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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 


 

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

 

For the year ended December 31, 2013

 

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

 

Commission file number 001-34835

 


 

Envestnet, Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

20-1409613

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S Employer

Identification No.)

 

 

 

35 East Wacker Drive, Suite 2400, Chicago, IL

 

60601

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:

(312) 827-2800

 


 

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

 

Title of Each Class:

 

Name of Each Exchange on Which Registered:

Common stock, par value $0.005 per share

 

NYSE

 

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

None

 

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

 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

o

Accelerated filer

x

 

 

 

 

Non-accelerated filer

o

Smaller reporting company

o

 

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

 

Aggregate market value of registrant’s common stock held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock on June 30, 2013 as reported on The New York Stock Exchange on that date: $551,089,200. For purposes of this calculation, shares of common stock held by (i) persons holding more than 5% of the outstanding shares of stock, and (ii) officers and directors of the registrant, as of June 30, 2013, are excluded in that such persons may be deemed to be affiliates. This determination is not necessarily conclusive of affiliate status.

 

As of March 7, 2014, 34,019,202 shares of the common stock with a par value of $0.005 per share were outstanding.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

 

PART I

 

Forward-Looking Statements

3

Item 1.

Business

4

Item 1A.

Risk Factors

14

Item 1B.

Unresolved Staff Comments

25

Item 2.

Properties

25

Item 3.

Legal Proceedings

25

Item 4.

Mine Safety Disclosures

25

 

 

 

 

PART II

 

Item 5.

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

26

Item 6.

Selected Financial Data

28

Item 7.

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

29

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

47

Item 8.

Financial Statements and Supplementary Data

48

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

78

Item 9A.

Controls and Procedures

79

Item 9B.

Other Information

81

 

 

 

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance

81

Item 11.

Executive Compensation

81

Item 12.

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

81

Item 13.

Certain Relationships and Related Transactions, and Director Independence

81

Item 14.

Principal Accountant Fees and Services

81

 

 

 

 

PART IV

 

Item 15.

Exhibits and Financial Statement Schedules

82

 

 

 

SIGNATURES

85

 

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Forward-Looking Statements

 

This annual report on Form 10-K contains forward-looking statements regarding future events and our future results within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, in particular, statements about our plans, strategies and prospects under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements are based on our current expectations and projections about future events and are identified by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “expected,” “intend,” “will,” “may,” or “should” or the negative of those terms or variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and other characteristics of future events or circumstances are forward-looking statements. Forward-looking statements may include, among others, statements relating to:

 

·                  difficulty in sustaining rapid revenue growth, which may place significant demands on the Company’s administrative, operational and financial resources,

 

·                  fluctuations in the Company’s revenue,

 

·                  the concentration of nearly all of the Company’s revenues from the delivery of investment solutions and services to clients in the financial advisory industry,

 

·                  the impact of market and economic conditions on the Company’s revenues,

 

·                  the Company’s reliance on a limited number of clients for a material portion of its revenue,

 

·                  the renegotiation of fee percentages or termination of the Company’s services by its clients,

 

·                  the Company’s ability to identify potential acquisition candidates, complete acquisitions and successfully integrate acquired companies,

 

·                  compliance failures,

 

·                  regulatory actions against the Company,

 

·                  the failure to protect the Company’s intellectual property rights,

 

·                  the Company’s inability to successfully execute the conversion of its clients’ assets from their technology platform to the Company’s technology platform in a timely and accurate manner,

 

·                  general economic conditions, political and regulatory conditions, and

 

·                  management’s response to these factors.

 

In addition, there may be other factors of which we are presently unaware or that we currently deem immaterial that could cause our actual results to be materially different from the results referenced in the forward-looking statements. All forward-looking statements contained in this annual report and documents incorporated herein by reference are qualified in their entirety by this cautionary statement. Forward-looking statements speak only as of the date they are made, and we do not intend to update or otherwise revise the forward-looking statements to reflect events or circumstances after the date of this annual report or to reflect the occurrence of unanticipated events. If we do update one or more forward-looking statements, no inference should be made that we will make additional updates with respect to those or other forward-looking statements.

 

Although we believe that our plans, intentions and expectations are reasonable, we may not achieve our plans, intentions or expectations.

 

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

 

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

 

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

 

Unless the context requires otherwise, the words “Envestnet,” “the Company,” “we,” “us” and “our” are references to Envestnet, Inc. and its subsidiaries as a whole.

 

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Except where we have otherwise indicated or the context otherwise requires, dollar amounts presented in this Form 10-K are in thousands, except for Item 9, Exhibits and per share amounts.

 

Item  1.                                        Business

 

General

 

We are a leading provider of unified wealth management software and services to financial advisors and institutions. By integrating a wide range of investment solutions and services, our technology platform provides financial advisors with the flexibility to address their clients’ needs. As of December 31, 2013, approximately 30,000 advisors used our technology platform, supporting approximately $537 billion of assets in approximately 2.2 million investor accounts.

 

Envestnet empowers financial advisors to deliver fee-based advice to their clients. We work with both Independent Registered Investment Advisors (“RIAs”), as well as advisors associated with financial institutions such as broker-dealers and banks. The services we offer and market to financial advisors address advisors’ ability to grow their practice as well as to operate more efficiently – the Envestnet platform spans the various elements of the wealth management process, from the initial meeting an advisor has with a prospective client to the ongoing day-to-day operations of managing an advisory practice.

 

Our centrally-hosted technology platform, which we refer to as having “open architecture” because of its flexibility, provides financial advisors with access to a series of integrated services to help them better serve their clients. These services include risk assessment and selection of investment strategies and solutions, asset allocation models, research and due diligence, portfolio construction, proposal generation and paperwork preparation, model management and account rebalancing, account monitoring, customized fee billing, overlay services covering asset allocation, tax management and socially responsible investing, aggregated multi-custodian performance reporting and communication tools, as well as access to a wide range of leading third-party asset custodians.

 

We offer these solutions principally through the following product and services suites:

 

·                  Envestnet’s wealth management software empowers advisors to better manage client outcomes and strengthen their practice. Our software unifies the applications and services advisors use to manage their practice and advise their clients, including financial planning; capital markets assumptions; asset allocation guidance; research and due diligence on investment managers and funds; portfolio management, trading and rebalancing; multi-custodial, aggregated performance reporting; and billing calculation and administration.

 

·                  Envestnet | PMC®, our Portfolio Management Consultants group primarily engages in consulting services aimed at providing financial advisors with additional support in addressing their clients’ needs, as well as the creation of proprietary investment solutions and products. Envestnet | PMC’s investment solutions and products include managed account and multi-manager portfolios, mutual fund portfolios and Exchange Traded Fund (“ETF”) portfolios. Envestnet | PMC also offers Prima Premium Research, comprising institutional-quality research and due diligence on investment managers, mutual funds, ETFs and liquid alternatives funds.

 

·                  Envestnet | Tamarac TM provides leading portfolio accounting, rebalancing, trading, performance reporting and client relationship management (“CRM”) software, principally to high-end RIAs.

 

·                  Vantage Reporting SolutionTM software aggregates and manages investment data, provides performance reporting and benchmarking, giving advisors an in-depth view of clients’ various investments, empowering advisors to give holistic, personalized advice and consulting.

 

·                    Envestnet | WMSTM offers financial institutions access to an integrated wealth platform, which helps construct and manage sophisticated portfolio solutions across an entire account life cycle, particularly in the area of unified managed account (“UMA”) trading. Envestnet | WMS’s Overlay Portfolio Management console helps wealth managers efficiently build customized client portfolios that consider both proprietary and open-architecture investment solutions.

 

We believe that our business model results in a high degree of recurring and predictable financial results. The majority of our revenue is asset-based, meaning it is derived from fees charged as a percentage of the assets that are managed or administered on our technology platform by financial advisors. We also generate revenues from recurring, contractual licensing fees for providing access to our technology platform and from professional services.

 

For the year ended December 31, 2013, we earned fees of $200,568 from assets under management (“AUM”) or assets under administration (“AUA” and collectively “AUM/A”). Asset-based fees accounted for approximately 83%, 81% and 81% of our total revenues for the years ended December 31, 2013, 2012 and 2011, respectively. Licensing and professional services revenues accounted for 17%, 19% and 19% of our total revenues for the years ended December 31, 2013, 2012 and 2011, respectively.

 

For over 85% of our asset-based fee arrangements, we bill customers at the beginning of each quarter based on the market value of customer assets on our technology platform as of the end of the prior quarter, providing for a high degree of revenue visibility

 

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in the current quarter. Furthermore, our licensing fees are highly predictable because they are generally established in multi-year contracts providing longer-term visibility regarding that portion of our total revenues.

 

As the tables below indicate, our business has experienced steady and significant growth over the last several years. We believe this growth is attributable not only to secular trends in the wealth management industry as described below but also to the uniqueness and comprehensiveness of our products.

 

The following table sets forth the AUM or AUA as of the end of the quarters indicated:

 

Quarterly Assets Under Management or Administration

($ in billions)

 

 

 

The following table sets forth the number of accounts with AUM or AUA as of the end of the quarters indicated:

 

Quarterly Accounts Under Management or Administration

(in thousands)

 

 

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

 

Total Advisors

 

 

We were founded in 1999 and through organic growth and strategic transactions we have grown to become a leading independent provider of integrated wealth management software and services to financial advisors and institutions. Our headquarters are located in Chicago, Illinois and we have offices in New York, New York; Denver, Colorado; Seattle, Washington; Sunnyvale, California; Boston, Massachusetts; Landis and Raleigh, North Carolina; Newark, New Jersey and Trivandrum, India.

 

Our Market Opportunity

 

The wealth management industry has experienced significant growth in terms of assets invested by retail investors in the past several years. According to the Federal Reserve, U.S. household and non-profit organization financial assets totaled $63.9 trillion as of September 30, 2013, up 17% from $54.4 trillion at December 31, 2012.

 

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

 

Increase in independent financial advisors. Based on industry news reports, we believe that over the past several years an increasing number of financial advisors have elected to leave large financial institutions and start their own financial advisory practices or move to smaller, more independent firms. According to an analysis done by Cerulli Associates, the number of RIAs and dually-registered advisors increased 5% annually from 36,000 in 2007 to 46,000 in 2012.

 

Increased reliance on technology among independent financial advisors.  In order to compete effectively in the marketplace, independent financial advisors are increasingly relying on technology service providers to help them provide comparable services cost effectively and efficiently.

 

Increased use of financial advisors. We believe, based on an analysis done by Cerulli Associates, that the volatility and increasing complexity in securities markets have resulted in increased investor interest in receiving professional financial advisory services.

 

Increased use of fee-based investment solutions. Based on our industry experience, we believe that in order for financial advisors to effectively manage their clients’ assets, advisors are seeking account types that offer the flexibility to choose among the widest range of investment solutions. Financial advisors typically charge their fees for these types of flexible accounts based on a percentage of assets rather than on a commission or other basis.  We estimate, based on an analysis done by Cerulli Associates, fee-based investment advisory assets totaled $6.0 trillion in 2013 based on Q3 2013 managed account assets of $3.3 trillion and estimated growth in RIA assets to $2.7 trillion.

 

More stringent standards applicable to financial advisors. Increased scrutiny of financial advisors to ensure compliance with current laws, coupled with the possibility of new laws focused on a fiduciary standard, may require changes to the way financial

 

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advisors offer advice. In order to adapt to these changes, we believe that financial advisors may benefit from utilizing a technology platform, such as ours, that allows them to address their clients’ wealth management needs.

 

Our Business Model

 

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

 

·                  Positioned to capitalize on favorable industry trends. As a leading provider of unified wealth management software and services to financial advisors, we believe we are well positioned to take advantage of favorable secular trends in the wealth management industry, particularly the increased prevalence and use of independent financial advisors, the movement toward fee-based pricing structures and advisors’ increased reliance on technology.

 

·                  Recurring and resilient revenue base. The substantial majority of our revenues is recurring and derived either from asset-based fees, which generally are billed at the beginning of each quarter or from fixed fees under multi-year license agreements. For the year ended December 31, 2013, we derived 83% of our total revenues from asset-based fees and 17% from licensing and professional services revenues.

 

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

 

·                  Substantial operating leverage. Because we have designed our systems architecture to accommodate growth in the number of advisors and accounts we support and to provide the flexibility to add new investment solutions and services, our technology platform and infrastructure allow us to grow our business efficiently, without the need for significant additional expenditures as assets grow. This, combined with low marginal costs required to add additional accounts and new investment solutions and services, enables us to generate substantial operating leverage during the course of our relationship with a financial advisor as the advisor adds accounts to our platform and the assets of the advisor’s clients grow through financial advisors’ use of additional investment solutions and services we provide.

 

Our Growth Strategy

 

Envestnet serves the fastest growing segments of the wealth management industry: independent financial advisors; fee-based solutions; and outsourced investment and technology solutions. We intend to increase revenue and profitability by continuing to pursue the following strategies:

 

·                  Increase the advisor base. Through the outreach and marketing activities of our sales and client service teams, we continue the process of leveraging existing enterprise client relationships to add new financial advisors to our technology platform, and building new relationships to add additional advisors. Generally, when we establish an enterprise client relationship, we are provided access to the client’s financial advisors and are given the opportunity to convert them to our technology platform. During the five-year period ended December 31, 2013, within existing enterprises, we increased the number of advisors with AUM or AUA on our platform at a compound annual growth rate of 12%. We further increased the number of advisors through new enterprise relationships established during the past five years, resulting in the total number of advisors with AUM or AUA on our platform growing at a compound annual growth rate of 28%. Even with that steady growth, we continue to have the opportunity to increase the number of financial advisors we serve within our existing enterprise client relationships as advisors increasingly shift their businesses to fee-based practices.

