Item 1. Business Forward-Looking Statements Certain information included, or incorporated by reference in this Annual Report on Form 10-K and other materials filed or to be filed by Epoch Holding Corporation (“Epoch” or the “Company”) with the Securities and Exchange Commission (the “SEC”) contain statements that may be considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” and the negative of these terms and other comparable terminology. These forward-looking statements, which are subject to known and unknown risks, uncertainties and assumptions about the Company, may include projections of the Company’s future financial performance based on the Company’s anticipated growth strategies and trends in the Company’s business. These statements are only predictions based on the Company’s current expectations and projections about future events. There are important factors that could cause the Company’s actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements. In particular, you should consider the risks and uncertainties outlined in Item 1A.
Item 1A. Risk Factors In addition to factors mentioned elsewhere in this Form 10-K or previously disclosed in our SEC filings, we believe these are all the material risks currently facing our business. Our business, financial condition or results of operations could be materially adversely affected by these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. You should carefully consider the risks described below before making an investment decision. Epoch undertakes no obligation to revise the forward-looking statements contained in this Form 10-K to reflect events after the date of this Form 10-K.
Risks Related to Our Business Investment performance affects the Company’s AUM relating to existing clients and is one of the most important factors in retaining clients and competing for new asset management business. Poor investment performance could impair the Company’s revenue and growth because:
• existing clients might withdraw funds from the Company’s asset management business in favor of better performing products, which would result in lower investment advisory fees;
• third-party financial intermediaries, advisers or consultants may rate the Company’s products poorly, which may result in client withdrawals and reduced asset flows from these third parties or their clients; or
• firms with which the Company has strategic alliances may terminate such relationships with the Company, and future strategic alliances may be unavailable.
Some members of management are critical to the Company’s success, and the inability to attract and retain key employees could compromise the Company’s future success. If key employees were to leave, whether to join a competitor or otherwise, the Company may suffer a decline in revenue or earnings and suffer an adverse effect on the Company’s financial position. Loss of key employees may occur due to perceived opportunity for promotion, increased compensation, work environment or other individual reasons, some of which may be beyond the Company’s control.
Future success will depend, to a significant extent, upon the services and efforts of the Company’s executive officers, particularly William W. Priest, Chief Executive Officer and Chief Investment Officer, Timothy T. Taussig, President and Chief Operating Officer, and, both J. Philip Clark and David N. Pearl, Executive Vice Presidents. These executives are responsible for determining the strategic direction of our business, and are integral to our brand and our reputation. Except for William W. Priest, there are no employment agreements with any other key employees. The loss of services of one or more these key employees, or failure to attract, retain and motivate qualified personnel could negatively impact the business, financial condition, results of operations and future prospects. As with other asset management businesses, future performance depends to a significant degree upon the continued contributions of certain officers, portfolio managers and other key marketing, client service and management personnel. There is substantial competition for these types of skilled personnel.
Negative performance of the securities markets could reduce revenues. The Company’s investment advisory and investment management business also would be expected to generate lower revenues in a market or general economic downturn. Under the Company’s asset management business arrangements, investment advisory fees the Company receives typically are based on the market value of AUM. Accordingly, a decline in the prices of securities would be expected to cause the Company’s revenue and income to decline by:
• causing the value of the Company’s AUM to decrease, which would result in lower investment advisory fees, and/or
• causing some of the Company’s clients to withdraw funds from the Company’s asset management business in favor of investments they perceive as offering greater opportunity or lower risk, which also would result in lower investment advisory fees.
Our future results are dependent upon maintaining an appropriate level of expenses, which is subject to fluctuation. The level of our expenses is subject to fluctuation and may increase for the following or other reasons: variations in the level of total compensation expense due to, among other things, bonuses, changes in our employee count and mix, and competitive factors. There may also be changes in costs to maintain and enhance our administrative and operating services infrastructure.
The Company’s investment style in the asset management business may underperform other investment approaches, which may result in significant client or asset departures or a reduction in AUM. Even when securities prices are rising, performance can be affected by investment style. Many of the equity investment strategies in the Company’s asset management business share a common investment orientation towards fundamental security selection. The Company believes this style tends to outperform the market in some market environments and underperform it in others. In particular, a prolonged “growth” environment (i.e., a prolonged period whereby growth stocks outperform value stocks) may cause the Company’s investment strategy to go out of favor with some clients, consultants or third-party intermediaries. In combination with poor performance relative to peers, any changes in personnel, extensive periods in particular market environments, or other difficulties, may result in significant client or asset departures or a reduction in AUM.
Because the Company’s clients can remove the assets the Company manages on short notice, the Company may experience unexpected declines in revenue and profitability. The Company’s investment advisory and sub-advisory contracts are generally cancellable upon very short notice. Institutional and individual clients, and firms with which the Company has strategic alliances, can terminate their relationship with the Company, reduce the aggregate amount of AUM or shift their funds to other types of accounts with different rate structures for a number of reasons - including investment performance, changes in prevailing interest rates and financial market performance. Poor performance relative to other investment management firms may result in decreased inflows into the Company’s investment products, increased withdrawals from the Company’s investment products, and the loss of institutional or individual accounts or strategic alliances. In addition, the ability to terminate relationships may allow clients to renegotiate for lower fees paid for asset management services.
In addition, in the U.S., as required by the Investment Advisers Act, each of the Company’s investment advisory contracts with the mutual funds the Company advises or sub-advises automatically terminates upon its “assignment,” or transfer of the Company’s responsibility for fund management. Each of the Company’s other investment advisory contracts subject to the provisions of the Investment Advisers Act, as required by this act, provides that the contract may not be “assigned” without the consent of the customer. A sale of a sufficiently large block of shares of the Company’s voting securities or other transactions could be deemed an “assignment” in certain circumstances. An assignment, actual or constructive, will trigger these termination provisions and could adversely affect the Company’s ability to continue managing these client accounts.
To the extent that a technical “assignment” of investment advisory contracts arises, the Company will take the necessary steps to provide clients an opportunity to consent to the continuation of their advisory agreements. Such new agreements may need approval by the stockholders of the respective funds. In the event that any of these clients do not consent to a renewal of their agreement, the Company could lose AUM, which would result in a loss of revenue.
There may not be a consistent pattern in the Company’s financial results from period to period, which may make it difficult for the Company to achieve steady earnings growth on a quarterly basis and may cause the price of the Company’s common stock to decline. The Company may experience significant fluctuations in revenue and profits. Because our revenues are based on the value of AUM, a decline in the value of AUM would adversely affect our revenues. As a result of market fluctuations, it may be difficult for the Company to achieve steady earnings growth on a quarterly basis, which could lead to large adverse movements in the price of the Company’s common stock or increased volatility in the Company’s stock price. Additionally, in periods of slowing growth or declining revenues, profits and profit margins are adversely affected because certain expenses remain relatively fixed.
Access to clients through intermediaries is important to the Company’s asset management business, and reductions in referrals from such intermediaries or poor reviews of the Company’s products or the Company’s organization by such intermediaries could materially reduce the Company’s revenue and impair the Company’s ability to attract new clients. The Company’s ability to market its services relies, in part, on receiving mandates from the client base of international and regional securities firms, banks, insurance companies, defined contribution plan administrators, investment consultants and other intermediaries. To an increasing extent, the Company’s business uses referrals from accountants, lawyers, financial planners and other professional advisers. The inability to have this access could materially adversely affect the Company’s business. In addition, many of these intermediaries review and evaluate the Company’s products and the Company’s organization. Poor reviews or evaluations of either the particular products or of the Company may result in client withdrawals or an inability to attract new assets through such intermediaries.
The Company derives a substantial percentage of its revenues from two significant clients. CI and Genworth accounted for approximately 16% and 25%, respectively, of revenues for FY 2008 and 15% and 21%, respectively, of revenues for the quarter ended June 30, 2008. A loss of either one of these clients could negatively impact results of operations of the Company.
Employee misconduct could harm the Company by impairing the Company’s ability to attract and retain clients and subjecting the Company to significant legal liability and reputational harm, and this type of misconduct is difficult to detect and deter. There have been a number of highly publicized cases involving fraud or other misconduct by employees in the financial services industry, and the Company runs the risk that employee misconduct could occur in the Company’s business, as well. For example, misconduct by employees could involve the improper use or disclosure of confidential information, which could result in regulatory sanctions and serious reputational or financial harm. In the Company’s business, the Company has discretion to trade client assets on the client’s behalf and must do so acting in the best interest of the client. As a result, the Company is subject to a number of obligations and standards, and the violation of those obligations or standards may adversely affect the Company’s clients and the Company. The Company has adopted and implemented a number of insider trading, code of ethics, and other related policies and procedures to address such obligations and standards. It is not always possible to deter employee misconduct, and the precautions the Company takes to detect and prevent this activity may not be effective in all cases.
