10-Q 1 v354173_10q.htm 10-Q

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

xQuarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the quarterly period ended July 31, 2013

or

¨Transition Report Pursuant to Section 13 or 15 (d) of The Securities Exchange Act of 1934

For the transition period from _____________ to ____________

 

Commission file no. 1-8100

 

EATON VANCE CORP.

(Exact name of registrant as specified in its charter)

 

Maryland 04-2718215
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)  

 

Two International Place, Boston, Massachusetts 02110

(Address of principal executive offices) (zip code)

 

(617) 482-8260

(Registrant's telephone number, including area code)

 

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

 

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

 

Indicate by check mark 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.

 

Large accelerated filer x Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if smaller reporting company) Smaller reporting company ¨

 

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

 

Shares outstanding as of July 31, 2013:

Voting Common Stock – 399,240 shares

Non-Voting Common Stock – 120,938,397 shares

 

 

 
 

 

Eaton Vance Corp.

Form 10-Q

As of July 31, 2013 and for the

Three and Nine Month Periods Ended July 31, 2013

 

Table of Contents

 

Required
Information

  Page
Number
Reference
     
Part I Financial Information  
Item 1. Consolidated Financial Statements 3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

40

Item 3. Quantitative and Qualitative Disclosures About Market Risk 68
Item 4. Controls and Procedures 68
     
Part II Other Information  
Item 1. Legal Proceedings 69
Item 1A. Risk Factors 69
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 72
Item 6. Exhibits 73
     
Signatures   74

 

2
 

 

Part I - Financial Information

 

Item 1. Consolidated Financial Statements

 

Eaton Vance Corp.

Consolidated Balance Sheets (unaudited)

 

   July 31,   October 31, 
(in thousands)  2013   2012 
         
Assets          
           
Cash and cash equivalents  $379,414   $462,076 
Investment advisory fees and other receivables   161,237    133,589 
Investments   545,474    486,933 
Assets of consolidated collateralized loan obligation ("CLO") entity:          
Cash and cash equivalents   58,300    36,758 
Bank loans and other investments   245,991    430,583 
Other assets   2,237    1,107 
Deferred sales commissions   18,859    19,336 
Deferred income taxes   57,422    51,234 
Equipment and leasehold improvements, net   49,713    54,889 
Intangible assets, net   76,892    59,228 
Goodwill   228,876    154,636 
Other assets   85,942    89,122 
Total assets  $1,910,357   $1,979,491 

 

See notes to Consolidated Financial Statements.

 

3
 

 

Eaton Vance Corp.        
Consolidated Balance Sheets (unaudited) (continued)        
   July 31,   October 31, 
(in thousands, except share data)  2013   2012 
         
Liabilities, Temporary Equity and Permanent Equity          
           
Liabilities:          
           
Accrued compensation  $133,686   $145,338 
Accounts payable and accrued expenses   58,645    59,397 
Dividend payable   24,273    23,250 
Debt   573,460    500,000 
Liabilities of consolidated CLO entity:          
Senior and subordinated note obligations   291,175    446,605 
Other liabilities   421    766 
Other liabilities   77,411    91,785 
Total liabilities   1,159,071    1,267,141 
           
Commitments and contingencies          
           
Temporary Equity:          
           
Redeemable non-controlling interests   97,051    98,765 
           
Permanent Equity:          
           
Voting Common Stock, par value $0.00390625 per share:          
Authorized, 1,280,000 shares          
Issued and outstanding, 399,240 and 413,167 shares, respectively   2    2 
Non-Voting Common Stock, par value $0.00390625 per share:          
Authorized, 190,720,000 shares          
Issued and outstanding, 120,938,397 and 115,878,384 shares, respectively   472    453 
Additional paid-in capital   134,464    26,730 
Notes receivable from stock option exercises   (6,861)   (4,155)
Accumulated other comprehensive income   686    3,923 
Appropriated retained earnings   13,107    18,699 
Retained earnings   511,034    566,420 
Total Eaton Vance Corp. shareholders' equity   652,904    612,072 
Non-redeemable non-controlling interests   1,331    1,513 
Total permanent equity   654,235    613,585 
Total liabilities, temporary equity and permanent equity  $1,910,357   $1,979,491 

 

See notes to Consolidated Financial Statements.

 

4
 

 

Eaton Vance Corp.                
Consolidated Statements of Income (unaudited)                
   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands, except per share data)  2013   2012   2013   2012 
Revenue:                    
Investment advisory and administrative fees  $293,589   $244,655   $833,791   $732,995 
Distribution and underwriter fees   22,681    22,066    67,597    67,132 
Service fees   32,259    30,760    94,521    95,124 
Other revenue   1,832    1,290    4,661    3,896 
Total revenue   350,361    298,771    1,000,570    899,147 
Expenses:                    
Compensation and related costs   115,379    94,700    334,220    288,949 
Distribution expense   35,452    32,670    104,645    97,958 
Service fee expense   29,013    28,165    86,488    84,926 
Amortization of deferred sales commissions   4,983    4,593    14,518    15,946 
Fund-related expenses   8,230    7,205    23,728    20,446 
Other expenses   38,454    36,422    109,371    104,275 
Total expenses   231,511    203,755    672,970    612,500 
Operating income   118,850    95,016    327,600    286,647 
Non-operating income (expense):                    
(Losses) gains and other investment income, net   (8,027)   1,927    2,223    12,900 
Interest expense   (9,167)   (8,525)   (26,309)   (25,350)
Loss on extinguishment of debt   (52,886)   -    (52,886)   - 
Other income (expense) of consolidated                    
CLO entity:                    
Gains and other investment income, net   1,704    12,872    7,881    32,047 
Interest expense   (2,939)   (4,399)   (10,211)   (12,844)
Total non-operating (expense) income   (71,315)   1,875    (79,302)   6,753 
Income before income taxes and equity in net income of affiliates   47,535    96,891    248,298    293,400 
Income taxes   (25,137)   (34,379)   (99,270)   (104,730)
Equity in net income of affiliates, net of tax   2,652    175    9,269    1,657 
Net income   25,050    62,687    158,297    190,327 
Net income attributable to non-controlling and other beneficial interests   (1,847)   (12,481)   (21,608)   (39,980)
Net income attributable to Eaton Vance Corp. shareholders  $23,203   $50,206   $136,689   $150,347 
Earnings per share:                    
Basic  $0.19   $0.44   $1.12   $1.30 
Diluted  $0.18   $0.43   $1.07   $1.27 
Weighted average shares outstanding:                    
Basic   117,594    112,110    116,399    112,354 
Diluted   123,872    114,591    122,155    115,031 
Dividends declared per share  $0.20   $0.19   $1.60   $0.57 

 

See notes to Consolidated Financial Statements.

 

5
 

 

Eaton Vance Corp.

Consolidated Statements of Comprehensive Income (unaudited)

 

   Three Months   Nine Months 
   Ended   Ended 
   July 31,   July 31, 
(in thousands)  2013   2012   2013   2012 
Net income  $25,050   $62,687   $158,297   $190,327 
Other comprehensive income (loss):                    
Change in unrealized gains on derivative instruments, net of income taxes of $788, $0, $788 and $0, respectively   1,227    -    1,227    - 
Amortization of net (gains) losses on derivatives, net of income taxes of $320, $39, $399 and $118, respectively   698    73    842    217 
Unrealized holding gains (losses) on available-for-sale investments, net of income taxes of $(229), $95, $874 and $(932), respectively   370    (156)   (1,426)   1,526 
Foreign currency translation adjustments, net of income taxes of $1,760, $233, $2,386 and $252, respectively   (2,860)   (384)   (3,880)   (453)
Other comprehensive (loss) income, net of tax   (565)   (467)   (3,237)   1,290 
Total comprehensive income   24,485    62,220    155,060    191,617 
Comprehensive income attributable to non-controlling and other beneficial interests   (1,847)   (12,481)   (21,608)   (39,980)
Total comprehensive income attributable to Eaton Vance Corp. shareholders  $22,638   $49,739   $133,452   $151,637 

 

See notes to Consolidated Financial Statements.

 

6
 

 

Eaton Vance Corp.

Consolidated Statements of Shareholders' Equity (unaudited)

 

   Permanent Equity   Temporary
Equity
 
(in thousands)  Voting
Common
Stock
   Non-Voting
Common
Stock
   Additional
Paid-In
Capital
   Notes
Receivable
from Stock
Option
Exercises
   Accumulated
Other
Comprehensive
Income
   Appropriated
Retained
Earnings
   Retained
Earnings
   Non-
Redeemable
Non-
Controlling
Interests
   Total
Permanent
Equity
   Redeemable
Non-
Controlling
Interests
 
Balance, November 1, 2012  $2   $453   $26,730   $(4,155)  $3,923   $18,699   $566,420   $1,513   $613,585   $98,765 
Net income   -    -    -    -    -    (5,592)   136,689    3,964    135,061    23,236 
Other comprehensive loss   -    -    -    -    (3,237)   -    -    -    (3,237)   - 
Dividends declared   -    -    -    -    -    -    (192,075)   -    (192,075)   - 
Issuance of Non-Voting Common Stock:                                                  
On exercise of stock options   -    18    98,968    (4,734)   -    -    -    -    94,252    - 
Under employee stock purchase plan   -    1    3,516    -    -    -    -    -    3,517    - 
Under employee incentive plan   -    -    2,079    -    -    -    -    -    2,079    - 
Under restricted stock plan, net of forfeitures   -    5    -    -    -    -    -    -    5    - 
Stock-based compensation   -    -    40,446    -    -    -    -    -    40,446    - 
Tax benefit of stock option exercises   -    -    15,682    -    -    -    -    -    15,682    - 
Repurchase of Voting Common Stock   -    -    (73)   -    -    -    -    -    (73)   - 
Repurchase of Non-Voting Common Stock   -    (5)   (48,157)   -    -    -    -    -    (48,162)   - 
Principal repayments on notes receivable from stock option exercises   -    -    -    2,028    -    -    -    -    2,028    - 
Net subscriptions (redemptions/distributions) of non-controlling interest holders   -    -    -    -    -    -    -    (3,922)   (3,922)   63,796 
Deconsolidation   -    -    -    -    -    -    -    -    -    (61,023)
Reclass to temporary equity   -    -    -    -    -    -    -    (224)   (224)   224 
Purchase of non-controlling interests   -    -    -    -    -    -    -    -    -    (46,601)
Issuance of subsidiary equity   -    -    -    -    -    -    -    -    -    13,927 
Other changes in non-controlling interests   -    -    (4,727)   -    -    -    -    -    (4,727)   4,727 
Balance, July 31, 2013  $2   $472   $134,464   $(6,861)  $686   $13,107   $511,034   $1,331   $654,235   $97,051 

 

See notes to Consolidated Financial Statements.

 

7
 

 

Eaton Vance Corp.

Consolidated Statements of Shareholders' Equity (unaudited) (continued)

 

   Permanent Equity   Temporary
Equity
 
(in thousands)  Voting
Common
Stock
   Non-Voting
Common
Stock
   Additional
Paid-In
Capital
   Notes
Receivable
from Stock
Option
Exercises
   Accumulated
Other
Comprehensive
Income
   Appropriated
Retained
(Deficit)
Earnings
   Retained
Earnings
   Non-
Redeemable
Non-
Controlling
Interests
   Total
Permanent
Equity
   Redeemable
Non-
Controlling
Interests
 
Balance, November 1, 2011  $2   $450   $-   $(4,441)  $1,340   $(3,867)  $466,931   $889   $461,304   $100,824 
Net income   -    -    -    -    -    16,352    150,347    2,747    169,446    20,881 
Other comprehensive income   -    -    -    -    1,290    -    -    -    1,290    - 
Dividends declared   -    -    -    -    -    -    (65,867)   -    (65,867)   - 
Issuance of Voting Common Stock   -    -    56    -    -    -    -    -    56    - 
Issuance of Non-Voting Common Stock:                                                  
On exercise of stock options   -    4    17,328    (211)   -    -    -    -    17,121    - 
Under employee stock purchase plan   -    1    3,653    -    -    -    -    -    3,654    - 
Under employee incentive plan   -    -    2,068    -    -    -    -    -    2,068    - 
Under restricted stock plan,  net of forfeitures   -    5    -    -    -    -    -    -    5    - 
Stock-based compensation   -    -    42,819    -    -    -    -    -    42,819    - 
Tax benefit of stock option exercises   -    -    2,228    -    -    -    -    -    2,228    - 
Repurchase of Non-Voting Common Stock   -    (12)   (65,210)   -    -    -    (11,364)   -    (76,586)   - 
Principal repayments on notes receivable from stock option exercises   -    -    -    764    -    -    -    -    764    - 
Net subscriptions (redemptions/distributions) of non-controlling interest holders   -    -    -    -    -    -    -    (2,613)   (2,613)   29,751 
Deconsolidation   -    -    -    -    -    -    -    -    -    (21,586)
Reclass to temporary equity   -    -    -    -    -    -    -    (132)   (132)   132 
Purchase of non-controlling interests   -    -    -    -    -    -    -    -    -    (19,864)
Other changes in non-controlling interests   -    -    (2,942)   -    -    -    -    -    (2,942)   2,942 
Balance, July 31, 2012  $2   $448   $-   $(3,888)  $2,630   $12,485   $540,047   $891   $552,615   $113,080 

 

See notes to Consolidated Financial Statements.

 

8
 

 

Eaton Vance Corp.

