312
EBITDA as adjusted(3)................ 587 1,371 7,596 10,201 45,675
Cash flow from operating
activities......................... 818 1,292 6,185 16,205 45,424
Cash flow used in investing
activities......................... (6,156) (37,781) (29,210) (327,275) (72,665)
Cash flow from financing
activities......................... 9,509 46,414 15,650 327,112 28,163
BALANCE SHEET DATA
Current assets....................... $ 4,791 $ 16,847 $ 23,064 $ 52,058 $ 95,811
Acquired client relationships, net... 3,482 18,192 30,663 142,875 169,065
Goodwill, net........................ 5,417 26,293 40,809 249,698 321,409
Total assets......................... 13,808 64,699 101,335 456,990 605,334
Current liabilities.................. 2,021 4,111 23,591 18,815 64,617
Senior debt.......................... -- 18,400 33,400 159,500 190,500
Total liabilities.................... 3,925 26,620 60,856 180,771 267,531
Minority interest(1)................. 80 1,212 3,490 16,479 24,148
Preferred stock...................... 10,004 40,008 42,476 -- --
Stockholders' equity................. 9,803 36,867 36,989 259,740 313,655
</TABLE>
- - ------------------------
(1) All but one of our affiliates are majority-owned subsidiaries (we own less
than a 50% interest in Paradigm). Minority interest consists of that portion
of each affiliate's operating results and net assets that are owned by
minority owners and is reflected as a reduction of net income and
stockholders' equity, respectively.
(2) As defined by Note (2) on page 11.
(3) As defined by Note (3) on page 11.
22
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD-LOOKING STATEMENTS
WHEN USED IN THIS FORM 10-K AND IN OUR FUTURE FILINGS WITH THE SECURITIES
AND EXCHANGE COMMISSION, IN OUR PRESS RELEASES AND IN ORAL STATEMENTS MADE WITH
THE APPROVAL OF AN AUTHORIZED EXECUTIVE OFFICER, THE WORDS OR PHRASES "WILL
LIKELY RESULT", "ARE EXPECTED TO", "WILL CONTINUE", "IS ANTICIPATED",
"BELIEVES", "ESTIMATE", "PROJECT" OR SIMILAR EXPRESSIONS ARE INTENDED TO
IDENTIFY "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. SUCH STATEMENTS ARE SUBJECT TO CERTAIN
RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED UNDER THE CAPTION
"BUSINESS-CAUTIONARY STATEMENTS" THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM HISTORICAL EARNINGS AND THOSE PRESENTLY ANTICIPATED OR
PROJECTED. WE WISH TO CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE MADE. WE WISH TO
ADVISE READERS THAT THE FACTORS UNDER THE CAPTION "BUSINESS--CAUTIONARY
STATEMENTS" COULD AFFECT OUR FINANCIAL PERFORMANCE AND COULD CAUSE OUR ACTUAL
RESULTS FOR FUTURE PERIODS TO DIFFER MATERIALLY FROM ANY OPINIONS OR STATEMENTS
EXPRESSED WITH RESPECT TO FUTURE PERIODS IN ANY CURRENT STATEMENTS.
IN ADDITION, THE DISCUSSION AND ANALYSIS WITH RESPECT TO THE YEAR 2000 ISSUE
IN THIS FORM 10-K, INCLUDING (i) OUR EXPECTATIONS OF WHEN YEAR 2000 COMPLIANCE
WILL ACTUALLY BE ACHIEVED, (ii) ESTIMATES OF THE COSTS INVOLVED IN ACHIEVING
YEAR 2000 READINESS AND (iii) OUR BELIEF THAT THE COSTS WILL NOT BE MATERIAL TO
OPERATING RESULTS, ARE BASED ON MANAGEMENT'S ESTIMATES WHICH, IN TURN, ARE BASED
UPON A NUMBER OF ASSUMPTIONS REGARDING FUTURE EVENTS, INCLUDING THIRD PARTY
MODIFICATION PLANS AND THE AVAILABILITY OF CERTAIN RESOURCES. THERE CAN BE NO
GUARANTEE THAT THESE ESTIMATES WILL BE ACHIEVED, AND ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM MANAGEMENT'S ESTIMATES. SPECIFIC FACTORS WHICH MIGHT CAUSE SUCH
MATERIAL DIFFERENCES WITH RESPECT TO THE YEAR 2000 ISSUE INCLUDE, BUT ARE NOT
LIMITED TO, THE FAILURE OF THIRD PARTY PROVIDERS TO ACHIEVE REPRESENTED OR
STATED LEVELS OF YEAR 2000 COMPLIANCE, AVAILABILITY AND COST OF PERSONNEL
TRAINED IN THIS AREA, THE ABILITY TO LOCATE AND CORRECT ALL RELEVANT COMPUTER
CODES, AND SIMILAR UNCERTAINTIES.
WE WILL NOT UNDERTAKE AND WE SPECIFICALLY DISCLAIM ANY OBLIGATION TO RELEASE
PUBLICLY THE RESULT OF ANY REVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING
STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS
OR TO REFLECT THE OCCURRENCE OF EVENTS, WHETHER OR NOT ANTICIPATED.
OVERVIEW
We acquire equity interests in mid-sized investment management firms and
currently derive all of our revenues from those firms. We refer to firms in
which we have purchased less than 100% (typically less than 80%) as our
"affiliates". We hold investments in 13 affiliates that managed $62.1 billion in
assets at December 31, 1998. Our most recent affiliate investments were in Essex
(March 1998), DHJA (December 1998) and Rorer (January 1999). On January 29,
1999, we entered into a definitive agreement to acquire substantially all of the
partnership interests in the Managers Funds, L.P. ("Managers"), which serves as
the adviser to a family of ten equity and fixed income no-load mutual funds.
These mutual funds had a total of $1.8 billion in assets under management at
December 31, 1998.
We have a revenue sharing arrangement with each of our affiliates which
allocates a specified percentage of revenues (typically 50-70%) for use by
management of that affiliate in paying operating expenses, including salaries
and bonuses (the "Operating Allocation"). The remaining portion of revenues of
the affiliate, typically 30-50% (the "Owners' Allocation"), is allocated to the
owners of that affiliate (including AMG), generally in proportion to their
ownership of the affiliate. One of the purposes of our revenue sharing
arrangements is to provide ongoing incentives for the managers of the affiliates
by allowing them:
- to participate in their firm's growth through their compensation from the
Operating Allocation,
- to receive a portion of the Owners' Allocation based on their ownership
interest in the affiliate, and
- to control operating expenses, thereby increasing the portion of the
Operating Allocation which is available for growth initiatives and bonuses
for management of the affiliate.
The managers of each affiliate, therefore, have an incentive to both
increase revenues (thereby increasing the Operating Allocation and their Owners'
Allocation) and to control expenses (thereby increasing the excess Operating
Allocation).
23
<PAGE>
The revenue sharing arrangements allow us to participate in the revenue
growth of each affiliate because we receive a portion of the additional revenue
as our share of the Owners' Allocation. However, we participate in that growth
to a lesser extent than the managers of the affiliate, because we do not share
in the growth of the Operating Allocation.
Under the organizational documents of the affiliates, the allocations and
distributions of cash to us generally take priority over the allocations and
distributions to the management owners of the affiliates. This further protects
us if there are any expenses in excess of the Operating Allocation of an
affiliate. Thus, if an affiliate's expenses exceed its Operating Allocation, the
excess expenses first reduce the portion of the Owners' Allocation allocated to
the affiliate's management owners, until that portion is eliminated, and then
reduce the portion allocated to us.
The portion of each affiliate's revenues which is included in its Operating
Allocation and retained by it to pay salaries, bonuses and other operating
expenses, as well as the portion of each affiliate's revenues which is included
in its Owners' Allocation and distributed to us and the other owners of the
affiliate, are both included as "revenues" on our Consolidated Statements of
Operations. The expenses of each affiliate which are paid out of the Operating
Allocation, as well as our holding company expenses which we pay out of the
amounts of the Owners' Allocation which we receive from the affiliates, are both
included in "operating expenses" on our Consolidated Statements of Operations.
The portion of each affiliate's Owners' Allocation which is allocated to owners
of the affiliates other than us is included in "minority interest" on our
Consolidated Statements of Operations.
The EBITDA Contribution of an affiliate represents the Owners' Allocation of
that affiliate allocated to AMG before interest, taxes, depreciation and
amortization of that affiliate. EBITDA Contribution does not include our holding
company expenses.
The affiliates' revenues are derived from the provision of investment
management services for fees. Investment management fees are usually determined
as a percentage fee charged on periodic values of a client's assets under
management. Certain of the affiliates bill advisory fees for all or a portion of
their clients based upon assets under management valued at the beginning of a
billing period ("in advance"). Other affiliates bill advisory fees for all or a
portion of their clients based upon assets under management valued at the end of
the billing period ("in arrears"). Advisory fees billed in advance will not
reflect subsequent changes in the market value of assets under management for
that period. Conversely, advisory fees billed in arrears will reflect changes in
the market value of assets under management for that period. In addition,
several of the affiliates charge performance-based fees to certain of their
clients; these performance-based fees result in payments to the applicable
affiliate if specified levels of investment performance are achieved. All
references to "assets under management" include assets directly managed as well
as assets underlying overlay strategies which employ futures, options or other
derivative securities to achieve a particular investment objective.
Our level of profitability will depend on a variety of factors including
principally: (i) the level of affiliate revenues, which is dependent on the
ability of our existing affiliates and future affiliates to maintain or increase
assets under management by maintaining their existing investment advisory
relationships and fee structures, marketing their services successfully to new
clients, and obtaining favorable investment results; (ii) the receipt of Owners'
Allocation, which is dependent on the ability of the affiliates and future
affiliates to maintain certain levels of operating profit margins; (iii) the
availability and cost of the capital with which we finance our investments; (iv)
our success in attracting new investments and the terms upon which such
transactions are completed; (v) the level of intangible assets and the
associated amortization expense resulting from our investments; (vi) the level
of expenses incurred for holding company operations, including compensation for
its employees; and (vii) the level of taxation to which we are subject, all of
which are, to some extent, dependent on factors which are not in our control,
such as general securities market conditions.
Assets under management on a historical basis increased by $12.0 billion to
$57.7 billion at December 31, 1998 from $45.7 billion at December 31, 1997, in
part due to the investments made in Essex and DHJA during 1998. Excluding the
initial assets under management at the dates of these investments, assets
24
<PAGE>
under management increased by $3.8 billion as a result of $3.6 billion in market
appreciation and $159.6 million from net client cash flows. Excluding assets
managed using "overlay" strategies (which generally carry fees at the lower end
of the range of fees for directly managed assets), assets increased by $1.7
billion for the year. Assets indirectly managed using such "overlay" strategies
declined by $1.6 billion for the year.
Our investments have been accounted for under the purchase method of
accounting under which goodwill is recorded for the excess of the purchase price
for the acquisition of interests in affiliates over the fair value of the net
assets acquired, including acquired client relationships.
As a result of the series of our investments, intangible assets, consisting
of acquired client relationships and goodwill, constitute a substantial
percentage of our consolidated assets and our results of operations have
included increased charges for amortization of those intangible assets. As of
December 31, 1998, our total assets were approximately $605.3 million, of which
approximately $169.1 million consisted of acquired client relationships and
$321.4 million consisted of goodwill.
The amortization period for intangible assets for each investment is
assessed individually, with amortization periods for our investments to date
ranging from nine to 28 years in the case of acquired client relationships and
15 to 35 years in the case of goodwill. In determining the amortization period
for intangible assets acquired, we consider a number of factors including: the
firm's historical and potential future operating performance and rate of
attrition among clients; the stability and longevity of existing client
relationships; the firm's recent, as well as long-term, investment performance;
the characteristics of the firm's products and investment styles; the stability
and depth of the firm's management team and the firm's history and perceived
franchise or brand value. We perform a quarterly evaluation of intangible assets
on an affiliate-by-affiliate basis to determine whether there has been any
impairment in their carrying value or their useful lives. If impairment is
indicated, then the carrying amount of intangible assets, including goodwill,
will be reduced to their fair values.
While amortization of intangible assets has been charged to the results of
operations and is expected to be a continuing material component of our
operating expenses, management believes it is important to distinguish this
expense from other operating expenses since such amortization does not require
the use of cash. Because of this, and because our distributions from our
affiliates are based on their Owners' Allocation, management has provided
additional supplemental information in this report for "cash" related earnings,
as an addition to, but not as a substitute for, measures related to net income.
Such measures are (i) EBITDA, which we believe is useful to investors as an
indicator of our ability to service debt, to make new investments and meet
working capital requirements, and (ii) EBITDA as adjusted, which we believe is
useful to investors as another indicator of funds available which may be used to
make new investments, to repay debt obligations, to repurchase shares of our
Common Stock or pay dividends on our Common Stock.