 

·                  Extend the account base within a given advisor relationship. We work with existing clients to shift an increasing portion of their business to the Envestnet platform. During the five-year period ended December 31, 2013, the average number of AUM or AUA accounts per advisor on our technology platform grew from approximately 21 to 32, an increase of over 50%. As a result, total AUM or AUA accounts increased at a compound annual growth rate of 43% during the same period.

 

·                  Expand the services utilized by each advisor. In most cases, an advisor will use only a portion of Envestnet’s services. Accordingly, through our sales and marketing efforts, we will continue to educate our financial advisor customers regarding our capabilities in order to expand the scope of our investment solutions and services they employ.

 

·                  Obtain new enterprise clients. Growing fee-based offerings has become a strategic priority for financial services firms. Envestnet is positioned in the marketplace to empower these firms to deliver fee-based solutions to their advisors. These enterprise clients provide us with access to a large number of financial advisors that may be interested in utilizing our technology platform, as well as to the assets that are managed by these financial advisors. We believe that the current market opportunity for enterprise conversions continues to be significant. New enterprise clients also provide further opportunities to execute on the other strategies discussed above.

 

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·                  Continue to invest in our technology platform. We intend to continue to invest in our technology platform to provide financial advisors with access to investment solutions and services that address the widest range of financial advisors’ front-, middle-and back-office needs. In the years ended December 31, 2013, 2012 and 2011, our technology development costs totaled $9,141, $8,659, and $6,424, respectively.

 

·                  Continue to pursue strategic transactions and other relationships. We intend to continue to selectively pursue acquisitions, investments and other relationships that we believe can enhance the attractiveness of our technology platform or expand our client base. Given our scale of operations and record of past transactions, we believe we are well-positioned to engage in such transactions in the future.

 

·                  In December 2011, we completed the acquisition of FundQuest Incorporated (“FundQuest”), a subsidiary of BNP Paribas Investment Partners USA Holdings, Inc. FundQuest (which was renamed Envestnet Portfolio Solutions, Inc.), a provider of fee-based managed services and solutions with approximately $15 billion in AUM or AUA, was integrated fully into Envestnet during 2012.

 

·                  In April 2012, we acquired Prima Capital Holding, Inc. (“Prima”). Prima, now part of Envestnet | PMC, provides Prima Premium Research, including investment manager due diligence, consulting, and custom research to the wealth management and retirement industries. Prima’s clientele includes banks, independent RIAs, regional broker-dealers, family offices and trust companies.

 

·                  In May 2012, we acquired Tamarac, Inc. (“Tamarac”). Tamarac, now operating as Envestnet | Tamarac, provides leading portfolio accounting, rebalancing, trading, performance reporting and client relationship management software, principally to high-end RIAs.

 

·              In July 2013, we acquired the Wealth Management Solutions (“WMS”) division of Prudential Investments. WMS offers financial institutions access to an integrated wealth platform, which helps construct and manage sophisticated portfolio solutions across an entire account life cycle, particularly in the area of UMA trading.

 

Our Technology Platform

 

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

 

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Envestnet’s wealth management software enables advisors to better advise their clients, invest portfolios, manage their practice and those portfolios, and report on their clients’ holdings.

 

 

Advise. Our technology platform provides financial advisors with a flexible proposal and presentation tool that is capable of creating highly customized documents, including signature-ready forms needed to open client accounts. Also, our platform includes a number of financial planning tools such as Monte Carlo simulations, portfolio diagnostics and retirement planning which enable financial advisors to create and implement financial plans that are tailored to each client’s investment goals, risk tolerance and assets. Our technology platform provides financial advisors with a customizable risk tolerance questionnaire, which assists advisors in understanding the investment objectives and preferences of their clients and also helps the advisor comply with applicable regulatory requirements regarding the suitability of investments and fiduciary obligations. Based on answers to the questionnaire, the advisor can analyze whether the current portfolio is appropriate to reach the client’s goals and suggest an investment policy. We also empower advisors to improve their research and advice through the institutional quality research we provide on investment managers, funds, and alternative investments, and asset allocation guidance through Envestnet | PMC and Prima Premium Research.

 

Invest. Once the investment solutions have been selected, our technology platform, through relationships we have established with a variety of investment managers, allows the financial advisor to access and choose from a wide range of investment programs, including separately managed accounts, unified managed accounts, third-party strategist programs, mutual fund and ETF programs, and others, depending on the financial advisor’s assessment of the client’s needs. Because our technology platform supports nearly every investment program type that is currently available, financial advisors are able to keep more of a client’s assets on one technology platform, thereby simplifying the operation of their practice, saving time and lowering costs. Envestnet | PMC provides consulting services aimed at providing financial advisors with additional support in addressing their clients’ needs, including asset allocation modeling, asset manager and mutual fund due diligence, manager and fund selection and ongoing monitoring, investment portfolio construction and overlay services, principally relating to ongoing portfolio management and asset allocation rebalancing. Envestnet | PMC also creates proprietary investment solutions and products, including separate account strategies, multi-manager portfolios, mutual funds, mutual fund wrap and ETF asset allocation strategies.

 

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Manage. Once a financial advisor has created a client account and selected investment solutions and programs, our technology platform provides access to ongoing account management services. Additionally, Envestnet | PMC portfolio managers and research analysts review all Envestnet | PMC models and proprietary portfolios to determine when to rebalance across asset classes. We also offer overlay services that can help enhance an advisor’s ability to carry out his or her fiduciary responsibility. Financial advisors can receive risk and style drift alerts, enabling them to adjust their clients’ portfolios to ensure that the portfolios remain in compliance with their clients’ stated investment objectives and risk tolerance levels. These services include ongoing review of investment portfolios for compliance with asset allocation criteria, with rebalancing recommendations made as necessary, assistance with investment portfolio tax management and review of investment accounts to ensure that investment decisions are consistent with the client’s investment objectives. We also offer a socially responsible overlay which the financial advisor may use to maintain compliance with clients’ investment restrictions. These may include securities issued by specific companies or from issuers in certain industries that clients want to exclude from their investment accounts.

 

Envestnet | Tamarac Advisor Xi integrates portfolio accounting, model management, monitoring, rebalancing, trading, performance reporting, and enterprise-level client relationship management software. Advisor Xi also empowers advisors to receive drift alerts and rebalancing notifications to help ensure that asset allocations conform to a client’s investment policy. Envestnet | Tamarac’s rebalancing software also can be configured to rebalance assets in the most tax-efficient manner for the client.

 

Report. Our technology platform helps advisors to better report on their clients’ consolidated holdings through our Vantage Reporting Solution and Envestnet | Tamarac offerings, which provide trade-ready, fully-reconciled aggregated performance reports to advisors and their end clients. Our technology platform provides financial advisors with access to more than 40 third-party custodians, real-time data and Web-based service tools. Our platform generates highly configurable aggregated reports showing holdings, investment performance, capital gains and losses and other information for financial advisors to provide to their clients that can be downloaded, viewed online or printed. In addition, through our India operations, our technology platform provides financial advisors with access to client account data reconciled daily with records maintained by multiple custodians. Accordingly, when securities markets open each day, financial advisors have the most up-to-date account data available. Our technology platform also supports a wide range of fee and billing structures. These include breakpoint pricing, where lower fee rates are applied as asset levels meet or exceed pre-established thresholds, fees based on aggregated client funds across several accounts held by family members, fees tailored to different investment programs and investment solution types and other customized fee and billing arrangements. Our technology platform includes configurable Fiduciary Oversight Notes (“FONs”) that help advisors understand implications of the decisions they make via educational text boxes, and then memorialize those decisions for client service and reporting. The FONs may be searched and reviewed by home offices or the advisors themselves.

 

Our Customers

 

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

 

Enterprise clients. We provide enterprise clients with a customized, private-labeled technology platform that enables them to support their affiliated financial advisors with a broad range of investment solutions and services. Our contracts with enterprise clients establish the applicable terms and conditions, including pricing terms, service level agreements and basic platform configurations. For the years ended December 31, 2013, 2012 and 2011, revenues associated with our relationship with our single largest enterprise client, FMR LLC, an affiliate of FMR Corp., or Fidelity, accounted for 20%, 22%, and 31%, respectively, of our total revenues. No other client accounted for more than 10% of our total revenues. Examples of our other enterprise clients include Northwestern Mutual, National Financial Partners and National Planning Holdings.

 

Sales and Marketing

 

Our sales and marketing staff of approximately 170 employees is organized by sales channel and product offering. Our enterprise sales team focuses on entering into agreements with enterprise clients, which enable us to sell our platform capabilities to those firms and the advisors associated with them. Our advisory sales team sells to the individual financial advisors of broker-dealers and enters into agreements with RIA firms. Envestnet | Tamarac sells rebalancing, performance reporting and CRM solutions principally to large RIA firms. Envestnet | PMC offers portfolio and investment management consulting services, including Prima Premium Research and due diligence capabilities. Envestnet | WMS offers financial institutions access to an integrated wealth platform, particularly in the area of UMA trading.

 

The principal aim of our marketing efforts is to create greater visibility of our company and our brands, and to provide thought leadership to the wealth management industry. Our marketing efforts are focused on our core markets: financial advisors and

 

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enterprise clients. We use advertising and public relations to communicate our message to these target markets. Examples of these marketing efforts include:

 

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

 

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

 

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

 

·                  hosting conferences on wealth management solutions;

 

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

 

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

 

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

 

Competition

 

We generally compete on the basis of several factors, including the breadth and quality of investment solutions and services to which we provide access through our technology platform, the number of custodians that are connected through our technology platform, the price of our investment solutions and services, the ease of use of our technology platform and the nature and scope of investment solutions and services that each client believes are necessary to address their needs. Our competitors offer a variety of products and services that compete with one or more of the investment solutions and services provided through our technology platform, although, based on our industry experience, we believe that none offers a more comprehensive set of products and services than we do. Our principal competitors include:

 

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

 

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

 

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

 

Technology

 

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

 

We devote significant resources to ensuring sufficient platform capacity and system uptime. In 2013, our actual uptime was 99.8%. We have achieved Service Organization Control Report (“SOC1”) compliance with our platform and we maintain multiple redundancies, back up our databases and safeguard technologies and proprietary information consistent with industry best practices. We also maintain a comprehensive business continuity plan and company-wide risk assessment program that is consistent with industry best practices and that complies with applicable regulatory requirements.

 

We have historically made significant investments in platform development in order to enhance and expand our technology platform and expect to continue to make significant investments in the future. In the years ended December 31, 2013, 2012 and 2011, we incurred technology development costs totaling approximately $9,141, $8,659 and $6,424, respectively. Of these costs, we capitalized approximately $3,143, $2,350 and $1,482, respectively, as internally developed software. The increase in the amount of technology development expenditures and the increase in the amount we capitalized in 2013 compared to 2012 is a result of technology development expenditures related to Envestnet | Tamarac and Envestnet | WMS products. We expect to continue focusing our technology development efforts principally on adding features to increase our market competitiveness, enhancements to improve operating efficiency and reduce risk, and client-driven requests for new capabilities.

 

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Intellectual Property and Proprietary Rights

 

We rely on a combination of trademark, copyright and trade secret protection laws to protect our proprietary technology and our intellectual property. We seek to control access to and distribution of our proprietary information. We enter into confidentiality agreements with our employees, consultants, customers and vendors that generally provide that any confidential or proprietary information developed by us or on our behalf be kept confidential. In the normal course of business, we provide our intellectual property to third parties through licensing or restricted use agreements. We have proprietary know-how in algorithms, implementation and business on-boarding functions, along with a wide variety of applications software. We have registered the mark “ENVESTNET” with the U.S. Patent and Trademark Office in addition to several marks commonly used by Envestnet. We also pursue the registration of certain of our other trademarks and service marks in the United States. In addition, we have registered our domain name, www.envestnet.com and several other websites, such as www.envestnetpmc.com, www.investpmc.com, www.fiduciaryopportunity.com, www.envestnetadvisor.com, www.tamaracinc.com and www.primacapital.com. We have established a system of security measures to protect our computer systems from security breaches and computer viruses. We have employed various technology and process-based methods, such as clustered and multi-level firewalls, intrusion detection mechanisms, vulnerability assessments, content filtering, antivirus software and access control mechanisms. We also use encryption techniques for data transmissions. We control and limit access to confidential and proprietary information on a “need to know” basis.