Consolidated Statements of Cash Flows (unaudited)

 

   Nine Months Ended 
   July 31, 
(in thousands)  2013   2012 
         
Cash Flows From Operating Activities:          
Net income  $158,297   $190,327 
Adjustments to reconcile net income to net cash (used for) provided by operating activities:          
Depreciation and amortization   19,673    19,007 
Unamortized gain on derivative instrument   2,015    - 
Amortization of deferred sales commissions   14,575    15,973 
Stock-based compensation   40,446    42,819 
Deferred income taxes   (4,117)   (7,315)
Net gains on investments and derivatives   (399)   (7,786)
Equity in net income of affiliates, net of amortization   (10,834)   (2,642)
Dividends received from affiliates   13,218    11,117 
Loss on extinguishment of debt   52,886    - 
Consolidated CLO entity operating activities:          
Net losses (gains) on bank loans, other investments and note obligations   4,197    (15,366)
Amortization of investments   (584)   (790)
Net decrease in other assets and liabilities, including cash   (23,119)   (19,655)
Changes in operating assets and liabilities:          
Investment advisory fees and other receivables   (21,852)   3,469 
Investments in trading securities   (194,121)   (72,400)
Deferred sales commissions   (14,098)   (8,462)
Other assets   28,424    (169)
Accrued compensation   (13,547)   (27,307)
Accounts payable and accrued expenses   (4,587)   6,027 
Other liabilities   (46,702)   17,941 
Net cash (used for) provided by operating activities   (229)   144,788 
           
Cash Flows From Investing Activities:          
Additions to equipment and leasehold improvements   (4,220)   (2,928)
Net cash paid in acquisition   (86,429)   (12,334)
Cash paid for intangible assets   (300)   (200)
Proceeds from sales of investments   71,414    72,597 
Purchase of investments   (747)   (21,624)
Consolidated CLO entity investing activities:          
Proceeds from sales and maturities of bank loans and other investments   192,036    182,784 
Purchase of bank loans and other investments   (6,547)   (163,037)
Net cash provided by investing activities   165,207    55,258 

 

See notes to Consolidated Financial Statements.

 

9
 

 

Eaton Vance Corp.

Consolidated Statements of Cash Flows (unaudited) (continued)

 

   Nine Months Ended 
   July 31, 
(in thousands)  2013   2012 
         
Cash Flows From Financing Activities:          
Purchase of additional non-controlling interest   (43,507)   (19,864)
Proceeds from issuance of subsidiary equity   1,092    - 
Line of credit issuance costs   -    (1,192)
Long-term debt issuance costs   (3,012)   - 
Proceeds from issuance of long-term debt   323,440    - 
Repayment of long-term debt   (250,000)   - 
Loss on extinguishment of debt   (52,886)   - 
Proceeds from issuance of Voting Common Stock   -    56 
Proceeds from issuance of Non-Voting Common Stock   99,853    22,848 
Repurchase of Voting Common Stock   (73)   - 
Repurchase of Non-Voting Common Stock   (48,162)   (76,586)
Principal repayments on notes receivable from stock option exercises   2,028    764 
Excess tax benefit of stock option exercises   15,682    2,228 
Dividends paid   (191,266)   (65,950)
Net subscriptions received from (redemptions/distributions paid to) non-controlling interest holders   59,874    27,138 
Consolidated CLO entity financing activities:          
Principal repayments of senior notes   (159,942)   - 
Net cash used for financing activities   (246,879)   (110,558)
Effect of currency rate changes on cash and cash equivalents   (761)   (219)
Net (decrease) increase in cash and cash equivalents   (82,662)   89,269 
Cash and cash equivalents, beginning of period   462,076    510,913 
Cash and cash equivalents, end of period  $379,414   $600,182 
Supplemental Cash Flow Information:          
Cash paid for interest  $20,473   $24,524 
Cash paid for interest by consolidated CLO entity   11,069    13,584 
Cash paid for income taxes, net of refunds   115,502    117,829 
Supplemental Disclosure of Non-Cash Information:          
Increase in equipment and leasehold improvements due to non-cash additions  $438   $174 
Exercise of stock options through issuance of notes receivable   4,734    211 
Non-controlling interest call option recorded in other liabilities   3,096    - 
Deconsolidations of Sponsored Investment Funds:          
Decrease in investments  $(59,889)  $(23,639)
Decrease in non-controlling interests   (61,023)   (21,586)

 

See notes to Consolidated Financial Statements.

 

10
 

 

Eaton Vance Corp.

Notes to Consolidated Financial Statements (unaudited)

 

1.   Basis of Presentation

 

In the opinion of management, the accompanying unaudited interim Consolidated Financial Statements of Eaton Vance Corp. (“the Company”) include all adjustments necessary to present fairly the results for the interim periods in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Such financial statements have been prepared in accordance with the instructions to Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures have been omitted pursuant to such rules and regulations. As a result, these financial statements should be read in conjunction with the audited Consolidated Financial Statements and related notes included in the Company’s latest annual report on Form 10-K.

 

2.   Principles of Consolidation

 

The Consolidated Financial Statements include the accounts of the Company and its controlled affiliates. The Company consolidates any voting interest entity in which the Company’s ownership exceeds 50 percent or where the Company has control. In addition, the Company consolidates any variable interest entity (“VIE”) (including the collateralized loan obligation (“CLO”) entity referred to in Note 9) for which the Company is considered the primary beneficiary. The Company recognizes non-controlling and other beneficial interests in consolidated affiliates in which the Company’s ownership is less than 100 percent. All intercompany accounts and transactions have been eliminated in consolidation.

 

From time to time, the Company may maintain a controlling interest in an Eaton Vance open-end registered investment company (a “sponsored fund”). Upon consolidation, the Company retains the specialized accounting treatment of the sponsored fund. Under the specialized accounting guidance for investment companies, underlying investments held by consolidated sponsored funds are carried at fair value, with corresponding changes in fair value reflected in gains and other investment income, net, in the Company’s Consolidated Statements of Income.

 

With limited exceptions, each of the Company’s sponsored funds is organized as a separately managed component (or “series”) of a series trust. All assets of a series irrevocably belong to that series and are subject to the liabilities of that series; under no circumstances are the liabilities of one series payable by another series. Series trusts themselves have no equity investment at risk, but decisions regarding the trustees of the trust and certain key activities of each sponsored fund within the trust, such as appointment of each sponsored fund’s investment adviser, typically reside at the trust level. As a result, shareholders of a sponsored fund that is organized as a series of a series trust lack the ability to control the key decision-making processes that most directly affect the performance of the sponsored fund. Accordingly, the Company believes that each trust is a VIE and each sponsored fund is a silo of a VIE that also meets the definition of a VIE. Having concluded that each silo is a VIE, the primary beneficiary evaluation defaults to an analysis of economic interest. The Company typically holds the majority of the shares of a sponsored fund corresponding to a majority economic interest during the seed investment stage when the fund’s investment track record is being established or when the fund is in the early stages of soliciting third-party investors. The Company consolidates the fund as primary beneficiary during this period. While the sponsored fund is consolidated, fee revenue is recorded, but is eliminated in consolidation.

 

The Company regularly seeds new sponsored funds and therefore may consolidate a variety of sponsored funds during a given reporting period. Due to the similarity of risks related to the Company’s involvement with each sponsored fund, disclosures required under the VIE model are aggregated, such as those disclosures regarding

 

11
 

 

the carrying amount and classification of assets of the sponsored funds, and the gains and losses that the Company recognizes from the sponsored funds.

 

When the Company is no longer deemed to control a sponsored fund, typically when either the Company redeems its shares or shares held by third parties exceed the number of shares held by the Company, the Company deconsolidates the sponsored fund and removes the related assets, liabilities and non-controlling interests from balance sheet accounts and classifies the Company’s remaining investment as either an equity method investment or an available-for-sale investment as applicable. Because consolidated sponsored funds utilize fair-value measurements, there is no incremental gain or loss recognized upon deconsolidation.

 

The extent of the Company’s exposure to loss with respect to a consolidated sponsored fund is the amount of the Company’s investment in the sponsored fund. The Company is not obligated to provide financial support to sponsored funds, and the assets of sponsored funds can only be used to settle obligations of the sponsored funds. Beneficial interest holders of sponsored funds do not have recourse to the general credit of the Company.

 

3.   New Accounting Standards Not Yet Adopted

 

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss or a Tax Credit Carryforward Exists

In July 2013, the Financial Accounting Standards Board (“FASB”) issued new guidance requiring an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for any net operating loss carryforward, similar tax loss or tax credit carryforward unless such tax loss or credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes resulting from the disallowance of a tax position. In the event that the tax position is disallowed or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit shall be presented in the financial statements as a liability and shall not be combined with deferred tax assets. The new guidance will be effective for the Company on November 1, 2014. The Company does not anticipate that the adoption of the new guidance will have a material impact on the Company’s consolidated financial statements.

 

Investment Companies

In June 2013, the FASB issued a final standard amending the current criteria for an entity to qualify as an investment company, creating new disclosure requirements and amending the measurement criteria for certain interests in other investment companies. The Company is evaluating the impact of this amendment and will adopt the new guidance on November 1, 2015.

 

Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity

In March 2013, the FASB issued new guidance on reporting a cumulative translation adjustment (“CTA”) with respect to foreign currency. The new guidance addresses the accounting for a CTA when a parent either sells a part of or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The Company is evaluating the impact of this change and will adopt the new guidance on November 1, 2014.

 

Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income

In February 2013, the FASB issued new guidance on reporting amounts reclassified out of accumulated other comprehensive income (“AOCI”). The new guidance does not change the requirements for reporting net income or other comprehensive income in the financial statements, but requires new footnote disclosures regarding the reclassification of AOCI by component into net income. The Company will implement the new disclosure requirements in the first quarter of fiscal 2014.

 

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4.   Consolidated Funds

 

Underlying investments held by consolidated sponsored funds were included in investments on the Company’s Consolidated Balance Sheets and classified as investment securities, trading, at July 31, 2013 and October 31, 2012. Net investment income related to consolidated sponsored funds was included in (losses) gains and other investment income, net, on the Company’s Consolidated Statements of Income for all periods presented. Net investment income was partially offset by amounts attributable to non-controlling interest holders, which are recorded in net income attributable to non-controlling and other beneficial interest holders in the Company’s Consolidated Statements of Income for all periods presented.

 

The following table sets forth the balances related to consolidated sponsored funds that are included on the Company’s Consolidated Balance Sheets at July 31, 2013 and October 31, 2012 as well as the Company’s net interest in these funds:

 

(in thousands)  July 31,
2013
   October 31,
2012
 
Investments  $181,275   $157,405 
Other assets   6,491    5,594 
Other liabilities   (19,051)   (16,928)
Redeemable non-controlling interests   (35,304)   (20,072)
Net interest in consolidated sponsored funds(1)  $133,411   $125,999 

 

(1)Excludes the Company's investment in its consolidated CLO entity, which is discussed in Note 9.

 

In both the nine months ended July 31, 2013 and 2012, the Company deconsolidated a total of five sponsored funds.

 

5.   Investments

 

The following is a summary of investments at July 31, 2013 and October 31, 2012:

 

(in thousands)  July 31,
2013
   October 31,
2012
 
Investment securities, trading:          
Cash management assets  $10,477   $- 
Consolidated sponsored funds   181,275    157,405 
Separately managed accounts   57,373    32,848 
Total investment securities, trading   249,125    190,253 
Investment securities, available-for-sale   17,457    31,148 
Investment in non-consolidated CLO entity   317    350 
Investments in equity method investees   271,044    257,652 
Investments, other   7,531    7,530 
Total investments(1)  $545,474   $486,933 

 

(1)Excludes the Company's investment in its consolidated CLO entity, which is discussed in Note 9.

 

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Investment securities, trading

 

Investment securities, trading, consist of cash management assets held by the Company, including certificates of deposit, commercial paper and corporate debt securities with original maturities ranging from three months up to twenty-four months, and debt and equity securities held in the portfolios of consolidated sponsored funds and separately managed accounts. A separately managed account seeded by the Company for product development purposes is not a legal entity subject to consolidation, but rather an individual portfolio of securities in the Company’s name managed to establish an investment track record. As a result, the Company looks through the construct of the portfolio to the underlying debt and equity securities and treats these securities as trading investments for accounting and disclosure purposes. The following is a summary of the fair value of investments classified as trading at July 31, 2013 and October 31, 2012:

 

(in thousands)  July 31,
2013
   October 31,
2012
 
Cash management assets  $10,477   $- 
Debt securities - consolidated sponsored funds and separately managed accounts   148,426    70,805 
Equity securities - consolidated sponsored funds and separately managed accounts   90,222    119,448 
Total investment securities, trading  $249,125   $190,253 

 

The Company seeds new investment strategies on a regular basis as a means of establishing investment records that can be used in marketing those strategies to retail and institutional clients. New investment strategies may be seeded as either sponsored funds or separately managed accounts. During the nine months ended July 31, 2013, the Company seeded investments in 10 sponsored funds and 15 separately managed accounts; during the nine months ended July 31, 2012, the Company seeded investments in 14 sponsored funds and 4 separately managed accounts.

 

The Company recognized trading (losses) gains related to trading securities still held at the reporting date of $(5.0) million and $(1.0) million for the three months ended July 31, 2013 and 2012, respectively, and $10.9 million and $5.8 million for the nine months ended July 31, 2013 and 2012, respectively.

 

Investment securities, available-for-sale

 

Investment securities, available-for-sale, consist exclusively of seed investments in certain sponsored funds, privately offered equity funds and closed-end funds, where the company has less than a 20 percent interest in the fund. The following is a summary of the gross unrealized gains and (losses) included in accumulated other comprehensive income related to securities classified as available-for-sale at July 31, 2013 and October 31, 2012:

 

July 31, 2013      Gross Unrealized     
(in thousands)  Cost   Gains   Losses   Fair Value 
Investment securities, available-for-sale  $10,939   $6,609   $(91)  $17,457 

 

October 31, 2012      Gross Unrealized     
(in thousands)  Cost   Gains   Losses   Fair Value 
Investment securities, available-for-sale  $22,331   $8,835   $(18)  $31,148 

 

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Net unrealized holding gains (losses) on investment securities, available-for-sale, included in other comprehensive (loss) income were $0.6 million and $(0.3) million for the three months ended July 31, 2013 and 2012, respectively, and $(2.3) million and $2.5 million for the nine months ended July 31, 2013 and 2012, respectively.

 

The Company reviewed gross unrealized losses of $91,000 as of July 31, 2013 and determined that these losses were not other-than-temporary, primarily because the Company has both the ability and intent to hold the investments for a period of time sufficient to recover such losses. The aggregate fair value of investments with unrealized losses was $1.2 million at July 31, 2013. No investment with a gross unrealized loss has been in a loss position for greater than one year.