Various factors may prevent the declaration and payment of common stock dividends. The Company began to pay a quarterly dividend, commencing in the quarter ended December 31, 2007. However, the payment of dividends in the future is subject to the discretion of the Company’s Board of Directors, and various other factors may prevent us from paying dividends. Our board of directors will take into account such matters as general business conditions, the Company’s financial results, contractual obligations, and legal and regulatory restrictions.
The Company may pursue acquisitions or joint ventures that could present unforeseen integration obstacles or costs and could dilute the stock ownership of the Company’s stockholders and holders of the Company’s equity securities. As part of the Company’s long-term business strategy, the Company may pursue joint ventures and other transactions aimed at expanding the geography and scope of the Company’s operations. The Company expects to explore partnership opportunities that the Company believes to be attractive. While the Company is not currently in negotiations with respect to material acquisitions or joint ventures, the Company routinely assesses its strategic position and may in the future seek acquisitions or other transactions to further enhance the Company’s competitive position. If the Company is not correct when it assesses the value, strengths and weaknesses, liabilities and potential profitability of acquisition candidates or is not successful in integrating the operations of the acquired business, the success of the combined business could be compromised.
Acquisitions and joint ventures involve a number of risks and present financial, managerial and operational challenges, including potential disruption of the Company’s ongoing business and distraction of management, difficulty with integrating personnel and financial and other systems, hiring additional management and other critical personnel and increasing the scope, geographic diversity and complexity of the Company’s operations. The Company’s clients may react unfavorably to the Company’s acquisition and joint venture strategy, the Company may not realize any anticipated benefits from acquisitions, and the Company may be exposed to additional liabilities of any acquired business or joint venture, any of which could materially adversely affect the Company’s revenue and results of operations. In addition, future acquisitions or joint ventures may involve the issuance of additional shares of the Company’s common stock, which would dilute existing ownership of the Company.
Other operational risks may disrupt the Company’s business, result in regulatory action against the Company, or limit the Company’s growth. The Company’s business is dependent on communications and information systems, including those of the Company’s vendors. Any failure or interruption of these systems, whether caused by fire, other natural disaster, power or telecommunications failure, act of terrorism or war or otherwise, could materially adversely affect the Company’s operating results. Although the Company has back-up systems in place, the Company’s back-up procedures and capabilities in the event of a failure or interruption may not be adequate.
The Company relies heavily on its financial, accounting, trading, compliance and other data processing systems. If any of these systems do not operate properly or are disabled, the Company could suffer financial loss, a disruption of the Company’s business, liability to clients, regulatory intervention or reputational damage. The inability of the Company’s systems to accommodate an increasing volume of transactions also could constrain the Company’s ability to expand its businesses. The Company expects that it will need to continue to upgrade and expand these capabilities in the future to avoid disruption of, or constraints on, the Company’s operations.
The Company may be exposed to data security risks. A failure to safeguard the integrity and confidentiality of client data from the infiltration by an unauthorized user that is either stored on or transmitted between our information systems or to other third party service provider systems may lead to modifications or theft of critical and sensitive data pertaining to our clients. The costs incurred to correct client data and prevent further unauthorized access could be extensive.
Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and stock price. We have documented and tested our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors regarding the Company’s internal control over financial reporting. We are in compliance with Section 404 of the Sarbanes-Oxley Act as of June 30, 2008. However, if we fail to maintain adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. In addition, failure to maintain an effective internal control environment could cause investors to lose confidence in our reported financial information, which could have a material adverse effect on our stock price.
Fluctuations in foreign currency exchange rates could lower the Company’s net income or negatively impact the portfolios of the Company’s clients and may affect the levels of the Company’s AUM. Although most portfolios are in U.S. dollar base currency, certain client portfolios are invested in securities denominated in foreign currencies. Foreign currency fluctuations can adversely impact investment performance for a client’s portfolio. Accordingly, foreign currency fluctuations may affect the levels of the Company’s AUM. As the Company’s AUM includes assets that are denominated in currencies other than U.S. dollars, an increase in the value of the U.S. dollar relative to those non-U.S. currencies may result in a decrease in the dollar value of the Company’s AUM, which, in turn, would result in lower U.S. dollar denominated revenue in the Company’s business. Additionally, while this risk may be limited by foreign currency hedging, some risks cannot be hedged and there is no guarantee that the Company’s hedging activity will be successful. Poor performance may result in decreased AUM, stemming from withdrawal of client assets or a decrease in new assets being raised in the relevant product.
Certain changes in accounting and/or financial reporting standards issued by the Financial Accounting Standards Board (“FASB”), the SEC or other standard-setting bodies could have a material adverse impact on the Company’s financial position or results of operations. The Company is subject to the application of U.S. generally accepted accounting principles (“GAAP”), which periodically are revised and/or expanded. As such, the Company periodically is required to adopt new or revised accounting and/or financial reporting standards issued by recognized accounting standard setters or regulators, including the FASB and the SEC. It is possible that future requirements, including the recently proposed implementation of International Financial Reporting Standards (“IFRS”), could change the Company’s current application of GAAP, resulting in a material adverse impact on the Company’s financial position or results of operations.
Sales of a substantial number of shares of our common stock may adversely affect the market price of our common stock. Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock.
Risks Related to Our Industry The Company faces strong competition from financial services firms, many of whom have the ability to offer clients a wider range of products and services than the Company can offer, which could lead to pricing pressures that could materially adversely affect the Company’s revenue and profitability. The financial services industry is intensely competitive and the Company expects it to remain so. In addition to performance, the Company competes on the basis of a number of factors including the quality of the Company’s employees, transaction execution, the Company’s products and services, innovation, reputation and price. The Company believes that it will experience pricing pressures in the future as some of the Company’s competitors seek to obtain increased market share by reducing fees.
The Company faces increased competition due to a trend toward consolidation. In recent years, there has been substantial consolidation and convergence among companies in the financial services industry. In particular, a number of large commercial banks, insurance companies and other broad-based financial services firms have established or acquired asset managers or have merged with other financial institutions. Many of these firms have the ability to offer a wide range of products, from loans, deposit-taking and insurance to brokerage and asset management services, which may enhance their competitive position. They also have the ability to support financial advisory services, with commercial banking, insurance and other financial services revenue in an effort to gain market share, which could result in pricing pressure in the Company’s business.
Any event that negatively affects the asset management industry could have a material adverse effect on the Company. Any event affecting the asset management industry that results in a general decrease in AUM or a significant general decline in the number of advisory clients or accounts could negatively impact revenues. Future growth and success depends, in part, upon the growth of the asset management industry.
The financial services industry faces substantial litigation and regulatory risks, and the Company may face damage to the Company’s professional reputation and legal liability if the Company’s services are not regarded as satisfactory or for other reasons. As a financial services firm, the Company depends, to a large extent, on the Company’s relationships with its clients and the Company’s reputation for integrity and high-caliber professional services to attract and retain clients. As a result, if a client is not satisfied with the Company’s services, such dissatisfaction may be more damaging to the Company’s business than to other types of businesses.
In recent years, the volume of claims and amount of damages claimed in litigation and regulatory proceedings against financial advisers has been increasing. In the Company’s business, the Company makes investment decisions on behalf of its clients which could result in substantial losses. This may subject the Company to the risk of legal liabilities or actions alleging negligent misconduct, breach of fiduciary duty or breach of contract. These risks often may be difficult to assess or quantify and their existence and magnitude often remain unknown for substantial periods of time. The Company’s engagements typically include broad indemnities from the Company’s clients and provisions designed to limit the Company’s exposure to legal claims relating to the Company’s services, but these provisions may not protect the Company or may not be adhered to in all cases. The Company also may be subject to claims arising from disputes with employees for alleged discrimination or harassment, among other things. These risks often may be difficult to assess or quantify, and their existence and magnitude often remain unknown for substantial periods of time. As a result, the Company may incur significant legal expenses in defending against litigation. Substantial legal liability or significant regulatory action against the Company could materially adversely affect the Company’s business, financial condition or results of operations or cause significant reputational harm to the Company, which could seriously harm the Company’s business.