 

Regulation

 

Overview

 

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

 

Our wholly-owned subsidiaries, Envestnet Asset Management, Inc., Portfolio Management Consultants, Inc., ERS, Inc. and Envestnet Portfolio Solutions, Inc. operate investment advisory businesses. These subsidiaries are registered with the U.S. Securities and Exchange Commission (“SEC”) as “investment advisers” under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), and are regulated thereunder.  They may also provide fiduciary services as defined in Section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974 (“ERISA”), including acting as an “investment manager” (as defined in Section 3(38) of ERISA).  As described further below, many of our investment advisory programs are conducted pursuant to the non-exclusive safe harbor from the definition of an “investment company” provided for under Rule 3a-4 of the Investment Company Act of 1940, as amended (the “Investment Company Act”). If Rule 3a-4 were to cease to be available, or if the SEC were to modify the rule or its interpretation of how the rule is applied, it could have a substantial effect on our business. Envestnet Asset Management, Inc. serves as the investment adviser to two mutual funds and a series of collective investment trusts managed towards retirement target dates. Mutual funds are registered as “investment companies” under the Investment Company Act. The Advisers Act, Investment Company Act and ERISA, together with related regulations and interpretations of the SEC, impose numerous obligations and restrictions on investment advisers and mutual funds, including recordkeeping requirements, limitations on advertising, disclosure and reporting obligations, prohibitions on fraudulent activities, and detailed operating requirements, including restrictions on transactions between an adviser and its clients, and between a mutual fund and its advisers and affiliates. The fiduciary obligations of investment advisers to their clients require advisers to, among other things, consider the suitability of the investment products and advice they provide, seek “best execution” for their clients’ securities transactions, conduct due diligence on third-party products offered to clients, consider the appropriateness of the adviser’s fees, and provide extensive and ongoing disclosure to clients. The application of these requirements to wrap fee programs is particularly complex and the SEC has in the past scrutinized firms’ compliance with these requirements. The SEC is authorized to institute proceedings and impose fines and sanctions for violations of the Advisers Act and the Investment Company Act and has the power to restrict or prohibit an investment adviser from carrying on its business in the event that it fails to comply with applicable laws and regulations. Although we believe we are in compliance in all material respects with the requirements of the Advisers Act and the Investment Company Act and the rules and interpretations promulgated thereunder, our failure to comply with such laws, rules and interpretations could have a material adverse effect on us. Collective investment trusts are unregistered funds operated by a trust company or a bank regulated by the Office of the Comptroller of Currency (the “OCC”). In our role as advisor to these funds, we operate under substantially similar obligations to those discussed above for mutual funds.

 

Portfolio Brokerage Services, Inc., (“PBS”), our broker-dealer subsidiary, is registered as a broker-dealer with the SEC under the Securities Exchange Act of 1934, (“Exchange Act”), in all 50 states and the District of Columbia. In addition, PBS is a member of the Financial Industry Regulatory Authority (“FINRA”), the securities industry self-regulatory organization that supervises and regulates the conduct and activities of broker-dealers. Broker-dealers are subject to regulations that cover all aspects of their business, including sales practices, market making and trading among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure, record-keeping and the conduct of directors, officers, employees, representatives and associated persons. FINRA and the SEC conduct periodic examinations of the operations of its members, including PBS. Violation of applicable regulations can result in the suspension or revocation of a broker-dealer’s registration, the imposition of censures or fines and the suspension or expulsion of the broker-dealer from FINRA. PBS is subject to minimum net capital requirements under the Exchange Act, SEC and FINRA rules

 

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and conducts its business pursuant to the exemption from the SEC’s customer protection rule provided by Rule 15c3-3(k)(2)(i) under the Exchange Act. As of December 31, 2013, PBS was required to maintain a minimum of $100 in net capital and its actual net capital was $1,000.

 

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

 

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

 

Investment Advisory Program Conducted Under Rule 3a-4

 

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

 

·                  Separately managed accounts;

 

·                  Unified managed account portfolios;

 

·                  Mutual fund portfolios and exchange-traded fund portfolios; and

 

·                  Advisor as portfolio manager.

 

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

 

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

 

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

 

·                  On no less than an annual basis, the client’s financial advisor contacts the client to determine whether there have been any changes in the client’s financial situation or investment objectives, and whether the client wishes to impose any reasonable restrictions on the management of the account or reasonably modify existing restrictions. This information is communicated to us and reflected in our management of client accounts;

 

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

 

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

 

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

 

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

 

·                  For all of the programs, each client retains, with respect to all securities and funds in the client’s account, the right to withdraw securities or cash, vote securities, or delegate the authority to vote securities to another person, receive written confirmation or other notification of each securities transaction by the client’s independent custodian, and proceed

 

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directly as a security holder against the issuer of any security in the client’s account without the obligation to include us or any other client of the program in any such action as a condition precedent to initiating such proceeding.

 

Employees

 

As of December 31, 2013, we had 948 employees, including 170 in sales and marketing, 292 in engineering and systems, 392 in operations, 30 in investment management and research, and 64 in executive and corporate functions. Of these 948 employees, 387 were located in India. None of our employees is represented by a labor union. We have never experienced a work stoppage and believe our relationship with our employees is good.

 

Executive Officers of the Registrant

 

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

 

Name 

 

Age

 

Position(s)

Judson Bergman

 

57

 

Chairman, Chief Executive Officer, Director

William Crager

 

50

 

President

Peter D’Arrigo

 

46

 

Chief Financial Officer

Scott Grinis

 

52

 

Chief Technology Officer

Shelly O’Brien

 

48

 

Chief Legal Officer, General Counsel and Corporate Secretary

Brandon Thomas

 

50

 

Chief Investment Officer

 

Judson Bergman, Age 57. Mr. Bergman is the founder of our company and has served as our Chairman, Chief Executive Officer and a director since 1999. Prior to founding our company, Mr. Bergman was Managing Director at Nuveen Investments, Inc. (“Nuveen”), a diversified investment manager. Mr. Bergman serves as a trustee of RS Investment Trust and RS Variable Products Trust, registered investment companies. Mr. Bergman received an MBA in finance and accounting from Columbia University and a BA from Wheaton College.

 

William Crager, Age 50. Mr. Crager has served as our President since 2002. Prior to joining us, Mr. Crager served as Managing Director of Marketing and Client Services at Rittenhouse Financial Services, Inc., an investment management firm affiliated with Nuveen.  Mr. Crager received an MA from Boston University and a BA from Fairfield University, with a dual major in economics and English.

 

Peter D’Arrigo, Age 46. Mr. D’Arrigo has served as our Chief Financial Officer since 2008. Prior to joining us, Mr. D’Arrigo worked at Nuveen where he served as Treasurer since 1999, as well as holding a variety of other titles after joining them in 1990. Mr. D’Arrigo received an MBA from the Northwestern University Kellogg Graduate School of Management and an undergraduate degree in applied mathematics from Yale University.

 

Scott Grinis, Age 52. Mr. Grinis has served as our Chief Technology Officer since 2004. Prior to joining us, Mr. Grinis co-founded Oberon Financial Technology, Inc., our subsidiary, prior to its acquisition by us. Mr. Grinis received a BS and an MS degree in electrical engineering from Stanford University.

 

Shelly O’Brien, Age 48. Ms. O’Brien has served as our Chief Legal Officer, General Counsel and Corporate Secretary since 2002. Prior to joining us, Ms. O’Brien was General Counsel and Director of Legal and Compliance for ING (U.S.) Securities, Futures & Options Inc., a broker-dealer, and futures commission merchant. Ms. O’Brien received a degree in political science from Northwestern University, a JD from Hamline University School of Law, and an LLM in taxation from John Marshall Law School.

 

Brandon Thomas, Age 50. Mr. Thomas is a co-founder of our company and has served as Chief Investment Officer and Managing Director of Portfolio Management Consultants, our internal investment management and portfolio consulting group, since 1999. Prior to joining us, Mr. Thomas was Director of Equity Funds for Nuveen. Mr. Thomas received an MBA from the University of Chicago, a JD from DePaul University and is a graduate of Brown University.

 

Item  1A.                               Risk Factors

 

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

 

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Risks Related to Our Business

 

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

 

Our revenues during the three years ended December 31, 2013 have grown at a compound annual growth rate of 40%. We expect our growth to continue, which could place additional demands on our resources and increase our expenses. Our future growth will depend on, among other things, our ability to successfully grow our total assets under management and administration and add additional clients. If we are unable to implement our growth strategy, develop new investment solutions and services and gain new clients, our results of operations, financial condition or business may be materially adversely affected.

 

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

 

·                  recruiting, training and retaining sufficiently skilled technical, marketing, sales and management personnel;

 

·                  preserving our culture, values and entrepreneurial environment;

 

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

 

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

 

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

 

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

 

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

 

Our revenue may fluctuate from period-to-period in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following events, as well as other factors described elsewhere in this document:

 

·                  a decline or slowdown of the growth in the value of financial market assets, which may reduce the value of assets under management and administration and therefore our revenues and cash flows;

 

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

 

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

 

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

 

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

 

·                  failure to obtain new clients;

 

·                  cancellation or non-renewal of existing contracts with clients;

 

·                  failure to protect our proprietary technology and intellectual property rights;

 

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

 

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

 

·                  changes in our pricing policies or the pricing policies of our competitors to which we have to adapt.

 

As a result of these and other factors, the results of operations for any quarterly or annual period may differ materially from the results of operations for any prior or future quarterly or annual period and should not be relied upon as indications of our future performance.

 

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

 

We compete with many different types of companies that vary in size and scope, including Pershing LLC (a subsidiary of BNY Mellon Corporation), The Charles Schwab Corporation, SEI Investments Company, AssetMark, Inc., Advent Software, Inc., and Lockwood Advisors (a subsidiary of BNY Mellon Corporation) and which are discussed in greater detail under “Business—Competition” included in this Form 10-K. In addition, some of our clients have developed or may develop the in-house capability to provide the technology and/or investment advisory services they have retained us to perform. These clients may also offer internally

 

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developed services to their financial advisors, obviating the need to hire us, and they may offer these services to third-party financial advisors or financial institutions, thereby competing directly with us for that business.

 

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

 

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

 

Our Envestnet | PMC group competes with other providers of investment solutions and products. These competitors may offer broader solutions and/or products and their solutions and/or products may have better investment returns during one or more periods. If the investment returns on our investment products are not perceived to be competitive, we could experience outflows of assets from these products and face difficulty attracting new assets to these products.

 

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

 

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

 

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

 

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

 

For the years ended December 31, 2013, 2012 and 2011, revenues associated with our relationship with our single largest client, FMR LLC, an affiliate of FMR Corp., or Fidelity, accounted for 20%, 22% and 31% respectively, of our total revenues and our ten largest clients accounted for 46%, 47% and 64%, respectively, of our total revenues. Our license agreements with large financial institutions are generally multi-year contracts that may be terminated upon the expiration of the contract term or prior to such time for cause, which may include breach of contract, bankruptcy, insolvency and other reasons. The license fee payments pursuant to our license agreement with Fidelity were renegotiated and reduced as of December 31, 2011 and were extended for an additional five years. The agreement, as amended, includes receiving ongoing platform services fees through the Fidelity relationship based upon asset-based fees. A majority of our agreements with financial advisors generally provides for termination at any time. If our contractual relationship with Fidelity were to terminate, or if a significant number of our most important clients were to terminate their contracts with us and we were unable to obtain a significant number of new clients, our results of operations, financial condition or business could be materially adversely affected.

 

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

 

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

 

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

 

Asset-based fees make up a significant portion of our revenues. Asset-based fees represented 83%, 81% and 81% of our total revenues for the years ended December 31, 2013, 2012 and 2011, respectively. We expect that asset-based fees will continue to represent a significant percentage of our total revenues in the future. Significant fluctuations in securities prices may materially affect the value of the assets managed by our clients and may also influence financial advisor and investor decisions regarding whether to invest in, or maintain an investment in, a mutual fund or other investment solution. If such market fluctuation led to less investment in the securities markets, our revenues and earnings derived from asset-based fees could be materially adversely affected.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Our reputation, which depends on earning and maintaining the trust and confidence of our clients, is critical to our business. Our reputation is vulnerable to many threats that can be difficult or impossible to control, and costly or impossible to remediate. Regulatory inquiries or investigations, lawsuits initiated by our clients or stockholders, employee misconduct, perceptions of conflicts

 

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of interest and rumors, among other developments, could substantially damage our reputation, even if they are baseless or satisfactorily addressed. In addition, any perception that the quality of our investment solutions and services may not be the same or better than that of other providers, can also damage our reputation. Any damage to our reputation could harm our ability to attract and retain clients, which would materially adversely affect our results of operations, financial condition and business.

 

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

 

Investment solutions and services we develop or license may contain undetected errors or defects despite testing. Such errors can exist at any point in the life cycle of our investment solutions or services, but are frequently found after introduction of new investment solutions and services or enhancements to existing investment solutions or services. We continually introduce new investment solutions and services and new versions of our investment solutions and services. Despite internal testing and testing by current and potential clients, our current and future investment solutions and services may contain serious defects or malfunctions. If we detect any errors before release, we might be required to delay the release of the investment solution or service for an extended period of time while we address the problem. We might not discover errors that affect our new or current investment solutions, services or enhancements until after they are deployed, and we may need to provide enhancements to correct such errors. Errors may occur that could have a material adverse effect on our results of operations, financial condition or business and could result in harm to our reputation, lost sales, delays in commercial release, third-party claims, contractual disputes, contract terminations or renegotiations, or unexpected expenses and diversion of management and other resources to remedy errors. In addition, negative public perception and reputational damage caused by such claims would adversely affect our client relationships and our ability to enter into new contracts. Any of these problems could have a material adverse effect on our results of operations, financial condition and business.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Our business relies heavily on our computer equipment (including our servers), electronic delivery systems and the Internet, but these technologies are vulnerable to disruptions, failures or slowdowns caused by fire, earthquake, power loss, telecommunications failure, terrorist attacks, wars, Internet failures, computer viruses and other events beyond our control. Furthermore, we rely on agreements with our suppliers, such as our current data hosting and service provider, to provide us with access to certain computer equipment, electric delivery systems and the Internet. We are unable to predict whether a future contractual dispute may arise with one

 

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of our suppliers that could cause a disruption in service, or whether our agreements with our suppliers can be obtained or renewed on acceptable terms, or at all. An unanticipated disruption, failure or slowdown affecting our key technologies or facilities may have significant ramifications, such as data-loss, data corruption, damaged software codes or inaccurate processing of transactions. We maintain off-site back-up facilities for our electronic information and computer equipment, but these facilities could be subject to the same interruptions that may affect our primary facilities. Any significant disruptions, failures, slowdowns, data-loss or data corruption could have a material adverse effect on our results of operations, financial condition or business and result in the loss of customers.