 

The following is a summary of the Company’s realized gains and losses upon disposition of investments classified as available-for-sale for the three and nine months ended July 31, 2013 and 2012:

 

   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands)  2013   2012   2013   2012 
Gains  $415   $41   $5,666   $288 
Losses   (235)   (230)   (235)   (353)
Net realized gains (losses)  $180   $(189)  $5,431   $(65)

 

Investments in equity method investees

 

On August 6, 2012, the Company completed the purchase of a 49 percent interest in Hexavest Inc. (“Hexavest”), a Montreal, Canada-based investment advisor that provides discretionary management of equity and tactical asset allocations using a predominantly top-down investment style. The Company accounted for the purchase using the equity method. As of July 31, 2013, the investment in Hexavest was comprised of $5.0 million of equity in the net assets of Hexavest, intangible assets of $39.7 million, goodwill of $142.6 million and a deferred tax liability of $10.7 million, for a total carrying value of $176.6 million. As of October 31, 2012, the investment in Hexavest was comprised of $3.4 million of equity in the net assets of Hexavest, intangible assets of $42.7 million, goodwill of $146.6 million and a deferred tax liability of $11.5 million, for a total carrying value of $181.2 million. The Company will be obligated to make two additional payments in respect of the acquired interest if Hexavest exceeds defined annual revenue thresholds in the first and second twelve-month periods following the closing. These payments, if made, will be considered goodwill and will be recorded as additions to the carrying amount of the equity method investment. The Company’s interest in finite-lived intangible assets acquired in the transaction is being amortized over an estimated useful life of seventeen years.

 

In connection with the transaction, the Company also acquired an option, executable in fiscal 2017, to purchase an additional 26 percent interest in Hexavest. As part of the purchase price allocation, a value of $8.1 million was assigned to this option. The option is included in other assets in the Company’s Consolidated Balance Sheet at July 31, 2013 and October 31, 2012.

 

The Company has a 7 percent equity interest in a private equity partnership managed by a third party that invests in companies in the financial services industry. The Company’s investment in the partnership was $5.0 million and $9.8 million at July 31, 2013 and October 31, 2012, respectively.

 

The Company had equity-method investments in the following sponsored funds as of July 31, 2013 and October 31, 2012:

 

15
 

 

   Equity Ownership Interest (%)   Carrying Value ($)(1) 
   July 31,   October 31,   July 31,   October 31, 
(dollar amounts in thousands)  2013   2012   2013   2012 
                 
Eaton Vance Atlanta Capital Select Equity Fund   39%   -   $23,835   $- 
Eaton Vance Hexavest Global Equity Fund   35%   -    23,308    - 
Eaton Vance Real Estate Fund   39%   48%   13,465    16,494 
Eaton Vance Municipal                    
Opportunities Fund   32%   -    10,250    - 
Eaton Vance Focused Value                    
Opportunities Fund   39%   -    6,609    - 
Eaton Vance Focused Growth                    
Opportunities Fund   41%   -    6,416    - 
Eaton Vance Tax-Advantaged Bond                    
Strategies Long Term Fund   28%   31%   5,609    10,346 
Eaton Vance Richard Bernstein                    
All Asset Strategy Fund   -    44%   -    23,341 
AGF Floating Rate Income Fund   -    21%   -    15,334 
Parametric Structured Currency Fund   -    33%   -    1,043 
Total            $89,492   $66,558 

 

(1)The carrying value of equity method investments in Eaton Vance-managed funds is measured based on the funds’ net asset values. The Company has the ability to redeem its investments in these funds at any time. Not shown are Company investments in certain of the above-listed funds that were not accounted for as equity method investments as of the indicated date.

 

The Company did not recognize any impairment losses related to its investments in equity method investees during the three and nine months ended July 31, 2013 and 2012, respectively.

 

During the nine months ended July 31, 2013 and 2012, the Company received dividends of $13.2 million and $11.1 million, respectively, from its investments in equity method investees.

 

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6.   Fair Value Measurements

 

The following tables summarize financial assets and liabilities measured at fair value on a recurring basis and their assigned levels within the valuation hierarchy at July 31, 2013 and October 31, 2012:

 

July 31, 2013                    
(in thousands)  Level 1   Level 2   Level 3   Other
Assets Not
Held at
Fair
Value
   Total 
                     
Financial assets:                         
Cash equivalents  $99,310   $3,700   $-   $-   $103,010 
Investments:                         
Investment securities, trading:                         
Cash management assets   -    10,477    -    -    10,477 
Debt - consolidated sponsored funds and separately managed accounts   74,601    73,825    -    -    148,426 
Equity - consolidated sponsored funds and separately managed accounts   52,137    38,085    -    -    90,222 
Investment securities, available-for-sale   12,099    5,358    -    -    17,457 
Investment in non-consolidated CLO entity(1)   -    -    -    317    317 
Investments in equity method investees(2)   -    -    -    271,044    271,044 
Investments, other(3)   -    61    -    7,470    7,531 
Derivative instruments   -    1,302    -    -    1,302 
Assets of consolidated CLO entity:                         
Cash equivalents   56,725    -    -    -    56,725 
Bank loans and other investments   -    242,946    3,045    -    245,991 
Total financial assets  $294,872   $375,754   $3,045   $278,831   $952,502 
                          
Financial liabilities:                         
Derivative instruments  $-   $6,668   $-   $-   $6,668 
Securities sold, not yet purchased   -    1,572    -    -    1,572 
Liabilities of consolidated CLO entity:                         
Senior and subordinated note obligations    -    2,635    288,540    -    291,175 
Total financial liabilities  $-   $10,875   $288,540   $-   $299,415 

 

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October 31, 2012                    
(in thousands)  Level 1   Level 2   Level 3   Other
Assets Not
Held at
Fair
Value
   Total 
                     
Financial assets:                         
Cash equivalents  $16,390   $139,469   $-   $-   $155,859 
Investments:                         
Investment securities, trading – debt   4,512    66,293    -    -    70,805 
Investment securities, trading – equity   87,991    31,457    -    -    119,448 
Investment securities, available-for-sale   26,736    4,412    -    -    31,148 
Investment in non-consolidated CLO entity(1)   -    -    -    350    350 
Investments in equity method investees(2)   -    -    -    257,652    257,652 
Investments, other(3)   -    60    -    7,470    7,530 
Derivative instruments   -    2,229    -    -    2,229 
Assets of consolidated CLO entity:                         
Cash equivalents   34,561    -    -    -    34,561 
Bank loans and other investments   98    428,282    2,203    -    430,583 
Total financial assets  $170,288   $672,202   $2,203   $265,472   $1,110,165 
                          
Financial liabilities:                         
Derivative instruments  $-   $788   $-   $-   $788 
Securities sold, not yet purchased   -    26,142    -    -    26,142 
Liabilities of consolidated CLO entity:                         
Senior and subordinated note obligations   -    2,659    443,946    -    446,605 
Total financial liabilities  $-   $29,589   $443,946   $-   $473,535 

 

(1)The Company’s investment in this CLO entity is measured at fair value on a non-recurring basis using Level 3 inputs. The investment is carried at amortized cost unless facts and circumstances indicate that the investment has been impaired, at which time the investment is written down to fair value. There was no re-measurement of this asset during the nine month period ended July 31, 2013 or the twelve month period ended October 31, 2012.
(2)Investments in equity method investees are not measured at fair value in accordance with GAAP.
(3)Investments, other include investments carried at cost that are not measured at fair value in accordance with GAAP.

 

Valuation methodologies

 

The following is a description of the valuation methodologies used for financial assets and liabilities measured at fair value on a recurring basis as well as the general classification of those assets and liabilities pursuant to the valuation hierarchy:

 

Cash equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash equivalents consist of investments in money market funds, government and agency securities, commercial paper and certificates of deposit. Money market funds are valued using published net asset values and are classified as Level 1 within the valuation hierarchy. Government and agency securities are valued based

 

18
 

 

upon quoted market prices for similar assets in active markets, quoted prices for identical or similar assets that are not active, and inputs other than quoted prices that are observable or corroborated by observable market data. Depending on the nature of the inputs, these assets are generally classified as Level 1 or 2 within the valuation hierarchy. The carrying amounts of commercial paper and certificates of deposit are valued at amortized cost, which approximates market value, and are generally classified as Level 2 within the valuation hierarchy.

 

Investment securities, trading cash management assets

Investment securities, trading – corporate cash management assets consist of certificates of deposit, commercial paper and corporate debt obligations with original maturities from three months to twenty-four months. Debt obligations are generally valued on the basis of valuations provided by third-party pricing services, as derived from such services’ pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker-dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security. Depending on the nature of the inputs, investment securities, trading – corporate cash management assets are generally classified as Level 1 or 2 within the valuation hierarchy.

 

Investment securities, trading debt-consolidated funds and separately managed accounts

Investment securities, trading – debt, consist of debt obligations held in the portfolios of consolidated sponsored funds and separately managed accounts. Debt obligations (including short-term obligations with a remaining maturity of more than sixty days) are generally valued on the basis of valuations provided by third-party pricing services, as derived from such services’ pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker-dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security. Short-term obligations purchased with a remaining maturity of sixty days or less (excluding those that are non-U.S. denominated, which typically are valued by a third-party pricing service or dealer quotes) are generally valued at amortized cost, which approximates market value. Depending upon the nature of the inputs, investment securities, trading – debt, are generally classified as Level 1 or 2 within the valuation hierarchy.

 

Investment securities, trading equity-consolidated funds and separately managed accounts

Investment securities, trading – equity, consist of foreign and domestic equity securities held in the portfolios of consolidated sponsored funds and separately managed accounts. Equity securities listed on a U.S. securities exchange generally are valued at the last sale or closing price on the day of valuation or, if no sales took place on such date, at the mean between the closing bid and asked prices on the exchange where such securities are principally traded. Equity securities listed on the NASDAQ Global or Global Select market generally are valued at the NASDAQ official closing price. Unlisted or listed securities for which closing prices or closing quotations are not available are valued at the mean between the latest available bid and asked prices. When valuing foreign equity securities that meet certain criteria as established by our fair value pricing service, the portfolios use a fair value service that values such securities to reflect market trading that occurs after the close of the applicable foreign markets of comparable securities or other instruments that have a strong correlation to the fair-valued securities. The service utilizes a multi-factor model that considers such information as an issue’s local closing price and post-closing fluctuations in relevant general market and sector indices, currencies, depositary receipts and futures, as applicable. The size of the adjustment is determined by the observed changes in these factors since the close of the applicable foreign market. The pricing service uses a multiple regression methodology and back testing to validate the quality and correlations of their evaluations. In addition, the Company performs its own independent back test review of fair values versus the subsequent local market opening prices when

 

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available. Depending upon the nature of the inputs, investment securities, trading – equity are generally classified as Level 1 or 2 within the valuation hierarchy.

 

Investment securities, available-for-sale

Investment securities, available-for-sale, consist of investments in sponsored mutual funds and privately offered equity funds. Sponsored mutual funds that are listed on an active exchange are valued using published net asset values and are classified as Level 1 within the valuation hierarchy. Investments in sponsored privately offered equity funds and portfolios that are not listed on an active exchange but have net asset values that are comparable to mutual funds and have no redemption restrictions are classified as Level 2 within the valuation hierarchy.

 

Derivative instruments

Derivative instruments, which include foreign exchange contracts, stock index futures contracts and commodity futures contracts, are recorded as either other assets or other liabilities on the Company’s Consolidated Balance Sheets. Foreign exchange contracts are valued by interpolating a value using the spot foreign exchange rate and forward points, which are based on spot rate and currency interest rate differentials. Index futures contracts and commodity futures contracts are valued using a third-party pricing service that determines fair value based on bid and ask prices. Derivative instruments are generally classified as Level 2 within the valuation hierarchy.

 

Assets of consolidated CLO entity

Assets of the consolidated CLO entity include investments in money market funds, equity securities, debt securities, bank loans and warrants. Fair value is determined utilizing unadjusted quoted market prices when available. Interests in senior floating-rate loans for which reliable market quotations are readily available are valued generally at the average mid-point of bid and ask quotations obtained from a third-party pricing service. Fair value may also be based upon valuations obtained from independent third-party brokers or dealers utilizing matrix pricing models that consider information regarding securities with similar characteristics. In certain instances, fair value has been determined utilizing discounted cash flow analyses or single broker non-binding quotes. Depending on the nature of the inputs, these assets are classified as Level 1, 2 or 3 within the valuation hierarchy.

 

Securities sold, not yet purchased

Securities sold, not yet purchased, are recorded as other liabilities on the Company’s Consolidated Balance Sheets and are valued by a third-party pricing service that determines fair value based on bid and ask prices. Securities sold, not yet purchased, are generally classified as Level 2 within the valuation hierarchy.

 

Liabilities of consolidated CLO entity

Liabilities of the consolidated CLO entity include debt securities and senior and subordinated note obligations of the consolidated CLO entity. The debt securities are valued based upon quoted prices for identical or similar liabilities that are not active and inputs other than quoted prices that are observable or corroborated by observable market data. The senior and subordinated notes are valued based upon model-based valuation techniques in which one or more significant inputs are unobservable in the market. Depending on the nature of the inputs, these liabilities are classified as Level 2 or 3 within the valuation hierarchy.

 

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Transfers in and/or out of Levels

 

The following table summarizes fair value transfers between Level 1 and Level 2 for the three and nine months ended July 31, 2013 and 2012:

 

   Three Months Ended
July 31,
   Nine Months Ended
July 31,
 
(in thousands)  2013   2012   2013   2012 
Transfers from Level 1 into Level 2(1)  $237   $7,861   $43   $18,104 
Transfers from Level 2 into Level 1(2)   149    -    1,332    - 

 

(1)Transfers from Level 1 into Level 2 primarily represent debt and equity securities that were valued based on prices of similar securities because unadjusted quoted market prices were not available in the current period.
(2)Transfers from Level 2 into Level 1 primarily represent debt and equity securities due to the availability of unadjusted quoted market prices in active markets.