Due to the extensive laws and regulations to which the Company is subject, management is required to devote substantial time and effort to legal and regulatory compliance issues. In addition, the regulatory environment in which the Company operates is subject to change. The Company may be adversely affected as a result of new or revised legislation or regulations or by changes in the interpretation or enforcement of existing laws and regulations.
Extensive regulation of the Company’s business limits the Company’s activities and results in ongoing exposure to the potential for significant penalties, including fines or limitations on the Company’s ability to conduct its business. The financial services industry is subject to extensive regulation. The Company is subject to regulation by governmental and self-regulatory organizations in the jurisdictions in which the Company operates around the world. Many of these regulators, including U.S. and non-U.S. government agencies and self-regulatory organizations, as well as state securities commissions in the U.S., are empowered to conduct administrative proceedings that can result in censure, fine, the issuance of cease-and-desist orders or the suspension or expulsion of an investment adviser. The requirements imposed by the Company’s regulators are designed to ensure the integrity of the financial markets and to protect customers and other third parties who deal with the Company and are not designed to protect the Company’s stockholders. Consequently, these regulations often serve to limit the Company’s activities, including customer protection and market conduct requirements.
The Company faces the risk of significant intervention by regulatory authorities, including extended investigation and surveillance activity, adoption of costly or restrictive new regulations and judicial or administrative proceedings that may result in substantial penalties. Among other things, the Company could be fined or be prohibited from engaging in some of the Company’s business activities. In addition, the regulatory environment in which the Company operates is subject to modifications and further regulation. New laws or regulations or changes in the enforcement of existing laws or regulations applicable to the Company and the Company’s clients also may adversely affect the Company’s business, and the Company’s ability to function in this environment will depend on the Company’s ability to constantly monitor and react to these changes. In addition, the regulatory environment in which the Company’s clients operate may impact the Company’s business. For example, changes in antitrust laws or the enforcement of antitrust laws could affect the level of mergers and acquisitions activity and changes in state laws may limit investment activities of state pension plans.
In particular, for asset management businesses in general, there have been a number of highly publicized regulatory inquiries that focus on the mutual funds industry. These inquiries already have resulted in increased scrutiny in the industry and new rules and regulations for mutual funds and their investment managers. This regulatory scrutiny, along with rulemaking initiatives, may result in an increase in operational and compliance costs or the assessment of significant fines or penalties against the Company and may otherwise limit the Company’s ability to engage in certain activities.
In addition, financial services firms are subject to numerous conflicts of interests or perceived conflicts. The Company has adopted various policies, controls and procedures to address or limit actual or perceived conflicts and regularly seeks to review and update the Company’s policies, controls and procedures. However, these policies and procedures may result in increased costs, additional operational personnel, and increased regulatory risk. Failure to adhere to these policies and procedures may result in regulatory sanctions or client litigation.
Specific regulatory changes also may have a direct impact on the revenue of the Company’s asset management business. In addition to regulatory scrutiny and potential fines and sanctions, regulators continue to examine different aspects of the asset management industry. Other proposed rules that are currently under consideration include potential limitations on investment activities in which an adviser may engage, such as hedge funds and mutual funds, increased disclosure of adviser and fund activities, and changes in compensation for mutual fund sales. These regulatory changes and other proposed or potential changes may result in a reduction of revenue associated with these activities.
Item 1B.
Item 1B. Unresolved Staff Comments None.
Item 2.
Item 2. Properties The Company leases all office space. Our principal offices consist of the following properties:
(1) Our principal executive office
The Company is also the primary party to a lease in New York, NY with approximately 8,500 square feet, which expires in November 2010. In January 2002, a sublease agreement was executed with an unrelated third party for this property. While the Company remains responsible under terms of the original lease, the subtenant has assumed those responsibilities and is performing its obligations under the sublease agreement. Proceeds from the sublease, net of profit sharing with the landlord, more than offset the Company’s obligations under this lease.
Management believes the office space utilized by the Company is adequate for its existing operating needs and that suitable additional space will be available as and when needed.
Additional information about our occupancy costs, including commitments under non-cancellable leases, is contained in Note 8 of the “Notes to Consolidated Financial Statements” included in this Form 10-K under Item 8.
Item 3.
Item 3. Legal Proceedings From time to time, the Company or its subsidiaries may become parties to claims, legal actions and complaints arising in the ordinary course of business. Management is not aware of any claims which would have a material adverse effect on its consolidated financial position, liquidity or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the Company’s security holders during the fourth quarter of our fiscal year ended June 30, 2008.
PART II Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The Company’s common stock trades on the NASDAQ Capital Market under the trading symbol “EPHC.”
Stock Performance Graph The graph and table on the following page compares the performance of an investment in our Common Stock from June 30, 2003 through June 30, 2008 with the Russell 2000 Index, an index comprised of public companies with the Standard Industrial Classification (“SIC”) Code 6282, Investment Advice, and the SNL Asset Managers Index, a composite of publicly traded asset management companies. The graph assumes a $100 investment in our Common Stock on June 30, 2003, and an equal investment in each of the selected indices, including reinvestment of dividends, if any. The performance shown in the graph represents past performance and should not be considered an indication of future performance.
It should be noted that we did not become involved in the investment advisory business until June 2004, and previously had been involved in other lines of business. Accordingly, we believe the selected indices represent a foundation for comparisons only since June 2, 2004.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Epoch Holdings Corporation, The Russell 2000 Index,
SIC Code 6282 and the SNL Asset Manager Index
*$100 invested on 6/30/03 in stock & index-including reinvestment of dividends.
Fiscal year ending June 30.
Vertical line represents commencement of investment advisory operations, June 2004
Source: Research Data Group, Inc.
The foregoing graph shall not be deemed to be “soliciting material” or “filed” or incorporated by reference in any previous or future documents filed by the Company with the SEC under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates the information by reference in any such document.
The following companies are included in the SNL Asset Manager Index: Affiliated Managers Group Inc., AllianceBernstein Holding L.P., Alternative Asset Management Acquisition Corp., August Financial Holding Co., BKF Capital Group Inc., BlackRock Inc., Blackstone Group L.P., Brookfield Asset Management, Calamos Asset Management Inc., Cohen & Steers Inc., Diamond Hill Investment Group, Eaton Vance Corp., Epoch Holding Corp., Federated Investors Inc., Fortress Investment Group LLC., Franklin Resources Inc., GAMCO Investors Inc., GLG Partners Inc., Hennessy Advisors Inc., Integrity Mutual Funds Inc., Invesco Ltd., Janus Capital Group Inc., Legg Mason Inc., Och-Ziff Capital Management Group, Pzena Investment Management Inc., SEI Investments Co., T. Rowe Price Group Inc., Tailwind Financial Inc., Triplecrown Acquisition Corp., U.S. Global Investors Inc., Value Line Inc., W.P. Stewart & Co. LTD., Waddell & Reed Financial Inc., Westwood Holdings Group Inc.
The following table sets forth the high and low closing prices during each fiscal quarter for the past two years as well as the closing price at the end of each fiscal quarter presented.
The closing price for our common stock as reported on the NASDAQ Capital Market on September 8, 2008 was $11.54. As of September 8, 2008 there were approximately 1,075 holders of record of the Company’s common stock. As many of the shares are held in street nominee name, management believes the number of beneficial owners of our common stock is substantially higher.
Common Stock Dividends The Company commenced declaring and paying quarterly dividends on its common stock in the quarter ended December 31, 2007. The dividend rate was $.025 per share per quarter, for each of the quarters ended December 31, 2007, March 31, 2008, and June 30, 2008. A total of $1.5 million of dividends were declared and paid during the fiscal year ended June 30, 2008. No cash dividends were paid on the Company’s common stock during the fiscal year ended June 30, 2007.
Effective with the first quarter of fiscal year 2009, the Company increased its quarterly dividend by 20%, from $0.025 to $0.03 per share. The Company expects quarterly dividends going forward to be paid in February, May, August and November of each fiscal year, and anticipates a total annual dividend of $0.12 per common share. However, the actual declaration of future cash dividends, and the establishment of record and payment dates, will be subject to final determination by the Board of Directors each quarter after its review of the Company’s financial performance, as well as general business conditions, capital requirements, and any contractual, legal and regulatory restrictions.