RESULTS OF OPERATIONS
SUPPLEMENTAL PRO FORMA INFORMATION
Affiliate operations are included in our historical financial statements
from their respective dates of acquisition. We consolidate affiliates when we
own a controlling interest and include in minority interest the portion of
capital and Owners' Allocation owned by persons other than us.
Because we have made investments in each of the periods for which financial
statements are presented, we believe that the operating results for these
periods are not directly comparable. Substantially all of the changes in our
income, expense and balance sheet categories result from the inclusion of the
acquired businesses from the dates of our investments in them. Therefore, we
have provided the following pro forma data, which should be read with our
consolidated financial statements and the notes to such statements, which are
included elsewhere in this report.
All amounts below are pro forma for the inclusion of the Essex, DHJA and
Rorer investments as if such transactions occurred on January 1, 1998.
25
<PAGE>
UNAUDITED PRO FORMA SUPPLEMENTAL INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
1998
---------------
(IN MILLIONS)
<S> <C>
Assets under Management--at period end:
Tweedy, Browne............................................................ $ 6,641
Other Affiliates.......................................................... 55,490
-------
Total....................................................................... $ 62,131
-------
-------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
(IN THOUSANDS)
-----------------
<S> <C>
Revenues:
Tweedy, Browne............................................................................... $ 78,243
Other Affiliates............................................................................. 200,084
--------
Total...................................................................................... $ 278,327
--------
--------
Owners' Allocation(1):
Tweedy, Browne............................................................................... $ 54,097
Other Affiliates............................................................................. 88,936
--------
Total...................................................................................... $ 143,033
--------
--------
EBITDA Contribution(2):
Tweedy, Browne............................................................................... $ 39,284
Other Affiliates............................................................................. 57,642
--------
Total...................................................................................... $ 96,926
--------
--------
OTHER PRO FORMA FINANCIAL DATA:
RECONCILIATION OF EBITDA CONTRIBUTION TO EBITDA
Total EBITDA Contribution (as above)......................................................... $ 96,926
Less holding company expenses................................................................ (7,648)
--------
EBITDA(3)...................................................................................... $ 89,278
--------
EBITDA as adjusted(4).......................................................................... $ 52,724
- - ------------------------------------------------------------------------------------------------------------------
OTHER HISTORICAL CASH FLOW DATA:
Cash flow from operating activities.......................................................... $ 45,424
Cash flow used in investing activities....................................................... (72,665)
Cash flow from financing activities.......................................................... 28,163
EBITDA(3).................................................................................... 76,312
EBITDA as adjusted(4)........................................................................ 45,675
</TABLE>
- - ------------------------
(1) As defined in "Revenue Sharing Arrangements" on page 6.
(2) As defined by Note(1) on page 11.
(3) As defined by Note(2) on page 11.
(4) As defined by Note(3) on page 11.
26
<PAGE>
The table below depicts the pro forma change in our assets under management
giving effect to all investments made as of December 31, 1998 and the Rorer
investment completed on January 6, 1999 as if such investments occurred on
January 1, 1998.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER
31, 1998
-----------
(IN
MILLIONS)
<S> <C>
Assets under management--beginning...................................... $ 54,961
Net new sales........................................................... 2,001
Market appreciation..................................................... 5,169
-----------
Assets under management--ending......................................... $ 62,131
-----------
-----------
</TABLE>
HISTORICAL
YEAR ENDED DECEMBER 31, 1998 AS COMPARED TO YEAR ENDED DECEMBER 31, 1997
We had net income of $25.6 million for the year ended December 31, 1998
compared to net income before extraordinary item of $1.6 million for the year
ended December 31, 1997. The increase in net income resulted substantially from
net income from new investments. We invested in Gofen and Glossberg in May 1997,
GeoCapital in September 1997, Tweedy, Browne in October 1997, and Essex in March
1998 (collectively, the "New Affiliates") and included their results from the
respective dates of investment. Our net loss after extraordinary item of $8.4
million for the year ended December 31, 1997 resulted from a $10.0 million
extraordinary item, net of related tax benefit, from the write-off of debt
issuance costs related to the early extinguishment of debt.
Revenues for the year ended December 31, 1998 were $238.5 million, an
increase of $143.2 million over the year ended December 31, 1997. Such increase
was primarily a result of the addition of the New Affiliates. Performance-based
fees earned by our affiliates remained approximately 18% of revenues, increasing
$26.8 million to $44.0 million for the year ended December 31, 1998 compared to
$17.2 million for the year ended December 31, 1997, primarily as a result of the
addition of the New Affiliates.
Operating expenses increased by $73.0 million to $145.7 million for the year
ended December 31, 1998 over the year ended December 31, 1997. Compensation and
related expenses increased by $46.1 million to $87.7 million, amortization of
intangible assets increased by $10.8 million to $17.4 million, selling, general
and administrative expenses increased by $12.7 million to $31.6 million, and
other operating expenses increased by $2.6 million to $6.3 million. The growth
in operating expenses was primarily a result of the addition of the New
Affiliates.
Minority interest increased by $26.6 million to $38.8 million for the year
ended December 31, 1998 over the year ended December 31, 1997, primarily as a
result of the addition of the New Affiliates.
Interest expense increased by $5.1 million to $13.6 million for the year
ended December 31, 1998 over the year ended December 31, 1997, as a result of
the increased indebtedness incurred in connection with the investments in the
New Affiliates.
Income tax expense was $17.0 million for the year ended December 31, 1998
compared to $1.4 million for the year ended December 31, 1997. The change in
income tax expense is principally related to the increase in income before taxes
in the year ended December 31, 1998.
EBITDA increased by $56.3 million to $76.3 million for the year ended
December 31, 1998 over the year ended December 31, 1997, primarily as a result
of the inclusion of the New Affiliates.
EBITDA as adjusted increased by $35.5 million to $45.7 million for the year
ended December 31, 1998 over the year ended December 31, 1997 as a result of the
factors affecting net income as described
27
<PAGE>
above, before non-cash expenses such as amortization of intangible assets and
depreciation of $20.1 million for the year ended December 31, 1998.
YEAR ENDED DECEMBER 31, 1997 AS COMPARED TO YEAR ENDED DECEMBER 31, 1996
We had a net loss of $8.4 million for the year ended December 31, 1997
compared to a net loss of $2.4 million for the year ended December 31, 1996. The
net loss for the year ended December 31, 1997 resulted primarily from the
extraordinary item of $10.0 million, net of related tax benefit, from the early
extinguishment of debt. Before extraordinary item, net income was $1.6 million
for the year ended December 31, 1997 compared to a net loss of $1.4 million for
the year ended December 31, 1996.
Total revenues for the year ended December 31, 1997 were $95.3 million, an
increase of $44.9 million or 89% over the year ended December 31, 1996. We
invested in Burridge in December 1996, Gofen and Glossberg in May 1997,
GeoCapital in September 1997 and Tweedy, Browne in October 1997, and included
their results from their respective purchase dates. In addition, we invested in
First Quadrant in March 1996 and its results were included in the results for
the year ended December 31, 1996 from its purchase date. Revenues from these
investments accounted for $43.1 million of the increase in revenues from 1996 to
1997 while revenues from other existing affiliates increased by $1.8 million to
$26.7 million. Performance-based fees, primarily earned by First Quadrant,
increased by $4.0 million to $17.2 million for the year ended December 31, 1997
compared to $13.2 million for the year ended December 31, 1996.
Compensation and related expenses increased by $20.5 million to $41.6
million for the year ended December 31, 1997 from $21.1 million for the year
ended December 31, 1996. The inclusion of the First Quadrant, Burridge, Gofen
and Glossberg, GeoCapital and Tweedy, Browne investments accounted for $19.3
million of this increase while the remainder of the increase was attributable to
the increased compensation costs of AMG personnel, including the cost of new
hires.
Amortization of intangible assets decreased by $1.5 million to $6.6 million
for the year ended December 31, 1997 from $8.1 million for the year ended
December 31, 1996. Amortization of intangible assets increased by $3.1 million
as a result of the inclusion of the First Quadrant, Burridge, and Gofen and
Glossberg, GeoCapital and Tweedy, Browne investments, which increase was offset
by an impairment loss of $4.6 million taken on the Systematic investment during
1996 with no similar item in 1997.
Selling, general and administrative expenses increased by $8.0 million to
$18.9 million for the year ended December 31, 1997 from $10.9 million for the
year ended December 31, 1996. The First Quadrant, Burridge, Gofen and Glossberg,
GeoCapital and Tweedy, Browne investments accounted for $6.0 million of this
increase and the remainder was primarily due to increases in our selling,
general and administrative expenses as well as our other affiliates.
Other operating expenses increased by approximately $1.3 million to $3.6
million for the year ended December 31, 1997 from $2.3 million for the year
ended December 31, 1996, primarily due to the results of operations of the new
affiliates described above.
Minority interest increased by $6.2 million to $12.2 million for the year
ended December 31, 1997 from $6.0 million for the year ended December 31, 1996.
Of this increase, $5.4 million was as a result of the addition of new affiliates
as described above and the remainder was due to the Owners' Allocation growth at
our existing affiliates.
Interest expense increased $5.8 million to $8.5 million for the year ended
December 31, 1997 from $2.7 million for the year ended December 31, 1996 as a
result of the increased indebtedness incurred in connection with the investments
described above.
Income tax expense was $1.4 million for the year ended December 31, 1997
compared to $181,000 for the year ended December 31, 1996. The effective tax
rate for the year ended December 31, 1997 was 46% compared to 15% for the year
ended December 31, 1996. The change in effective tax rates from 1996 to
28
<PAGE>
1997 is related primarily to the change in the provision for federal taxes from
1996 to 1997. In 1996, we recorded a federal deferred tax benefit of $233,000 on
a pretax loss of $1.2 million. In 1997, we recorded a deferred tax expense of
$776,000 on pretax income of $3.0 million. The deferred taxes account for the
effects of temporary differences between the recognition of deductions for book
and tax purposes primarily related to the accelerated amortization of certain
intangible assets.
EBITDA increased by $9.5 million to $20.0 million for the year ended
December 31, 1997 from $10.5 million for the year ended December 31, 1996 as a
result of the inclusion of new affiliates as described above and revenue growth.
EBITDA as adjusted increased by $2.6 million to $10.2 million for the year
ended December 31, 1997 from $7.6 million for the year ended December 31, 1996
as a result of the factors affecting net income as described above, before
non-cash expenses such as amortization of intangible assets, depreciation and
extraordinary items of $18.6 million for the year ended December 31, 1997 and
$10.0 million for the year ended December 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
We have met our cash requirements primarily through cash generated by
operating activities, bank borrowings, and the issuance of equity and debt
securities in public and private placement transactions. We anticipate that we
will use cash flow from our operating activities to repay debt and to finance
our working capital needs and will use bank borrowings and issue equity and debt
securities to finance future affiliate investments. Our principal uses of cash
have been to make investments in affiliates, to retire indebtedness, repurchase
shares and to support our and our affiliates' operating activities. We expect
that our principal use of funds for the foreseeable future will be for
investments in additional affiliates, repayments of debt, including interest
payments on outstanding debt, distributions of the Owners' Allocation to owners
of affiliates other than us, additional investments in existing affiliates,
including upon management owners' sales of their retained equity to us, and for
working capital purposes. We do not expect to make commitments for material
capital expenditures.
At December 31, 1998, we had outstanding borrowings of senior debt under our
credit facility of $190.5 million. On January 29, 1999 we exercised our option
to expand the credit facility from $300 to $330 million and added another major
commercial bank to our group of lenders. We have the option, with the consent of
our lenders, to increase the facility by another $70 million to a total of $400
million. Our credit facility bears interest at either LIBOR plus a margin
ranging from .50% to 2.25% or the Prime Rate plus a margin ranging up to 1.25%
and matures during December 2002. In order to offset our exposure to changing
interest rates we enter into interest rate hedging contracts. See "Interest Rate
Hedging Contracts." We pay a commitment fee of up to 1/2 of 1% on the daily
unused portion of the facility.
Our borrowings under the credit facility are collateralized by pledges of
all of our interests in affiliates (including all interests in affiliates which
are directly held by us, as well as all interests in affiliates which are
indirectly held by us through wholly-owned subsidiaries), which interests
represent substantially all of our assets. Our credit facility contains a number
of negative covenants, including those which generally prevent us and our
affiliates from: (i) incurring additional indebtedness (other than subordinated
indebtedness), (ii) creating any liens or encumbrances on material assets (with
certain enumerated exceptions), (iii) selling assets outside the ordinary course
of business or making certain fundamental changes with respect to our
businesses, including a restriction on our ability to transfer interests in any
majority owned affiliate if, as a result of such transfer, we would own less
than 51% of such affiliate, and (iv) declaring or paying dividends on our Common
Stock.