 

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

 

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

 

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

 

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

 

We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols imposed by law, regulation, industry standards or contractual obligations. Increased domestic or international regulation of data utilization and distribution practices could require us to modify our operations and incur significant additional expense, which could have a material adverse effect on our results of operations, financial condition or business.

 

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

 

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

 

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

 

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

 

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

 

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

 

Certain of our subsidiaries are registered as “investment advisers” with the SEC under the Advisers Act and are regulated thereunder. In addition, many of our investment advisory services are conducted pursuant to the non-exclusive safe harbor from the definition of an “investment company” provided under Rule 3a-4 under the Investment Company Act. If Rule 3a-4 were to cease to be available, or if the SEC were to modify the rule or its interpretation of how the rule is applied, our business could be adversely affected. Certain of our registered investment adviser subsidiaries provide advice to mutual fund clients and collective investment trusts. Mutual funds are registered as “investment companies” under the Investment Company Act. The Advisers Act and the

 

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Investment Company Act, together with related regulations and interpretations of the SEC, impose numerous obligations and restrictions on investment advisers and mutual funds, including requirements relating to the safekeeping of client funds and securities, limitations on advertising, disclosure and reporting obligations, prohibitions on fraudulent activities, restrictions on transactions between an adviser and its clients, and between a mutual fund and its advisers and affiliates, and other detailed operating requirements, as well as general fiduciary obligations. Collective investment trusts are unregistered funds operated by a trust company or a bank regulated by the OCC. In our role as advisor to these funds, we operate under substantially similar obligations to those discussed above for mutual funds.

 

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

 

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

 

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

 

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

 

A deemed “change of control” of our company could require us to obtain the consent of our clients and a failure to do so properly could adversely affect our results of operations, financial condition or business.

 

Under the Advisers Act, the investment advisory agreements entered into by our investment adviser subsidiaries may not be assigned without the client’s consent. Under the Investment Company Act, advisory agreements with registered funds terminate automatically upon assignment and, any assignment of an advisory agreement must be approved by the board of directors and the shareholders of the registered fund. Under the Advisers Act and the Investment Company Act, such an assignment may be deemed to occur upon a change of control of the Company. A change of control includes either gaining or losing a “controlling person.” Whether someone is a controlling person for these purposes depends significantly on the specific facts and circumstances. There can be no assurance that if we undergo a change of control, we would be successful in obtaining all necessary consents or that the method by which we obtain such consents could not be challenged at a later time. If we are unable to obtain all necessary consents or if such a challenge were to be successful it could have a material adverse effect on our results of operations, financial condition or business.

 

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

 

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

 

If government regulation of the Internet or other areas of our business changes, or if consumer attitudes toward use of the Internet change, we may need to change the manner in which we conduct our business or incur greater operating expenses.

 

The adoption, modification or interpretation of laws or regulations relating to the Internet or other areas of our business could adversely affect the manner in which we conduct our business. Such laws and regulations may cover sales practices, taxes, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts, consumer protection, broadband residential

 

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

 

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

 

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

 

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

 

·                  our intellectual property rights will provide competitive advantages to us;

 

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

 

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

 

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

 

·                  our trademark applications will lead to registered trademarks; or

 

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

 

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

 

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

 

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

 

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or misappropriation, we may be required to enter into licensing agreements, if available on acceptable terms or at all, pay substantial damages or make changes to the investment solutions and services that we offer. Any of the foregoing could prevent us from competing effectively, result in substantial costs to us, divert management’s attention and our resources away from our operations and otherwise harm our reputation.

 

If our intellectual property and proprietary technology are not adequately protected to prevent use or appropriation by our competitors, our business and competitive position would suffer.

 

Our future success and competitive position depend in part on our ability to protect our intellectual property rights. The steps we have taken to protect our intellectual property rights may be inadequate to prevent the misappropriation of our proprietary technology. There can be no assurance that others will not develop or patent similar or superior technologies, investment solutions or services. Unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our intellectual property rights without paying us for doing so, which could harm our business. Policing unauthorized use of proprietary technology is difficult and expensive and our monitoring and policing activities may not be sufficient to identify any misappropriation and protect our proprietary technology. In addition, third parties may knowingly or unknowingly infringe our trademarks and other intellectual property rights, and litigation may be necessary to protect and enforce our intellectual property rights. If litigation is necessary to protect and enforce our intellectual property rights, any such litigation could be very costly and could divert management attention and resources. If we are unable to protect our intellectual property rights or if third parties independently develop or gain access to our or similar technologies, investment solutions or services, our results of operations, financial condition and business could be materially adversely affected.

 

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

 

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

 

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

 

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

 

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

 

We expect to grow our business by, among other things, making acquisitions. In December 2011, we completed the acquisition of FundQuest and in the second quarter of 2012, we completed the acquisitions of Prima and Tamarac.  On July 1, 2013, we completed the acquisition of WMS.  Acquisitions involve a number of risks. They can be time-consuming and may divert management’s attention from day-to-day operations. Financing an acquisition could result in dilution from issuing equity securities or a weaker balance sheet from using cash or incurring debt. Acquisitions might also result in losing key employees. In addition, we may fail to successfully integrate acquisitions. We may also fail to generate enough revenues or profits from an acquisition to earn a return on the associated purchase price.

 

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

 

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

 

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

 

·                  insufficient knowledge of the operations and markets of acquired businesses;

 

·                  loss of key personnel;

 

·                  failure to obtain necessary customer consents or retain key customers;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We expect technological developments to continue at a rapid pace in our industry. Our success will depend, in part, on our ability to:

 

·                  continue to develop our technology expertise;

 

·                  recruit and retain skilled technology professionals;

 

·                  enhance our current investment solutions and services;

 

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

 

·                  advertise and market our investment solutions and services;

 

·                  protect our proprietary technology and intellectual property rights; or

 

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

 

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

 

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

 

The market for our investment solutions and services is characterized by shifting client demands, evolving market practices and, for some of our investment solutions and services, rapid technological change. Changing client demands, new market practices or new technologies can render existing investment solutions and services obsolete and unmarketable. As a result, our future success will continue to depend upon our ability to develop new investment solutions and services and investment solution and service enhancements that address the future needs of our target markets and respond to technological and market changes. We incurred technology development expenditures of $9,141, $8,659 and $6,424 in the years ended December, 31, 2013, 2012 and 2011, respectively. We expect that our technology development expenditures will continue at this level or they may increase in the future. We may not be able to accurately estimate the impact of new investment solutions and services on our business or how their benefits will be perceived by our clients. Further, we may not be successful in developing, introducing, marketing and licensing our new investment solutions or services or investment solution or service enhancements on a timely and cost effective basis, or at all, and our new investment solutions and services and enhancements may not adequately meet the requirements of the marketplace or achieve

 

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market acceptance. In addition, clients may delay purchases in anticipation of new investment solutions or services or enhancements. Any of these factors could materially adversely affect our results of operations, financial condition or business.

 

Risks Related to our Common Stock

 

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

 

An active, liquid and orderly market for our common stock may not be sustained, which could depress the trading price of our common stock. The price of our common stock has been, and is likely to continue to be, volatile, which means that it could decline substantially within a short period of time. The market price of shares of our common stock could be subject to wide fluctuations in response to many risk factors listed in this section, many of which are beyond our control, including:

 

·                  actual or anticipated fluctuations in our financial condition and operating results;

 

·                  changes in the economic performance or market valuations of other companies engaged in providing wealth management software and services;

 

·                  loss of a significant amount of existing business;

 

·                  actual or anticipated changes in our growth rate relative to our competitors;

 

·                  actual or anticipated fluctuations in our competitors’ operating results or changes in their growth rates;

 

·                  issuance of new or updated research reports by securities analysts;

 

·                  our announcement of actual results for a fiscal period that are higher or lower than projected results or our announcement of revenue or earnings guidance that is higher or lower than expected;

 

·                  regulatory developments in our target markets affecting us, our customers or our competitors;

 

·                  fluctuations in the valuation of companies perceived by investors to be comparable to us;

 

·                  share price and volume fluctuations attributable to inconsistent trading volume levels of our shares;

 

·                  sales or expected sales of additional common stock;

 

·                  terrorist attacks or natural disasters or other such events impacting countries where we or our customers have operations; and

 

·                  general economic and market conditions.

 

Furthermore, the financial markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, interest rate changes or international currency fluctuations, may cause the market price of shares of our common stock to decline. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

 

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

 

Our directors and executive officers, together with members of their immediate families, as a group, beneficially owned, in the aggregate, approximately 13% of our outstanding capital stock as of December 31, 2013. As a result, when acting together, this group has the ability to exercise significant influence over most matters requiring our stockholders’ approval, including the election and removal of directors and significant corporate transactions. The interests of our insider stockholders may not be aligned with the interests of our other stockholders and conflicts of interest may arise. In addition, the concentration of our shares may have the effect of delaying, deterring or preventing significant corporate transactions which may otherwise adversely affect the market price of our shares.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Item 1B.                                  Unresolved Staff Comments

 

None.

 

Item  2.                                        Properties

 

Our headquarters are located in Chicago, Illinois, and consist of approximately 38,000 square feet of leased space. We also lease office space in Denver, Colorado; New York, New York; Sunnyvale, California; Boston, Massachusetts; Seattle, Washington; Landis and Raleigh, North Carolina; Newark, New Jersey and Trivandrum, India. We believe that our office facilities are adequate for our immediate needs and that additional or substitute space is available if needed to accommodate the foreseeable growth of our operations.

 

Item 3.                                           Legal Proceedings

 

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

 

Item 4.                                           Mine Safety Disclosures

 

This section is not applicable.

 

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PART II

 

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

 

(a) Market Information

 

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

 

The following table sets forth, for the periods indicated, the high and low closing sale prices of our common stock, for each of the periods presented below as reported in the consolidated reporting system for the New York Stock Exchange Composite Transactions.

 

 

 

2012

 

 

 

High

 

Low

 

Quarter ended March 31, 2012

 

$

13.01

 

$

11.34

 

Quarter ended June 30, 2012

 

$

12.98

 

$

10.94

 

Quarter ended September 30, 2012

 

$

12.75

 

$

11.23

 

Quarter ended December 31, 2012

 

$

13.98

 

$

11.77

 

 

 

 

2013

 

 

 

High

 

Low

 

Quarter ended March 31, 2013

 

$

17.54

 

$

13.31

 

Quarter ended June 30, 2013

 

$

24.94

 

$

17.14

 

Quarter ended September 30, 2013

 

$

31.76

 

$

24.83

 

Quarter ended December 31, 2013

 

$

40.30

 

$

28.62

 

 

(b) Holders

 

The approximate number of holders of record of our common stock was 172 as of March 1, 2014.

 

(c) Dividends

 

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

 

Common Stock

 

As of December 31, 2013, we had 500,000,000 common shares authorized at a par value of $0.005, of which 33,876,020 shares were outstanding.

 

Preferred Stock

 

As of December 31, 2013, we had 50,000,000 preferred shares authorized at a par value of $0.005, of which no shares were outstanding.

 

(d) Securities Authorized for Issuance Under Equity Compensation Plan

 

For a description of securities authorized under our equity compensation plans, see Note 12 to the notes to consolidated financial statements in Part II, Item 8.

 

(e) Stock Performance Graph

 

The following graph compares the cumulative return to stockholders on our common stock relative to the cumulative total returns of the Russell® 2000 Index and The S&P North American Technology-Services IndexTM from the effective date of our initial public offering on July 28, 2010 through December 31, 2013. In calculating total annual stockholder return, reinvestment of dividends, if any, is assumed. The indices are included for comparative purposes only. This graph is not “soliciting material,” is not deemed filed with the SEC and is not to be incorporated by reference in any of our filings under the Securities Act of 1933, as amended, or the Exchange Act, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

 

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Table of Contents

 

41 MONTH STOCK PERFORMANCE GRAPH

 

GRAPHIC

 

 

 

7/28/2010

 

12/31/2010

 

12/31/2011

 

12/31/2012

 

12/31/2013

 

Envestnet, Inc.