Preferred Stock Dividends As a result of the November 7, 2006 preferred stock issuance, the Company began paying semi-annual dividends on newly issued Series A Convertible Preferred Stock, payable December 31 and June 30 of each year. The semi-annual dividend payments were $230 thousand. The Company paid $460 thousand in preferred dividends during the fiscal year ended June 30, 2008 and $299 thousand in preferred dividends during the fiscal year end June 30, 2007 which represents dividends for the period November 7, 2006 through June 30, 2007.
On July 1, 2008, the holder of the 10,000 shares of Series A Convertible Preferred Stock (“the Preferred Stock”) outstanding, with a face value of $10,000,000, converted the Preferred Stock to 1,666,667 shares of Common Stock. Accordingly, the Series A Convertible Preferred Stock has been cancelled and the conversion eliminates the holder’s rights to receive the semi-annual dividends on the Preferred Stock.
Rule 10b5-1 Plans Our executive officers may purchase or sell shares of our common stock in the market from time to time. The Company’s management encourages these officers to make these transactions through plans that comply with Exchange Act Rule 10b5-1(c). The Company does not receive any proceeds related to these transactions.
Equity Compensation Plan Information The following table provides information regarding the status of the Company’s equity plans at June 30, 2008:
(a) The Company’s 1992 Incentive and Non-qualified Stock Option Plan expired on September 30, 2002. The remaining options under this plan will remain outstanding until they are exercised, cancelled or expire.
(b) Stockholders of the Company approved the 2004 Omnibus Long-Term Incentive Compensation Plan at the Company’s Annual Meeting of Stockholders on November 18, 2004. All securities currently issued under this plan are currently outstanding in the form of restricted stock, which vest over a three year period for employees and one year for non-employee directors. In the event recipients do not fulfill their continuing employment or director obligations, unvested shares of restricted stock will be cancelled and returned to the plan for future issuance, unless the Compensation Committee of the Company waives the forfeiture provisions in whole or in part.
(c) On September 14, 1999, non-qualified stock options to purchase an aggregate of 140,000 shares of Common Stock were granted to the J Net Board of Directors and a non-employee then serving as the Secretary at an exercise price of $9.00 per share, the fair market value on the date of grant. The options vested 50% on each of the first and second anniversaries of the date of grant and expire ten years from the date of grant. On October 31, 2001, 30,000 options were cancelled as a result of a director’s resignation. Additionally, 35,000 options were exercised in FY 2007.
On June 21, 2000, non-qualified stock options to purchase an aggregate of 500,000 shares of Common Stock were granted to the former President and Chief Operating Officer and the former Executive Vice President and Chief Financial Officer at an exercise price of $13.13 per share, the fair market value on the date of the grant. The options vested in thirds on each of the first, second and third anniversaries of the date of grant and expire ten years from the date of the grant. As of June 30, 2003, all of the options were exercisable. On June 21, 2003, the former President and Chief Operating Officer and the former Executive Vice President and Chief Financial Officer’s employment contracts expired and were not renewed. The expiration of those contracts did not affect the expiration of the options, which will occur on June 21, 2010.
Recent Sales of Unregistered Securities None.
Issuer Purchases of Equity Securities On June 24, 2008, the Company’s Board of Directors approved the repurchase of up to a maximum of 250,000 shares, or just over 1%, of the Company’s fully diluted outstanding common stock. The repurchase plan calls for the repurchases to be made in the open market and/or in privately negotiated transactions from time to time in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended, subject to prevailing market and business conditions. The plan does not obligate the Company to purchase any particular number of shares, and may be suspended or discontinued at any time. The repurchase plan will expire on June 30, 2009.
The following displays information with respect to the treasury shares the Company purchased during the fiscal year ended June 30, 2008.
In addition to this program, for the year ended June 30, 2008, the Company repurchased 136,235 shares from employees, and subsequently sold those shares as part of a share withholding program to satisfy employees’ payroll tax liabilities attributable to the vesting of restricted stock awards.
Item 6.
Item 6. Selected Financial Data The table on the following page presents selected financial data of the Company. This data was derived from the Company’s consolidated financial statements and reflects the operations and financial position of the Company at the dates and periods indicated. Due to the reverse merger accounting treatment for the EIP business combination, the June 30, 2004 results of operations reflect the April 14, 2004 (the date on which EIP began conducting business operations) through June 30, 2004 operations for EIP and June 2, 2004 (the date of the business combination) through June 30, 2004 operations for J Net.
The following selected historical consolidated financial data should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K.
SELECTED FINANCIAL DATA
(Dollars in Thousands, Except Share Data)
(1) Other income includes both cumulative dividends received and realized gains recognized from dispositions of certain of the Company’s privately held investments. See Note 5 to the financial statements for further details.
(2) Provision for income taxes was reduced in FY 2008 by the release of a valuation allowance against certain deferred tax assets, and in FY 2007 by the utilization of net operating loss carryforwards (see Note 13 to the Consolidated Financial Statements).
(3) The Company commenced paying dividends in the quarter ended December 31, 2007.
(4) Weighted average shares outstanding for 2004 are based on 1,000 shares from April 14, 2004 through June 1, 2004, representing issued and outstanding shares of Epoch up to the date of the merger. Beginning June 2, 2004, issued and outstanding shares were 17,834,737. Accordingly, the total weighted average shares outstanding from April 14, 2004 (date of inception) to June 30, 2004 were 6,717,602.
(5) Current ratio is derived by dividing current assets by current liabilities.
(6) Certain prior year amounts have been reclassified to conform to the 2008 presentation.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview The Company provides investment advisory and investment management services to its clients. Its operating subsidiary, EIP, is a registered investment adviser under the Investment Advisers Act of 1940, as amended (the “Investment Advisors Act”). Its business operations are to manage investment assets for retirement plans, mutual funds, endowments, foundations, and high net worth individuals. Revenues are generally derived as a percentage of assets under management (“AUM”). Therefore, among other factors, revenues are dependent on (i) performance of financial markets, (ii) the ability to maintain existing clients, and (iii) changes in the composition of AUM. The management team is led by William W. Priest. Mr. Priest has over 40 years of experience in the investment advisory business. The overall investment philosophy is focused on achieving a superior risk-adjusted return by investing in companies that generate free cash flow and are undervalued relative to the investment team’s fair value determinations. Security selection and portfolio construction are designed to protect capital in declining markets while participating in rising markets.
Financial Highlights The Company continued to achieve positive operating leverage for the fiscal year ended June 30, 2008, which is defined as the total revenue growth rate that exceeds the rate of growth of expenses. Total operating revenue increased by 41% while total operating expenses increased by 13%. Operating margins continue to improve. The Company achieved a positive operating margin, climbing to 11% for the fiscal year ended June 30, 2008. The main driver of this positive trend has been the increase in AUM, led primarily by an increase in sub-advisory and institutional mandates. The Company finished the fiscal year ended June 30, 2008 with AUM of $6.6 billion, an increase of $0.6 billion, or approximately 11%, from $6.0 billion a year ago.
For the year ended June 30, 2008, the Company achieved an operating profit of $3.9 million, an improvement of $6.4 million from the same period a year ago. This increase was the result of a $9.9 million, or 41% increase in operating revenues - led by higher AUM levels, driven by new business mandates and flows into existing accounts.
Partially offsetting this revenue increase was a $3.8 million, or 28%, increase in employee related costs from the prior year primarily due to higher incentive based compensation as well as additions of senior staff in the latter part of the prior fiscal year and during the current year.
For the year ended June 30, 2008, the Company recorded net income of $9.0 million, an increase of $1.1 million from the same period a year ago. Offsetting the $6.4 million improvement in operating profit were the following:
• Other income decreased by $4.5 million from the prior year. The prior year included $8.1 million in non-recurring dividends and realized gains from the disposition of privately held investments. In the current year, non-recurring realized gains from the sale of marketable securities received in conjunction with one of the above dispositions were $3.7 million (see “Significant Transactions”).
• Income tax expense increased by $0.8 million from the prior year.
Business Environment As an investment advisory and management firm, our results of operations can be directly impacted by global market, political, and economic trends. A favorable business environment can be characterized by many factors, including a stable geopolitical climate, global economic growth, strong business profitability, robust investor confidence, low inflation, low unemployment, and financial market transparency. These factors can directly affect capital appreciation, which in turn, impacts our investment advisory and management business.