In order to provide the funds necessary for us to continue to acquire
interests in investment management firms, including our existing affiliates upon
the management owners' sales of their retained equity to us, it will be
necessary for us to incur, from time to time, additional long-term bank debt
and/or
29
<PAGE>
issue equity or debt securities, depending on market and other conditions. There
can be no assurance that such additional financing will be available or become
available on terms acceptable to us.
Net cash flow from operating activities was $45.4 million, $16.2 million and
$6.2 million for the years ended December 31, 1998, 1997 and 1996, respectively.
The increase in net cash flow from operating activities from 1997 to 1998 was
principally due to our investments in new affiliates in 1997 and 1998.
Net cash flow used in investing activities was $72.7 million, $327.3 million
and $29.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Of these amounts, $66.1 million, $325.9 million, and $25.6
million, respectively, were used to make investments in affiliates.
On March 20, 1998, we acquired a majority interest in Essex. We paid $69.6
million in cash, in addition to 1,750,942 newly-issued shares of our Series C
Convertible Non-Voting Stock which converted into an equal number of shares of
Common Stock on March 20, 1999. The Company funded the cash portion of this
investment with borrowings under its credit facility.
On December 31, 1998, we acquired a 65% interest in DHJA. DHJA is a Houston
based asset management firm with approximately $3.5 billion of assets under
management at December 31, 1998. On January 6, 1999, we acquired an
approximately 65% interest in Rorer. Rorer is a Philadelphia based investment
adviser with approximately $4.4 billion of assets under management at December
31, 1998. We paid $65 million in cash for our investment in Rorer. We financed
these two investments with borrowings under our credit facility.
On January 29, 1999, we entered into a definitive agreement to acquire
substantially all of the partnership interests in The Managers Funds, L.P.,
which serves as the adviser to a family of ten equity and fixed income no-load
mutual funds. These mutual funds had a total of $1.8 billion in assets under
management at December 31, 1998. This transaction is subject to customary
closing conditions. We intend to finance the investment with a borrowing under
our credit facility.
Net cash flow from financing activities was $28.2 million, $327.1 million
and $15.7 million for the years ended December 31, 1998, 1997 and 1996. The
principal sources of cash from financing activities has been from borrowings
under senior credit facilities and subordinated debt, private placements of our
equity securities and our initial public offering. The uses of cash from
financing activities during these periods were for the repayment of bank debt,
repayment of subordinated debt, repayment of notes issued as purchase price
consideration and for the payment of debt issuance costs.
On September 11, 1998, our Board of Directors authorized a share repurchase
program pursuant to which we could repurchase up to five percent of our issued
and outstanding shares of Common Stock. Through December 31, 1998, we purchased
147,000 shares of Common Stock for $2.6 million.
On March 3, 1999, we completed a public offering of 5,529,954 shares of
Common Stock, of which 4,000,000 shares were sold by us and 1,529,954 shares
were sold by selling stockholders. We used the net proceeds from the 4,000,000
shares sold by us to reduce indebtedness and did not receive any proceeds from
the sale of Common Stock by the selling stockholders.
YEAR 2000
The "Year 2000" poses a concern to our business as a result of the fact that
computer applications have historically used the last two digits, rather than
all four digits, to store year data. If left unmodified, these applications
would misinterpret the Year 2000 for the Year 1900 and would in many cases be
unable to function properly in the Year 2000 and beyond.
We have based our evaluation of our ability to prepare for the Year 2000
upon a number of assumptions regarding future events, including third party
modification plans and the availability of needed resources. We cannot guarantee
that these estimates will be achieved, and actual results may differ materially
from our estimates. Specific factors which might cause such material differences
with respect to
30
<PAGE>
the Year 2000 issue include, but are not limited to, the failure of our
affiliates to achieve represented or stated levels of Year 2000 compliance, the
availability and cost of personnel trained in this area and the ability to
locate and correct all relevant computer codes and similar uncertainties.
AMG'S READINESS
In anticipation of this problem, we have identified all of the significant
computers, software applications and related equipment used at our holding
company that need to be modified, upgraded or replaced to minimize the
possibility of a material disruption to our business based on the advent of the
Year 2000. We anticipate completing our Year 2000 preparations at the holding
company by the end of the second quarter of 1999. We estimate our total cost
will be less than $800,000 for the four year period ending on December 31, 1999.
We cannot be certain that we will not encounter unforeseen delays or costs in
completing our preparations.
OUR AFFILIATES' READINESS
We have also established a time line with each of our affiliates to complete
their Year 2000 preparations and have received estimates from each of them of
the costs required to complete their preparations. As part of our general
preparedness program, each of our affiliates has assigned responsibility for
preparing for the Year 2000 to a member of its senior management in order to
ensure that both proprietary and third party vendor systems will be ready for
the Year 2000. Each of our affiliates has completed its assessment and plans are
in place for the renovation or replacement of all non-compatible systems. We
anticipate that the affiliates will complete the renovation or replacement of
all non-compatible systems and the subsequent testing of all systems by the end
of the second quarter of 1999. Most of our affiliates pay for the costs of their
Year 2000 preparations out of their operating allocation, which is the portion
of their revenues that is allocated to pay their operating expenses. As a
result, these costs will only reduce an affiliate's distributions to us based on
our ownership interest in the affiliate if the affiliate's operating expenses
exceed its operating allocation and the portion of revenues allocated to the
management owners.
OUTSIDE SERVICE PROVIDERS
Outside service providers perform several processes which are critical to
our affiliates' business operations, including transfer agency and custody
functions. Our affiliates have surveyed these parties and are monitoring their
progress. However, our affiliates have limited control, if any, over the actions
of these outside parties and in some instances have no alternative vendors. If
outside service providers fail to resolve their Year 2000 issues, we anticipate
that our affiliates' operations will experience material disruptions caused by
the inability to process trades and access client and investment research data
files and, accordingly, our and our affiliates' businesses would be adversely
affected.
INTEREST RATE SENSITIVITY
Our revenues are derived primarily from fees which are based on the values
of assets managed. Such values are affected by changes in the broader financial
markets which are, in part, affected by changing interest rates. We cannot
predict the effects that interest rates or changes in interest rates may have on
either the broader financial markets or our affiliates' assets under management
and associated fees.
With respect to our debt financings, we are exposed to potential
fluctuations in the amount of interest expense resulting from changing interest
rates. We seek to offset such exposure in part by entering into interest rate
hedging contracts. See "Interest Rate Hedging Contracts".
Our annual interest expense increases or decreases by $195,250 for each 1/8
of 1% change in interest rates assuming LIBOR is between 5% and 6.78% and
assuming current interest rate margins on current bank debt.
31
<PAGE>
INTEREST RATE HEDGING CONTRACTS
We seek to offset our exposure under our debt financing arrangements to
changing interest rates by entering into interest rate hedging contracts. As of
December 31, 1998, we were a party, with two major commercial banks as
counterparties, to $185 million notional amount of swap contracts which are
designed to limit interest rate increases on our borrowings and are linked to
the three-month LIBOR. These swap contracts, upon quarterly reset dates, cap
interest rates on the notional amounts at rates ranging between 6.67% and 6.78%.
When LIBOR is below 5%, our floating interest rate debt is swapped for fixed
rate debt at rates ranging between 6.67% and 6.78%. We generally borrow at LIBOR
and pay an additional interest margin as described above. The hedging contracts
limit the effects of our payment of interest at equivalent LIBOR rates of 6.78%
or less on up to $185 million of indebtedness.
As of January 15, 1999, we have entered into a swap contract to cap
potential interest rate increases on $75 million of the $185 million notional
amount of swap contracts identified above at 5.99%.
There can be no assurance that we will continue to maintain such hedging
contracts at their existing levels of coverage or that the amount of coverage
maintained will cover all of our indebtedness outstanding at any such time. In
addition, as noted above, our existing hedging contracts subject us to the risk
of payments of higher interest rates when prevailing LIBOR rates are less than
5%. Therefore, there can be no assurance that the hedging contracts will meet
their overall objective of reducing our interest expense. In addition, there can
be no assurance that we will be successful in obtaining hedging contracts in the
future on our existing or any new indebtedness.
RECENT ACCOUNTING DEVELOPMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS
133"). FAS 133 standardizes the accounting for derivative instruments by
requiring that all derivatives be recognized as assets and liabilities and
measured at fair value. FAS 133 is effective for financial statements for fiscal
years beginning after June 15, 1999.
We do not believe that the implementation of FAS 133 will have a material
impact on our financial statements.
ECONOMIC AND MARKET CONDITIONS
The financial markets and the investment management industry in general have
experienced both record performance and record growth in recent years. For
example, between January 1, 1995 and December 31, 1998, the S&P 500 Index
appreciated at a compound annual rate of approximately 30.5% and the aggregate
assets under management of mutual and pension funds grew at a compound annual
rate of 20.7% during 1995-1997, according to the Federal Reserve Board and the
Investment Company Institute. Domestic and foreign economic conditions and
general trends in business and finance, among other factors, affect the
financial markets and businesses operating in the securities industry. We cannot
guarantee that broader market performance will be favorable in the future. Any
decline in the financial markets or a lack of sustained growth may result in a
corresponding decline in our affiliates' performance and may cause our
affiliates to experience declining assets under management and/or fees, which
would reduce cash flow distributable to us.
INTERNATIONAL OPERATIONS
First Quadrant Limited is organized and headquartered in London, England.
Tweedy, Browne, based in New York, also maintains a research office in London.
In the future, we may seek to invest in other investment management firms which
are located and/or conduct a significant part of their operations outside of the
United States. There are certain risks inherent in doing business
internationally, such as changes in applicable laws and regulatory requirements,
difficulties in staffing and managing foreign
32
<PAGE>
operations, longer payment cycles, difficulties in collecting investment
advisory fees receivable, political instability, fluctuations in currency
exchange rates, expatriation controls and potential adverse tax consequences.
There can be no assurance that one or more of such factors will not have a
material adverse effect on First Quadrant Limited or other non-U.S. investment
management firms in which we may invest in the future and, consequently, on our
business, financial condition and results of operations.
INFLATION
We do not believe that inflation or changing prices have had a material
impact on our results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use interest-rate swaps to manage market exposures associated with our
variable rate debt by creating offsetting market exposures. These instruments
are not held for trading purposes. In the normal course of operations, we also
face risks that are either nonfinancial or nonquantifiable. Such risks
principally include country risk, credit risk, and legal risk, and are not
represented in the analysis that follows.
This analysis presents the hypothetical loss in earnings of the derivative
instruments we held at December 31, 1998 that are sensitive to changes in
interest rates. Interest rate swaps allow us to achieve a level of variable-rate
and fixed-rate debt that is acceptable to us, and to reduce interest rate
exposure. In each of our interest rate swaps, we have agreed with another party
to exchange the difference between fixed-rate and floating rate interest amounts
calculated by reference to an agreed notional principal amount. Under each of
our interest rate swaps, interest rates on the notional amounts are capped at
rates ranging between 6.67% and 6.78% upon quarterly reset dates. In addition,
if LIBOR falls below 5% at a quarterly reset date, we are required to make a
payment to our counterparty equal to the difference between the interest rate on
our floating rate LIBOR debt on an annualized rate of between 6.67% and 6.78%,
multiplied by the notional principal amount. At December 31, 1998, a total of
$185 million of our outstanding debt was subject to interest rate swaps, (the
"Original Swaps"), and our exposure was to changes in three-month LIBOR rates.
Beginning in January 1999, we became a party to additional contracts with a $75
million notional amount, (the "Subsequent Swaps"). These contracts are designed
to limit interest rate increases to 5.99% on this notional amount if three month
LIBOR rates fall below 5%.
The hypothetical loss in earnings on all derivative instruments that would
have resulted from a hypothetical change of 10 percent in three-month LIBOR
rates, sustained for three months, is estimated to be $390,000. Because our
net-earnings exposure under the combined debt and interest-rate swap was to
three-month LIBOR rates, the hypothetical loss was calculated as follows:
multiplying the notional amount of the swap by the effect of a 10% reduction in
LIBOR under the Original Swaps, partially offset by the Subsequent Swaps and
interest savings on the underlying debt.