 

$

100.00

 

$

189.55

 

$

132.89

 

$

155.00

 

$

447.78

 

Russell® 2000 Index

 

 

100.00

 

 

119.02

 

 

114.05

 

 

132.70

 

 

181.05

 

S&P North American Technology-Services IndexTM

 

 

100.00

 

 

112.38

 

 

126.21

 

 

153.33

 

 

217.42

 

 

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

 

(f) Recent Sales of Unregistered Securities

 

None

 

(g) Issuer Purchases of Equity Securities

 

None

 

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Table of Contents

 

Item 6. Selected Financial Data

 

Consolidated Statements of Operations

 

 

 

Year ended December 31,

 

 

 

2013

 

2012

 

2011

 

2010

 

2009

 

 

 

(in thousands, except for share and per share information)

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Assets under management or administration

 

$

200,568

 

$

127,213

 

$

99,236

 

$

75,951

 

$

56,857

 

Licensing and professional services

 

41,967

 

30,053

 

23,942

 

22,101

 

21,067

 

Total revenues

 

242,535

 

157,266

 

123,178

 

98,052

 

77,924

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

98,970

 

56,119

 

42,831

 

31,444

 

24,624

 

Compensation and benefits

 

77,442

 

54,973

 

40,305

 

37,027

 

28,763

 

General and administration

 

44,808

 

30,617

 

21,856

 

21,607

 

15,726

 

Depreciation and amortization

 

15,329

 

12,400

 

6,376

 

5,703

 

4,499

 

Restructuring charges

 

474

 

115

 

434

 

961

 

 

Total operating expenses

 

237,023

 

154,224

 

111,802

 

96,742

 

73,612

 

Income from operations

 

5,512

 

3,042

 

11,376

 

1,310

 

4,312

 

Other income (expense)

 

200

 

26

 

(796

)

(403

)

(3,368

)

Income before income tax provision

 

5,712

 

3,068

 

10,580

 

907

 

944

 

Income tax provision

 

2,052

 

2,603

 

2,975

 

1,533

 

1,816

 

Net income (loss)

 

3,660

 

465

 

7,605

 

(626

)

(872

)

Less preferred stock dividends

 

 

 

 

(422

)

(720

)

Income (loss) attributable to common shareholders

 

$

3,660

 

$

465

 

$

7,605

 

$

(1,048

)

$

(1,592

)

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share attributable to common stockholders

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.11

 

$

0.01

 

$

0.24

 

$

(0.05

)

$

(0.12

)

Diluted

 

$

0.10

 

$

0.01

 

$

0.23

 

$

(0.05

)

$

(0.12

)

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

33,191,088

 

32,162,672

 

31,643,390

 

20,805,911

 

12,910,998

 

Diluted

 

35,666,575

 

33,341,615

 

32,863,834

 

20,805,911

 

12,910,998

 

 

Consolidated Balance Sheet Data

 

 

 

December 31,

 

 

 

2013

 

2012

 

2011

 

2010

 

2009

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

49,942

 

$

29,983

 

$

64,909

 

$

67,668

 

$

31,525

 

Working capital

 

26,384

 

14,785

 

62,530

 

62,979

 

27,262

 

Goodwill and intangible assets

 

110,033

 

92,794

 

33,411

 

3,213

 

3,261

 

Total assets

 

221,242

 

162,399

 

136,863

 

141,029

 

74,064

 

Stockholders’ equity

 

147,772

 

125,996

 

114,800

 

101,480

 

57,252

 

 

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Table of Contents

 

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

 

Except where we have otherwise indicated or the context otherwise requires, dollar amounts presented in this Form 10-K are in thousands, except for Item 9, Exhibits and per share amounts.

 

Overview

 

We are a leading provider of unified wealth management software and services to financial advisors and institutions. By integrating a wide range of investment solutions and services, our Web-based platform provides financial advisors with the flexibility to address their clients’ needs.

 

Envestnet empowers financial advisors to deliver fee-based advice to their clients. We work with both independent advisors (RIAs), as well as advisors associated with financial institutions (broker-dealers, banks). The services we offer and market to financial advisors address advisors’ ability to grow their practice as well as operate more efficiently — the Envestnet platform spans from the initial meeting an advisor has with a prospective client to the ongoing day-to-day operations of managing an advisory practice.

 

Our centrally-hosted technology platform, which we refer to as having “open architecture” because of its flexibility, provides financial advisors with access to a series of integrated services to help them better serve their clients. These services include risk assessment and selection of investment strategies and solutions, asset allocation models, research and due diligence, portfolio construction, proposal generation and paperwork preparation, model management and account rebalancing, account monitoring, customized fee billing, overlay services covering asset allocation, tax management and socially responsible investing, aggregated multi-custodian performance reporting and communication tools, as well as access to a wide range of leading third-party asset custodians.

 

We offer these solutions principally through the following product and services suites:

 

·                  Envestnet’s wealth management software empowers advisors to better manage client outcomes and strengthen their practice. Our software unifies the applications and services advisors use to manage their practice and advise their clients, including financial planning; capital markets assumptions; asset allocation guidance; research and due diligence on investment managers and funds; portfolio management, trading and rebalancing; multi-custodial, aggregated performance reporting; and billing calculation and administration.

 

·                  Envestnet | PMC®, our Portfolio Management Consultants group, primarily engages in consulting services aimed at providing financial advisors with additional support in addressing their clients’ needs, as well as the creation of proprietary investment solutions and products. Envestnet | PMC’s investment solutions and products include managed account and multi-manager portfolios, mutual fund portfolios and ETF portfolios. Envestnet | PMC also offers Prima Premium Research, comprising institutional-quality research and due diligence on investment managers, mutual funds, ETFs and liquid alternatives funds.

 

·                  Envestnet | TamaracTM provides leading portfolio accounting, rebalancing, trading, performance reporting and CRM software, principally to high-end RIAs.

 

·                  Vantage Reporting SolutionTM software aggregates and manages investment data, provides performance reporting and benchmarking, giving advisors an in-depth view of clients’ various investments, empowering advisors to give holistic, personalized advice.

 

·                  Envestnet | WMSTM offers financial institutions access to an integrated wealth platform, which helps construct and manage sophisticated portfolio solutions across an entire account life cycle, particularly in the area of UMA trading. Envestnet | WMS’s Overlay Portfolio Management console helps wealth managers efficiently build customized client portfolios that consider both proprietary and open-architecture investment solutions.

 

We believe that our business model results in a high degree of recurring and predictable financial results.

 

Revenues

 

Overview

 

We earn revenues primarily under two pricing models. First, a majority of our revenues is derived from fees charged as a percentage of the assets that are managed or administered on our technology platform by financial advisors. These revenues are recorded under revenues from assets under management (“AUM”) or administration (“AUA”) or collectively (“AUM/A”). Our asset-based fees vary based on the types of investment solutions and services that financial advisors utilize. Asset-based fees accounted for approximately 83%, 81% and 81% of our total revenues for the years ended December 31, 2013, 2012 and 2011, respectively. In future periods, the percentage of our total revenues attributable to asset-based fees is expected to vary based on fluctuations in securities markets, whether we enter into significant license agreements, the mix of AUM or AUA, and other factors. As of December 31, 2013, approximately $180 billion of investment assets subject to asset-based fees were managed or administered utilizing our technology platform by approximately 23,000 financial advisors through approximately 740,000 investor accounts.

 

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Table of Contents

 

We also generate revenues from recurring, contractual licensing fees for providing access to our technology platform. These revenues are recorded under revenues from licensing and professional services. Licensing fees are generally fixed in nature for the contract term and are based on the level of investment solutions and services provided, rather than on the amount of client assets on our technology platform. Licensing fees accounted for 15%, 15% and 16% of our total revenues for the years ended December 31, 2013, 2012 and 2011, respectively. Fees received in connection with professional services accounted for the remainder of our total revenues. As of December 31, 2013, approximately $360 billion of investment assets for which we receive licensing fees for utilizing our technology platform were serviced by approximately 7,800 financial advisors through approximately 1,508,000 investor accounts.

 

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

 

 

 

As of December 31,

 

 

 

2013

 

2012

 

2011

 

 

 

(in millions except accounts and advisors data)

 

Platform Assets

 

 

 

 

 

 

 

Assets Under Management (AUM)

 

$

45,706

 

$

30,970

 

$

22,936

 

Assets Under Administration (AUA)

 

132,215

 

67,368

 

47,148

 

Subtotal AUM/A

 

177,921

 

98,338

 

70,084

 

Licensing

 

358,919

 

269,729

 

69,514

 

Total Platform Assets

 

$

536,840

 

$

368,067

 

$

139,598

 

 

 

 

 

 

 

 

 

Platform Accounts

 

 

 

 

 

 

 

AUM

 

211,039

 

156,327

 

124,636

 

AUA

 

524,806

 

293,151

 

216,038

 

Subtotal AUM/A

 

735,845

 

449,478

 

340,674

 

Licensing

 

1,508,254

 

1,228,016

 

588,038

 

Total Platform Accounts

 

2,244,099

 

1,677,494

 

928,712

 

 

 

 

 

 

 

 

 

Advisors

 

 

 

 

 

 

 

AUM/A

 

22,838

 

16,085

 

13,887

 

Licensing

 

7,794

 

6,941

 

5,709

 

Total Advisors

 

30,632

 

23,026

 

19,596

 

 

Revenues from assets under management or administration

 

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

 

For over 85% of our revenues from assets under management or administration, we bill customers at the beginning of each quarter based on the market value of customer assets on our platform as of the end of the prior quarter. For example, revenues from assets under management or administration recognized during the fourth quarter of 2013 were primarily based on the market value of assets as of September 30, 2013. Our revenues from assets under management or administration are generally recognized ratably throughout the quarter based on the number of days in the quarter.

 

Our revenues from assets under management or administration are affected by the amount of new assets that are added to existing and new client accounts, which we refer to as gross sales. Gross sales, from time to time also include conversions of client assets to our technology platform. The amount of assets that are withdrawn from client accounts are referred to as redemptions. We refer to the difference between gross sales and redemptions as net flows. Positive net flows indicate that the market value of assets added to client accounts exceeds the market value of assets that have been withdrawn from client accounts.

 

Our revenues from assets under management or administration are also affected by changes in the market values of securities held in client accounts due to fluctuations in the securities markets. Certain types of securities have historically experienced greater

 

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Table of Contents

 

market price fluctuations, such as equity securities, than other securities, such as fixed income securities, though in any given period the type of securities that experience the greatest fluctuations may vary.

 

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

 

 

 

Asset Rollforward - 2013

 

 

 

As of
12/31/12

 

WMS

 

Gross
Sales

 

Redemptions

 

Net
Flows

 

Market
Impact

 

As of
12/31/13

 

 

 

(in millions except account data)

 

Assets under Management (AUM)

 

$

30,970

 

$

 

$

20,043

 

$

(9,663

)

$

10,380

 

$

4,356

 

$

45,706

 

Assets under Administration (AUA)

 

67,368

 

24,680

 

51,261

 

(22,478

)

28,783

 

11,384

 

132,215

 

Total AUM/A

 

$

98,338

 

$

24,680

 

$

71,304

 

$

(32,141

)

$

39,163

 

$

15,740

 

$

177,921

 

Fee-Based Accounts

 

449,478

 

86,014

 

314,111

 

(113,758

)

200,353

 

 

 

735,845

 

 

During 2013, we added $24.5 billion of conversions included in the above AUM/A gross sales figures, and an additional $33.6 billion of conversions in licensing.

 

 

 

Asset Rollforward - 2012

 

 

 

 

 

As of
12/31/11

 

Gross
Sales

 

Redemptions

 

Net
Flows

 

Market
Impact

 

As of
12/31/12

 

 

 

 

 

(in millions except account data)

 

 

 

Assets under Management (AUM)

 

$

22,936

 

$

12,487

 

$

(6,850

)

$

5,637

 

$

2,397

 

$

30,970

 

 

 

Assets under Administration (AUA)

 

47,148

 

28,381

 

(12,520

)

15,861

 

4,359

 

67,368

 

 

 

Subtotal AUM/A

 

$

70,084

 

$

40,868

 

$

(19,370

)

$

21,498

 

$

6,756

 

$

98,338

 

 

 

Fee-Based Accounts

 

340,674

 

191,551

 

(82,747

)

108,804

 

 

 

449,478

 

 

 

 

During 2012, we added $10.4 billion of conversions included in the above AUM/A gross sales figures, and an additional $13.2 billion of conversions in licensing.

 

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

 

 

 

December 31,

 

 

 

2013

 

2012

 

2011

 

Assets under management (AUM)

 

26

%

31

%

33

%

Assets under administration (AUA)

 

74

%

69

%

67

%

 

 

100

%

100

%

100

%

 

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

 

Revenues from licensing and professional services fees

 

Our revenues received under license agreements are recognized over the contractual term. To a lesser degree we also receive revenues from professional services fees by providing customers with certain technology platform software development and implementation services. In the years ended December 31, 2013, 2012 and 2011, our revenues from professional services fees were $5,089, $6,145 and $3,818, respectively. These revenues are generally recognized under a proportional performance model utilizing an output-based approach. Our contracts generally have fixed prices, and generally specify or quantify interim deliverables.

 

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

 

Expenses

 

The following is a description of our principal expense items.

 

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Table of Contents

 

Cost of revenues

 

Cost of revenues primarily includes expenses related to our receipt of sub-advisory and clearing, custody and brokerage services from third parties. The largest component of cost of revenues is paid to third party investment managers. Clearing, custody and brokerage services are performed by third-party providers. These expenses are typically calculated based upon a contractual percentage of the market value of assets held in customer accounts measured as of the end of each fiscal quarter and are recognized ratably throughout the quarter based on the number of days in the quarter. Also included in cost of revenues are vendor specific expenses related to the direct support of revenues associated with the Envestnet | Tamarac products.