The financial environment globally and in the United States was volatile during fiscal 2008 and challenging market conditions persisted throughout most of our fiscal year. Continued contraction in worldwide credit markets due in part to sub-prime lending issues, which began in the summer of 2007, a weaker U.S. dollar, major write-downs related to the credit crisis within the financial sector, and record high oil prices continued to concern investors about the state of the U.S. and global economies. During fiscal 2008 the U.S. Federal Reserve reduced the federal funds rate to 2.25%, down from 5.25% a year ago, in an effort to ease the impact of the credit crisis. All three major U.S. equity market indices declined during the fiscal year. Investors with globally diversified exposure to equity markets also saw declines during the year.
Assuming dividend reinvestment, the Dow Jones Industrial Average,(1) NASDAQ Composite Index(2) and the S&P 500(3) were down 13.3%, 11.2% and 13.1%, respectively, for the fiscal year. On a broad basis, developed global markets, as represented by the MSCI World Index,(4) decreased by 10.2%. The financial environment in which we operate continues to be challenging moving into fiscal 2009. We expect the challenges presented by the credit markets to persist throughout the next fiscal year. We cannot predict how these uncertainties will impact the Company’s results.
(1) Dow Jones Industrial Average is a trademark of Dow Jones & Company, which is not affiliated with Epoch.
(2) NASDAQ is a trademark of the NASDAQ Stock Market, Inc., which is not affiliated with Epoch.
(3) S&P is a trademark of Standard & Poor’s, a division of the McGraw-Hill Companies, Inc., which is not affiliated with Epoch.
(4) MSCI World Index is a trademark of MSCI Inc., which is not affiliated with Epoch.
Results of Operations Assets Under Management The Company’s AUM has continued to increase, although at a reduced pace compared with the previous year. The graph below depicts the AUM growth by distribution channel for the past three fiscal years.
AUM as of June 30, 2008 was $6.6 billion compared with AUM of $6.0 billion and $3.3 billion at June 30, 2007 and 2006, respectively. A summary of AUM by distribution channel at each fiscal year end follows (dollars in millions):
During the fiscal year ended June 30, 2008, approximately $28 million of AUM in separate accounts within the High net worth distribution channel transferred to the Epoch Global Absolute Return Fund, LLC, and approximately $8 million transferred to the Epoch U.S. All Cap Equity Fund, both of which are included within the Institutional distribution channel above.
The charts presented below depict the fiscal year end composition of AUM by distribution channel, as a percentage of total AUM for FY 2008, FY 2007, and FY 2006, respectively:
FY 2008 Versus FY 2007 Assets Under Management and Flows AUM increased to $6.6 billion at June 30, 2008, from $6.0 billion at June 30, 2007. This increase was primarily attributable to the ongoing expansion of the Company’s client base and flows into existing accounts, offset by market depreciation. The Company continued to expand its institutional and sub-advisory businesses. The Company experienced growth in AUM in nearly all products, and particularly in its U.S. Value and Global Absolute Return products as a percentage of AUM.
For the fiscal years ended June 30, 2008 and 2007, approximately 55% and 50%, respectively, of investment advisory and management fees were earned from services to mutual funds under advisory and sub-advisory contracts whose fees are calculated based upon daily net asset values, and approximately 45% and 50%, respectively, of fees were earned from services provided for separate accounts whose fees are calculated based upon asset values at the end of the quarter.
No material impact to revenues or operating results arose during the periods presented as a result of differences between the average daily AUM for the funds where our fees are calculated based upon daily net asset values and the quarter-ending AUM for those funds.
The following charts show the Company’s products as a percentage of AUM as of June 30, 2008 and 2007, respectively.
The increase in total revenues for the fiscal year ended June 30, 2008 was attributable to an increase in AUM, driven by new business mandates and flows into existing accounts, offset by market depreciation. Partially offsetting this increase was a reduction in performance fees, stemming from reduced overall market returns compared to the prior year.
AUM increased by 11% during fiscal year 2008, to $6.6 billion. Institutional business increased 18%, to $3.3 billion during fiscal year 2008, while the sub-advisory business increased by 7%, to $3.1 billion.
A significant percentage of revenues in FY 2008 were derived from two clients, CI and Genworth. CI represented 16% of FY 2008 consolidated revenues while Genworth, through its investments in the Epoch International Small Cap Fund (“EPIEX”) and the Epoch Global Equity Shareholder Yield Fund (“EPSYX”), as well as separate account mandates, represented approximately 25%.
Increased employee headcount to support the growth and expansion of the business, coupled with higher incentive based compensation, were the primary reasons for the increase in this expense. Employee headcount averaged 46 persons for FY 2008 compared with 40 persons for FY 2007. These expenses for the fiscal year ended June 30, 2008 included $9.4 million of bonuses and sales commissions as compared to $7.3 million for the fiscal year ended June 30, 2007. We expect the level of overall employee related costs to increase in future periods due to changes in staffing levels to support the growth and expansion of our business.
The Company believes that share-based compensation promotes unity in the workplace and a common objective with shareholders. Employee share-based compensation expense is recognized as follows: 12.5% immediately and the remaining 87.5% ratably over the three-year vesting period of those awards.
Amortization of the shares issued to employee owners in connection with the acquisition of EIP in June 2004, which equaled approximately $3.1 million per year, was completed as of June 30, 2007. This is the primary reason for the reduction in this expense. This reduction was partially offset by amortization of new stock awards.
In the fiscal year ended June 30, 2008, a total of 491,528 shares of restricted stock were issued to employees. A total of 61,441 shares of the awards, or approximately 12.5% of the shares issued, were immediately vested. The remaining 87.5% of the shares vest over the subsequent three years. A total of 163,365 shares were forfeited by terminated employees in the fiscal year ended June 30, 2008.
During the fiscal year ended June 30, 2008, a total of 35,604 shares were granted to non-employee directors of the Company for FY 2008 services. These directors’ shares are subject to a one-year vesting period, or immediately in the event of death or disability. The related share-based compensation expense is recognized ratably over the one-year vesting period of those awards.
General, administrative and occupancy expenses consist primarily of office rentals, travel and entertainment expenses, information technology expenses, utilities, and other office related expenses. Increases in market data services and information technology costs due to continued business expansion, increased travel to support distribution efforts, as well as rent on additional office space leased at the Company’s headquarters in February 2007, were the primary contributors for this expense increase. This increase is expected to continue during the next fiscal year as a result of increased travel to support distribution efforts as well as increased market data services and technology costs.
Professional service fees consist primarily of outside legal fees for SEC compliance and general corporate legal affairs, independent accountants’ fees, employee placement fees, and other professional services.
The primary reason for this increase was increased tax consulting services. In addition, increased legal fees in conjunction with our continued business expansion and review of strategic opportunities also contributed to the increase.
The increase in depreciation and amortization expense is the result of a full year of amortization of the costs of new leasehold improvements incurred in connection with the Company’s additional space obtained at its headquarters in February 2007.
For the year ended June 30, 2008, other income was $6.0 million, a decrease of $4.5 million from the comparable period a year ago. The current year includes non-recurring realized gains of $3.7 million from the sales of marketable securities and $0.5 million of realized gains from the Strategic Data Corporation transaction. The comparable period a year ago included $8.1 million of non-recurring cumulative dividends and realized gains recognized from the disposition of privately held investments (see “Significant Transactions”).
The Company does not anticipate other income levels being as high during the next fiscal year.
The Company was not subject to regular income tax rates in the prior year because of its net operating loss carry forwards, but was obligated to pay tax under the federal alternative minimum tax (“AMT”), which limits the application of net operating loss carry forwards to 90% of taxable income, in addition to certain AMT adjustments.
The Company is subject to regular income tax rates in the current year, as the remaining net operating losses available to be utilized by the Company are subject to annual limitations, and are less, in the aggregate, than were available in the prior year. The total provision for income taxes in the current year was significantly reduced by a release of valuation allowances against certain deferred tax assets.
FY 2007 Versus FY 2006
This increase in total revenues was attributable to an increase in AUM, driven by new business mandates, flows into existing accounts, as well as market appreciation.
AUM increased approximately 84% to $6.0 billion. Institutional business increased 122%, to $2.8 billion during fiscal year 2007, while the sub-advisory business increased by 68%, to $2.9 billion.