33
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
Affiliated Managers Group, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, comprehensive income, changes in
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Affiliated Managers Group, Inc. and Affiliates at
December 31, 1997 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which required that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit 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, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 22, 1999
34
<PAGE>
AFFILIATED MANAGERS GROUP INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................. $ 22,766 $ 23,735
Investment advisory fees receivable................................... 27,061 66,939
Other current assets.................................................. 2,231 5,137
--------- ---------
Total current assets.............................................. 52,058 95,811
Fixed assets, net....................................................... 4,724 8,001
Equity investment in Affiliate.......................................... 1,237 1,340
Acquired client relationships, net of accumulated amortization of $6,142
in 1997 and $13,870 in 1998........................................... 142,875 169,065
Goodwill, net of accumulated amortization of $13,502 in 1997 and $23,191
in 1998............................................................... 249,698 321,409
Other assets............................................................ 6,398 9,708
--------- ---------
Total assets...................................................... $ 456,990 $ 605,334
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.............................. $ 18,815 $ 42,617
Notes payable to related parties...................................... -- 22,000
--------- ---------
Total current liabilities......................................... 18,815 64,617
Senior bank debt........................................................ 159,500 190,500
Other long-term liabilities............................................. 1,656 11,614
Subordinated debt....................................................... 800 800
--------- ---------
Total liabilities................................................. 180,771 267,531
Minority interest....................................................... 16,479 24,148
Commitments and contingencies........................................... -- --
Stockholders' equity:
Preferred stock......................................................... -- --
Convertible stock....................................................... -- 30,992
Common stock............................................................ 177 177
Additional paid-in capital.............................................. 273,475 273,413
Accumulated other comprehensive income.................................. (30) 16
Retained earnings (deficit)............................................. (13,882) 11,669
--------- ---------
259,740 316,267
Less treasury shares.................................................... -- (2,612)
--------- ---------
Total stockholders' equity........................................ 259,740 313,655
--------- ---------
Total liabilities and stockholders' equity........................ $ 456,990 $ 605,334
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
35
<PAGE>
AFFILIATED MANAGERS GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1996 1997 1998
--------- ---------- ------------
<S> <C> <C> <C>
Revenues.................................................................... $ 50,384 $ 95,287 $ 238,494
Operating expenses:
Compensation and related expenses......................................... 21,113 41,619 87,669
Amortization of intangible assets......................................... 8,053 6,643 17,417
Depreciation and other amortization....................................... 932 1,915 2,707
Selling, general and administrative....................................... 10,854 18,912 31,643
Other operating expenses.................................................. 2,261 3,637 6,278
--------- ---------- ------------
43,213 72,726 145,714
--------- ---------- ------------
Operating income...................................................... 7,171 22,561 92,780
Non-operating (income) and expenses:
Investment and other income............................................... (337) (1,174) (2,251)
Interest expense.......................................................... 2,747 8,479 13,603
--------- ---------- ------------
2,410 7,305 11,352
--------- ---------- ------------
Income before minority interest, income taxes and extraordinary item........ 4,761 15,256 81,428
Minority interest........................................................... (5,969) (12,249) (38,843)
--------- ---------- ------------
Income (loss) before income taxes and extraordinary item.................... (1,208) 3,007 42,585
Income taxes................................................................ 181 1,364 17,034
--------- ---------- ------------
Income (loss) before extraordinary item..................................... (1,389) 1,643 25,551
--------- ---------- ------------
Extraordinary item, net..................................................... (983) (10,011) --
--------- ---------- ------------
Net income (loss)........................................................... $ (2,372) $ (8,368) $ 25,551
--------- ---------- ------------
--------- ---------- ------------
Income (loss) per share--basic:
Income (loss) before extraordinary item................................... $ (3.22) $ 0.72 $ 1.45
Extraordinary item, net................................................... (2.27) (4.41) --
--------- ---------- ------------
Net income (loss)......................................................... $ (5.49) $ (3.69) $ 1.45
--------- ---------- ------------
--------- ---------- ------------
Income (loss) per share--diluted:
Income (loss) before extraordinary item................................... $ (3.22) $ 0.20 $ 1.33
Extraordinary item, net................................................... (2.27) (1.22) --
--------- ---------- ------------
Net income (loss)......................................................... $ (5.49) $ (1.02) $ 1.33
--------- ---------- ------------
--------- ---------- ------------
Average shares outstanding--basic........................................... 431,908 2,270,684 17,582,900
Average shares outstanding--diluted......................................... 431,908 8,235,529 19,222,831
</TABLE>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Net income (loss)............................................ $ (2,372) $ (8,368) $ 25,551
Foreign currency translation adjustment, net of taxes........ 22 (52) 46
--------- --------- ---------
Comprehensive income (loss).................................. $ (2,350) $ (8,420) $ 25,597
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
36
<PAGE>
AFFILIATED MANAGERS GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
--------- ---------- ---------
<S> <C> <C> <C>
Cash flow from operating activities:
Net income (loss).............................................................. $ (2,372) $ (8,368) $ 25,551
Adjustments to reconcile net income (loss) to net cash flow from operating
activities:
Amortization of intangible assets.............................................. 8,053 6,643 17,417
Extraordinary item............................................................. 983 10,011 --
Depreciation and other amortization............................................ 932 1,915 2,707
Deferred income tax provision (benefit)........................................ (215) 1,012 10,410
Changes in assets and liabilities:
Increase in investment advisory fees receivable................................ (8,473) (3,980) (38,053)
Increase in other current assets............................................... (1,881) (977) (2,766)
Increase (decrease) in accounts payable, accrued expenses and other
liabilities.................................................................... 6,849 (3,159) 22,489
Minority interest.............................................................. 2,309 13,108 7,669
--------- ---------- ---------
Cash flow from operating activities........................................ 6,185 16,205 45,424
--------- ---------- ---------
Cash flow used in investing activities:
Purchase of fixed assets....................................................... (922) (1,648) (4,313)
Costs of investments, net of cash acquired..................................... (25,646) (325,896) (66,102)
Sale of investment............................................................. 642 -- --
Distributions received from Affiliate equity investment........................ 275 229 675
Increase (decrease) in other assets............................................ (3,639) 40 (1,225)
Loans to employees............................................................. -- -- (1,700)
Repayment on notes recorded in purchase of business............................ 80 -- --
--------- ---------- ---------
Cash flow used in investing activities..................................... (29,210) (327,275) (72,665)
--------- ---------- ---------
Cash flow from financing activities:
Borrowings of senior bank debt................................................. 21,000 303,900 78,800
Repayments of senior bank debt................................................. (6,000) (177,800) (47,800)
Repayments of notes payable.................................................... (1,212) (5,878) --
Borrowings of subordinated bank debt........................................... -- 58,800 --
Repayments of subordinated bank debt........................................... -- (60,000) --
Issuances of equity securities................................................. 2,485 217,021 (62)
Issuance of warrants........................................................... -- 1,200 --
Repurchase of stock............................................................ (13) -- (2,612)
Debt issuance costs............................................................ (610) (10,131) (163)
--------- ---------- ---------
Cash flow from financing activities........................................ 15,650 327,112 28,163
Effect of foreign exchange rate changes on cash flow............................. 46 (43) 47
Net increase (decrease) in cash and cash equivalents............................. (7,329) 15,999 969
Cash and cash equivalents at beginning of year................................... 14,096 6,767 22,766
--------- ---------- ---------
Cash and cash equivalents at end of year......................................... $ 6,767 $ 22,766 $ 23,735
--------- ---------- ---------
--------- ---------- ---------
Supplemental disclosure of cash flow information:
Interest paid.................................................................. $ 2,905 $ 8,559 $ 11,780
Income taxes paid.............................................................. 436 256 3,358
Supplemental disclosure of non-cash investing activities:
Decrease in liabilities related to acquisitions................................ -- (3,200) --
Supplemental disclosure of non-cash financing activities:
Stock issued in acquisitions................................................... -- 11,101 30,992
Common stock issued in exchange for Affiliate equity interests................. -- 1,849 --
Notes issued in acquisitions................................................... 6,686 -- 22,000
Conversion of preferred stock to common stock.................................. -- 83,576 --
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
37
<PAGE>
AFFILIATED MANAGERS GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED COMMON CONVERTIBLE PREFERRED COMMON CONVERTIBLE PAID-IN RETAINED
SHARES SHARES SHARES STOCK STOCK STOCK CAPITAL EARNINGS
----------- --------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
December 31, 1995............. 109,851 825,000 -- $ 40,008 $ -- $ -- $ 1 $ (3,142)
Issuance of common stock...... -- 162,500 -- -- -- -- 4 --
Issuance of preferred stock... 3,703 -- -- 2,481 -- -- -- --
Repurchase of preferred
stock....................... (20) -- -- (13) -- -- -- --
Net loss...................... -- -- -- -- -- -- -- (2,372)
Other comprehensive income.... -- -- -- -- -- -- -- 22
----------- --------- ----------- ----------- ----- ----------- ----------- -----------
December 31, 1996............. 113,534 987,500 -- 42,476 -- -- 5 (5,492)
Issuance of common stock...... -- 8,753,667 -- -- 98 -- 188,773 --
Issuance of preferred stock
and warrants................ 45,715 -- -- 41,100 -- -- 1,200 --
Conversion of preferred
stock....................... (159,249) 7,962,450 -- (83,576) 79 -- 83,497 --
Net loss...................... -- -- -- -- -- -- -- (8,368)
Other comprehensive income.... -- -- -- -- -- -- -- (52)
----------- --------- ----------- ----------- ----- ----------- ----------- -----------
December 31, 1997............. -- 17,703,617 -- -- 177 -- 273,475 (13,912)
Issuance of common stock...... -- -- -- -- -- -- (62) --
Issuance of convertible
stock....................... -- -- 1,750,942 -- -- 30,992 -- --
Purchase of common stock...... -- -- -- -- -- -- -- --
Net income.................... -- -- -- -- -- -- -- 25,551
Other comprehensive income.... -- -- -- -- -- -- -- 46
----------- --------- ----------- ----------- ----- ----------- ----------- -----------
December 31, 1998............. -- 17,703,617 1,750,942 $ -- $ 177 $ 30,992 $ 273,413 $ 11,685
----------- --------- ----------- ----------- ----- ----------- ----------- -----------
----------- --------- ----------- ----------- ----- ----------- ----------- -----------
<CAPTION>
TREASURY
TREASURY SHARES AT
SHARES COST
----------- -----------
<S> <C> <C>
December 31, 1995............. -- $ --
Issuance of common stock...... -- --
Issuance of preferred stock... -- --
Repurchase of preferred
stock....................... -- --
Net loss...................... -- --
Other comprehensive income.... -- --
----------- -----------
December 31, 1996............. -- --
Issuance of common stock...... -- --
Issuance of preferred stock
and warrants................ -- --
Conversion of preferred
stock....................... -- --
Net loss...................... -- --
Other comprehensive income.... -- --
----------- -----------
December 31, 1997............. -- --
Issuance of common stock...... -- --
Issuance of convertible
stock....................... -- --
Purchase of common stock...... (172,000) (2,612)
Net income.................... -- --
Other comprehensive income.... -- --
----------- -----------
December 31, 1998............. (172,000) $ (2,612)
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
38
<PAGE>
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF OPERATIONS
The principal business activity of Affiliated Managers Group, Inc. ("AMG" or
the "Company") is the acquisition of equity interests in investment management
firms ("Affiliates"). AMG's Affiliates operate in one industry segment, that of
providing investment management services, primarily in the United States and
Europe, to mutual funds, partnerships and institutional and individual clients.
Affiliates are either organized as limited partnerships, general
partnerships or limited liability companies. AMG has contractual arrangements
with each Affiliate whereby a percentage of revenues is allocable to fund
Affiliate operating expenses, including compensation (the Operating Allocation),
while the remaining portion of revenues (the Owners' Allocation) is allocable to
AMG and the other partners or members, generally with a priority to AMG.
Affiliate operations are consolidated in these financial statements. The portion
of the Owners' Allocation allocated to owners other than AMG is included in
minority interest in the statement of operations. Minority interest on the
consolidated balance sheets includes capital and undistributed Owners'
Allocation owned by owners other than AMG.
CONSOLIDATION
These consolidated financial statements include the accounts of AMG and each
Affiliate in which AMG has a controlling interest. In each such instance, AMG
is, directly or indirectly, the sole general partner (in the case of Affiliates
which are limited partnerships), sole managing general partner (in the case of
the Affiliate which is a general partnership) or sole manager member (in the
case of Affiliates which are limited liability companies). Investments where AMG
does not hold a controlling interest are accounted for under the equity method
of accounting and AMG's portion of net income is included in investment and
other income. All intercompany balances and transactions have been eliminated.
All dollar amounts in the text and tables herein are stated in thousands unless
otherwise indicated. Certain reclassifications have been made to prior years'
financial statements to conform with the current year's presentation.