 

Compensation and benefits

 

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

 

General and administration

 

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

 

Depreciation and amortization

 

Depreciation and amortization expenses include depreciation and amortization related to:

 

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

 

·                  internally developed software; and

 

·                  intangible assets, primarily related to customer lists, proprietary technology and trade names, the value of which are capitalized in connection with our acquisitions.

 

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

 

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

 

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

 

General Conditions and Trends Affecting Our Business

 

Our exposure to market risk is directly related to the market value of assets on our platform, as we earn revenues from assets under management (“AUM”) or administration (“AUA”) based upon a contractual percentage of AUM or AUA. As a result, our net flows, revenues and profitability have been and could be impacted negatively or positively by changes in overall market conditions going forward. The broad equity markets improved during 2013 compared to 2012, as the Nasdaq Composite Index, Standard & Poor’s 500 Index, MSCI World Index, and Dow Jones Industrial Average increased 38%, 30%, 24%, and 27%, respectively. The Barclays U.S. Aggregate Index decreased 2% over the same period. During the year ended December 31, 2013, our AUM and AUA increased by $15.7 billion due to the overall favorable market impact.

 

Market Trends

 

The wealth management industry has experienced significant growth in terms of assets invested by retail investors in the past several years. According to the Federal Reserve, U.S. household and non-profit organization financial assets totaled $63.9 trillion as of September 30, 2013, up 17% from $54.4 trillion at December 31, 2012. As a leading provider of unified wealth management software and services to financial advisors, we believe we are well positioned to take advantage of favorable secular trends in the wealth management industry, including those described below:

 

Increase in independent financial advisors. Based on industry news reports, we believe that over the past several years an increasing number of financial advisors have elected to leave large financial institutions and start their own financial advisory practices or move to smaller, more independent firms. According to an analysis done by Cerulli Associates, the number of RIAs and dually-registered advisors increased 5% annually from 36,000 in 2007 to 46,000 in 2012.

 

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Increased reliance on technology among independent financial advisors. In order to compete effectively in the marketplace, independent financial advisors are increasingly relying on technology service providers to help them provide comparable services cost effectively and efficiently.

 

Increased use of fee-based investment solutions. Based on our industry experience, we believe that in order for financial advisors to effectively manage their clients’ assets, they are seeking account types that offer the flexibility to choose among the widest range of investment solutions. Financial advisors typically charge their fees for these types of flexible accounts based on a percentage of assets rather than on a commission or other basis.

 

Our Growth Strategy

 

We serve the fastest growing segments of the wealth management industry. We intend to grow by increasing our advisor base, increasing the share of our clients’ business on the Envestnet platform, expanding our services utilized by each advisor and obtaining new enterprise clients through the use of marketing and internal sales personnel. In addition, we intend to selectively pursue acquisitions, investments and other relationships that we believe can enhance the attractiveness of our technology platform or expand our client base. Acquisitions involve a number of risks, including our ability to integrate acquired companies into ours in an effective and timely manner. We have historically financed our acquisitions with available cash; however, the financing of future acquisitions could result in dilution from issuing equity securities or a weakening of our balance sheet from using available cash or incurring debt.

 

Recent Developments

 

2013 Developments

 

Wealth Management Solutions

 

On July 1, 2013, the Company completed the acquisition of the Wealth Management Solutions (“WMS”) division of Prudential Investments for $8,992 in cash upon closing, plus contingent consideration of up to a total of $23,000 in cash, based upon meeting certain performance targets, to be paid over three years. WMS is a provider of technology solutions that enables financial services firms to develop and enhance their wealth management offerings.

 

Public Offering of Common Shares

 

On October 11, 2013, the Company completed a public offering of common shares on behalf of selling stockholders. A total of 5,801,997 shares were sold, including an overallotment option exercised by the underwriters, at a public offering price of $29.25 per share. The Company did not receive any proceeds from the sale of shares by the selling stockholders. The Company incurred costs of $1,089 during the year ended December 31, 2013 in relation to the public offering and this amount is included in general and administration expenses in the consolidated statement of operations.

 

2012 Developments

 

Prima Capital Holding, Inc.

 

On April 5, 2012, we completed the acquisition of Prima. In accordance with the stock purchase agreement, we acquired all of the outstanding shares of Prima for consideration of $13,925. Prima, now part of Envestnet | PMC, provides investment management due diligence, research applications, asset allocation modeling and multi-manager portfolios to the wealth management and retirement industries. Prima’s clientele includes banks, independent RIAs, regional broker-dealers, family offices and trust companies.

 

Tamarac, Inc.

 

On May 1, 2012, we completed the acquisition of Tamarac. In accordance with the merger agreement, a newly formed subsidiary of Envestnet merged with and into Tamarac, and Tamarac became a wholly-owned subsidiary of Envestnet. Under the terms of the merger agreement, net consideration was $48,427 for all of the outstanding stock of Tamarac. Tamarac provides leading portfolio accounting, rebalancing, trading, performance reporting and client relationship management software, principally to high-end RIAs.

 

In accordance with the terms of the merger agreement between Envestnet and Tamarac, Tamarac senior management was required to apply at least 50% (up to 100%) of the aggregate proceeds of the Tamarac change of control payment totaling $2,759 to purchase registered shares of Envestnet common stock (232,150 shares) in an amount equal to 95% multiplied by the Envestnet closing market price on the day before the merger closed (See Notes 3 and 11 to the notes to consolidated financial statements).

 

In addition, we adopted the Envestnet, Inc. Management Incentive Plan for Envestnet | Tamarac Management Employees (the “2012 Plan”). The 2012 Plan provides for the grant of up to 559,551 shares of unvested common stock. The unvested common stock vests based upon Tamarac meeting certain performance conditions and then a subsequent two-year service condition. We also granted to certain Tamarac employees 232,150 stock options to acquire Envestnet common stock at an exercise price of $12.51. These stock options vest on the second anniversary of the grant date (See Notes 3 and 12 to the notes to consolidated financial statements).

 

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Critical Accounting Policies

 

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

 

Revenue recognition

 

We recognize revenues when all four of the following criteria have been met:

 

·                  Persuasive evidence of an arrangement exists;

 

·                  The product has been delivered or the service has been performed;

 

·                  The fee is fixed or determinable; and

 

·                  Collectability is reasonably assured.

 

Types of revenues

 

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

 

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

 

Recognition of revenues

 

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

 

The Company derives licensing fees from recurring contractual fixed fee contracts with larger financial institutions or enterprise clients. Licensing contracts allow the customer to provide a unique configuration of platform features and investment solutions for their advisors. The licensing fees vary based on the type of services provided and our revenues received under license agreements are recognized over the contractual term. The Company’s license agreements do not generally provide its customers the ability to take possession of the software or host the software on the customers’ own systems or through a hosting arrangement with an unrelated party.

 

When the Company enters into arrangements with multiple deliverables, exclusive of arrangements with software deliverables, it applies the FASB’s guidance for revenue arrangements with multiple deliverables and evaluates each deliverable to determine whether it represents a separate unit of accounting based on the following criteria: (i) whether the delivered item has value to the customer on a stand-alone basis, and (ii) if the contract includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. Revenue is allocated to each unit of accounting or element based on relative selling prices. The Company determines relative selling prices by using either (i) vendor-specific objective evidence (“VSOE”) if it exists; or (ii) third-party evidence (“TPE”) of selling price. When neither VSOE nor TPE of selling price exists for a deliverable, the Company uses its best estimate of the selling price for that deliverable.

 

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After determining which deliverables represent a separate unit of accounting, each unit is then accounted for under the applicable revenue recognition guidance. In cases where elements cannot be treated as separate units of accounting, the elements are combined into a single unit of accounting for revenue recognition purposes. If one of the elements that are combined into a single unit of accounting is fees from professional services, including implementation related services or customized service platform software development, the professional service fees are recognized over the course of the expected customer relationship. We have estimated the life of the customer relationship by considering both the historical retention rate of our customers while not exceeding the number of years over which we can accurately forecast future revenues. We currently estimate this term to be five years.

 

When the Company enters into arrangements with multiple deliverables involving software, the Company applies the American Institute of Certified Public Accountants’ (“AICPA”) accounting guidance for software. The entire arrangement fee is allocated to each element in the arrangement based on the respective VSOE of fair value of each element.

 

The Company also derives professional service fees from providing contractual customized platform software development and implementation services, which are recognized under a proportional performance model utilizing an output-based approach.  The Company’s contracts generally have fixed prices, and generally specify or quantify interim deliverables.

 

Our revenue recognition is also affected by our judgment in determining whether collectability is reasonably assured.  With regard to allowances for uncollectible receivables, we consider customer-specific information related to delinquent accounts and past loss experience, as well as current economic conditions in establishing the amount of the allowance.

 

Purchase accounting

 

During the fourth quarter of 2011, we completed the acquisition of FundQuest for consideration totaling $27,796. In the second quarter of 2012, we completed the acquisitions of Prima and Tamarac for consideration totaling $13,925 and $48,427, respectively.  In the third quarter of 2013, the Company completed the acquisition of WMS for total consideration of $24,730.  For more information on the acquisitions see Note 3 to the notes to consolidated financial statements.

 

Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values, and the values of assets in use, and often requires the application of judgment regarding estimates and assumptions. While the ultimate responsibility resides with management, for material acquisitions, we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets.

 

Acquired intangible assets, excluding goodwill, are valued using a discounted cash flow methodology based on future cash flows specific to the type of intangible asset purchased. This methodology incorporates various estimates and assumptions, the most significant being projected revenue growth rates,margins, and forecasted cash flows based on the discount rate and terminal growth rate. Management projects revenue growth rates,margins and cash flows based on the historical operating results of the acquired entity adjusted for synergies anticipated to be achieved through integration, expected future performance, operational strategies, and the general macroeconomic environment. We review finite-lived intangible assets for triggering events such as significant changes in operations, customers or future revenue that might indicate the need to impair the assets acquired or change the useful lives of the assets acquired. There was no impairment or change in useful lives recognized on other intangible assets in 2013, 2012 or 2011.

 

Assumed liabilities are valued based on estimates of anticipated expenditures to be incurred to satisfy the assumed obligations, including contractual liabilities assumed, which require the exercise of professional judgment.

 

Assumed contracts may have favorable or unfavorable terms that must be valued as of the acquisition date. Such valuation is subject to management judgment regarding the evaluation and interpretation of contract terms in relation to other economic circumstances, such as the market rates for office space leases.

 

If we assume a performance obligation to customers as of the acquisition date, a deferred revenue obligation is recognized. Judgment is required to evaluate whether a future performance obligation exists and to assign a value to the performance obligation.

 

Estimation of working capital settlement amounts, if not resolved prior to the first reporting period after an acquisition, but before the end of the purchase measurement period, requires exercise of management judgment. We measure these amounts at the acquisition date fair value, if their fair value can be determined during the measurement period. If these estimated working capital settlement amounts are not resolved prior to the first reporting period after acquisition, we recognize the asset or liability if it can be reasonably estimated. Subsequent adjustments to these provisional working capital settlement amounts are evaluated by management to determine the proper accounting treatment under relevant authoritative guidance.

 

Assumed acquired tax liabilities for uncertain tax positions are dependent on assessing the past practices of the acquisition target based on our review of actual tax filings and information obtained through due diligence procedures. Evaluation of the validity of tax positions taken by the acquisition target are subject to management judgment. Transaction costs associated with business combinations are expensed as they are incurred.

 

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Internally developed software

 

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

 

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

 

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

 

Internally developed software is amortized on a straight-line basis over its estimated useful life. We evaluate the useful lives of these assets on an annual basis and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to internally developed software during the years ended December 31, 2013, 2012 and 2011.

 

Non-cash stock-based compensation expense

 

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

 

We use the “simplified” method in developing an estimate of expected term of stock options. We base the risk-free interest rate on zero-coupon yields implied from U.S. Treasury issues with remaining terms similar to the expected term on the options. We estimate expected volatility based on historical volatility of Envestnet’s common stock and that of comparable companies from a representative peer group based on industry and market capitalization data. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option-pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. If we use different assumptions for estimating stock-based compensation expense in future periods or if actual forfeitures differ materially from our estimated forfeitures, future stock-based compensation expense may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and net income per share.

 

The 2012 Plan provides for the grant of up to 559,551 shares of unvested common stock (“Target Incentive Awards”). The Target Incentive Awards vest based upon Tamarac meeting certain performance conditions and then a subsequent two-year service condition. We measured the cost of these awards based on the estimated fair value of the award as of the market closing price on the day before the acquisition closed. We are recognizing the estimated expense on a graded-vesting method over a requisite service period of three to five years, which is the estimated vesting period. We estimate expected vesting amounts and recognize compensation expense only for those awards expected to vest. This estimate is reassessed by management at each reporting period and may change based upon new facts and circumstances. Changes in the assumptions impact the total amount of expense ultimately recognized over the vesting period.

 

Income taxes

 

We are subject to income taxes in the United States, India and Canada. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes.

 

We use the asset and liability method to account for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Company’s income tax provision in the period that includes the enactment date. We record a valuation allowance to reduce deferred tax assets to an amount that we determine is more-likely-than-not to be realized in the future.

 

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

 

The amount of income tax we pay is subject to audits by federal, state and foreign tax authorities, which may result in proposed assessments. Our estimate of the potential outcome for any uncertain tax issue is highly judgmental. We believe that we have adequately provided for the foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, audits are closed or when statutes of limitations on potential assessments expire. Additionally, the jurisdictions in which our earnings or deductions are realized may differ from our current estimates. As a result, our effective tax rate may fluctuate significantly on a quarterly basis.