 

Level 3 assets and liabilities

 

The following table shows a reconciliation of the beginning and ending fair value measurements of assets and liabilities that are valued on a recurring basis and classified as Level 3 for the three and nine months ended July 31, 2013 and 2012:

 

   Three Months Ended   Three Months Ended 
   July 31, 2013   July 31, 2012 
(in thousands)  Bank loans
and other
investments of
consolidated
CLO entity
   Senior and
subordinated
note
obligations of
consolidated
CLO entity
   Bank loans
and other
investments of
consolidated
CLO entity
   Senior and
subordinated
note
obligations of
consolidated
CLO entity
 
                 
Beginning balance  $2,819   $365,460   $2,150   $483,062 
Net gains (losses) on investments and note obligations included in net income(1)   (101)   (720)   (139)   (8,599)
Principal paydown   -    (76,200)   -    - 
Transfers into Level 3(2)   327    -    122    - 
Transfers out of Level 3(3)   -    -    (15)   - 
Ending balance  $3,045   $288,540   $2,118   $474,463 
Change in unrealized (losses) gains included in net income relating to assets and liabilities held  $(101)  $(720)  $(139)  $(8,599)

 

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   Nine Months Ended   Nine Months Ended 
   July 31, 2013   July 31, 2012 
(in thousands)  Bank loans
and other
investments of
consolidated
CLO entity
   Senior and
subordinated
note
obligations of
consolidated
CLO entity
   Bank loans
and other
investments of
consolidated
CLO entity
   Senior and
subordinated
note
obligations of
consolidated
CLO entity
 
                 
Beginning balance  $2,203   $443,946   $5,910   $477,699 
Net gains (losses) on investments and note obligations included in net income(1)   (80)   4,536    (139)   (603)
Principal paydown   -    (159,942)   -    - 
Transfers into Level 3(2)   922    -    137    - 
Transfers out of Level 3(3)   -    -    (3,790)   (2,633)
Ending balance  $3,045   $288,540   $2,118   $474,463 
Change in unrealized (losses) gains included in net income relating to  assets and liabilities held  $(80)  $4,536   $(139)  $(603)

 

(1)Substantially all net gains and losses on investments and note obligations attributable to the assets and borrowings of the Company's consolidated CLO entity are allocated to non-controlling and other beneficial interests on the Company's Consolidated Statements of Income.
(2)Transfers into Level 3 were the result of a reduction in the availability of significant observable inputs used in determining the fair value of a second lien term loan. Fair value was determined utilizing a discounted cash flow analysis.
(3)Transfers out of Level 3 into Level 2 were due to an increase in the observability of the inputs used in determining the fair value of certain instruments.

 

The following table shows the valuation technique and significant unobservable inputs utilized in the fair value measurement of Level 3 liabilities at July 31, 2013 and October 31, 2012:

 

July 31, 2013      Valuation  Unobservable   
($ in thousands)  Fair Value   Technique  Inputs(1)  Range
              
Liabilities of consolidated CLO entity:              
               
Senior and subordinated note obligations  $288,540   Income approach 

Prepayment rate

Recovery rate
Default rate
Discount rate

 

30 percent

70 percent

200 bps

110-475 bps

 

22
 

 

October 31, 2012      Valuation  Unobservable   
($ in thousands)  Fair Value   Technique  Inputs(1)  Range
              
Liabilities of consolidated CLO entity:              
               
Senior and subordinated note obligations  $443,946   Income approach  Prepayment rate
Recovery rate
Default rate
Discount rate
 

30 percent

70 percent

200 bps

135-700 bps

 

(1)Discount rate refers to spread over LIBOR. Lower spreads relate to the more senior tranches in the CLO note structure; higher spreads relate to the less senior tranches. The default rate refers to the constant annual default rate. Recovery rate is the expected recovery of defaulted amounts received through asset sale or recovery through bankruptcy restructuring or other settlement processes. Prepayment rate is the rate at which the underlying collateral is expected to repay principal.

 

Valuation process

The Company elected the fair value option for both the collateral assets held and senior and subordinated notes issued by its consolidated CLO entity upon consolidation to mitigate any accounting inconsistencies between the carrying value of the assets held to provide cash flows for the note obligations and the carrying value of those note obligations.

 

Senior and subordinated note obligations of the Company’s consolidated CLO entity are issued in various tranches with different risk profiles. The notes are valued on a quarterly basis by the Company’s bank loan investment team utilizing an income approach that projects the cash flows of the collateral assets using the team’s projected default rate, prepayment rate, recovery rate and discount rate, as well as observable assumptions about market yields, collateral reimbursement assumptions, callability and other market factors that vary based on the nature of the investments in the underlying collateral pool. Once the undiscounted cash flows of the collateral assets have been determined, the bank loan team applies appropriate discount rates that it believes a reasonable market participant would use to determine the discounted cash flow valuation of the notes. The bank loan team routinely monitors market conditions and model inputs for cyclical and secular changes in order to identify any material factors that could influence the Company’s valuation method. The bank loan team reports directly to the Chief Income Investment Officer.

 

Sensitivity to changes in significant unobservable inputs

For senior and subordinated notes issued by the Company’s consolidated CLO entity, a change in the assumption used for the probability of default is generally accompanied by a directionally similar change in the assumption used for discount rates. Significant increases in either of these inputs would result in a significantly lower measurement of fair value.

 

Although the Company believes the valuation methods described above are appropriate, the use of different methodologies or assumptions to determine fair value could result in a different estimate of fair value at the reporting date.

 

7.   Derivative Financial Instruments

 

Derivative financial instruments designated as cash flow hedges

 

On June 25, 2013, the Company issued $325 million in aggregate principal amount of 3.625 percent ten-year Senior Notes due in June 2023 (the “2023 Senior Notes”). In anticipation of the offering, the Company entered

 

23
 

 

into a forward-starting interest rate swap intended to hedge changes in the benchmark interest rate between the time at which the decision was made to issue the debt and the pricing of the securities. The benchmark interest rate increased during this time and the Company received payment to settle the hedge for a gain of $2.0 million. At termination, the hedge was determined to be an effective cash flow hedge and the $2.0 million gain was recorded in other comprehensive (loss) income, net of taxes of $0.8 million. The gain recorded in other comprehensive (loss) income will be reclassified to earnings as a component of interest expense over the term of the debt. During the three months ended July 31, 2013, approximately $25,000 of this deferred gain was reclassified into interest expense. During the next twelve months, the Company expects to reclassify approximately $0.2 million of the gain into interest expense.

 

During the nine months ended July 31, 2013 and 2012, the Company reclassified into interest expense $0.3 million of the loss on a Treasury lock transaction in connection with the Company’s 2007 issuance of ten-year Senior notes due in October 2017 (the “2017 Senior Notes”). The Company also recognized an additional $0.9 million in interest expense to accelerate the amortization of the treasury lock tied to the portion of the 2017 Senior Notes retired on June 28, 2013. At July 31, 2013, the remaining unamortized loss on the Treasury lock was $0.9 million. During the next twelve months, the Company expects to reclassify approximately $0.2 million of the loss on the Treasury lock transaction into interest expense.

 

Other derivative financial instruments not designated for hedge accounting

 

In June 2013, the Company entered into a reverse treasury lock in conjunction with the Company’s tender offer to purchase up to $250 million of its outstanding 6.5 percent Senior Notes due in October 2017 (the “2017 Senior Notes”). The transaction effectively locked in the benchmark interest rate to be used in determining the premium above par to be paid to note holders in conjunction with the repurchase of the 2017 Senior Notes tendered. The reference U.S. Treasury rate increased during the time the reverse treasury lock was outstanding and the Company recognized a $3.1 million loss upon termination in June. This loss was included in (losses) gains and other investment income, net in the Company’s Consolidated Statement of Income.

 

The Company has entered into a series of foreign exchange contracts, stock index futures contracts and commodity futures contracts to hedge currency risk exposure and market risk associated with its investments in separately managed accounts and consolidated sponsored funds seeded for new product development purposes.

 

At July 31, 2013, the Company had 36 foreign exchange contracts outstanding with one counterparty with an aggregate notional value of $53.6 million; 2,824 stock index futures contracts outstanding with one counterparty with an aggregate notional value of $192.2 million; and 245 commodity futures contracts outstanding with one counterparty with an aggregate notional value of $12.6 million.

 

The following tables present the fair value of derivative instruments not designated as hedging instruments as of July 31, 2013 and October 31, 2012:

 

July 31, 2013              
   Assets    Liabilities  
(in thousands)  Balance Sheet
Location
  Fair Value   Balance Sheet
Location
  Fair Value 
Foreign exchange contracts  Other assets  $767   Other liabilities  $90 
Stock index futures contracts  Other assets   202   Other liabilities   6,407 
Commodity futures contracts  Other assets   333   Other liabilities   171 
Total     $1,302      $6,668 

 

24
 

 

 

October 31, 2012              
   Assets    Liabilities  
(in thousands)  Balance Sheet
Location
  Fair Value   Balance Sheet
Location
  Fair Value 
Foreign exchange contracts  Other assets  $226   Other liabilities  $300 
Stock index futures contracts  Other assets   1,505   Other liabilities   367 
Commodity futures contracts  Other assets   498   Other liabilities   121 
Total     $2,229      $788 

 

The following is a summary of the net (losses) gains recognized in income for the three and nine months ended July 31, 2013 and 2012:

 

   Income Statement  Three Months Ended
July 31,
   Nine Months Ended
July 31,
 
(in thousands)  Location  2013   2012   2013   2012 
Foreign exchange contracts  (Losses) gains and other investment income, net  $1,212   $299   $2,406   $727 
                        
Stock index futures contracts  (Losses) gains and other investment income, net   (3,028)   616    (21,939)   (9,285)
                        
Commodity futures contracts  (Losses) gains and other investment income, net   483    56    1,177    1,069 
                        
Interest rate contracts  (Losses) gains and other investment income, net   (3,075)   -    (3,075)   - 
Total     $(4,408)  $971   $(21,431)  $(7,489)

 

8.   Fair Value Measurements of Other Financial Instruments

 

Certain financial instruments are not carried at fair value. The following is a summary of the carrying amounts and estimated fair values of these financial instruments at July 31, 2013 and October 31, 2012:

 

   July 31, 2013      October 31, 2012     
(in thousands)  Carrying
Value
   Fair
Value
   Fair
Value
Level
   Carrying
Value
   Fair
Value
   Fair
Value
Level
 
Investments, other  $7,470   $7,470    3   $7,470   $7,470    3 
Other assets  $8,075   $8,075    3   $8,307   $8,307    3 
Debt  $573,460   $601,121    2   $500,000   $604,316    2 

 

Included in investments, other, is a $6.6 million non-controlling capital interest in Atlanta Capital Management Holdings, LLC (“ACM Holdings”), a partnership that owns certain non-controlling interests of Atlanta Capital Management LLC (“Atlanta Capital”). The Company’s interest in ACM Holdings is non-voting and entitles the Company to receive $6.6 million when put or call options for certain non-controlling interests of Atlanta Capital are exercised. The carrying value of this investment approximates fair value. The fair value of the investment is determined using a cash flow model which projects future cash flows based upon contractual obligations. Once

 

25
 

 

the undiscounted cash flows have been determined, the Company applies an appropriate discount rate. The inputs to the model are considered Level 3.

 

Included in other assets is a five-year option to acquire an additional 26 percent interest in Hexavest. The $8.1 million carrying value of this option approximates fair value. The fair value of the option is determined using a Monte Carlo model which simulates potential future market multiples of earnings before interest and taxes (“EBIT”) and compares this to the contractually fixed multiple of Hexavest’s EBIT at which the option can be exercised. The Monte Carlo model uses this array of simulated multiples and their difference from the contractual multiple times the projected EBIT for Hexavest to estimate the future exercise value of the option, which is then adjusted to present value. The inputs to the model are considered Level 3.

 

The fair value of the Company’s debt has been determined using publicly available market prices, which are considered Level 2 inputs.

 

9.   VIEs

 

In the normal course of business, the Company maintains investments in sponsored CLO entities, sponsored funds and privately offered equity funds that are considered VIEs. These variable interests generally represent seed investments made by the Company, as collateral manager or investment advisor, to launch or market these vehicles. The Company receives management fees for the services it provides as collateral manager or investment advisor to these entities. These fees may also be considered variable interests.

 

To determine whether or not the Company should be treated as the primary beneficiary of a VIE, management must make significant estimates and assumptions regarding probable future cash flows of the VIE. These estimates and assumptions relate primarily to market interest rates, credit default rates, prepayment rates, discount rates, the marketability of certain securities and the probability of certain outcomes.

 

Investments in VIEs that are consolidated

 

Sponsored funds

From time to time the Company invests in investment companies that meet the definition of a VIE. Disclosure regarding such consolidated sponsored funds is included in Note 4. In the ordinary course of business, the Company may elect to contractually waive investment advisory fees that it is entitled to receive from sponsored funds, and these waivers are disclosed in Note 20.

 

Consolidated CLO entity

The Company is the primary beneficiary of one CLO entity where it has, by design and in its role as collateral manager, the power to direct the activities that most significantly impact the economic performance of the entity. In developing its conclusion that it is the primary beneficiary of this entity, the Company determined that it has variable interests in the entity by virtue of both its residual interest in, and collateral management fees it receives from, the entity and that these variable interests may represent an obligation to absorb losses of or a right to receive benefits from the entity that could potentially be significant to the entity. Quantitative distinguishing factors supporting the Company’s qualitative conclusion included the relative size of the Company’s economic interest (approximately 8 percent, which is greater than the Company’s investment in the non-consolidated CLO entities in which the Company holds variable interests and serves as collateral manager) and the presence of an incentive management fee which, when combined with returns on the Company’s residual interest, may result in more than an insignificant economic interest in the total returns of the entity. In consideration of these factors, the Company concluded that it was the primary beneficiary of that CLO entity for consolidation accounting purposes.