SEGMENT REPORTING
In 1998, the Company adopted Statement of Financial Accounting Standards
(FAS) 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION.
FAS 131 supersedes FAS 14, FINANCIAL REPORTING FOR SEGMENTS OF A BUSINESS
ENTERPRISE, replacing the "industry segment" approach with the "management"
approach. The management approach designates the internal organization that is
used by management for making operating decisions and assessing performance as
the source of the Company's reportable segments. FAS 131 also requires
disclosures about products and services, geographic areas, and major customers.
The adoption of FAS 131 did not affect results of operations or financial
position (see Note 16).
REVENUE RECOGNITION
The Company's consolidated revenues represent advisory fees billed quarterly
and annually by Affiliates for managing the assets of clients. Asset-based
advisory fees are recognized monthly as services are rendered and are based upon
a percentage of the market value of client assets managed. Any fees collected in
advance are deferred and recognized as income over the period earned.
Performance-based advisory fees are recognized when earned based upon either the
positive difference between the investment returns on a client's portfolio
compared to a benchmark index or indices, or an absolute percentage of gain in
the client's account, and are accrued in amounts expected to be realized.
39
<PAGE>
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents. Cash equivalents are stated at
cost, which approximates market value due to the short-term maturity of these
investments.
FIXED ASSETS
Equipment and other fixed assets are recorded at cost and depreciated using
the straight-line method over their estimated useful lives ranging from three to
five years. Leasehold improvements are amortized over the shorter of their
estimated useful lives or the term of the lease.
ACQUIRED CLIENT RELATIONSHIPS AND GOODWILL
The purchase price for the acquisition of interests in Affiliates is
allocated based on the fair value of assets acquired, primarily acquired client
relationships. In determining the allocation of purchase price to acquired
client relationships, the Company analyzes the net present value of each
acquired Affiliate's existing client relationships based on a number of factors
including: the Affiliate's historical and potential future operating
performance; the Affiliate's historical and potential future rates of attrition
among existing clients; the stability and longevity of existing client
relationships; the Affiliate's recent, as well as long-term, investment
performance; the characteristics of the firm's products and investment styles;
the stability and depth of the Affiliate's management team and the Affiliate's
history and perceived franchise or brand value. The cost assigned to acquired
client relationships is amortized using the straight line method over periods
ranging from nine to 28 years. The expected useful lives of acquired client
relationships are analyzed separately for each acquired Affiliate and determined
based on an analysis of the historical and potential future attrition rates of
each Affiliate's existing clients, as well as a consideration of the specific
attributes of the business of each Affiliate.
The excess of purchase price for the acquisition of interests in Affiliates
over the fair value of net assets acquired, including acquired client
relationships, is classified as goodwill. Goodwill is amortized using the
straight-line method over periods ranging from 15 to 35 years. In determining
the amortization period for goodwill, the Company considers a number of factors
including: the firm's historical and potential future operating performance; the
characteristics of the firm's clients, products and investment styles; as well
as the firm's history and perceived franchise or brand value. Unamortized
intangible assets, including acquired client relationships and goodwill, are
periodically re-evaluated and if experience subsequent to the acquisition
indicates that there has been an impairment in value, other than temporary
fluctuations, an impairment loss is recognized. Management evaluates the
recoverability of unamortized intangible assets quarterly for each acquisition
using estimates of undiscounted cash flows factoring in known or expected
trends, future prospects and other relevant information. If impairment is
indicated, the Company measures its loss as the excess of the carrying value of
the intangible assets for each Affiliate over its fair value determined using
valuation models such as discounted cash flows and market comparables. Included
in amortization expense for 1996 is an impairment loss of $4,628 relating to one
of AMG's affiliates following periods of significant client asset withdrawals.
Fair value in such cases was determined using market comparables based on
revenues, cash flow and assets under management. No impairment loss was recorded
for the years ended December 31, 1997 or December 31, 1998.
DEBT ISSUANCE COSTS
Debt issuance costs incurred in securing credit facility financing are
capitalized and subsequently amortized over the term of the credit facility
using the effective interest method. Unamortized debt issuance costs of $10,011,
net of tax were written off as an extraordinary item in 1997 as part of the
Company's replacement of its previous credit facilities with new facilities.
40
<PAGE>
INTEREST-RATE HEDGING AGREEMENTS
The Company periodically enters into interest-rate hedging agreements to
hedge against potential increases in interest rates on the Company's outstanding
borrowings. The Company's policy is to accrue amounts receivable or payable
under such agreements as reductions or increases in interest expense,
respectively.
INCOME TAXES
The Company has adopted FAS 109, which requires the use of the asset and
liability approach for accounting for income taxes. Under FAS 109, the Company
recognizes deferred tax assets and liabilities for the expected consequences of
temporary differences between the financial statement basis and tax basis of the
Company's assets and liabilities. A deferred tax valuation allowance is
established if, in management's opinion, it is more likely than not that all or
a portion of the Company's deferred tax assets will not be realized.
FOREIGN CURRENCY TRANSLATION
The assets and liabilities of non-U.S. based Affiliates are translated into
U.S. dollars at the exchange rates in effect as of the balance sheet date.
Revenues and expenses are translated at the average monthly exchange rates then
in effect.
PUTS AND CALLS
As further described in Note 10, the Company periodically purchases
additional equity interests in Affiliates from minority interest owners.
Resulting payments made to such owners are considered purchase price for such
acquired interests. The estimated cost of purchases from equity holders who have
been awarded equity interests in connection with their employment is accrued,
net of estimated forfeitures, over the service period as equity-based
compensation.
EQUITY-BASED COMPENSATION PLANS
FAS No. 123, "Accounting for Stock-Based Compensation", encourages but does
not require adoption of a fair value-based accounting method for stock-based
compensation arrangements which include stock option grants, sales of restricted
stock and grants of equity based interests in Affiliates to certain limited
partners or members. An entity may continue to apply Accounting Principles Board
Opinion No. 25 ("APB 25") and related interpretations, provided the entity
discloses its pro forma net income and earnings per share as if the fair value
based method had been applied in measuring compensation cost. The Company
continues to apply APB 25 and related interpretations.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts included in the financial
statements and disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results could differ from those estimates.
RECENT ACCOUNTING DEVELOPMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS
133"). FAS 133 standardizes the accounting for derivative instruments by
requiring that all derivatives be recognized as assets and liabilities and
measured at fair value. FAS 133 is effective for financial statements for fiscal
years beginning after June 15, 1999.
41
<PAGE>
The Company does not believe that the implementation of FAS 133 will have a
material impact on the Company's financial statements.
2. CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments and
investment advisory fees receivable. The Company maintains cash and cash
equivalents, short-term investments and certain off-balance-sheet financial
instruments with various financial institutions. These financial institutions
are located in cities in which AMG and its Affiliates operate. For AMG and
certain Affiliates, cash deposits at a financial institution may exceed FDIC
insurance limits.
Substantially all of the Company's revenues are derived from the investment
management operations of its Affiliates. For the year ended December 31, 1998,
one of those Affiliates accounted for approximately 44% of AMG's share of the
Owners' Allocation.
3. FIXED ASSETS AND LEASE COMMITMENTS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Office equipment................................................... $ 5,870 $ 8,282
Furniture and fixtures............................................. 3,530 4,534
Leasehold improvements............................................. 2,007 3,473
Computer software.................................................. 760 1,742
--------- ---------
Total fixed assets........................................... 12,167 18,031
--------- ---------
Accumulated depreciation........................................... (7,443) (10,030)
--------- ---------
Fixed assets, net............................................ $ 4,724 $ 8,001
--------- ---------
--------- ---------
</TABLE>
The Company and its Affiliates lease computer equipment and office space for
their operations. At December 31, 1998, the Company's aggregate future minimum
payments for operating leases having initial or noncancelable lease terms
greater than one year are payable as follows:
<TABLE>
<CAPTION>
REQUIRED
MINIMUM
YEAR ENDING DECEMBER 31, PAYMENTS
- - -------------------------------------------------------------------------------------------- -----------
<S> <C>
1999........................................................................................ $ 5,349
2000........................................................................................ 5,323
2001........................................................................................ 4,438
2002........................................................................................ 4,023
2003........................................................................................ 2,662
Thereafter.................................................................................. 8,592
</TABLE>
Consolidated rent expense for 1996, 1997 and 1998 was $2,359, $3,637 and
$6,278, respectively.
42
<PAGE>
4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following:
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------
<S> <C> <C>
1997 1998
--------- ---------
Accounts payable.................................................................. $ 940 $ 928
Accrued compensation.............................................................. 6,480 25,201
Accrued income taxes.............................................................. 52 6,297
Accrued rent...................................................................... 2,769 2,413
Accrued interest.................................................................. 63 1,858
Deferred revenue.................................................................. 1,481 1,602
Accrued professional services..................................................... 2,552 524
Other............................................................................. 4,478 3,794
--------- ---------
$ 18,815 $ 42,617
--------- ---------
--------- ---------
</TABLE>
5. RETIREMENT PLANS
AMG has a defined contribution retirement plan covering substantially all of
its full-time employees and four of its Affiliates. Seven of AMG's other
Affiliates had separate defined contribution retirement plans. Under each of the
plans, AMG and each Affiliate is able to make discretionary contributions to
qualified plan participants up to IRS limits. Consolidated expenses related to
these plans in 1996, 1997 and 1998 were $656, $1,020 and $2,589, respectively.
6. SENIOR BANK DEBT AND SUBORDINATED DEBT
The Company has a $300 million revolving Credit Facility ("Credit
Facility"), with principal repayment due in December 2002. Interest is payable
at rates up to 1.25% over the Prime Rate or up to 2.25% over LIBOR on amounts
borrowed. The Company pays a commitment fee of up to 1/2 of 1% on the daily
unused portion of the facility. The Company had $190.5 million outstanding on
the Credit Facility at December 31, 1998.
The effective interest rates on the outstanding borrowings were 5.7% and
7.2% at December 31, 1998 and 1997, respectively. All borrowings under the
Credit Facility are collateralized by pledges of all capital stock or other
equity interests in each AMG Affiliate owned and acquired. The credit agreement
contains certain financial covenants which require the Company to maintain
specified minimum levels of net worth and interest coverage ratios and maximum
levels of indebtedness, all as defined in the credit agreement. The credit
agreement also limits the Company's ability to pay dividends and incur
additional indebtedness.
As of December 31, 1998, the Company was a party, with two major commercial
banks as counterparties, to $185 million notional amount of swap contracts which
are designed to limit interest rate increases on the Company's borrowings and
are linked to the three-month LIBOR. The swap contracts, upon quarterly reset
dates, cap interest rates on the notional amounts at rates ranging between 6.67%
and 6.78%. When LIBOR is below 5%, the Company's floating interest rate debt is
swapped for fixed rate debt at rates ranging between 6.67% and 6.78%. The
Company generally borrows at LIBOR and pays an additional interest margin as
described above. The hedging contracts limit the effects of the Company's
payment of interests at equivalent LIBOR rates of 6.78% or less on up to $185
million of indebtedness. The contracts mature between March 2001 and October
2002.
Beginning in January 1999, the Company became a party to a swap contract
that limits interest rates on $75 million of the $185 million of swap contracts
identified above at 5.99%. These contracts are designed to limit interest rate
increases if floating rate debt is swapped for higher fixed rate debt under the
terms of the original swap contracts.
43
<PAGE>
One of the Company's Affiliates also operates as a broker-dealer and must
maintain specified minimum amounts of "net capital" as defined in SEC Rule
15c3-1. In connection with this requirement, the Affiliate has $800 thousand of
subordinated indebtedness which qualifies as net capital under the net capital
rule. The subordinated indebtedness is subordinated to claims of general
creditors and is secured by notes and marketable securities of certain of the
Affiliate's members other than AMG.
7. INCOME TAXES
A summary of the provision for income taxes is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C> <C>
Federal: Current........................................................ $ -- $ -- $ --
Deferred....................................................... (233) 776 10,238
State: Current........................................................ 397 352 6,624
Deferred....................................................... 17 236 172
--------- --------- ---------
Provision for income taxes................................................ $ 181 $ 1,364 $ 17,034
--------- --------- ---------
--------- --------- ---------
</TABLE>
The effective income tax rate differs from the amount computed on income
(loss) before income taxes and extraordinary item by applying the U.S. federal
income tax rate because of the effect of the following items:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Tax at U.S. federal income tax rate................................ (35)% 35% 35%
Nondeductible expenses, primarily amortization of intangibles...... 21 15 2
State income taxes, net of federal benefit......................... 23 13 5
Valuation allowance................................................ 6 (17 ) (2 )
-- -- --
15% 46% 40%
-- -- --
-- -- --
</TABLE>
The components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Deferred assets (liabilities):
Net operating loss carryforwards............................... $ 11,816 $ 6,086
Intangible amortization........................................ (10,337) (17,455)
Accruals....................................................... 849 2,363
Other, net..................................................... (339) --
--------- ---------
1,989 (9,006)
--------- ---------
Valuation allowance.............................................. (1,989) (1,404)
--------- ---------
Net deferred income taxes........................................ $ -- $ (10,410)
--------- ---------
--------- ---------
</TABLE>
Deferred taxes reported at December 31, 1997 have been adjusted from prior
year to reflect the filing of the Company's 1997 tax return.