 

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

 

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

 

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

 

Our India subsidiary is currently under examination by the India Tax Authority for the fiscal years ended March 31, 2009, 2011 and 2012. Based on the outcome of examinations of our subsidiary or the result of the expiration of statutes of limitations, it is reasonably possible that the related unrecognized tax benefits could change from those recorded in the consolidated balance sheets. It is possible that one or more of these audits may be finalized within the next twelve months.

 

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Results of Operations

 

Year ended December 31, 2013 compared to year ended December 31, 2012

 

 

 

Year Ended December 31,

 

Increase (Decrease)

 

 

 

2013

 

2012

 

Amount

 

%

 

 

 

(in thousands)

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Assets under management or administration

 

$

200,568

 

$

127,213

 

$

73,355

 

58

%

Licensing and professional services

 

41,967

 

30,053

 

11,914

 

40

%

Total revenues

 

242,535

 

157,266

 

85,269

 

54

%

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of revenues

 

98,970

 

56,119

 

42,851

 

76

%

Compensation and benefits

 

77,442

 

54,973

 

22,469

 

41

%

General and administration

 

44,808

 

30,617

 

14,191

 

46

%

Depreciation and amortization

 

15,329

 

12,400

 

2,929

 

24

%

Restructuring charges

 

474

 

115

 

359

 

312

%

Total operating expenses

 

237,023

 

154,224

 

82,799

 

54

%

Income from operations

 

5,512

 

3,042

 

2,470

 

81

%

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

18

 

29

 

(11

)

-38

%

Interest expense

 

 

(3

)

3

 

-100

%

Other income

 

182

 

 

182

 

100

%

Total other income (expense)

 

200

 

26

 

174

 

669

%

Income before income tax provision

 

5,712

 

3,068

 

2,644

 

86

%

Income tax provision

 

2,052

 

2,603

 

(551

)

-21

%

Net income

 

$

3,660

 

$

465

 

$

3,195

 

687

%

 

Revenues

 

Total revenues increased 54% from $157,266 in 2012 to $242,535 in 2013. The increase was primarily due to an increase in revenues from assets under management or administration of $73,355. Revenues from assets under management or administration comprised 83% and 81% of total revenues in 2013 and 2012, respectively.

 

Assets under management or administration

 

Revenues earned from assets under management or administration increased 58% from $127,213 in 2012 to $200,568 in 2013. The increase was primarily due to an increase in asset values applicable to our quarterly billing cycles in 2013, relative to the corresponding period in 2012.  In 2013, revenues were positively affected by new account growth and positive net flows of AUM or AUA during 2012 and 2013, as well as an increase in revenues related to the WMS acquisition, on July 1, 2013.

 

The number of financial advisors with AUM or AUA on our technology platform increased from 16,085 as of December 31, 2012 to 22,838 as of December 31, 2013 and the number of AUM or AUA client accounts increased from approximately 450,000 as of December 31, 2012 to approximately 736,000 as of December 31, 2013.

 

Licensing and professional services

 

Licensing and professional services revenues increased 40% from $30,053 in 2012 to $41,967 in 2013. This increase was primarily due to an increase in licensing revenue of $12,978, primarily due to a full year of Tamarac operations in 2013, and a decrease in professional services revenue of $1,056.

 

Cost of revenues

 

Cost of revenues increased 76% from $56,119 in 2012 to $98,970 in 2013, primarily due to the corresponding increase in revenues from AUM or AUA, inclusive of an increase related to the WMS acquisition. As a percentage of total revenues, cost of revenues increased from 36% in 2012 to 41% in 2013.

 

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Compensation and benefits

 

Compensation and benefits increased 41% from $54,973 in 2012 to $77,442, primarily due to an increase in salaries, benefits and commission expense of $14,126 related to an increase in headcount, an increase in incentive compensation of $2,797 and an increase in non-cash compensation expense of $4,701, primarily related to Tamarac meeting certain performance metrics related to the 2012 Plan, as well as the accounting impact of a modification to the 2012 Plan in April of 2013.  Headcount increased from an average of 655 in 2012 to an average of 857 in 2013, primarily to support the growth of our operations, as well as increased headcount from the WMS acquisition. As a percentage of total revenues, compensation and benefits decreased from 35% in 2012 to 32% in 2013.

 

General and administration

 

General and administration expenses increased 46% from $30,617 in 2012 to $44,808 in 2013, primarily due to one-time re-audit related expenses of $3,110, and year-over-year increases in website and systems development costs of $3,239, professional and legal fees of $2,094, travel and entertainment of $1,125, occupancy costs of $1,238, imputed interest expense on contingent consideration of $787, fair value of contingent consideration adjustment of $501 and communication, research and data services costs of $1,533. As a percentage of total revenues, general and administration expenses decreased from 19% in 2012 to 18% in 2013. Excluding re-audit related expenses of $3,110, general and administration expenses as a percentage of total revenues would have been 17% for the year ended December 31, 2013.

 

Depreciation and amortization

 

Depreciation and amortization expense increased 24% from $12,400 in 2012 to $15,329 in 2013, primarily due to an increase in intangible asset amortization of $2,287 as a result of intangible assets recorded in purchase accounting related to the Prima and Tamarac acquisitions in 2012 and the WMS acquisition in the third quarter of 2013 (see Note 3 to the notes to consolidated financial statements). The increase in depreciation and amortization expense was also due to increases in capitalized computer equipment and software to support the growth of our operations. As a percentage of total revenues, depreciation and amortization decreased from 8% in 2012 to 6% in 2013.

 

Restructuring charges

 

In 2013, we incurred restructuring charges of $474 due to lease termination penalties incurred to terminate the Denver and Raleigh leases in the third quarter of 2013.  In 2012, we incurred restructuring charges of $115 primarily for severance charges related to the termination of certain Prima and Tamarac employees related to these acquisitions.

 

Income tax provision

 

 

 

Year Ended December 31,

 

 

 

2013

 

2012

 

 

 

(in thousands)

 

Income tax provision

 

$

2,052

 

$

2,603

 

Effective tax rate

 

35.9

%

84.8

%

 

Our 2013 effective tax rate differs from the statutory rate primarily as a result of non-deductible transaction costs, unrecognized tax benefits in the U.S., the benefit of foreign tax credits, as well as the benefit of research and development credits.  The non-deductible transaction costs relate to a secondary offering of our common stock completed in the fourth quarter.  The unrecognized tax benefits are a result of positions taken on prior year tax returns and the research and development credits are a result of a comprehensive study completed by the Company for tax years 2007-2013.

 

Our 2012 effective tax rate differs from the statutory rate primarily as a result of unrecognized tax benefits recorded in India, the effect of state tax rate changes, permanent differences, and changes in the valuation of federal and state net operating losses and adjustments to state deferred tax assets. The unrecognized tax benefits recorded relate to India tax exposure resulting from an examination performed by the India Taxing Authority. The change in state tax rates was primarily related to recognizing the benefit of state tax deductions on our federal tax return as well as changes in state tax laws regarding the sourcing of state taxable income. The adjustments to state deferred tax assets result from an analysis performed on the tax basis of fixed assets. It was determined that our net deferred tax assets did not properly reflect the future state tax benefits that will be recorded, and therefore we adjusted our balances accordingly.

 

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Year ended December 31, 2012 compared to year ended December 31, 2011

 

 

 

Year Ended December 31,

 

Increase (Decrease)

 

 

 

2012

 

2011

 

Amount

 

%

 

 

 

(in thousands)

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Assets under management or administration

 

$

127,213

 

$

99,236

 

$

27,977

 

28

%

Licensing and professional services

 

30,053

 

23,942

 

6,111

 

26

%

 

 

 

 

 

 

 

 

 

 

Total revenues

 

157,266

 

123,178

 

34,088

 

28

%

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of revenues

 

56,119

 

42,831

 

13,288

 

31

%

Compensation and benefits

 

54,973

 

40,305

 

14,668

 

36

%

General and administration

 

30,617

 

21,856

 

8,761

 

40

%

Depreciation and amortization

 

12,400

 

6,376

 

6,024

 

94

%

Restructuring charges

 

115

 

434

 

(319

)

-74

%

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

154,224

 

111,802

 

42,422

 

38

%

 

 

 

 

 

 

 

 

 

 

Income from operations

 

3,042

 

11,376

 

(8,334

)

-73

%

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

29

 

77

 

(48

)

-62

%

Interest expense

 

(3

)

(786

)

783

 

-100

%

Other income

 

 

1,100

 

(1,100

)

-100

%

Other expense

 

 

(1,183

)

1,183

 

-100

%

Unrealized gain (loss) on investments

 

 

(4

)

4

 

-100

%

 

 

 

 

 

 

 

 

 

 

Total other income (expense)

 

26

 

(796

)

822

 

-103

%

 

 

 

 

 

 

 

 

 

 

Income before income tax provision

 

3,068

 

10,580

 

(7,512

)

-71

%

Income tax provision

 

2,603

 

2,975

 

(372

)

-13

%

 

 

 

 

 

 

 

 

 

 

Net income

 

$

465

 

$

7,605

 

$

(7,140

)

-94

%

 

Revenues

 

Total revenues increased 28% from $123,213 in 2011 to $157,266 in 2012. The increase was primarily due to an increase in revenues from assets under management or administration of $27,977. Revenues from assets under management or administration comprised 81% of total revenues in both 2012 and 2011.

 

Assets under management or administration

 

Revenues earned from assets under management or administration increased 28% from $99,236 in 2011 to $127,213 in 2012. This increase was primarily due to an increase in asset values applicable to our quarterly billing cycles in 2012, relative to those used in 2011. Our 2012 revenues were positively affected by new account growth and positive net flows of AUM and AUA during 2011 and through September 2012, as well as an increase in revenues related to FundQuest.

 

The number of financial advisors with AUM or AUA on our technology platform increased from 13,887 as of December 31, 2011 to 16,085 as of December 31, 2012 and the number of AUM or AUA client accounts increased from approximately 341,000 as of December 31, 2011 to approximately 450,000 as of December 31, 2012.

 

Licensing and professional services

 

Licensing and professional services revenues increased 26% from $23,942 in 2011 to $30,053 in 2012. This increase was primarily due to an increase in licensing revenue of $3,787 and an increase in professional services revenue of $2,327. The increase in licensing revenue was primarily a result of the acquisitions of Prima and Tamarac, partially offset by the renegotiated license agreement with Fidelity.

 

Cost of revenues

 

Cost of revenues increased 31% from $42,831 in 2011 to $56,119 in 2012, primarily due to the corresponding increase in revenues from AUM or AUA. As a percentage of total revenues, cost of revenues increased from 35% in 2011 to 36% in 2012.

 

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Compensation and benefits

 

Compensation and benefits increased 36% from $40,305 in 2011 to $54,973 in 2012, primarily due to an increase in salaries, benefits and commissions of $12,416 related to an increase in headcount as a result of the FundQuest, Prima and Tamarac acquisitions. In addition, incentive compensation and non-cash compensation expense increased $1,137 and $1,280, respectively, over the prior year period. Headcount increased from an average of 486 in 2011 to an average of 655 in 2012, primarily to support the growth of our operations, as well as increased headcount from acquisitions. As a percentage of total revenues, compensation and benefits increased from 33% in 2011 to 35% in 2012.

 

General and administration

 

General and administration expenses increased 40% from $21,856 in 2011 to $30,617 in 2012, primarily due to increases in transaction-related costs of $2,051, occupancy costs of $1,814, communication, research and data services expense of $1,283, travel and entertainment costs of $998, marketing expenses of $655 and website hosting and development expenses of $600. As a percentage of total revenues, general and administration expenses increased from 18% in 2011 to 19% in 2012.

 

Depreciation and amortization

 

Depreciation and amortization expense increased 94% from $6,376 in 2011 to $12,400 in 2012, primarily due to an increase in intangible asset amortization of $5,230 and fixed asset depreciation of $823. The increase in intangible asset amortization was due to an increase in intangible assets as a result of the FundQuest, Prima and Tamarac acquisitions (see Note 3 to the notes to consolidated financial statements). The increase in depreciation and amortization expense was primarily due to increases in capitalized computer equipment and software to support the growth of our operations. As a percentage of total revenues, depreciation and amortization increased from 5% in 2011 to 8% in 2012.

 

Restructuring charges

 

In 2012, we incurred restructuring charges of $115 primarily for severance charges related to the termination of certain Prima and Tamarac employees related to these acquisitions. In 2011, we incurred restructuring charges of $434 primarily for severance charges related to the termination of certain FundQuest and Envestnet employees related to the FundQuest acquisition.

 

Interest expense

 

Interest expense decreased from $786 in 2011 to $3 in 2012, primarily due to eleven months of imputed interest on payments due to FundQuest in 2011 compared to no imputed interest in 2012. As discussed in Note 3 to the notes to consolidated financial statements, as a result of the FundQuest acquisition and the related termination of the Platform Services Agreement with FundQuest, we ceased imputing interest expense as of the date of acquisition.

 

Other income

 

Other income decreased from $1,100 in 2011 to $0 in 2012. In 2011, the Company received proceeds from an insurance recovery (see Note 14 to the notes to consolidated financial statements).