 

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The Company irrevocably elected the fair value option for all financial assets and liabilities of the consolidated CLO entity. Unrealized gains and losses on assets and liabilities for which the fair value option has been elected are reported in gains and other investment income, net, in the Company’s Consolidated Statements of Income. Although the subordinated note obligations of the CLO entity have certain equity characteristics, the Company has determined that the subordinated notes should be recorded as liabilities in the Company’s Consolidated Balance Sheets.

 

The assets of this CLO entity are held solely as collateral to satisfy the obligations of the entity. The Company has no right to the benefits from, nor does the Company bear the risks associated with, the assets held by the entity beyond the Company’s minimal direct investment and beneficial interest therein and management fees generated from the entity. The note holders of the CLO entity have no recourse to the Company’s general assets. There are no explicit arrangements nor does the Company hold implicit variable interests that would require the Company to provide any ongoing financial support to the entity.

 

The following tables present, as of July 31, 2013 and October 31, 2012, the fair value of the consolidated CLO entity’s assets and liabilities subject to fair value accounting:

 

July 31, 2013            
   CLO Bank Loan Investments     
(in thousands)  Total CLO
bank loan
investments
   90 days or
more past
due
   Senior and
subordinated
note obligations
 
Unpaid principal balance  $241,835   $908   $311,580 
Unpaid principal balance over fair value   (2,166)   (570)   (20,405)
Fair value  $239,669   $338   $291,175 

 

October 31, 2012            
   CLO Bank Loan Investments     
(in thousands)  Total CLO
bank loan
investments
   90 days or
more past
due
   Senior and
subordinated
note obligations
 
Unpaid principal balance  $425,153   $500   $471,546 
Unpaid principal balance over fair value   (863)   (485)   (24,941)
Fair value  $424,290   $15   $446,605 

 

During the three months ended July 31, 2013 and 2012, the changes in the fair values of the CLO entity’s bank loans and other investments resulted in net losses of $2.2 million and $1.1 million, respectively, while changes in the fair value of the CLO’s note obligations resulted in net gains of $0.7 million and $8.5 million, respectively. The combined net losses of $1.5 million and net gains of $7.4 million for the three months ended July 31, 2013 and 2012, respectively, were recorded as gains and other investment income, net, of the consolidated CLO entity in the Company’s Consolidated Statement of Income for those periods.

 

During the nine months ended July 31, 2013 and 2012, the changes in the fair values of the CLO entity’s bank loans and other investments resulted in net gains of $0.3 million and $14.8 million, respectively, while changes in the fair value of the CLO’s note obligations resulted in net losses of $4.5 million and net gains of $0.6

 

27
 

 

million, respectively. The combined net losses of $4.2 million and net gains of $15.4 million for the nine months ended July 31, 2013 and 2012, respectively, were recorded as gains and other investment income, net, of the consolidated CLO entity in the Company’s Consolidated Statement of Income for those periods.

 

Substantially all gains (losses) related to the CLO entity’s bank loans, other investments and note obligations recorded in earnings for the periods were attributable to changes in instrument-specific credit risk.

 

The CLO entity’s note obligations bear interest at variable rates based on LIBOR plus a pre-defined spread, which ranges from 0.21 percent to 1.50 percent. The principal amounts outstanding of the note obligations issued by the CLO entity mature on April 20, 2019. It is expected that prepayments received will be used to pay down the entity’s note obligations. During the nine months ended July 31, 2013, $159.9 million of prepayments were used to pay down the entity’s note obligations. The holders of a majority of the subordinated notes have the option to liquidate the CLO entity, provided there is sufficient value to repay the senior notes in full.

 

Interest income and expense are recorded on an accrual basis and reported as gains and other investment income, net and as interest expense in other income (expense) of the consolidated CLO entity in the Company’s Consolidated Statements of Income for the three and nine months ended July 31, 2013 and 2012, respectively.

 

The following carrying amounts related to the consolidated CLO entity were included in the Company’s Consolidated Balance Sheets at July 31, 2013 and October 31, 2012:

 

   July 31,   October 31, 
(in thousands)  2013   2012 
Assets of consolidated CLO entity:          
Cash and cash equivalents  $58,300   $36,758 
Bank loans and other investments   245,991    430,583 
Other assets   2,237    1,107 
Liabilities of consolidated CLO entity:          
Senior and subordinated note obligations   291,175    446,605 
Other liabilities   421    766 
Appropriated retained earnings   13,107    18,699 
Net interest in consolidated CLO entity  $1,825   $2,378 

 

The Company had a subordinated interest in the consolidated CLO entity of $1.5 million and $1.9 million as of July 31, 2013 and October 31, 2012, respectively, which was eliminated in consolidation.

 

For the three months ended July 31, 2013 and 2012, the Company recorded a net loss of $1.3 million and net income of $8.4 million, respectively, related to the consolidated CLO entity. The Company recorded a $2.4 million net loss attributable to other beneficial interests and $7.5 million of net income attributable to other beneficial interests for three months ended July 31, 2013 and 2012, respectively, reflecting the interests of third-party note holders of the consolidated CLO entity. Net income attributable to Eaton Vance Corp. shareholders included $1.0 million and $0.9 million related to the consolidated CLO entity for each of the three months ended July 31, 2013 and 2012, respectively.

 

For the nine months ended July 31, 2013 and 2012, the Company recorded a net loss of $2.6 million and net income of $18.9 million, respectively, related to the consolidated CLO entity. The Company recorded a $5.6 million net loss attributable to other beneficial interests and $16.4 million of net income attributable to other beneficial interests for the nine months ended July 31, 2013 and 2012, respectively, reflecting the interests of third-party note holders of the consolidated CLO entity. Net income attributable to Eaton Vance Corp.

 

28
 

 

shareholders included $2.9 million and $2.5 million related to the consolidated CLO entity for each of the nine months ended July 31, 2013 and 2012, respectively.

 

Investments in VIEs that are not consolidated

 

Sponsored funds

The Company classifies its investments in certain sponsored funds that are considered VIEs as either equity method investments (generally when the Company owns more than 20 percent but less than 50 percent of the fund) or as available-for-sale investments (generally when the Company owns less than 20 percent of the fund), when it is not considered the primary beneficiary of those VIEs. The Company has provided aggregated disclosures with respect to these non-consolidated sponsored fund VIEs in Note 5.

 

Non-consolidated CLO entities

The Company is not deemed the primary beneficiary of several CLO entities in which it holds variable interests. In its role as collateral manager, the Company has the power to direct the activities of the CLO entities that most significantly impact the economic performance of these entities. In developing its conclusion that it is not the primary beneficiary of these entities, the Company determined that, although it has variable interests in each entity by virtue of its residual interests therein and the collateral management fees it receives, its variable interests neither individually nor in the aggregate represent an obligation to absorb losses of or a right to receive benefits from any such entity that could potentially be significant to that entity. Quantitative factors supporting the Company’s qualitative conclusion in each case included the relative size of the Company’s residual interest (in each instance representing less than 6 percent of the residual interest tranche and less than 1 percent of the total capital of the entity) and the overall magnitude and design of the collateral management fees within each structure.

 

These non-consolidated entities had total assets of $1.8 billion as of July 31, 2013 and October 31, 2012. The Company’s investment in these entities totaled $0.3 million and $0.4 million as of July 31, 2013 and October 31, 2012, respectively, and collateral management fees receivable for these entities totaled $2.1 million and $2.0 million on July 31, 2013 and October 31, 2012, respectively. In the first nine months of fiscal 2013, the Company did not provide any financial or other support to these entities that it was not previously contractually required to provide. The Company’s risk of loss with respect to these entities is limited to the carrying value of its investments in, and collateral management fees receivable from, the CLO entities as of July 31, 2013.

 

The Company’s investment in non-consolidated CLO entities is carried at amortized cost and is disclosed as a component of investments in Note 5. Income from non-consolidated CLO entities is recorded as a component of gains and other investment income, net, in the Company’s Consolidated Statements of Income, based upon projected investment yields.

 

Other entities

The Company holds variable interests in, but is not deemed to be the primary beneficiary of, certain sponsored privately offered equity funds with total assets of $9.6 billion and $9.0 billion as of July 31, 2013 and October 31, 2012, respectively. The Company’s variable interests in these entities consist of the Company’s direct ownership in these entities and any investment advisory fees earned but uncollected. The Company held investments in these entities totaling $5.4 million and $4.4 million on July 31, 2013 and October 31, 2012, respectively, and investment advisory fees receivable totaling $0.5 million and $0.4 million on July 31, 2013 and October 31, 2012, respectively. In the first nine months of fiscal 2013, the Company did not provide any financial or other support to these entities that it was not previously contractually required to provide. The Company’s risk of loss with respect to these managed entities is limited to the carrying value of its investments in and investment advisory fees receivable from the entities as of July 31, 2013.

 

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The Company’s investments in privately offered equity funds are carried at fair value and included in investment securities, available for sale, which are disclosed as a component of investments in Note 5. The Company records any change in fair value, net of income tax, in other comprehensive income (loss).

 

10.   Acquisitions

 

The Clifton Group Investment Management Company (“Clifton”)

On December 31, 2012, the Company’s subsidiary, Parametric Portfolio Associates LLC (“Parametric”), acquired Clifton. The operating results of Clifton have been included in the Company’s consolidated statements since that date. Pro forma results of operations have not been presented because the results of operations would not have been materially different from those reported in the accompanying Consolidated Statements of Income. Clifton is a provider of futures- and options-based overlay services and risk management solutions for institutional investors based in Minneapolis, Minnesota. The Clifton acquisition complements and expands the range of engineered portfolio solutions offered by Parametric. The Company paid $72.3 million in cash and issued an indirect ownership interest in Parametric with a fair market value of $12.8 million to certain Clifton principals. These indirect interests are subject to certain put and call arrangements at fair value that may be executed over a five-year period. There are no future contingent payments to be made in connection with the acquisition. Upon closing, Clifton became a division of Parametric.

 

In conjunction with the purchase, the Company recorded $24.5 million of intangible assets, which consist primarily of client relationship intangible assets acquired. The client relationship intangible assets will be amortized over an eighteen-year period. The Company also recorded goodwill of $60.1 million, which is deductible for tax purposes. During the three months ended July 31, 2013, revenue and earnings from Clifton were $7.2 million and $2.1 million, respectively. During the nine months ended July 31, 2013, revenue and earnings from Clifton were $15.6 million and $4.3 million, respectively.

 

Tax Advantaged Bond Strategies (“TABS”)

In fiscal 2009, the Company acquired the TABS business of M.D. Sass Investors Services, a privately held investment manager based in New York, New York, for cash and future consideration. During the first quarter of fiscal 2013, the Company made a contingent payment of $14.1 million to the selling group based upon prescribed multiples of TABS’s revenue for the twelve months ended December 31, 2012. The payment increased goodwill by $14.1 million. The Company will be obligated to make three additional annual contingent payments to certain remaining members of the selling group based on prescribed multiples of TABS’s revenue for the twelve months ending December 31, 2014, 2015 and 2016. All future payments will be in cash and will result in an addition to goodwill. These payments are not contingent upon any member of the selling group remaining an employee of the Company.

 

Parametric

In December 2012, certain non-controlling interest holders of Parametric exercised their final put option pursuant to the terms of the original acquisition agreement requiring the Company to purchase an additional 3.4 percent capital and 5.7 percent profit interest in the entity. The $43.5 million exercise price of the put option was based on a multiple of estimated earnings before taxes for the calendar year ended December 31, 2012. The payment was treated as an equity transaction and reduced redeemable non-controlling interests at closing on December 20, 2012. Indirect profit interests granted to Parametric employees under a long-term equity incentive plan of that entity increased to 4.9 percent on July 31, 2013, reflecting a 0.76 percent profit interest granted on November 1, 2012 under the plan. Indirect capital and profit interests in Parametric held by the principals of Clifton totaled 1.9 percent on July 31, 2013, reflecting indirect interests issued in conjunction with the Clifton acquisition on December 31, 2012. Capital and profit interests in Parametric held by the Company increased to 98.1 percent and 93.3 percent, respectively, on July 31, 2013, reflecting the transactions described above.

 

30
 

 

Parametric Risk Advisors LLC (“Parametric Risk Advisors”)

On June 18, 2013, the Company exercised a call option requiring the non-controlling interest holders of Parametric Risk Advisors to sell units representing a 10 percent ownership interest in Parametric Risk Advisors for $3.1 million. Pursuant to the acquisition agreement, the exercise price of the call option was based on a multiple of earnings before interest and taxes for the twelve months ended April 30, 2013. Upon execution of the call option, the Company reduced redeemable non-controlling interests and recorded a liability within other liabilities on the Company’s Consolidated Balance Sheet. The transaction is anticipated to settle on November 1, 2013 and will increase the Company’s ownership interest from 70 percent to 80 percent.

 

11.   Intangible Assets

 

The following is a summary of intangible assets at July 31, 2013 and October 31, 2012:

 

July 31, 2013            
(dollars in thousands)  Gross
carrying
amount
   Accumulated
amortization
   Net
carrying
amount
 
             
Amortizing intangible assets:               
Client relationships acquired  $133,927   $(65,394)  $68,533 
Intellectual property acquired   1,000    (174)   826 
Trademark acquired   900    (75)   825 
                
Non-amortizing intangible assets:               
Mutual fund management contract acquired   6,708    -    6,708 
Total  $142,535   $(65,643)  $76,892 

 

October 31, 2012            
(dollars in thousands)  Gross
carrying
amount
   Accumulated
amortization
   Net
carrying
amount
 
             
Amortizing intangible assets:               
Client relationships acquired  $110,327   $(58,681)  $51,646 
Intellectual property acquired   1,000    (126)   874 
                
Non-amortizing intangible assets:               
Mutual fund management contract acquired   6,708    -    6,708 
Total  $118,035   $(58,807)  $59,228 

 

Amortization expense was $2.4 million and $2.0 million for the three months ended July 31, 2013 and 2012 and $6.8 million and $6.0 million for the nine months ended July 31, 2013 and 2012, respectively. Estimated remaining amortization expense for the next five fiscal years, on a straight-line basis, is as follows:

 

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Year Ending October 31,  Estimated
Amortization
 
(in thousands)  Expense 
Remaining 2013  $2,359 
2014   9,408 
2015   9,183 
2016   8,741 
2017   8,628 
2018   8,188 

 

12.   Debt

 

Senior Notes

 

On June 25, 2013, the Company issued $325.0 million in aggregate principal amount of 3.625 percent ten-year senior notes due June 15, 2023 (previously defined as the “2023 Senior Notes”), resulting in net proceeds of approximately $321.3 million after underwriting discounts and transaction fees. Interest is payable semi-annually in arrears on June 15th and December 15th of each year, commencing on December 15th, 2013. The 2023 Senior Notes are unsecured and unsubordinated obligations of the Company.