At December 31, 1998, the Company had federal tax net operating loss
carryforwards of approximately $6 million which expire beginning in the year
2010 and other state net operating loss carryforwards which begin to expire in
the year 2000. The realization of these carryforwards is dependent on generating
44
<PAGE>
sufficient taxable income prior to their expiration. The valuation allowance at
December 31, 1998 is related to the uncertainty of the realization of the
Company's state net operating loss carryforwards.
8. CONTINGENCIES
The Company and its Affiliates are subject to claims, legal proceedings and
other contingencies in the ordinary course of their business activities. Each of
these matters is subject to various uncertainties, and it is possible that some
of these matters may be resolved unfavorably to the Company or its Affiliates.
The Company and its Affiliates establish accruals for matters that are probable
and can be reasonably estimated. Management believes that any liability in
excess of these accruals upon the ultimate resolution of these matters will not
have a material adverse effect on the consolidated financial condition or
results of operations of the Company.
9. ACQUISITIONS AND COMMITMENTS
1998
On March 20, 1998, the Company completed its investment in Essex. Essex is a
Boston-based manager which specializes in investing in growth equities, using a
fundamental research driven approach. AMG paid $69.6 million in cash and
1,750,942 shares of its Series C Convertible Non-Voting Stock, for an indirect
68.0% interest in the Owner's Allocation (as defined in Note 1 above) of Essex.
The Series C Stock is non-voting stock and carries no preferences with respect
to dividends or liquidation. Each share of Series C Stock converted into one
share of Common Stock on March 20, 1999.
On December 31, 1998, AMG acquired a 65% interest in Davis Hamilton Jackson.
DHJA is a Houston based asset management firm with approximately $3.5 billion of
assets under management at December 31, 1998. The Company issued notes to close
the transaction which were settled on January 4, 1999. On January 6, 1999, the
Company acquired an approximately 65% interest in Rorer. Rorer is a Philadelphia
based investment advisor with approximately $4.4 billion of assets under
management at December 31, 1998. AMG paid approximately $65 million in cash for
its investment in Rorer. AMG financed these two investments with borrowings
under its Credit Facility.
The results of operations of Essex and DHJA are included in the consolidated
results of operations of the Company from their respective dates of acquisition,
March 20, 1998 and December 31, 1998.
1997
During 1997, the Company acquired in purchase transactions majority
interests in Gofen and Glossberg, GeoCapital and Tweedy, Browne. The Company
also acquired additional interests in two of its existing Affiliates.
The Company issued 10,667 shares of Class D Convertible Preferred Stock as
partial consideration in the GeoCapital transaction. The preferred stock was
exchanged for 533,350 shares of the Company's Common Stock in connection with
the Company's initial public offering.
The results of operations of Gofen and Glossberg, GeoCapital and Tweedy,
Browne are included in the consolidated results of operations of the Company
from their respective dates of acquisition, May 7, 1997, September 30, 1997 and
October 9, 1997.
1996
During 1996, the Company acquired in purchase transactions majority
interests in First Quadrant and Burridge. In addition, the Company acquired
additional partnership interests from limited partners of two of its existing
Affiliates.
45
<PAGE>
On December 31, 1996, the Company issued notes in the amount of $6.7 million
as partial consideration in the purchase to Burridge selling shareholders who
remained as employees. On January 3, 1997, the notes were settled in cash for
$5.2 million and the issuance of 1,715 shares of Series B-1 Voting Convertible
Preferred Stock. The Convertible Preferred Stock was subsequently exchanged for
85,750 shares of Common Stock in connection with the Company's initial public
offering.
The results of operations of First Quadrant and Burridge are included in the
consolidated results of operations of the Company from their respective dates of
acquisition, March 28, 1996 and December 31, 1996.
PURCHASE PRICE OF INVESTMENTS
The total purchase price, including cash, notes, common and preferred stock
and capitalized transaction costs, associated with these investments is
allocated as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1996 1997 1998
--------- ------------ ----------
<S> <C> <C> <C>
Allocation of Purchase Price:
Net tangible assets............................................. $ 2,198 $ 5,924 $ 3,776
Intangible assets............................................... 35,040 331,421 115,318
--------- ------------ ----------
Total purchase price........................................ $ 37,238 $ 337,345 $ 119,094
--------- ------------ ----------
--------- ------------ ----------
</TABLE>
Unaudited pro forma data for the years ended December 31, 1997 and 1998 are
set forth below, giving consideration to the acquisitions occurring in the
respective two-year period as if such transactions occurred as of the beginning
of 1997, assuming revenue sharing arrangements had been in effect for the entire
period and after making certain other pro forma adjustments.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Revenues...................................................... $ 194,831 $ 257,569
Income before extraordinary item.............................. 16,375 28,715
Extraordinary item............................................ (10,011) --
Net income.................................................... $ 6,364 $ 28,715
Income before extraordinary item per share--basic............. $ 0.85 $ 1.64
Income before extraordinary item per share--diluted........... 0.84 1.47
Net income per share--basic................................... 0.33 1.64
Net income per share--diluted................................. 0.33 1.47
</TABLE>
In conjunction with certain acquisitions, the Company has entered into
agreements and is contingently liable, upon achievement of specified revenue
targets over a five-year period, to make additional purchase payments of up to
$25 million plus interest as applicable. These contingent payments, if achieved,
will be settled for cash with most coming due beginning January 1, 2001 and
January 1, 2002 and will be accounted for as an adjustment to the purchase price
of the Affiliate. In addition, subject to achievement of performance goals,
certain key Affiliate employees have options to receive additional equity
interests in their Affiliates.
Related to one of the Company's Affiliates, a former institutional
shareholder is entitled to redeem a cash value warrant on April 30, 1999. Using
the actual results of operations of this Affiliate to date, the cash value
warrant had no value and, therefore, no amounts have been accrued in these
financial statements.
46
<PAGE>
10. PUTS AND CALLS
To ensure the availability of continued ownership participation to future
key employees, the Company has options to repurchase ("Calls") certain equity
interests in Affiliates owned by partners or members. The options were
exercisable beginning in 1998. In addition, Affiliate management owners have
options ("Puts"), exercisable beginning in the year 2000, which require the
Company to purchase certain portions of their equity interests at staged
intervals. The Company is also obligated to purchase ("Purchase") such equity
interests in Affiliates upon death, disability or termination of employment. All
of the Puts and Purchases would take place based on a multiple of the respective
Affiliate's Owners' Allocation but using reduced multiples for terminations for
cause or for voluntary terminations occurring prior to agreed upon dates, all as
defined in the general partnership, limited partnership or limited liability
company agreements of the Affiliates. Resulting payments made to former owners
of acquired Affiliates are accounted for as adjustments to the purchase price
for such Affiliates. Payments made to equity holders who have been awarded
equity interests in connection with their employment are accrued, net of
estimated forfeitures, over the service period as equity-based compensation.
The Company's contingent obligations under the Put and Purchase arrangements
at December 31, 1998 ranged from $11.0 million on the one hand, assuming all
such obligations occur due to early resignations or terminations for cause, and
$227.5 million on the other hand, assuming all such obligations occur due to
death, disability or terminations without cause. The Put and Purchase amounts
above were calculated based upon $32.0 million of average annual historical
Owners' Allocation. Assuming the closing of all such Put and Purchase
transactions, AMG would own all the prospective Owners' Allocations.
11. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue up to 5,000,000 shares of Preferred Stock
in classes or series and to fix the designations, powers, preferences and the
relative, participating, optional or other special rights of the shares of each
series and any qualifications, limitations and restrictions thereon as set forth
in the Certificate. Any such Preferred Stock issued by the Company may rank
prior to the Common Stock as to dividend rights, liquidation preference or both,
may have full or limited voting rights and may be convertible into shares of
Common Stock.
CONVERTIBLE STOCK
In March 1998, the Company issued 1,750,942 shares of Series C Convertible
Stock in completing its investment in Essex Investment Management Company, LLC.
This stock is a series of the Preferred Stock described above. Each share of
Series C Stock converted into one share of Common Stock on March 20, 1999.
COMMON STOCK
The Company has 43,000,000 authorized shares of Common Stock (including
Class B Common Stock) of which 17,703,617 and 17,531,617 shares were issued and
outstanding at December 31, 1997 and 1998, respectively. On September 11, 1998,
the Company's Board of Directors authorized a share repurchase program pursuant
to which the Company could repurchase up to five percent of its outstanding
shares of Common Stock. During 1998, the Company repurchased 147,000 shares for
$2.6 million. The Company also repurchased 25,000 shares of Common Stock for $5
thousand during 1998 pursuant to the terms of a Stock Purchase and Restriction
Agreement.
On March 3, 1999, the Company completed a public offering of 5,529,954
shares of Common Stock, of which 4,000,000 shares were sold by the Company and
1,529,954 shares were sold by selling stockholders.
47
<PAGE>
AMG used the net proceeds from the offering to reduce indebtedness and will not
receive any proceeds from the sale of Common Stock by the selling stockholders.
STOCK INCENTIVE PLANS
The Company has established three incentive stock plans ("Stock Plans"),
primarily to incent key employees, under which it is authorized to grant
incentive and non-qualified stock options and to grant or sell shares of stock
which are subject to certain restrictions ("Restricted Stock"). Under the terms
of the Stock Plans, the exercise price of incentive stock options granted must
not be less than 100% of the fair market value of the Common Stock on the date
of grant, as determined by the Board of Directors. At December 31, 1998, a total
of 2,300,000 shares of Common Stock have been reserved for issuance under these
plans, with a total of 312,500 shares of Restricted Stock sold and outstanding
and 1,171,750 stock options granted and outstanding. The plans are administered
by a committee of the Board of Directors. Restricted Stock sales were made at
their then fair market value, as approved by the Board of Directors of the
Company, and generally vest over two to four years and are subject to
significant forfeiture provisions and other restrictions.
The 1994 Incentive Stock Plan provides for the issuance of 125,000 shares of
Common Stock. As of December 31, 1998, all 125,000 shares of Restricted Stock
had been sold and all are now vested.
The 1995 Incentive Stock Plan (the "1995 Plan") provides for the issuance of
425,000 shares of Common Stock. As of December 31, 1998, the Company had sold an
aggregate 212,500 shares of Restricted Stock under the 1995 Plan. At December
31, 1998, 146,875 of these shares were vested. In 1998, 25,000 of these shares
of Restricted Stock were repurchased by the Company for $5 thousand. In 1997,
the Company granted options to purchase 92,500 shares to officers of the Company
with an exercise price of $9.10 per share under the 1995 Plan. These options
vest over a three year period and expire ten years from the grant date. As of
December 31, 1998, none of the options granted under the 1995 Plan had been
exercised. The Company does not intend to make any further grants under the 1995
Plan.
The 1997 Stock Option and Incentive Plan (the "1997 Plan") provides for the
issuance of 1,750,000 shares of Common Stock. In connection with the Company's
initial public offering on November 21, 1997, the Company granted options to
purchase 590,000 shares of Common Stock to officers and employees of the Company
with an exercise price of $23.50 per share. These options are exercisable over
seven years, with 15% exercisable on each of the first six anniversaries of the
date of grant and 10% exercisable on the seventh anniversary of the date of
grant. The vesting period of these options will be accelerated upon a change in
control of the Company or upon the achievement of certain financial goals. In
1998, 57,500 of these options were forfeited and accordingly 532,500 are
outstanding at December 31, 1998. On December 11, 1997, the Company granted an
option to purchase 10,000 shares of Common Stock with an exercise price of
$24.9375 per share to a newly elected director of the Company. This option
becomes exercisable in equal installments of 6.25% on the first day of each
calendar quarter commencing April 1, 1998. The vesting period of this option
will be accelerated upon a change in control of the Company. The above options
expire ten years after the grant date.
In 1998, the Company granted options to purchase 536,750 shares of Common
Stock to officers and employees of the Company. The exercise price of 356,000 of
these options is $34.63. The exercise price of 5,250 of these options is $14.25,
and the exercise price of 175,500 of these options is $27.69. All of these
options expire ten years after the grant date.