 

Other expense

 

Other expense decreased from $1,183 in 2011 to $0 in 2012. In 2011, the Company incurred non-cash contract settlement charges related to the termination of the Platform Services Agreement between the Company and FundQuest (see Note 3 to the notes to consolidated financial statements).

 

Income tax provision

 

 

 

Year Ended December 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

Income tax provision

 

$

2,603

 

$

2,975

 

Effective tax rate

 

84.8

%

28.1

%

 

Our 2012 effective tax rate differs from the statutory rate primarily as a result of unrecognized tax benefits recorded in India, the effect of state tax rate changes, permanent differences, and prior period adjustments such as changes in the valuation of federal and state net operating losses and adjustments to state deferred tax assets.  The unrecognized tax benefits recorded relate to India tax exposure resulting from an examination performed by the India Tax Authority.  The change in state tax rates was primarily related to recognizing the benefit of state tax deductions on our federal tax return as well as changes in state tax laws regarding the sourcing of state taxable income.  The adjustments to state deferred tax assets result from an analysis performed on the tax basis of fixed assets. It

 

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was determined that our net deferred tax assets did not properly reflect the future state tax benefits that will be recorded, and therefore we adjusted our balances accordingly.

 

Our 2011 effective tax rate differs from the statutory rate primarily as a result of changes in our estimates of our state income tax obligations for prior years, changes in state tax rates and the effect of permanent differences. Our 2011 effective tax rate also differs from the statutory rate primarily as a result of the reversal of certain deferred income tax liabilities totaling $1,186 related to the termination of the Platform Services Agreement between Envestnet and FundQuest (see Note 3 to the notes to consolidated financial statements).

 

Non-GAAP Financial Measures

 

 

 

Year Ended December 31,

 

 

 

2013

 

2012

 

2011

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

Adjusted revenues

 

$

242,695

 

$

158,514

 

$

123,178

 

Adjusted EBITDA

 

38,594

 

23,988

 

27,436

 

Adjusted net income

 

19,094

 

10,570

 

13,754

 

Adjusted net income per share

 

0.54

 

0.32

 

0.42

 

 

Adjusted revenues” excludes the effect of purchase accounting on the fair value of acquired deferred revenue. Under U.S. GAAP, we record at fair value the acquired deferred revenue for contracts in effect at the time the entities were acquired. Consequently, revenue related to acquired entities for periods subsequent to the acquisition does not reflect the full amount of revenue that would have been recorded by these entities had they remained stand-alone entities.

 

“Adjusted EBITDA” represents net income (loss) before deferred revenue fair value adjustment, interest income, interest expense, income tax provision, depreciation and amortization, non-cash compensation expense, restructuring charges and transaction costs, severance, litigation-related expense, gain (loss) on investments, other income, impairment of customer inducement asset, contract settlement charges, bad debt expense, fair market value adjustment on contingent consideration, imputed interest on contingent consideration and customer inducement costs.

 

“Adjusted net income” represents net income (loss) before deferred revenue fair value adjustment, non-cash compensation expense, severance, amortization of acquired intangibles, litigation-related expense, non-recurring tax items, bad debt expense, customer inducement costs, contract settlement charges, contract settlement — reversal of deferred taxes, impairment of customer inducement asset, other income, fair market value adjustment on contingent consideration and imputed interest on contingent consideration. Reconciling items, excluding bad debt expense, contract settlement charges, contract settlement — reversal of deferred taxes and non-deductible transaction costs, are tax effected using the income tax rates in effect on the applicable date.

 

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

 

Our Board of Directors and our management use adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share:

 

·                  As measures of operating performance;

 

·                  For planning purposes, including the preparation of annual budgets;

 

·                  To allocate resources to enhance the financial performance of our business;

 

·                  To evaluate the effectiveness of our business strategies; and

 

·                  In communications with our Board of Directors concerning our financial performance.

 

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

 

We also present adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share as supplemental performance measures because we believe that they provide our Board of Directors, management and investors with additional information to assess our performance. Adjusted revenues provide comparisons from period to period by excluding the effect of purchase accounting on the fair value of acquired deferred revenue. Adjusted EBITDA provide comparisons from period to period by excluding potential differences caused by variations in the age and book depreciation of fixed assets affecting relative depreciation expense and amortization of internally developed software, amortization of acquired intangible assets, amortization of customer inducement costs, litigation-related expense, severance, gain on investments, and changes in interest expense and interest income that are influenced by capital structure decisions and capital market conditions. Our management also believes it is useful to exclude non-

 

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cash stock-based compensation expense from adjusted EBITDA and adjusted net income because non-cash equity grants made at a certain price and point in time do not necessarily reflect how our business is performing at any particular time.

 

We believe adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share are useful to investors in evaluating our operating performance because securities analysts use adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share as supplemental measures to evaluate the overall performance of companies, and we anticipate that our investor and analyst presentations will include adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share.

 

Adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share are not measurements of our financial performance under U.S. GAAP and should not be considered as an alternative to revenues, net income, operating income or any other performance measures derived in accordance with U.S. GAAP, or as an alternative to cash flows from operating activities as a measure of our profitability or liquidity.

 

We understand that, although adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share are frequently used by securities analysts and others in their evaluation of companies, these measures have limitations as an analytical tool, and you should not consider them in isolation, or as a substitute for an analysis of our results as reported under U.S. GAAP. In particular you should consider:

 

·                  Adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;

 

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

 

·                  Adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share do not reflect non-cash components of employee compensation;

 

·                  Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements;

 

·                  Due to either net losses before income tax expenses or the use of federal and state net operating loss carryforwards in 2013, 2012 and 2011, we had cash income tax payments, net of refunds, of $4,708, $796 and $813 in the years ended December 31, 2013, 2012 and 2011, respectively. Income tax payments will be higher if we continue to generate taxable income and our existing net operating loss carryforwards for federal and state income taxes have been fully utilized or have expired; and

 

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

 

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

 

The following table sets forth a reconciliation of total revenues to adjusted revenues based on our historical results:

 

 

 

Year Ended December 31,

 

 

 

2013

 

2012

 

2011

 

 

 

(in thousands)

 

Total revenues

 

$

242,535

 

$

157,266

 

$

123,178

 

Deferred revenue fair value adjustment

 

160

 

1,248

 

 

Adjusted revenues

 

$

242,695

 

$

158,514

 

$

123,178

 

 

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The following table sets forth the reconciliation of net income to adjusted EBITDA based on our historical results:

 

 

 

Year Ended December 31,

 

 

 

2013

 

2012

 

2011

 

 

 

(in thousands)

 

Net income

 

$

3,660

 

$

465

 

$

7,605

 

Add (deduct):

 

 

 

 

 

 

 

Deferred revenue fair value adjustment

 

160

 

1,248

 

 

Interest income

 

(18

)

(29

)

(77

)

Interest expense

 

 

3

 

786

 

Income tax provision

 

2,052

 

2,603

 

2,975

 

Depreciation and amortization

 

15,329

 

12,400

 

6,376

 

Non-cash compensation expense

 

8,919

 

4,037

 

3,062

 

Restructuring charges and transaction costs

 

3,297

 

2,718

 

1,054

 

Re-audit related expenses

 

3,110

 

 

 

Severance

 

790

 

278

 

698

 

Imputed interest on contingent consideration

 

787

 

 

 

Fair market value adjustment on contingent consideration

 

501

 

 

 

Litigation related expense

 

7

 

265

 

128

 

Loss on investments

 

 

 

4

 

Other income

 

 

 

(1,100

)

Impairment of customer inducement asset

 

 

 

174

 

Contract settlement charges

 

 

 

1,183

 

Customer inducement costs

 

 

 

4,568

 

Adjusted EBITDA

 

$

38,594

 

$

23,988

 

$

27,436

 

 

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Table of Contents

 

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

 

 

 

Year Ended December 31,

 

 

 

2013 *

 

2012 *

 

2011 *

 

 

 

(in thousands)

 

Net income

 

$

3,660

 

$

465

 

$

7,605

 

Add:

 

 

 

 

 

 

 

Deferred revenue fair value adjustment

 

93

 

746

 

 

Non-cash compensation expense

 

5,173

 

2,414

 

1,831

 

Restructuring charges and transaction costs

 

2,252

 

1,810

 

630

 

Re-audit related expenses

 

1,804

 

 

 

Severance

 

458

 

166

 

417

 

Amortization of acquired intangible assets

 

4,903

 

3,687

 

559

 

Imputed interest on contingent consideration

 

456

 

 

 

Fair market value adjustment on contingent consideration

 

291

 

 

 

Litigation related expense

 

4

 

158

 

77

 

Non-recurring tax items

 

 

1,124

 

 

Bad debt expense

 

 

 

 

Customer inducement costs

 

 

 

2,732

 

Contract settlement charges

 

 

 

1,183

 

Contract settlement - reversal of deferred taxes

 

 

 

(1,187

)

Impairment of customer inducement asset

 

 

 

104

 

Other income

 

 

 

(658

)

Imputed interest expense

 

 

 

461

 

Adjusted net income

 

$

19,094

 

$

10,570

 

$

13,754

 

 

 

 

 

 

 

 

 

Basic number of weighted-average shares outstanding

 

33,191,088

 

32,162,672

 

31,643,390

 

Effect of dilutive shares:

 

 

 

 

 

 

 

Options to purchase common stock

 

1,979,474

 

954,056

 

974,192

 

Common warrants

 

378,282

 

177,257

 

211,495

 

Restricted stock

 

117,731

 

47,630

 

34,757

 

Diluted number of weighted-average shares outstanding

 

35,666,575

 

33,341,615

 

32,863,834

 

 

 

 

 

 

 

 

 

Adjusted net income per share

 

$

0.54

 

$

0.32

 

$

0.42

 

 


*Adjustments, excluding non-recurring tax items, bad debt expense, contract settlement charges, contract settlement — reversal of deferred taxes and non-deductible transaction costs, are tax-effected using income tax rates as follows: 42% for 2013, and 40.2% for 2012 and 2011.

 

Liquidity and Capital Resources

 

As of December 31, 2013, we had total cash and cash equivalents of $49,942, compared to $29,983 as of December 31, 2012. We plan to use existing cash as of December 31, 2013 and cash generated in the ongoing operations of our business to fund our current operations and capital expenditures in 2014.

 

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Cash Flows

 

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

 

 

 

Year Ended December 31,

 

 

 

2013

 

2012

 

2011

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

28,857

 

$

28,548

 

$

24,749

 

Net cash used in investing activities

 

(18,260

)

(69,714

)

(30,161

)

Net cash provided by financing activities

 

9,362

 

6,240

 

2,653

 

Net increase (decrease) in cash and cash equivalents

 

19,959

 

(34,926

)

(2,759

)

Cash and cash equivalents, end of period

 

49,942

 

29,983

 

64,909

 

 

Operating Activities

 

Net cash provided by operating activities in 2013 increased by $309 compared to 2012, primarily due to an increase in net income of $3,195 in 2013 compared to the prior year period, an increase in depreciation and amortization of $2,929, an increase in stock-based compensation of $4,396, offset by an increase of $2,629 in deferred income taxes, an increase of $2,030 in excess tax benefits from stock-based compensation and an overall net decrease in the change in operating assets and liabilities of $5,498.

 

Net cash provided by operating activities in 2012 increased by $3,799 compared to 2011, primarily due to a decrease in net earnings of $7,140 in 2012 compared to the prior year period, a decrease in amortization of customer inducements of $4,568, offset by an increase in $6,024 in depreciation and amortization expense, and an overall net increase in the change in operating assets and liabilities of $12,939.

 

Investing Activities

 

Net cash used in investing activities in 2013 decreased by $51,454 compared to 2012. In 2013, the Company acquired WMS for net cash totaling $8,992 and in 2012, the Company acquired Prima and Tamarac for net cash totaling $62,352 (see Note 3 to the notes to consolidated financial statements). The decrease in cash used in acquisitions of $53,360 was offset by cash disbursements in 2013 and 2012 of $9,268 and $7,188, respectively, for purchases of property and equipment and capitalization of internally developed software.

 

Net cash used in investing activities in 2012 increased by $39,553 compared to 2011. In 2012, the Company acquired Prima and Tamarac for net cash totaling $62,352 and in 2011, the Company acquired FundQuest for net cash totaling $23,719 (see Note 3 to the notes to consolidated financial statements). Additionally, cash disbursements in 2012 and 2011 totaled $7,188 and $6,280, respectively, for purchases of property and equipment and capitalization of internally developed software.

 

Financing Activities

 

Net cash provided by financing activities in 2013 increased by $3,122 compared to 2012, primarily a result of an increase in the proceeds from exercise of stock options of $4,331 and an increase in the excess tax benefits from stock-based compensation of $2,030, offset by a decrease in the issuance of restricted stock of $2,759 and increase in treasury stock purchases of $485.

 

Net cash provided by financing activities in 2012 increased by $3,587 compared to 2011, primarily a result of the proceeds from the issuance of restricted stock in the Tamarac acquisition of $2,759 (see Notes 3 and 11 to the notes to consolidated financial statements) offset by a decrease in proceeds from the exercise of stock options of $678.

 

Commitments

 

The following table sets forth information regarding our contractual obligations as of December 31, 2013:

 

 

 

Payments Due by Period

 

 

 

 

 

Less than

 

1-3

 

3-5

 

More than

 

 

 

Total

 

1 year

 

years

 

years