 

Tender Offer

 

On June 14, 2013, the Company announced a tender offer to purchase for cash up to $250.0 million in aggregate principal amount of its outstanding 2017 Senior Notes and ultimately accepted for purchase $250.0 million of the 2017 Senior Notes (“Tendered Notes”) on June 28, 2013. Pursuant to the terms of the Indenture that governs the 2017 Senior Notes, the consideration paid to the holders of the Tendered Notes, which totaled $301.5 million, was calculated as the sum of the present values of the remaining scheduled payments of principal and interest through October 2, 2017, discounted to June 28, 2013 using a reference U.S. Treasury security rate (0.625 percent U.S. Treasury Notes due September 30, 2017) plus 30 basis points. The holders of the Tendered Notes were also paid $3.9 million in interest that accrued from April 2, 2013 (the last interest payment date) through June 28, 2013.

 

The Company recognized a $52.9 million loss on extinguishment of debt, which includes the tender premium paid ($51.5 million excess of the Consideration Amount over the $250.0 million face amount of the 2017 Senior Notes tendered), acceleration of certain deferred financing costs and original issue discount associated with the Tendered Notes, and transaction costs associated with the tender offer.

 

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13.   Stock-Based Compensation Plans

 

The Company recognized total compensation cost related to its stock-based compensation plans as follows:

 

   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands)  2013   2012   2013   2012 
2008 Plan:                    
Stock options  $3,316   $6,314   $10,841   $21,758 
Restricted shares   8,102    6,014    24,539    18,021 
Phantom stock units   109    67    382    190 
Employee Stock Purchase Plan   859    318    1,235    426 
Incentive Plan – Stock Alternative   110    25    308    151 
Atlanta Capital Plan   352    232    1,055    695 
Parametric Plan   823    595    2,468    1,768 
Total stock-based compensation expense  $13,671   $13,565   $40,828   $43,009 

 

The total income tax benefit recognized for stock-based compensation arrangements was $4.4 million and $4.1 million for the three months ended July 31, 2013 and 2012, respectively, and $14.9 million and $13.3 million for the nine months ended July 31, 2013 and 2012, respectively.

 

2008 Omnibus Incentive Plan (“2008 Plan”)

 

The 2008 Plan, which is administered by the Compensation Committee of the Board, allows for awards of stock options, restricted shares and phantom stock units to eligible employees and non-employee Directors. A total of 19.8 million shares of Non-Voting Common Stock have been reserved for issuance under the 2008 Plan. Through July 31, 2013, 6.0 million restricted shares and options to purchase 14.5 million shares have been issued pursuant to the 2008 Plan.

 

Stock Options

 

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option valuation model. The Black-Scholes option valuation model incorporates assumptions as to dividend yield, volatility, an appropriate risk-free interest rate and the expected life of the option. Many of these assumptions require management’s judgment. The Company’s stock volatility assumption is based upon its historical stock price fluctuations. The Company uses historical data to estimate option forfeiture rates and the expected term of options granted. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve at the time of grant.

 

The weighted-average fair value per share of stock options granted during the nine months ended July 31, 2013 and 2012 using the Black-Scholes option pricing model were as follows:

 

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   2013   2012 
Weighted-average grant date fair value of options granted  $7.69   $6.69 
           
Assumptions:          
Dividend yield   2.8% to 5.5%    2.9% to 3.1% 
Volatility   36% to 37%    35% to 36% 
Risk-free interest rate   1.2% to 2.1%    1.0% to 1.6% 
Expected life of options   7.1 years    7.2 years 

 

Stock option transactions under the 2008 Plan and predecessor plans for the nine months ended July 31, 2013 are summarized in the below table.

 

(share and intrinsic value figures in thousands)  Shares   Weighted-
Average
Exercise
Price
   Weighted-
Average
Remaining
Contractual
Term (in
years)
   Aggregate
Intrinsic
Value
 
Options outstanding, beginning of period   27,653   $26.90           
Granted   2,271    28.41           
Exercised   (4,703)   21.05           
Forfeited/expired   (237)   29.70           
Options outstanding, end of period   24,984   $28.11    4.9   $328,574 
Options exercisable, end of period   16,114   $28.98    3.4   $204,875 
Vested or expected to vest   24,629   $28.13    4.9   $323,626 

 

The number of shares subject to option and the weighted-average exercise price of options reflected in the table above have been adjusted pursuant to certain anti-dilution provisions of the Company’s 2008 Plan and predecessor plans to reflect the effect of a $1.00 per share special dividend declared and paid in December 2012.

 

The Company received $94.3 million and $17.1 million related to the exercise of options for the nine months ended July 31, 2013 and 2012, respectively. Options exercised represent newly issued shares. The total intrinsic value of options exercised during the nine months ended July 31, 2013 and 2012 was $66.2 million and $10.4 million, respectively. The total fair value of options that vested during the nine months ended July 31, 2013 was $28.1 million.

 

As of July 31, 2013, there was $31.4 million of compensation cost related to unvested stock options granted not yet recognized. That cost is expected to be recognized over a weighted-average period of 3.1 years.

 

Restricted Shares

Compensation expense related to restricted share grants is recorded over the forfeiture period of the restricted shares, as they are contingently forfeitable. As of July 31, 2013, there was $77.7 million of compensation cost related to unvested awards not yet recognized. That cost is expected to be recognized over a weighted-average period of 3.3 years.

 

A summary of the Company's restricted share activity for the nine months ended July 31, 2013 under the 2008 Plan and predecessor plans is summarized in the below table:

 

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       Weighted- 
       Average 
       Grant 
       Date Fair 
(share figures in thousands)  Shares   Value 
Unvested, beginning of period   3,233   $26.43 
Granted   1,625    29.27 
Vested   (767)   26.32 
Forfeited   (133)   27.98 
Unvested, end of period   3,958   $27.60 

 

The total fair value of restricted stock that vested during the nine months ended July 31, 2013 and 2012 was $20.2 million and $12.6 million, respectively.

 

Phantom Stock Units

In the nine months ended July 31, 2013, 9,565 phantom stock units were issued to non-employee Directors pursuant to the 2008 Plan. Because these units are contingently forfeitable, compensation expense is recorded over the forfeiture period. The total liability paid out associated with phantom stock during the nine months ended July 31, 2013 and 2012 was $0.3 million and $0.2 million, respectively. As of July 31, 2013, there was $0.3 million of compensation cost related to unvested awards not yet recognized. That cost is expected to be recognized over a weighted-average period of 1.1 years.

 

14.   Common Stock Repurchases

 

The Company’s current share repurchase program was announced on October 26, 2011. The Board authorized management to repurchase and retire up to 8.0 million shares of its Non-Voting Common Stock on the open market and in private transactions in accordance with applicable securities laws. The timing and amount of share purchases are subject to management’s discretion. The Company’s share repurchase program is not subject to an expiration date.

 

In the first nine months of fiscal 2013, the Company purchased and retired approximately 1.3 million shares of its Non-Voting Common Stock under the current repurchase authorization. Approximately 2.6 million additional shares may be repurchased under the current authorization.

 

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15.   Non-operating Income (Expense)

 

The components of non-operating income (expense) for the three and nine months ended July 31, 2013 and 2012 were as follows:

 

   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands)  2013   2012   2013   2012 
Non-operating income (expense):                    
Interest and other income  $909   $1,581   $4,936   $5,274 
Net (losses) gains on investments and derivatives   (8,902)   106    (2,676)   7,786 
Net foreign currency (losses) gains   (34)   240    (37)   (160)
(Losses) gains and other investment income, net   (8,027)   1,927    2,223    12,900 
Interest expense   (9,167)   (8,525)   (26,309)   (25,350)
Loss on extinguishment of debt   (52,886)   -    (52,886)   - 
                     
Other income (expense) of consolidated                    
CLO entity:                    
Interest income   3,162    5,469    12,078    16,681 
Net (losses) gains on bank loans, other investments and note    obligations   (1,458)   7,403    (4,197)   15,366 
Gains and other investment income, net   1,704    12,872    7,881    32,047 
Interest expense   (2,939)   (4,399)   (10,211)   (12,844)
Total non-operating (expense) income  $(71,315)  $1,875   $(79,302)  $6,753 

 

16.   Income Taxes

 

The provision for income taxes was $25.1 million and $34.4 million, or 52.9 percent and 35.5 percent of pre-tax income, for the three months ended July 31, 2013 and 2012, respectively. The provision for income taxes was $99.3 million and $104.7 million, or 40.0 percent and 35.7 percent of pre-tax income, for the nine months ended July 31, 2013 and 2012, respectively. The Company’s tax rate for the three and nine month periods ending July 31, 2013 was increased by 14.1 percent and 2.7 percent, respectively, due to the state tax settlement described below.

 

The provision for income taxes in the three and nine months ended July 31, 2013 and 2012 is comprised of federal, state, and foreign taxes. The primary difference between the Company’s effective tax rate and the statutory federal rate of 35.0 percent are state income taxes, income and losses recognized by the consolidated CLO entity, other non-controlling interests and the tax benefit of disqualifying dispositions of incentive stock options.

 

The Company records a valuation allowance when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized. There was no valuation allowance recorded as of July 31, 2013 or October 31, 2012.

 

The Company is currently under audit by several states. The tax authority of one state previously provided the Company with draft work papers challenging a tax position in the Company’s previously filed tax returns. During the quarter ended July 31, 2013, the tax authority presented the Company with a settlement offer, which the Company accepted and executed on July 30, 2013. The settlement agreement stipulated a lump sum payment of $19.6 million to settle all matters relating to the tax authority's audit of the fiscal years ended

 

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October 31, 2004 through October 31, 2009. The $19.6 million payment resulted in a net increase to income tax expense in the third quarter of fiscal 2013 of $6.7 million, equal to the amount of the payment less previously recorded reserves of $9.3 million and a federal tax benefit on the increased state tax of $3.6 million.

 

17.   Non-controlling and Other Beneficial Interests

 

Net income attributable to non-controlling and other beneficial interest holders totaled $1.8 million and $12.5 million for the three months ended July 31, 2013 and 2012, respectively, and $21.6 million and $40.0 million for the nine months ended July 31, 2013 and 2012, respectively.

 

The components of net income attributable to non-controlling and other beneficial interest holders for the three and nine months ended July 31, 2013 and 2012 were as follows:

 

   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands)  2013   2012   2013   2012 
Consolidated sponsored funds  $206   $(839)  $(3,886)  $(3,167)
Majority-owned subsidiaries   (4,007)   (3,354)   (11,596)   (10,465)
Non-controlling interest value adjustments(1)   (405)   (796)   (11,718)   (9,996)
Consolidated CLO entity   2,359    (7,492)   5,592    (16,352)
Net income attributable to non-controlling and other beneficial interests  $(1,847)  $(12,481)  $(21,608)  $(39,980)

 

(1) Relates to non-controlling interests redeemable at other than fair value.

 

18.   Earnings per Share

 

The following table sets forth the calculation of earnings per basic and diluted share for the three and nine months ended July 31, 2013 and 2012 using the two-class method:

 

   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands, except per share data)  2013   2012   2013   2012 
Net income attributable to Eaton Vance Corp. shareholders  $23,203   $50,206   $136,689   $150,347 
Less: Allocation of earnings to participating restricted shares   793    1,423    6,258    4,213 
Net income available to common shareholders  $22,410   $48,783   $130,431   $146,134 
Weighted-average shares outstanding – basic   117,594    112,110    116,399    112,354 
Incremental common shares   6,278    2,481    5,756    2,677 
Weighted-average shares outstanding – diluted   123,872    114,591    122,155    115,031 
Earnings per share:                    
Basic  $0.19   $0.44   $1.12   $1.30 
Diluted  $0.18   $0.43   $1.07   $1.27 

 

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Antidilutive common shares related to stock options excluded from the computation of earnings per diluted share were approximately 3.0 million and 14.4 million for the three months ended July 31, 2013 and 2012, respectively, and were approximately 3.0 million and 15.0 million for the nine months ended July 31, 2013 and 2012, respectively.

 

19.   Commitments and Contingencies

 

In the normal course of business, the Company enters into agreements that include indemnities in favor of third parties, such as engagement letters with advisors and consultants, information technology agreements, distribution agreements and service agreements.  In certain circumstances, these indemnities in favor of third parties relate to service agreements entered into by investment funds managed and/or advised by Eaton Vance Management or Boston Management and Research, both wholly owned subsidiaries of the Company. The Company has also agreed to indemnify its directors, officers and employees in accordance with the Company’s Articles of Incorporation, as amended. Certain agreements do not contain any limits on the Company’s liability and, therefore, it is not possible to estimate the Company’s potential liability under these indemnities. In certain cases, the Company has recourse against third parties with respect to these indemnities. Further, the Company maintains insurance policies that may provide coverage against certain claims under these indemnities.

 

The Company and its subsidiaries are subject to various legal proceedings. In the opinion of management, after discussions with legal counsel, the ultimate resolution of these matters will not have a material adverse effect on the consolidated financial condition or results of operations of the Company.

 

In July 2006, the Company committed to invest $15.0 million in a private equity partnership that invests in companies in the financial services industry. The Company has invested $13.9 million of the total $15.0 million of committed capital at July 31, 2013. The Company believes the remaining $1.1 million will likely be invested by March 2015.