48
<PAGE>
The following table summarizes the transactions of the Company's stock
option plans for the two year period ended December 31, 1998. No options were
granted in the year ended December 31, 1996 or prior.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
NUMBER OF SHARES EXERCISE PRICE
----------------- -----------------
<S> <C> <C>
Unexercised options outstanding--December 31, 1996................. -- $ --
Options granted.................................................... 692,500 21.60
Options exercised.................................................. -- --
Options forfeited.................................................. -- --
----------------- ------
Unexercised options outstanding--December 31, 1997................. 692,500 21.60
Options granted.................................................... 536,750 32.16
Options exercised.................................................. -- --
Options forfeited.................................................. (57,500) 23.50
----------------- ------
Unexercised options outstanding--December 31, 1998................. 1,171,750 $ 26.34
Exercisable options
December 31, 1997................................................ 30,833 $ 9.10
December 31, 1998................................................ 233,730 $ 23.90
</TABLE>
The following table summarizes information about the Company's stock options
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------------------------------- OPTIONS
WEIGHTED AVG. NUMBER EXERCISABLE
RANGE OF NUMBER REMAINING WEIGHTED AVG. EXERCISABLE ---------------
EXERCISE OUTSTANDING AS CONTRACTUAL EXERCISE AS OF WEIGHTED AVG.
PRICES OF 12/31/98 LIFE (YEARS) PRICE 12/31/98 EXERCISE PRICE
- - -------------- ---------------- --------------- ------------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
$ 9.10-14.25 97,750 8.5 $ 9.38 62,980 $ 9.21
23.50-27.69 718,000 9.2 24.54 81,750 23.50
34.63 356,000 9.3 34.63 89,000 34.63
--
---------------- ------ ------------- ------
$ 9.10-34.63 1,171,750 9.1 $ 26.34 233,730 $ 23.90
--
--
---------------- ------ ------------- ------
---------------- ------ ------------- ------
</TABLE>
SUPPLEMENTAL DISCLOSURE FOR EQUITY-BASED COMPENSATION
The Company continues to apply APB 25 and related interpretations in
accounting for its sales of Restricted Stock, grants of stock options and equity
based interests in Affiliates. FAS 123 defines a fair value method of accounting
for the above arrangements whose impact requires disclosure. Under the fair
value method, compensation cost is measured at the grant date based on the fair
value of the award and is recognized over the expected service period. The
required disclosures under FAS 123 as if the Company had applied the new method
of accounting are made below.
49
<PAGE>
Had compensation cost for the Company's equity-based compensation
arrangements been determined based on the fair value at grant date for awards
consistent with the requirements of FAS 123, the Company's net income (loss) and
net income (loss) per share would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- ---------
Net income (loss)--as reported.......................................... $ (2,372) $ (8,368) $ 25,551
Net income (loss)--FAS 123 pro forma.................................... (2,141) (8,837) 24,408
Net income (loss) per share--basic--as reported......................... (5.49) (3.69) 1.45
Net income (loss) per share--basic--FAS 123 pro forma................... (4.96) (3.89) 1.39
Net income (loss) per share--diluted--as reported....................... (5.49) (1.02) 1.33
Net income (loss) per share--diluted--FAS 123 pro forma................. (4.96) (1.07) 1.27
</TABLE>
The fair value of options granted in the year ended December 31, 1997 was
estimated using the minimum value method prior to the initial public offering in
November 1997 and the Black-Scholes option pricing model after the offering. The
weighted average fair value of options granted in the year ended December 31,
1998 was estimated at $14.24 per option using the Black-Scholes option pricing
model. The following weighted average assumptions were used for the option
valuations.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Dividend yield....................................................... 0% 0%
Volatility........................................................... 26% 60%
Risk-free interest rates............................................. 5.96% 5.38%
Expected option lives in years....................................... 6.7 7
</TABLE>
12. EARNINGS (LOSS) PER SHARE
The calculation for the basic earnings per share is based on the weighted
average of common shares outstanding during the period. The calculation for the
diluted earnings per share is based on the weighted average of common and common
equivalent shares outstanding during the period. The following is a
reconciliation of the numerators and denominators of the basic and diluted EPS
computations.
<TABLE>
<CAPTION>
1996 1997 1998
------------- ------------ -------------
<S> <C> <C> <C>
Numerator:
Income (loss) before extraordinary item................... $ (1,389,000) $ 1,643,000 $ 25,551,000
Denominator:
Average shares outstanding--basic......................... 431,908 2,270,684 17,582,900
Convertible preferred stock............................... -- 5,496,330 1,376,768
Stock options and unvested restricted stock............... -- 468,515 263,163
------------- ------------ -------------
Average shares outstanding--diluted....................... 431,908 8,235,529 19,222,831
------------- ------------ -------------
------------- ------------ -------------
Income (loss) before extraordinary item per share:
Basic..................................................... $ (3.22) $ 0.72 $ 1.45
Diluted................................................... $ (3.22) $ 0.20 $ 1.33
</TABLE>
13. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
The Company is exposed to market risks brought on by changes in interest
rates. Derivative financial instruments are used by the Company to reduce those
risks, as explained in this note.
50
<PAGE>
(A) NOTIONAL AMOUNTS AND CREDIT EXPOSURES OF DERIVATIVES
The notional amount of derivatives do not represent amounts that are
exchanged by the parties, and thus are not a measure of the Company's exposure.
The amounts exchanged are calculated on the basis of the notional or contract
amounts, as well as on other terms of the interest rate swap derivatives, and
the volatility of these rates and prices.
The Company would be exposed to credit-related losses in the event of
nonperformance by the counter-parties that issued the financial instruments. The
Company does not expect that the counter-parties to interest rate swaps will
fail to meet their obligations, given their high credit ratings. The credit
exposure of derivative contracts is represented by the positive fair value of
contracts at the reporting date, reduced by the effects of master netting
agreements. The Company generally does not give or receive collateral on
interest rate swaps due to its own credit rating and that of its
counter-parties.
(B) INTEREST RATE RISK MANAGEMENT
The Company enters into interest rate swaps to reduce exposure to
interest-rate risk connected to existing liabilities. The Company does not hold
or issue derivative financial instruments for trading purposes. Interest rate
swaps allow the Company to achieve a level of variable-rate and fixed-rate debt
that is acceptable to management, and to cap interest rate exposure. The Company
agrees with another party to exchange the difference between fixed-rate and
floating rate interest amounts calculated by reference to an agreed notional
principal amount.
(C) FAIR VALUE
FASB Statement No. 107, "Disclosures about Fair Value of Financial
Instruments" ("FAS 107"), requires the Company to disclose the estimated fair
values for certain of its financial instruments. Financial instruments include
items such as loans, interest rate contracts, notes payable, and other items as
defined in FAS 107.
Fair value of a financial instrument is the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale.
Quoted market prices are used when available, otherwise, management
estimates fair value based on prices of financial instruments with similar
characteristics or using valuation techniques such as discounted cash flow
models. Valuation techniques involve uncertainties and require assumptions and
judgments regarding prepayments, credit risk and discount rates. Changes in
these assumptions will result in different valuation estimates. The fair value
presented would not necessarily be realized in an immediate sale; nor are there
plans to settle liabilities prior to contractual maturity. Additionally, FAS 107
allows companies to use a wide range of valuation techniques, therefore, it may
be difficult to compare the Company's fair value information to other companies'
fair value information.
51
<PAGE>
The following tables present a comparison of the carrying value and
estimated fair value of the Company's financial instruments at December 31, 1997
and 1998:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------
ESTIMATED
CARRYING VALUE FAIR VALUE
-------------- -----------
<S> <C> <C>
Financial assets:
Cash and cash equivalents................................................ $ 23,046 $ 23,046
Financial liabilities:
Senior bank debt......................................................... (159,500) (159,500)
Off-balance sheet financial instruments:
Interest-rate hedging agreements......................................... -- (2,528)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
---------------------------
ESTIMATED
CARRYING VALUE FAIR VALUE
-------------- -----------
<S> <C> <C>
Financial assets:
Cash and cash equivalents................................................ $ 23,735 $ 23,735
Notes receivable......................................................... 1,700 1,700
Financial liabilities:
Notes payable............................................................ (22,000) (22,000)
Senior bank debt......................................................... (190,500) (190,500)
Off-balance sheet financial instruments:
Interest-rate hedging agreements......................................... -- (7,446)
</TABLE>
The carrying amount of cash and cash equivalents approximates fair value
because of the short term nature of these instruments. The carrying value of
notes receivable approximate fair value because interest rates and other terms
are at market rates. The carrying value of notes payable approximates fair value
principally because of the short term nature of the note. The carrying value of
senior bank debt approximates fair value because the debt is a revolving credit
facility with variable interest based on three month LIBOR rates. The fair
values of interest rate hedging agreements are quoted market prices based on the
estimated amount necessary to terminate the agreements.
52
<PAGE>
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
of the Company for 1997 and 1998.
<TABLE>
<CAPTION>
1997
------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues.................................................... $ 16,568 $ 16,302 $ 20,410 $ 42,007
Operating income............................................ 3,561 2,141 3,270 13,589
Income (loss) before income taxes and extraordinary item.... 1,220 (419) 253 1,953
Income before extraordinary item............................ $ 674 $ 32 $ 127 $ 810
Income before extraordinary item per share--basic........... $ 1.31 $ 0.06 $ 0.21 $ 0.11
Income before extraordinary item per share--diluted......... $ 0.10 $ -- $ 0.02 $ 0.07
</TABLE>
<TABLE>
<CAPTION>
1998
------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues.................................................... $ 45,723 $ 56,586 $ 55,892 $ 80,293
Operating income............................................ 16,693 22,233 21,349 32,505
Income before income taxes.................................. 7,437 9,858 9,773 15,517
Net income.................................................. $ 4,462 $ 5,915 $ 5,864 $ 9,310
Net income per share--basic................................. $ 0.25 $ 0.34 $ 0.33 $ 0.53
Net income per share--diluted............................... $ 0.25 $ 0.30 $ 0.30 $ 0.48
</TABLE>
During the fourth quarter of 1998, the Company experienced increases in
revenues, operating income, income before income taxes and extraordinary item,
and income before extraordinary item from the same period in 1997 substantially
as a result of new Affiliate investments.
15. RELATED PARTY TRANSACTIONS
During 1998, the Company initiated an employee loan program. Loans to
employees accrue interest at the Company's borrowing rate and have a stated
30-year maturity date. Outstanding balances are payable in full when employees
terminate employment with the Company. At December 31, 1998 loans outstanding
totaled $1.7 million.
16. SEGMENT INFORMATION
The Company and its affiliates provide investment advisory services to
mutual funds and individual and institutional accounts. The Company's revenues
are generated substantially from providing these investment advisory services to
domestic customers.
The Affiliates are all managed by separate Affiliate management teams in
accordance with the respective agreements between the Company and each
Affiliate. While the Company has determined that each of its Affiliates
represents a separate reportable operating segment, because the Affiliates offer
comparable investment products and services, have similar customers and
distribution channels, and operate in a similar regulatory environment, the
Affiliates have been aggregated into one reportable segment for financial
statement disclosure purposes.
53
<PAGE>
17. EVENTS SUBSEQUENT TO DECEMBER 31, 1998
On January 6, 1999, the Company completed its investment in Rorer. The total
purchase price associated with this investment is allocated as follows:
<TABLE>
<S> <C>
Net tangible assets........................................................ $ 744
Intangible assets.......................................................... 64,621
---------
Total purchase price..................................................... $ 65,365
---------
---------
</TABLE>
The amortization periods used for intangible assets for this investment are
24 years for acquired client relationships and 30 years for goodwill. Unaudited
pro forma data for the years ended December 31, 1997 and 1998 are set forth
below, giving consideration to investments occurring in the two years ended
December 31, 1998, as well as the investment in Rorer, as if such transactions
had occurred as of the beginning of 1997, assuming revenue sharing arrangements
had been in effect for the entire period and after making certain other pro
forma adjustments.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Revenues..................................................... $ 208,940 $ 278,327
Income before extraordinary item............................. 15,579 28,338
Extraordinary item........................................... (10,011) --
Net income................................................... 5,568 28,338
Income before extraordinary item per share--basic............ $ 0.81 $ 1.61
Income before extraordinary item per share--diluted.......... 0.80 1.45
Net income per share--basic.................................. 0.29 1.61
Net income per share--diluted................................ 0.29 1.45
</TABLE>
On January 29, 1999 the Company expanded the Credit Facility to $330
million, adding another major commercial bank to its group of lenders. The
Company has the option, with the consent of its lenders, to increase the
facility by another $70 million to a total of $400 million.