A significant percentage of revenues in FY 2007 were derived from two clients, CI and Genworth. CI represented 17% of FY 2007 consolidated revenues while Genworth, through its investments in the Epoch International Small Cap Fund (“EPIEX”) and the Epoch Global Equity Shareholder Yield Fund (“EPSYX”) as well as separate account mandates, represented approximately 24%.
Increased employee headcount to support the growth and expansion of the business was the primary reason for this increase. Employee headcount averaged 40 persons for FY 2007 compared with 32 persons for FY 2006. These expenses for the fiscal year ended June 30, 2007 included $7.3 million of bonuses and sales commissions as compared to $3.9 million for the fiscal year ended June 30, 2006.
Increased employee headcount as well as the amortization of prior year awards was the primary reason for this increase.
In the fiscal year ended June 30, 2007, a total of 695,893 shares of restricted stock were issued to employees. A total of 87,003 shares of the awards, or approximately 12.5% of the shares issued, were immediately vested. The remaining 87.5% of the shares vest over the subsequent three years. A total of 26,201 shares were forfeited by terminated employees in the fiscal year ended June 30, 2007.
During the fiscal year ended June 30, 2007, a total of 66,228 shares were granted to non-employee directors of the Company for FY 2007 services. These directors’ shares were subject to a one-year vesting period, or immediately in the event of death or disability. The related share-based compensation expense is recognized ratably over the one-year vesting period of those awards.
Amortization of the shares issued to employee owners in connection with the acquisition of EIP in June 2004 was $3.1 million in FY 2007 and FY 2006.
Increases in market data services and information technology costs due to continued business expansion, increases in insurance, as well as rent on additional office space leased at the Company’s headquarters in February 2007, were the primary contributors.
Increased consulting and audit fees in connection with compliance with Section 404 of the Sarbanes-Oxley Act of 2002 accounted for approximately $0.4 million of this increase. At the end of the second fiscal quarter ended December 31, 2006, the Company achieved a market capitalization of shares held by non-affiliates in excess of $75 million. As a result, the Company became an accelerated filer beginning with the Annual Report on Form 10-K for the year ended June 30, 2007.
Other contributors to this increase included employee placement fees as several senior experienced professionals were added to staff, as well as technology consulting fees to help support the upgrading of systems and expansion of operations.
The increase in depreciation and amortization expense includes amortization of the costs of new leasehold improvements incurred in connection with the Company’s additional space obtained at its headquarters in February 2007.
For the fiscal year ended June 30, 2007, other income increased by $9.4 million compared with the previous fiscal year. This increase stems primarily from approximately $8.1 million of non-recurring cumulative dividends and realized gains recognized from dispositions of certain of the Company’s privately held investments (see “Significant Transactions”). Additionally, the reversal of a previously recorded estimate of $0.9 million contributed to this increase.
Interest income on higher cash balances and short-term investments, stemming from higher management fees and the preferred stock proceeds received in November 2006, generated the remaining increase in other income.
For the fiscal year ended June 30, 2007 the Company recorded an income tax expense of $99 thousand. The Company was not subject to regular income taxes because of its net operating loss carry forwards but was obligated to pay federal alternative minimum tax (“AMT”), which limits the application of net operating loss carry forwards to 90% of taxable income, in addition to certain AMT adjustments.
Capital Resources and Liquidity A summary of cash flow data for the fiscal years ended June 30 is as follows (in thousands):
2008 Cash Flows: For the fiscal year ended June 30, 2008, net cash provided by operating activities was $11.3 million, an improvement of $9.0 million from the prior year. The increase in cash provided by operations stems from improved operating results and changes in operating assets and liabilities.
Net cash generated from investing activities includes approximately $22 million in proceeds from the maturity of short-term investments.
Sources of funds for the Company’s operations are primarily derived from investment advisory and investment management fees and interest on the Company’s cash, cash equivalents and short-term investments. As of June 30, 2008, the Company had $37.4 million of cash and cash equivalents and $6.4 million of accounts receivable to fund its business growth strategy.
Management believes the existing cash and cash equivalents are adequate to provide the necessary resources to meets its operating needs for the foreseeable future as well as to implement its growth strategies. The Company’s current financial condition is highly liquid, with cash and cash equivalents comprising approximately 69% of its total assets. The Company has no debt.
The Company, from time to time, may also consider pursuing opportunities to raise additional capital to expand its market base and support its growth objectives. The Company’s business does not require it to maintain significant capital balances.
2007 Cash Flows: For the fiscal year ended June 30, 2007, net cash provided by operating activities was $2.4 million, an improvement of $3.5 million from the prior year. The increase in cash provided by operations stemmed primarily from improved operating results.
2006 Cash Flows: For the fiscal year ended June 30, 2006, the use of cash flows from operations was primarily due to the process of establishing and expanding the business during the Company’s second full year of operations.
Working Capital: The Company’s working capital for the past two years is set forth in the table below (dollars in thousands):
Current Assets: Current assets increased $9.3 million at June 30, 2008 compared with June 30, 2007 primarily as a result of higher revenues from business expansion as well as $3.7 million in realized gains from the sales of marketable securities.
Current Liabilities: Current liabilities at June 30, 2008 increased $5.2 million. This increase is primarily the result of higher income taxes payable and an increase in accrued compensation. In the prior fiscal year, accrued incentive compensation for several senior executives was paid as of June 30, 2007. Such amounts accrued in the current year were paid subsequent to June 30, 2008.
Common Stock Dividends The Company commenced declaring and paying quarterly dividends on its common stock in the quarter ended December 31, 2007. The dividend rate was $.025 per share per quarter, for each of the quarters ended December 31, 2007, March 31, 2008, and June 30, 2008. A total of $1.5 million of dividends were declared and paid during the fiscal year ended June 30, 2008. No cash dividends were paid on the Company’s common stock during the fiscal year ended June 30, 2007.
Effective with the first quarter of fiscal year 2009, the Company increased its quarterly dividend by 20%, from $0.025 to $0.03 per share. The Company expects quarterly dividends going forward to be paid in February, May, August and November of each fiscal year, and anticipates a total annual dividend of $0.12 per common share. However, the actual declaration of future cash dividends, and the establishment of record and payment dates, will be subject to final determination by the Board of Directors each quarter after its review of the Company’s financial performance, as well as general business conditions, capital requirements, and any contractual, legal and regulatory restrictions.
Preferred Stock Dividends: As a result of the November 7, 2006 preferred stock issuance, the Company began paying semi-annual dividends on newly issued Series A Convertible Preferred Stock, payable December 31 and June 30 of each year. The semi-annual dividend payments were $230 thousand. The Company paid $460 thousand in preferred dividends during the fiscal year ended June 30, 2008 and $299 thousand in preferred dividends during the fiscal year end June 30, 2007 which represents dividends for the period November 7, 2006 through June 30, 2007.
On July 1, 2008, the holder of the 10,000 shares of Series A Convertible Preferred Stock (“the Preferred Stock”) outstanding, with a face value of $10,000,000, converted the Preferred Stock to 1,666,667 shares of Common Stock. Accordingly, the Series A Convertible Preferred Stock has been cancelled and the conversion eliminates the holder’s rights to receive the semi-annual dividends on the Preferred Stock.
Common Stock Repurchase Plan: On June 24, 2008, the Company’s Board of Directors approved the repurchase of up to a maximum of 250,000 shares, or just over 1%, of the Company’s fully diluted outstanding common stock. The repurchase plan calls for the repurchases to be made in the open market and/or in privately negotiated transactions from time to time in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended, subject to prevailing market and business conditions. The plan does not obligate the Company to purchase any particular number of shares, and may be suspended or discontinued at any time. The repurchase plan will expire on June 30, 2009. During the fiscal year ended June 30, 2008, the Company repurchased 8,900 shares at a weighted average price of $9.25.
Contractual Obligations The Company’s primary headquarters and operations are located in New York, NY. Business is conducted at a location with approximately 10,000 square feet under a long-term lease that expires in September 2015. To accommodate for the growth in business, the Company entered into a sublease agreement for an additional 3,100 square feet at its Company headquarters effective February 1, 2007. This sublease expires in June 2010.
The Company is also the primary party to another lease in New York, NY with approximately 8,500 square feet, which expires in December 2010. This property is subleased to an unrelated third party. While the Company remains responsible for obligations under the lease, the sublease income, net of profit sharing with the landlord, more than offsets the Company’s obligations under this lease. The subtenant has performed its obligations under the sublease agreement and the Company is not aware of any credit issues with the subtenant. As of June 30, 2008, the remaining future minimum payments under this lease total $1.2 million. Future minimum receipts from the subtenant, net of profit sharing with the landlord, slightly exceed $1.2 million as of June 30, 2008.