 

The Company has entered into transactions in financial instruments in which it has sold securities, not yet purchased as part of its corporate hedging program. As of July 31, 2013, the Company has $1.6 million included within other liabilities on its Consolidated Balance Sheet related to securities sold, not yet purchased.

 

20.   Related Party Transactions

 

Funds

 

The Company is an investment advisor to, and has administrative agreements with, certain sponsored funds, privately offered equity funds and closed-end funds for which certain employees are officers and/or directors. Substantially all of the services to these entities for which the Company earns a fee, including investment advisory, distribution, shareholder and administrative, are provided under contracts that set forth the services to be provided and the fees to be charged. These contracts are subject to annual review and approval by the funds’ boards of directors or trustees. Revenue for services provided or related to these funds for the three and nine months ended July 31, 2013 and 2012 are as follows:

 

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   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands)  2013   2012   2013   2012 
Investment advisory and administrative fees  $214,894   $183,469   $608,876   $555,622 
Distribution fees   20,350    19,982    60,268    60,757 
Service fees   32,259    30,760    94,521    95,124 
Shareholder services fees   752    616    1,840    1,843 
Other revenue   442    -    845    - 
Total  $268,697   $234,827   $766,350   $713,346 

 

For the three months ended July 31, 2013 and 2012, the Company had investment advisory agreements with certain sponsored funds pursuant to which the Company contractually waived $2.5 million and $2.1 million of investment advisory fees it was otherwise entitled to receive, respectively. For the nine months ended July 31, 2013 and 2012, the Company waived $6.9 million and $6.7 million, respectively, of investment advisory fees it was otherwise entitled to receive.

 

Sales proceeds and net realized gains (losses) from investments in sponsored funds classified as available-for-sale for the three and nine months ended July 31, 2013 and 2012 are as follows:

 

   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in thousands)  2013   2012   2013   2012 
Proceeds from sales  $2,927   $16,390   $42,217   $56,396 
Net realized gains (losses)   180    (189)   5,431    (65)

 

The Company bears the non-advisory expenses of certain sponsored funds for which it earns an all-in management fee and provides subsidies to startup and other smaller sponsored funds to enhance their competitiveness. For the three months ended July 31, 2013 and 2012, expenses of $5.5 million and $5.3 million, respectively, were incurred by the Company pursuant to these arrangements. For the nine months ended July 31, 2013 and 2012, expenses of $16.2 million and $14.0 million, respectively, were incurred by the Company pursuant to these arrangements.

 

Included in investment advisory fees and other receivables at July 31, 2013 and October 31, 2012 are receivables due from sponsored funds of $92.0 million and $84.4 million, respectively.

 

Employee Loan Program

 

The Company has established an Employee Loan Program under which a program maximum of $20.0 million is available for loans to officers (other than executive officers) and other key employees of the Company for purposes of financing the exercise of employee stock options. Loans are written for a seven-year period, at varying fixed interest rates (currently ranging from 0.9 percent to 5.0 percent), are payable in annual installments commencing with the third year in which the loan is outstanding, and are collateralized by the stock issued upon exercise of the option. All loans under the program must be made on or before October 31, 2014. Loans outstanding under the program, which are full recourse in nature, are reflected as notes receivable from stock option exercises in shareholders’ equity and amounted to $6.9 million and $4.2 million at July 31, 2013 and October 31, 2012, respectively.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Item includes statements that are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, intentions or strategies regarding the future. All statements, other than statements of historical facts, included in this Form 10-Q regarding our financial position, business strategy and other plans and objectives for future operations are forward-looking statements. The terms “may”, “will”, “could”, “anticipate”, “plan”, “continue”, “project”, “intend”, “estimate”, “believe”, “expect” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such words. Although we believe that the assumptions and expectations reflected in such forward-looking statements are reasonable, we can give no assurance that they will prove to have been correct or that we will take any actions that may now be planned. Certain important factors that could cause actual results to differ materially from our expectations are disclosed in the “Risk Factors” section of this Form 10-Q and Item 1A in our latest annual report on Form 10-K. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by such factors. We do not assume any obligation to update any forward-looking statements. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

General

 

Our principal business is managing investment funds and providing investment management and advisory services to high-net-worth individuals and institutions. Our core strategy is to develop and sustain management expertise across a range of investment disciplines and to offer leading investment products and services through multiple distribution channels. In executing this strategy, we have developed broadly diversified investment management capabilities and a powerful marketing, distribution and customer service organization. Although we manage and distribute a wide range of investment products and services, we operate in one business segment, namely as an investment adviser to funds and separate accounts.

 

We are a market leader in a number of investment areas, including value equity, equity income, quality core and growth equity, systematic emerging market equity, floating-rate bank loan, municipal bond, investment grade, global and high-yield bond investing. Through our subsidiary Parametric Portfolio Associates LLC (“Parametric”) we offer a leading range of engineered portfolio implementation services, including tax-managed core and specialty index strategies, futures- and options-based portfolio overlays and centralized portfolio management of multi-manager portfolios. Our breadth of investment management capabilities supports a wide range of products and services offered to fund shareholders, retail managed account investors, institutional investors and high-net-worth clients. Our equity strategies encompass a diversity of investment objectives, risk profiles, income levels and geographic representation. Our income investment strategies cover a broad duration and credit quality range and encompass both taxable and tax-free investments. We offer a range of alternative investment strategies, including commodity-based investments and a spectrum of absolute return strategies. As of July 31, 2013, we had $268.8 billion in assets under management.

 

Our principal retail marketing strategy is to distribute funds and separately managed accounts through financial intermediaries in the advice channel. We have a broad reach in this marketplace, with distribution partners including national and regional broker-dealers, independent broker-dealers, independent financial advisory firms, banks and insurance companies. We support these distribution partners with a team of approximately 135 sales professionals covering U.S. and international markets.

 

We also commit significant resources to serving institutional and high-net-worth clients who access investment management services on a direct basis. Through our wholly owned affiliates and consolidated subsidiaries we manage investments for a broad range of clients in the institutional and high-net-worth global marketplace,

 

40
 

 

including corporations, sovereign wealth funds, endowments, foundations, family offices and public and private employee retirement plans.

 

Our revenue is derived primarily from investment advisory, administrative, distribution and service fees received from Eaton Vance funds and investment advisory fees received from separate accounts. Our fees are based primarily on the value of the investment portfolios we manage and fluctuate with changes in the total value and mix of assets under management. As a matter of course, investors in our sponsored open-end funds and separate accounts have the ability to redeem their shares or investments at any time, without prior notice, and there are no material restrictions that would prevent them from doing so. Our major expenses are employee compensation, distribution-related expenses, facilities expense and information technology expense.

 

Our discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to goodwill and intangible assets, income taxes, investments and stock-based compensation. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under current circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates.

 

Business Developments

 

The first nine months of fiscal 2013 was a period of favorable market action, as reflected by the 21.4 percent total return of the S&P 500 Index. Over the last twelve months, the S&P 500 Index has returned 25.0 percent.

 

The Company’s ending consolidated assets under management increased by $69.2 billion, or 35 percent, in the first nine months of fiscal 2013 to $268.8 billion on July 31, 2013, reflecting the acquisition of The Clifton Group Investment Management Company (“Clifton”) on December 31, 2012, strong net inflows into floating-rate income, alternative and implementation services mandates, and favorable market action. Average consolidated assets under management increased sequentially by $10.2 billion, or 4 percent, to $263.7 billion in the third quarter of fiscal 2013.

 

The Clifton acquisition, as anticipated, has had a significant impact on both our overall average effective fee rate and our average effective investment advisory and administrative fee rate in the first nine months of fiscal 2013. Upon acquisition, the Clifton business had an average effective fee rate of approximately 7 basis points. The acquisition reduced our overall average effective fee rate to 53 basis points and 54 basis points in the third quarter and first nine months of fiscal 2013, respectively, from 62 basis points in both the third quarter and first nine months of fiscal 2012. Our average effective investment advisory and administrative fee rate similarly decreased to 45 basis points and 46 basis points in the third quarter and first nine months of fiscal 2013, respectively, from 51 basis points in both the third quarter and first nine months of last year. The primary driver of our overall average effective fee rate continues to be the mix of assets by distribution channel and mandate.

 

Consolidated Assets under Management

 

Consolidated assets under management of $268.8 billion on July 31, 2013 increased $75.9 billion, or 39 percent, over the $192.9 billion of managed assets reported a year earlier. Consolidated assets under management on July 31, 2013 included $129.0 billion in long-term funds, $89.5 billion in institutional separate accounts, $19.1 billion in high-net-worth separate accounts, $30.9 billion in retail managed accounts and $0.2 billion in cash management fund assets. Long-term fund net inflows of $12.8 billion over the last twelve months reflect gross inflows of $40.6 billion offset by outflows of $27.7 billion. Long-term fund net inflows include $0.1 billion and

 

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$0.2 billion raised in the initial public offerings of closed-end funds Eaton Vance Floating-Rate Income Plus Fund and Eaton Vance Municipal Income Term Trust in the third quarter and second quarter of fiscal 2013, respectively. Institutional separate account net inflows were $8.2 billion, high-net-worth separate account net inflows were $1.4 billion and retail managed account net inflows were $0.6 billion over the past twelve months. Clifton assets acquired totaled $34.8 billion and net price appreciation in managed assets increased assets under management by $18.1 billion over the last twelve months.

 

We report managed assets and flow data by investment mandate. The “Alternative” category includes a range of absolute return strategies, as well as commodity- and currency-linked investments. In fiscal 2013, we added a new category, “Implementation Services,” to reflect the growing importance to our business of Parametric’s tax-managed core, centralized portfolio management and specialty index businesses and the former Clifton Group’s futures- and options-based overlay services.

 

Consolidated Assets under Management by Investment Mandate (1) (4)

 

   July 31,   % 
(in millions)  2013   % of Total   2012   % of Total   Change 
Equity(2)  $90,774    34%  $80,260    42%   13%
Fixed income   45,821    17%   48,198    25%   -5%
Floating-rate income   38,170    14%   25,245    13%   51%
Alternative   16,098    6%   10,612    5%   52%
Implementation services(3)   77,673    29%   28,323    15%   174%
Cash management   219    0%   220    0%   0%
Total  $268,755    100%  $192,858    100%   39%

 

(1)Consolidated Eaton Vance Corp. See table on page 47 for directly managed assets and flows of 49 percent-owned Hexavest Inc.
(2)Balances include assets in balanced accounts holding income securities.
(3)Balances include amounts reclassified from equity for the prior year period.
(4)Assets under management for which we estimate fair value are not material to the total value of the assets we manage.

 

Equity and implementation services assets under management included $61.7 billion and $49.8 billion of assets managed for after-tax returns on July 31, 2013 and 2012, respectively. Fixed income assets included $26.7 billion and $28.9 billion of tax-exempt municipal bond assets on July 31, 2013 and 2012, respectively.

 

Net inflows totaled $8.8 billion in the third quarter of fiscal 2013 compared to net outflows of $1.4 billion in the third quarter of fiscal 2012. Long-term fund net inflows of $3.7 billion in the third quarter of fiscal 2013 reflect gross inflows of $11.6 billion, net of redemptions of $7.9 billion, as well as the $0.1 billion initial public offering of Eaton Vance Floating-Rate Income Plus Fund. Long-term fund net outflows of $2.3 billion in the third quarter of fiscal 2012 reflect gross inflows of $6.3 billion, net of redemptions of $8.6 billion.

 

Separate account net inflows totaled $5.2 billion in the third quarter of fiscal 2013, compared to $0.8 billion in the third quarter of fiscal 2012. Institutional separate account net inflows totaled $4.6 billion in the third quarter of fiscal 2013 compared to $0.3 billion in the third quarter of fiscal 2012, reflecting gross inflows of $13.5 billion and $2.3 billion in the third quarter of fiscal 2013 and 2012, respectively, net of redemptions of $8.9 billion and $2.0 billion, respectively. High-net-worth separate account net inflows of $0.4 billion in the third quarter of fiscal 2013 reflect gross inflows of $1.1 billion net of redemptions of $0.6 billion. In the third quarter of fiscal 2012, high-net-worth separate account gross inflows of $0.8 billion were offset by $0.5 billion of gross

 

42
 

 

outflows. Retail managed account net inflows of $0.1 billion in the third quarter of fiscal 2013 reflect gross inflows of $1.9 billion, net of redemptions of $1.8 billion. In the third quarter of fiscal 2012, retail managed account gross inflows of $1.6 billion were offset by gross redemptions of $1.3 billion.

 

As of July 31, 2013, the Clifton division of Parametric managed $40.7 billion of client assets, an increase of 13 percent from the $36.0 billion of managed assets on April 30, 2013. Net inflows into Clifton-managed funds and accounts were $5.1 billion in the third quarter of fiscal 2013 and have totaled $5.0 billion since the Clifton acquisition closed on December 31, 2013. Clifton managed assets have increased by $5.9 billion, or 17 percent, from $34.8 billion at the date of acquisition. The managed assets and flows of Clifton since the date of acquisition are included in Eaton Vance consolidated totals and are reflected as assets and flows of Parametric.