On January 29, 1999, the Company entered into a definitive agreement to
acquire substantially all of the partnership interests in The Managers Funds,
L.P., which serves as the adviser to a family of ten equity and fixed income
no-load mutual funds. The Managers Funds, L.P. managed a total of $1.8 billion
in these funds at December 31, 1998. This transaction is subject to customary
closing conditions.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
54
<PAGE>
PART III
The information in Part III (Items 10, 11, 12 and 13) is incorporated by
reference to the Company's definitive Proxy Statement, which will be filed not
later than 120 days after the end of the Company's fiscal year.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a)(1) Financial Statements: See Item 8
(2) Financial Statement Schedules: See Item 8
(3) Exhibits
<TABLE>
<S> <C>
2.1 Purchase Agreement dated August 15, 1997 by and among the Registrant, Tweedy, Browne
Company L.P. and the partners of Tweedy, Browne Company L.P. (excluding schedules
and exhibits, which the Registrant agrees to furnish supplementally to the
Commission upon request) (2)
2.2 Agreement and Plan of Reorganization dated August 15, 1997 by and among the
Registrant, AMG Merger Sub, Inc., GeoCapital Corporation, GeoCapital, LLC and the
stockholders of GeoCapital Corporation (excluding schedules and exhibits, which the
Registrant agrees to furnish supplementally to the Commission upon request) (2)
2.3 Stock Purchase Agreement dated as of January 17, 1996 by and among the Registrant,
First Quadrant Holdings, Inc., Talegen Holdings, Inc., certain employees of First
Quadrant Corp. and the other parties identified therein (excluding schedules and
exhibits, which the Registrant agrees to furnish supplementally to the Commission
upon request) (2)
2.4 Amendment to Stock Purchase Agreement by and among the Registrant, First Quadrant
Holdings, Inc., Talegen Holdings, Inc., certain managers of First Quadrant Corp.
and the Management Corporations identified therein, effective as of March 28, 1996
(2)
2.5 Partnership Interest Purchase Agreement dated as of June 6, 1995 by and among the
Registrant, Mesirow Asset Management, Inc., Mesirow Financial Holdings, Inc.,
Skyline Asset Management, L.P., certain managers of Mesirow Asset Management, Inc.
and the Management Corporations identified therein (excluding schedules and
exhibits, which the Registrant agrees to furnish supplementally to the Commission
upon request) (2)
2.6 Amendment, made by and among Mesirow Financial Holdings, Inc. and the Registrant, to
Partnership Interest Purchase Agreement by and among the Registrant, Mesirow Asset
Management, Inc., Mesirow Financial Holdings, Inc., Skyline Asset Management, L.P.,
certain managers of Mesirow Asset Management, Inc. and the Management Corporations
identified therein, effective as of August 30, 1995 (2)
2.7 Agreement and Plan of Reorganization dated January 15, 1998 by and among the
Registrant, Constitution Merger Sub, Inc., Essex Investment Management Company,
Inc. and certain of the stockholders of Essex Investment Management Company, Inc.
(excluding schedules and exhibits, which the Registrant agrees to furnish
supplementally to the Commission upon request)(3)
</TABLE>
55
<PAGE>
<TABLE>
<S> <C>
2.8 Amendment to Agreement and Plan of Reorganization dated March 19, 1998 by and among
the Registrant, Constitution Merger Sub, Inc., Essex Investment Management Company,
Inc. and certain of the stockholders of Essex Investment Management Company, Inc.
(excluding schedules and exhibits, which the Registrant agrees to furnish
supplementally to the Commission upon request) (3)
2.9 Stock Purchase Agreement dated November 9, 1998 by and among the Registrant, Edward
C. Rorer & Co., Inc. and the stockholders of Edward C. Rorer & Co., Inc. (excluding
schedules and exhibits, which the Registrant agrees to furnish supplementally to
the Commission upon request) (4)
3.1 Amended and Restated Certificate of Incorporation (2)
3.2 Amended and Restated By-laws (2)
3.3 Certificate of Designations, Preferences and Rights of a Series of Stock (5)
4.1 Specimen certificate for shares of Common Stock of the Registrant (2)
4.2 Credit Agreement dated as of December 22, 1997 by and among Chase Manhattan Bank,
Nations Bank N.A. and the other lenders identified therein and the Registrant
(excluding schedules and exhibits, which the Registrant agrees to furnish
supplementally to the Commission upon request) (3)
4.3 Stock Purchase Agreement dated November 7, 1995 by and among the Registrant, TA
Associates, NationsBank, The Hartford, and the additional parties listed on the
signature pages thereto (excluding schedules and exhibits, which the Registrant
agrees to furnish supplementally to the Commission upon request) (2)
4.4 Preferred Stock and Warrant Purchase Agreement dated August 15, 1997 between the
Registrant and Chase Equity Associates (excluding schedules and exhibits, which the
Registrant agrees to furnish supplementally to the Commission upon request) (2)
4.5 Amendment No. 1 to Preferred Stock and Warrant Purchase Agreement dated as of October
9, 1997 between the Registrant and Chase Equity Associates (2)
4.6 Securities Purchase Agreement dated August 15, 1997 between the Registrant and Chase
Equity Associates (excluding schedules and exhibits, which the Registrant agrees to
furnish supplementally to the Commission upon request) (2)
4.7 Securities Purchase Agreement Amendment No. 1 dated as of October 9, 1997 between the
Registrant and Chase Equity Associates (2)
10.1 Amended and Restated Stockholders' Agreement dated October 9, 1997 by and among the
Registrant and TA Associates, NationsBank, The Hartford, Chase Capital and the
additional parties listed on the signature pages thereto (2)
10.2 Tweedy, Browne Company LLC Limited Liability Company Agreement dated October 9, 1997
by and among the Registrant and the other members identified therein (excluding
schedules and exhibits, which the Registrant agrees to furnish supplementally to
the Commission upon request) (2)
10.3 GeoCapital, LLC Amended and Restated Limited Liability Company Agreement dated
September 30, 1997 by and among the Registrant and the members identified therein
(excluding schedules and exhibits, which the Registrant agrees to furnish
supplementally to the Commission upon request) (2)
</TABLE>
56
<PAGE>
<TABLE>
<S> <C>
10.4 First Quadrant, L.P. Amended and Restated Limited Partnership Agreement dated March
28, 1996 by and among the Registrant and the partners identified therein (excluding
schedules and exhibits, which the Registrant agrees to furnish supplementally to
the Commission upon request) (2)
10.5 Amendment to First Quadrant, L.P. Amended and Restated Limited Partnership Agreement
by and among the Registrant and the partners identified therein, effective as of
October 1, 1996 (2)
10.6 Second Amendment to First Quadrant, L.P. Amended and Restated Limited Partnership
Agreement by and among the Registrant and the partners identified therein,
effective as of December 31, 1996 (2)
10.7 First Quadrant U.K., L.P. Limited Partnership Agreement dated March 28, 1996 by and
among the Registrant and the partners identified therein (excluding schedules and
exhibits, which the Registrant agrees to furnish supplementally to the Commission
upon request) (2)
10.8 Skyline Asset Management, L.P. Amended and Restated Limited Partnership Agreement
dated August 31, 1995 by and among the Registrant and the partners identified
therein (excluding schedules and exhibits, which the Registrant agrees to furnish
supplementally to the Commission upon request) (2)
10.9 Amendment to Skyline Asset Management, L.P. Amended and Restated Limited Partnership
Agreement by and among the Registrant and the partners identified therein,
effective as of August 1, 1996 (2)
10.10 Second Amendment to Skyline Asset Management, L.P. Amended and Restated Limited
Partnership Agreement by and among the Registrant and the partners identified
therein, effective as of December 31, 1996 (2)
10.11 Affiliated Managers Group, Inc. 1997 Stock Option and Incentive Plan (2)
10.13 Affiliated Managers Group. Inc. 1995 Incentive Stock Plan (2)
10.14 Form of Tweedy, Browne Employment Agreement (2)
10.15 Essex Investment Management Company, LLC Amended and Restated Limited Liability
Company Agreement dated March 20, 1998 by and among the Registrant and the members
identified therein (excluding schedules and exhibits, which the Registrant agrees
to furnish supplementally to the Commission upon request) (3)
10.16 Form of Essex Employment Agreement (3)
10.17 Rorer Asset Management, LLC Amended and Restated Limited Liability Company Agreement
dated January 6, 1999 by and among the Registrant and the members identified
therein (excluded schedules and exhibits, which the Registrant agrees to furnish
supplementally to the Commission upon request) (6)
10.18 Form of Rorer Employment Agreement (6)
21.1 Schedule of Subsidiaries (1)
23.2 Consent of PricewaterhouseCoopers LLP (1)
23.5 Consent of KPMG Peat Marwick LLP (1)
24.1 Financial Data Schedule (1)
</TABLE>
- - ------------------------
(1) Filed herewith
57
<PAGE>
(2) Incorporated by reference to the Company's Registration Statement on Form
S-1 (No. 333-34679), filed August 29, 1997 as amended
(3) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997
(4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the three months ended September 30, 1998
(5) Incorporated by reference to the Company's Registration Statement on Form
S-3 (No. 333-71561), filed February 1, 1999, as amended
(6) Incorporated by reference to the Company's Current Report on Form 8-K filed
January 21, 1999
ITEM 14b. REPORTS ON 8-K
There have been no reports on Form 8-K filed by the Company during the
quarter ended December 31, 1998.
58
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
Board of Directors and Stockholders
Affiliated Managers Group, Inc.
Our audits of the consolidated financial statements referred to in our
report dated March 22, 1999 of Affiliated Managers Group, Inc. (which report and
consolidated financial statements are included in this Annual Report on Form
10-K) also included an audit of the financial statement schedule listed in Item
14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 22, 1999
59
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement
of Affiliated Managers Group, Inc. on Form S-3 (File No. 333-71561) and Form S-8
(File No. 333-72967) of our reports dated March 22, 1999, on our audits of the
consolidated financial statements and financial statement schedule of Affiliated
Managers Group, Inc. as of December 31, 1997 and 1998, and for the years ended
December 31, 1996, 1997, and 1998, which report is included in this Annual
Report on Form 10-K.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 31, 1999
60
<PAGE>
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO DEDUCTIONS BALANCE
BEGINNING COSTS AND AND END OF
OF PERIOD EXPENSES WRITE-OFFS PERIOD
----------- ----------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Income Tax Valuation Allowance
Year Ending December 31,
1998.................................................. $ 1,989 $ -- $ (585) $ 1,404
1997.................................................. 477 1,512 -- 1,989
1996.................................................. -- 477 -- 477
</TABLE>
61
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
AFFILIATED MANAGERS GROUP, INC.
---------------------------------------------
(Registrant)
Date: March 31, 1999 By: /s/ WILLIAM J. NUTT
-----------------------------------------
William J. Nutt
PRESIDENT AND CHIEF EXECUTIVE OFFICER AND
CHAIRMAN OF THE BOARD OF DIRECTORS
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
<TABLE>
<C> <S> <C>
President, Chief Executive
/s/ WILLIAM J. NUTT Officer and Chairman of
- - ------------------------------ the Board of Directors March 31, 1999
(William J. Nutt) (Principal Executive
Officer)
Senior Vice President,
/s/ DARRELL W. CRATE Chief Financial Officer
- - ------------------------------ and Treasurer (Principal March 31, 1999
(Darrell W. Crate) Financial and Principal
Accounting Officer)
/s/ RICHARD E. FLOOR
- - ------------------------------ Director March 31, 1999
(Richard E. Floor)
/s/ P. ANDREWS MCLANE
- - ------------------------------ Director March 31, 1999
(P. Andrews McLane)
/s/ JOHN M.B. O'CONNOR
- - ------------------------------ Director March 31, 1999
(John M.B. O'Connor)
/s/ W.W. WALKER, JR.
- - ------------------------------ Director March 31, 1999
(W.W. Walker, Jr.)
/s/ WILLIAM F. WELD
- - ------------------------------ Director March 31, 1999
(William F. Weld)
</TABLE>
62
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 23735
<SECURITIES> 0
<RECEIVABLES> 66939
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 95811
<PP&E> 8001
<DEPRECIATION> 0
<TOTAL-ASSETS> 605334
<CURRENT-LIABILITIES> 64617
<BONDS> 0
0
0
<COMMON> 270978
<OTHER-SE> 42677
<TOTAL-LIABILITY-AND-EQUITY> 605334
<SALES> 238494
<TOTAL-REVENUES> 238494
<CGS> 0
<TOTAL-COSTS> 145714
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13603
<INCOME-PRETAX> 42585
<INCOME-TAX> 17034
<INCOME-CONTINUING> 25551
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 25551
<EPS-PRIMARY> 1.45
<EPS-DILUTED> 1.33
</TABLE>