The Company also has an office lease in Sherman Oaks, CA with an annual option to renew. The obligations under this lease are minimal.
As previously disclosed in the Company’s Current Report on form 8-K dated November 28, 2007, the Company entered into a three year employment agreement with its Chief Executive Officer, effective January 1, 2008. The agreement calls for a base annual salary of $350 thousand and bonus compensation in accordance with the Company’s bonus and incentive compensation plans then in effect. The agreement was reviewed and approved by the Company’s Compensation Committee and the Board of Directors. There are no employment contracts with any other officers or employees of the Company.
Summary of Contractual Obligations The following table summarizes all contractual obligations, including the aforementioned office leases (dollars in thousands):
Off-Balance Sheet Arrangements As of June 30, 2008, the Company had no off-balance sheet arrangements.
Significant Transactions eStara Transaction During the fiscal year ended June 30, 2000, J Net Enterprises, Inc. (“J Net”), the predecessor company to Epoch, made a $4.0 million preferred stock investment in eStara, Inc. (“eStara”), a technology-related company that provided conversion and tracking solutions to enhance on-line sales. During the fiscal years ended June 30, 2001 and 2002, the carrying value of this investment was deemed, by J Net’s management, impaired and written down. During the fiscal year ended June 30, 2003, J Net’s management concluded its ability to recover its investment was remote and wrote down the remaining carrying value to zero. On October 2, 2006, eStara’s stockholders approved the acquisition of its stock by Art Technology Group, Inc. (NASDAQ ticker symbol “ARTG”). Under the terms of the agreement, ARTG acquired all of the outstanding common stock, preferred stock, and vested and unvested stock options of eStara.
The Company, as a holder of preferred stock of eStara, received an amount per share equal to the original issue price, plus the amount of any accrued but unpaid cumulative dividends. Additionally, the Company was entitled to its approximately 5% proportionate share of remaining merger consideration. Accordingly, the Company received 2,431,577 common shares of ARTG and $267 thousand in cash. An additional $42 thousand of cash was held in escrow and released to the Company by the first anniversary of the closing. A final $31 thousand was realized during the quarter ended March 31, 2008 pursuant to the earn-out provisions set forth in the merger agreement. The resultant shares held by the Company were classified as Marketable securities on the Consolidated Balance Sheet in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The common shares received from ARTG were subject to a lock-up agreement pursuant to which the shares were released to the Company in equal monthly installments over a period of 12 months, which commenced January 2007.
For the fiscal year ended June 30, 2008, the Company sold approximately 1.4 million shares of ARTG and recorded realized gains of approximately $3.7 million. Upon sale, these gains were reclassified, in accordance with the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” from Accumulated other comprehensive income, a separate component of stockholders’ equity, to Realized gains on investments in the Consolidated Statement of Operations. As of June 30, 2008 the Company no longer held shares of ARTG.
For the fiscal year ended June 30, 2007, realized gains of $0.2 million and dividend income of $2.4 million were recognized for cash and common shares received as payment for the cumulative dividends on the eStara preferred stock. Additionally, the Company sold approximately 1.0 million shares of ARTG and recorded realized gains of approximately $1.5 million.
Strategic Data Corporation Transaction During the fiscal year ended June 30, 2000, J Net, the predecessor company to Epoch, made a $1.1 million investment in Strategic Data Corp. (“SDC”), a technology-related company that specialized in advertising optimization technology. During the fiscal year ended June 30, 2001, the carrying value of this investment was deemed to be impaired by J Net’s management and written down to zero.
On February 20, 2007, SDC’s stockholders approved the acquisition of its stock by Fox Interactive Media, Inc. (“FIM”). Under the terms of the agreement, FIM acquired all of the outstanding common stock, preferred stock, and vested and unvested stock options of SDC. As a result of the merger, the Company, as a holder of preferred stock of SDC, received an initial cash payment of approximately $2.2 million on March 22, 2007, which was recorded as realized gains of $1.6 million and dividend income of $0.6 million.
The SDC merger also calls for contingent payments, upon the achievement of certain targets and milestones, payable over a period of approximately 3.5 years from the closing, as well as release of an escrow fund. The Company’s share of additional contingent payments and escrow funds stemming from the acquisition ranges from zero to approximately $15.4 million.
The first target measurement date was November 2007 and the Company accrued approximately $344 thousand at that time. The Company received those proceeds during the quarter ended March 31, 2008. The second target measurement date was June 2008 and the Company has accrued an additional $200 thousand as of June 30, 2008, with proceeds received subsequently. Both amounts have been included in Realized gains on investments in the Consolidated Statement of Operations for the year ended June 30, 2008. No further amounts related to the contingent payments or escrow fund have been accrued as of June 30, 2008, as no such amounts are readily estimable or determinable at this time.
Tellme Corporation Transaction During the fiscal year ended June 30, 2001, J Net, the predecessor company to Epoch, made a $2.0 million preferred stock investment in Tellme Networks, Inc. (“Tellme”), a technology-related company that specialized in voice technologies. The investment in Tellme was reduced from $2.0 million to $157 thousand at June 1, 2004, in connection with the Company’s acquisition of EIP.
On March 12, 2007, Tellme announced an agreement by Microsoft Corporation (“Microsoft”) to acquire all of the outstanding common stock, preferred stock, and vested and unvested stock options of Tellme. This merger closed on April 30, 2007. As a result of the merger, the Company, as a holder of preferred stock of Tellme, received a cash payment of approximately $2.0 million during the quarter ended June 30, 2007. Accordingly, approximately $1.8 million was included in Realized gains on investments in the Consolidated Statement of Operations for the fiscal year ended June 30, 2007.
Critical Accounting Policies and Critical Accounting Estimates General The policies outlined below are critical to the Company’s operations and the understanding of the results of operations. The impact of these policies on operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect the reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, refer to Note 2 in the Notes to the Consolidated Financial Statements contained in this Annual Report on Form 10-K. Note that preparation of this Annual Report on Form 10-K requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates.
Revenue Recognition Investment advisory and management fees are recognized as services are provided, pursuant to specific terms contained in advisory or sub-advisory contracts between EIP and its clients. Such contracts generally call for revenue to be determined as a percentage of assets under management (“AUM”). Separate account fees are billed on a quarterly basis, in arrears, generally based on the account’s asset value at the end of a quarter. Fees for services performed for mutual funds under advisory and sub-advisory contracts are calculated based upon the daily net asset values of the respective fund, and are generally received in arrears. Advance payments, if received, are deferred and recognized during the periods for which services are provided.
The Company also has certain contracts which contain “incentive clauses” that allow the Company to earn performance fees in the event that investment returns meet or exceed targeted amounts specified in the contracts. Revenues for these incentives are recognized only when such performance targets are met or exceeded at the end of the contract’s year, typically at the end of each calendar year - the Company’s second fiscal quarter. Due to the inability to forecast financial markets, no revenues are recognized until the contract year ends, even when investment returns are exceeding the contractual targets within the contract year.
Share-Based Compensation Effective July 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Compensation (“SFAS 123R”), which requires employee and qualifying director share-based payments to be accounted for using the fair value method. The fair value of the Company’s restricted stock awards is based on the closing price of the Company’s common stock at the grant date. Share-based compensation costs related to equity instruments are charged against income ratably over the fixed vesting period for the related equity instruments, with the initial charge generally recorded in the first full month following the grant. The Company’s accounting treatment of restricted stock awards under SFAS 123R is consistent with that of the Company’s previous policies under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees and the pro forma disclosures required in accordance with SFAS 123, Accounting for Stock-Based Compensation.
Under the modified prospective method transition of SFAS 123R, compensation costs related to any non-vested portion of stock option awards outstanding at the adoption date are based on the grant date fair value of those awards. Since all stock options previously granted were fully vested prior to the adoption of SFAS 123R, there were no deferred compensation costs resulting from stock options to be accounted for on a prospective basis. There were no further stock options issued for all years presented.