 

The following tables summarize our consolidated assets under management and asset flows by investment mandate and investment vehicle for the three and nine months ended July 31, 2013 and 2012:

 

43
 

 

Consolidated Net Flows by Investment Mandate(1)

 

   Three Months Ended       Nine Months Ended     
   July 31,   %   July 31,   % 
(in millions)  2013   2012   Change   2013   2012   Change 
Equity assets - beginning of period(2)  $89,534   $86,040    4%  $80,782   $84,281    -4%
Sales and other inflows   4,056    3,551    14%   13,823    12,743    8%
Redemptions/outflows   (4,185)   (6,660)   -37%   (14,135)   (20,132)   -30%
Net flows   (129)   (3,109)   -96%   (312)   (7,389)   -96%
Assets acquired(4)   -    -    NM(3)   1,572    -    NM 
Exchanges   46    (19)   NM    162    (32)   NM 
Market value change   1,323    (2,652)   NM    8,570    3,400    152%
Equity assets - end of period  $90,774   $80,260    13%  $90,774   $80,260    13%
Fixed income assets - beginning of period   49,949    46,891    7%   49,003    43,708    12%
Sales and other inflows   2,065    2,886    -28%   8,732    9,139    -4%
Redemptions/outflows   (3,595)   (1,973)   82%   (10,318)   (6,702)   54%
Net flows   (1,530)   913    NM    (1,586)   2,437    NM 
Assets acquired(4)   -    -    NM    472    -    NM 
Exchanges   (277)   30    NM    (358)   70    NM 
Market value change   (2,321)   364    NM    (1,710)   1,983    NM 
Fixed income assets - end of period  $45,821   $48,198    -5%  $45,821   $48,198    -5%
Floating-rate income assets - beginning of period   33,679    24,847    36%   26,388    24,322    8%
Sales and other inflows   6,636    2,091    217%   15,987    5,212    207%
Redemptions/outflows   (2,152)   (1,535)   40%   (4,664)   (4,274)   9%
Net flows   4,484    556    706%   11,323    938    NM 
Exchanges   169    5    NM    251    24    946%
Market value change   (162)   (163)   -1%   208    (39)   NM 
Floating-rate income assets - end of period  $38,170   $25,245    51%  $38,170   $25,245    51%
Alternative assets - beginning of period   16,022    10,517    52%   12,864    10,650    21%
Sales and other inflows   2,348    1,343    75%   6,925    3,570    94%
Redemptions/outflows   (1,770)   (1,201)   47%   (3,785)   (3,440)   10%
Net flows   578    142    307%   3,140    130    NM 
Assets acquired(4)   -    -    NM    650    -    NM 
Exchanges   (22)   (13)   69%   (138)   (74)   86%
Market value change   (480)   (34)   NM    (418)   (94)   345%
Alternative assets - end of period  $16,098   $10,612    52%  $16,098   $10,612    52%
Implementation services assets - beginning of period  (5)   70,966    28,852    146%   30,302    24,574    23%
Sales and other inflows   12,933    1,052    NM    26,663    4,980    435%
Redemptions/outflows   (7,504)   (996)   653%   (18,396)   (3,090)   495%
Net flows   5,429    56    NM    8,267    1,890    337%
Assets acquired(4)   -    -    NM    32,064    -    NM 
Exchanges   -    -    NM    (14)   (1)   NM 
Market value change   1,278    (585)   NM    7,054    1,860    279%
Implementation services assets - end of period  $77,673   $28,323    174%  $77,673   $28,323    174%
Long-term assets - beginning of period   260,150    197,147    32%   199,339    187,535    6%
Sales and other inflows   28,038    10,923    157%   72,130    35,644    102%
Redemptions/outflows   (19,206)   (12,365)   55%   (51,298)   (37,638)   36%
Net flows   8,832    (1,442)   NM    20,832    (1,994)   NM 
Assets acquired(4)   -    -    NM    34,758    -    NM 
Exchanges   (84)   3    NM    (97)   (13)   646%
Market value change   (362)   (3,070)   -88%   13,704    7,110    93%
Total long-term assets - end of period  $268,536   $192,638    39%  $268,536   $192,638    39%
Cash management fund assets - end of period   219    220    0%   219    220    0%
Total assets under management - end of period  $268,755   $192,858    39%  $268,755   $192,858    39%

 

(1)Consolidated Eaton Vance Corp. See table on page 47 for directly managed assets and flows of 49 percent-owned Hexavest Inc.
(2)Balances include assets in balanced accounts holding income securities.
(3)Not meaningful ("NM")
(4)Balances represent Clifton assets acquired on December 31, 2012.
(5)Balances include amounts reclassified from equity for fiscal 2012.

 

44
 

 

Consolidated Net Flows by Investment Vehicle(1)

 

   Three Months Ended       Nine Months Ended     
   July 31,   %   July 31,   % 
(in millions)  2013   2012   Change   2013   2012   Change 
Long-term fund assets - beginning of period  $127,014   $114,029    11%  $113,249   $111,705    1%
Sales and other inflows   11,597    6,266    85%   33,307    19,819    68%
Redemptions/outflows   (7,932)   (8,554)   -7%   (21,316)   (24,483)   -13%
Net flows   3,665    (2,288)   NM    11,991    (4,664)   NM 
Assets acquired(2)   -    -    NM    638    -    NM 
Exchanges   (241)   3    NM    (262)   (13)   NM 
Market value change   (1,396)   (1,487)   -6%   3,426    3,229    6%
Long-term fund assets - end of period  $129,042   $110,257    17%  $129,042   $110,257    17%
Institutional separate account assets - beginning of period   84,724    40,883    107%   43,338    38,003    14%
Sales and other inflows   13,480    2,262    496%   28,366    7,347    286%
Redemptions/outflows   (8,901)   (1,970)   352%   (21,792)   (6,979)   212%
Net flows   4,579    292    NM    6,574    368    NM 
Assets acquired(2)   -    -    NM    34,120    -    NM 
Exchanges   152    -    NM    157    11    NM 
Market value change   18    (890)   NM    5,284    1,903    178%
Institutional separate account assets - end of period  $89,473   $40,285    122%  $89,473   $40,285    122%
High-net-worth separate account assets - beginning of period   18,027    14,704    23%   15,036    13,256    13%
Sales and other inflows   1,055    752    40%   3,931    3,110    26%
Redemptions/outflows   (614)   (540)   14%   (2,385)   (1,626)   47%
Net flows   441    212    108%   1,546    1,484    4%
Exchanges   (9)   -    NM    (16)   (999)   -98%
Market value change   612    (234)   NM    2,505    941    166%
High-net-worth separate account assets - end of period  $19,071   $14,682    30%  $19,071   $14,682    30%
Retail managed account assets - beginning of period   30,385    27,531    10%   27,716    24,571    13%
Sales and other inflows   1,906    1,643    16%   6,526    5,368    22%
Redemptions/outflows   (1,759)   (1,301)   35%   (5,805)   (4,550)   28%
Net flows   147    342    -57%   721    818    -12%
Exchanges   14    -    NM    24    988    -98%
Market value change   404    (459)   NM    2,489    1,037    140%
Retail managed account assets - end of period  $30,950   $27,414    13%  $30,950   $27,414    13%
Total long-term assets - beginning of period   260,150    197,147    32%   199,339    187,535    6%
Sales and other inflows   28,038    10,923    157%   72,130    35,644    102%
Redemptions/outflows   (19,206)   (12,365)   55%   (51,298)   (37,638)   36%
Net flows   8,832    (1,442)   NM    20,832    (1,994)   NM 
Assets acquired(2)   -    -    NM    34,758    -    NM 
Exchanges   (84)   3    NM    (97)   (13)   646%
Market value change   (362)   (3,070)   -88%   13,704    7,110    93%
Total long-term assets - end of period  $268,536   $192,638    39%  $268,536   $192,638    39%
Cash management fund assets - end of period   219    220    0%   219    220    0%
Total assets under management -  end of period  $268,755   $192,858    39%  $268,755   $192,858    39%

 

(1)Consolidated Eaton Vance Corp. See page 47 for directly managed assets and flows of 49 percent-owned Hexavest Inc.
(2)Balances represent Clifton assets acquired on December 31, 2012.

 

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The following table summarizes our assets under management by investment affiliate as of July 31, 2013 and 2012:

 

Consolidated Assets under Management by Investment Affiliate (1)

 

   July 31,   % 
(in millions)  2013   2012   Change 
Eaton Vance Management (2)  $143,229   $128,953    11%
Parametric   107,192    49,023    119%
Atlanta Capital   18,334    14,882    23%
Total  $268,755   $192,858    39%

 

(1)Consolidated Eaton Vance Corp. See page 47 for directly managed assets and flows of 49 percent-owned Hexavest Inc.
(2)Includes managed assets of wholly owned subsidiaries Eaton Vance Investment Counsel and Fox Asset Management LLC, as well as certain Eaton Vance-sponsored funds and accounts managed by Hexavest and unaffiliated third-party advisors under Eaton Vance supervision.

 

As of July 31, 2013, 49 percent-owned affiliate Hexavest Inc. (“Hexavest”) managed $15.7 billion of client assets, an increase of 30 percent from the $12.1 billion of managed assets on October 31, 2012. Net inflows into Hexavest-managed funds and separate accounts were $0.5 billion in the third quarter of fiscal 2013. Other than Eaton Vance-sponsored funds for which Hexavest is advisor or sub-advisor, the managed assets of Hexavest are not included in Eaton Vance consolidated totals. The following table summarizes assets under management and asset flow information for Hexavest for the three and nine months ended July 31, 2013:

 

46
 

 

Hexavest Assets under Management and Net Flows

 

   Three Months Ended   Nine Months Ended 
   July 31,   July 31, 
(in millions)  2013   2013 
Eaton Vance distributed:          
Eaton Vance sponsored funds - beginning of period(1)  $161   $37 
Sales and other inflows   19    130 
Redemptions/outflows   (6)   (12)
Net flows   13    118 
Market value change   (1)   18 
Eaton Vance sponsored funds - end of period  $173   $173 
Eaton Vance distributed separate accounts - beginning of period(2)  $1,283   $- 
Sales and other inflows   227    1,378 
Redemptions/outflows   (1)   (1)
Net flows   226    1,377 
Market value change   6    138 
Eaton Vance distributed separate accounts - end of period  $1,515   $1,515 
Total Eaton Vance distributed - beginning of period  $1,444   $37 
Sales and other inflows   246    1,508 
Redemptions/outflows   (7)   (13)
Net flows   239    1,495 
Market value change   5    156 
Total Eaton Vance distributed - end of period  $1,688   $1,688 
Hexavest directly distributed - beginning of period(3)  $13,831   $12,073 
Sales and other inflows   785    2,003 
Redemptions/outflows   (530)   (1,363)
Net flows   255    640 
Market value change   (40)   1,333 
Hexavest directly distributed - end of period  $14,046   $14,046 
Total Hexavest assets - beginning of period  $15,275   $12,110 
Sales and other inflows   1,031    3,511 
Redemptions/outflows   (537)   (1,376)
Net flows   494    2,135 
Market value change   (35)   1,489 
Total Hexavest assets - end of period  $15,734   $15,734 

 

(1)Managed assets and flows of Eaton Vance-sponsored pooled investment vehicles for which Hexavest is advisor or sub-advisor. Eaton Vance receives management and/or distribution revenue on these assets, which are included in the Eaton Vance consolidated results.
(2)Managed assets and flows of Eaton Vance-distributed separate accounts managed by Hexavest. Eaton Vance receives distribution revenue, but not management revenue, on these assets, which are not included in the Eaton Vance consolidated results.
(3)Managed assets and flows of pre-transaction Hexavest clients and post-transaction Hexavest clients in Canada. Eaton Vance receives no management or distribution revenue on these assets, which are not included in the Eaton Vance consolidated results.

 

47
 

 

Consolidated Ending Assets under Management by Asset Class(1)

 

   July 31,     
(in millions)  2013   % of
Total
   2012   % of
Total
   %
Change
 
Open-end funds:                         
Class A  $31,511    12%  $29,857    16%   6%
Class B   707    0%   1,031    1%   -31%
Class C   9,839    4%   9,572    5%   3%
Class I   40,776    15%   27,954    14%   46%
Class R   345    0%   321    0%   7%
Other(2)   1,067    0%   792    0%   35%
Total open-end funds   84,245    31%   69,527    36%   21%
Private funds(3)   20,736    8%   17,745    9%   17%
Closed-end funds   24,280    9%   23,205    12%   5%
Total fund assets   129,261    48%   110,477    57%   17%
Institutional account assets   89,473    33%   40,285    21%   122%
High-net-worth account assets   19,071    7%   14,682    8%   30%
Retail managed account assets   30,950    12%   27,414    14%   13%
Total separate account assets   139,494    52%   82,381    43%   69%
Total  $268,755    100%  $192,858    100%   39%

 

(1)Consolidated Eaton Vance Corp. See table on page 47 for directly managed assets and flows of 49 percent-owned Hexavest Inc.
(2)Includes other classes of Eaton Vance open-end funds.
(3)Includes privately offered equity, fixed income and floating-rate bank loan funds and CLO entities.

 

We currently sell our sponsored open-end mutual funds under four primary pricing structures: front-end load commission (“Class A”); level-load commission (“Class C”); institutional no-load (“Class I”); and retirement plan no-load (“Class R”). We waive the front-end sales load on Class A shares under certain circumstances. In such cases, the shares are sold at net asset value.

 

Fund assets represented 48 percent of total assets under management on July 31, 2013, down from 57 percent on July 31, 2012, while separate account assets, which include institutional, high-net-worth and retail managed account assets, increased to 52 percent of total assets under management on July 31, 2013 from 43 percent on July 31, 2012. Fund assets under management increased $15.8 billion, or 14 percent, from $113.4 billion on October 31, 2012, reflecting 14 percent annualized internal growth, market appreciation of $3.4 billion and $0.6 billion of managed assets gained from the Clifton acquisition. Separate account assets under management increased $53.4 billion, or 62 percent, from $86.1 billion on October 31, 2012, reflecting $34.1 billion of managed assets gained from the Clifton acquisition, annualized internal growth of 14 percent and market appreciation of $10.3 billion.

 

Average assets under management presented in the following table represent average month-end amounts by asset class. This table is intended to provide information useful in the analysis of our asset-based revenue and distribution expenses. With the exception of our separate account investment advisory fees, which are generally calculated as a percentage of either beginning, average or ending quarterly assets, our investment advisory, administrative, distribution and service fees, as well as certain expenses, are generally calculated as a percentage of average daily assets.

 

48
 

 

Consolidated Average Assets under Management by Asset Class(1)

 

   Three Months Ended       Nine Months Ended     
   July 31,   %   July 31,   % 
(in millions)  2013   2012   Change   2013   2012   Change 
Open-end funds:                              
Class A  $31,590   $30,328    4%  $31,184   $31,674    -2%
Class B   775    1,063    -27%&nb