Provision for (Benefit from) Income Taxes Management’s judgment is required in developing the Company’s provision for (benefit from) income taxes, including the determination of deferred tax assets and liabilities and any valuation allowances that might be required against net deferred tax assets. The Company’s ability to utilize accumulated net operating losses (“NOLs”) to their full extent prior to their expiration cannot be reasonably assured. Until a history of profitability can be achieved, and utilization of NOLs can be more definitive, the Company has provided a full valuation allowance on its accumulated NOLs and temporary differences for all years presented. The Company is obligated to pay tax under the federal AMT, which limits the application of net operating loss carry forwards to 90% of taxable income in addition to certain AMT adjustments.
Recently Issued Accounting Standards In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements. FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 at the beginning of its fiscal year commencing July 1, 2007. The adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position, results of operations, or cash flows.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier application permitted. The Company does not expect the adoption of this statement to have a material impact on its consolidated financial position, results of operations, or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits certain financial assets and financial liabilities to be measured at fair value, using an instrument-by-instrument election. The initial effect of adopting SFAS 159 must be accounted for as a cumulative effect adjustment to opening retained earnings for the fiscal year of adoption. Retrospective application to fiscal years preceding the effective date is not permitted. SFAS 159 is effective for the Company beginning July 1, 2008, although early adoption is permitted. The Company does not expect the adoption of this statement to have a material impact on its consolidated financial position, results of operations, or cash flows.
In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) in EITF Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (“EITF 06-11”). EITF 06-11 requires that the realized income tax benefit from dividends paid on nonvested equity-classified employee share-based payment awards that are charged to retained earnings be recorded as an increase to additional paid-in capital, rather than a reduction to tax expense. The amount recognized in additional paid-in capital for the realized income tax benefit from dividends on those awards should be included in the pool of excess tax benefits available to absorb tax deficiencies on share-based payment awards. EITF 06-11 applies prospectively to the income tax benefits on dividends paid on unvested common shares, for fiscal years beginning after December 15, 2007, with early adoption permitted. There were no dividends declared or paid on unvested common shares prior to the ratification of EITF 06-11. The Company paid a dividend in November 2007, February 2008, and May 2008 and has declared a dividend payable in August 2008. The Company is accounting for the tax benefits on all dividends declared on unvested common shares as an increase to additional paid-in capital, in accordance with EITF 06-11. The adoption of this pronouncement did not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (“SFAS 161”), which requires enhanced disclosures about an entity’s derivative and hedging activities. The effective date of SFAS 161 is the Company’s fiscal year beginning July 1, 2009. The Company does not currently engage in hedging or derivative transactions and, accordingly, does not expect the adoption of this pronouncement to have a material impact on its consolidated financial position, results of operations, or cash flows.
In June 2008, the FASB issued FASB Staff Position (“FSP”) EITF No. 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, Earnings per Share. The FSP requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. The FSP is effective for fiscal years beginning after December 15, 2008; earlier application is not permitted. The Company does not expect the adoption of FSP EITF No. 03-6-1 to have a material effect on its results of operations or earnings per share.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk Investment Advisory and Management Fees As noted in “Risk Factors” in Item 1A, the Company’s exposure to market risk is directly related to its role as an investment adviser for the mutual funds and separate accounts the Company manages. The revenues earned under these agreements are typically based on the market value of AUM which can be affected by changes in interest rates, fluctuations in financial markets, and fluctuations in foreign currency. Accordingly, a decline in the prices of securities may cause the Company’s revenue to decline by:
• causing the value of AUM to decrease, which would result in lower investment advisory and management fees.
• causing the Company’s clients to withdraw funds in favor of investments that they perceive as offering greater reward or lower risk, which would also result in lower investment advisory and management fees.
Underperformance of client accounts relative to competing products could intensify these factors.
Performance Fees Performance fee revenue is derived from certain separate accounts. The Company recorded performance fees of $0.2 million, $1.0 million, and $0.1 million for the fiscal years ended June 30, 2008, 2007, and 2006, respectively. Performance fees are specified in client contracts and are based on investment performance as compared to an established benchmark over a specified period of time. Performance fees are recognized at the end of the contractual period if the stated performance criteria are achieved. At June 30, 2008, less than 2% of assets under management were subject to performance fees.
Other Investments The Company is exposed to fluctuations in the market price of its Other investments presented on its Consolidated Balance Sheets. The total fair value of these Other investments as of June 30, 2008 was $4.0 million. The Company does not hedge its market risk related to these securities and does not intend to do so in the future.
At June 30, 2008, the Company performed sensitivity analysis to assess the potential loss in the fair value of these market-risk sensitive securities. The following table represents the estimated impact on the Company’s financial position assuming a hypothetical 10% decline in associated market indices (dollars in thousands):
(1) Investments in the Epoch mutual funds and the separate account of Epoch’s Global All Cap product are classified as available-for-sale securities. Unrealized losses on available-for-sale securities are excluded from earnings and recorded in other comprehensive income as a separate component of stockholders’ equity until realized. The investment in the Epoch Global Absolute Return Fund, LLC is accounted for using the equity method, under which the Company’s share of net realized and unrealized earnings or losses from the limited liability company is reflected in income.
Cash and Cash Equivalents Cash and cash equivalents are exposed to market risk due to changes in interest rates, which impacts interest income. The Company maintains its cash in institutions which have superior credit ratings. The Company consistently monitors the quality of the institution where its cash is deposited, the balance of which, at times, may be in excess of the FDIC insurance limits. Presently, the Company neither participates in hedging activities nor does it have any derivative financial instruments.
Item 8.
Item 8. Financial Statements and Supplementary Data The financial statements and supplementary financial information required by this Item, included in this Report in Item 15(a)(1) and (2), beginning on page, are listed in the Index to Financial Statements appearing on page and are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.
Item 9A.
Item 9A. Controls and Procedures Disclosure Controls and Procedures The Company has established and maintains disclosure controls and other procedures that are designed to ensure that material information relating to Epoch Holding Corporation and its subsidiaries on a consolidated basis required to be disclosed in its reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. For the fiscal year ended June 30, 2008, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective during the period covered by this report.
The Company has also established and maintains internal control over financial reporting as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States. In the ordinary course of business, the Company routinely enhances its internal controls and procedures for financial reporting by either upgrading its current systems or implementing new systems. Changes have been made to the Company’s internal controls and procedures for financial reporting as a result of these efforts. During the fiscal quarter ended June 30, 2008, there was no change in the Company’s internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Report of Management on Internal Control over Financial Reporting and the Report of Independent Registered Public Accounting Firm are set forth in the financial statements beginning on page hereof and are incorporated herein by reference.
Item 9B.
Item 9B. Other Information None.
PART III Item 10.
Item 10. Directors, Executive Officers and Corporate Governance Item 11.
Item 11. Executive Compensation Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence Item 14.
Item 14. Principal Accountant Fees and Services The information required by items 10, 11, 12, 13 and 14 are incorporated by reference from the definitive proxy statement for our 2008 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Exchange Act.
PART IV Item 15.
Item 15. Exhibits and Financial Statement Schedules (a) (1) and (2) Consolidated Financial Statements and Schedules.
For a list of the consolidated financial statements and consolidated financial statement schedules filed as a part of this Annual Report on Form 10-K, see “Index to Financial Statements, Supplementary Data and Financial Statement Schedules” on.
(a) (3) The exhibits filed and incorporated by reference are listed in the Index of Exhibits required by Item 601 of Regulation S-K at Item b below.
(b) Exhibits
(A) Incorporated by reference to Registrant’s Form 8-K dated June 3, 2004.
(B) Incorporated by reference to Registrant’s Form 8-K dated December 7, 2004.
(C) Incorporated by reference to Registrant’s Form 8-K dated July 12, 1994.
(D) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2003.
(E) Incorporated by reference to Registrant’s 1992 Proxy Statement.
(F) Incorporated by reference to Registrant’s Form 8-K dated September 14, 2004.
(G) Incorporated by reference to Registrant’s Form 8-K dated November 19, 2004.
(H) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2005.
(I) Incorporated by reference to Registrant’s Annual Report on Form 10-K/A for the fiscal year ended June 30, 2007.
(J) Incorporated by reference to Registrant’s Form 8-K dated November 9, 2006.
(K) Incorporated by reference to Registrant’s Form 8-K dated November 28, 2007.
(L) Incorporated by reference to Registrant’s Form 8-K dated April 2, 2008.
(M) Filed herewith.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS, SUPPLEMENTARY DATA
AND FINANCIAL STATEMENT SCHEDULES
[ITEMS 8 AND 15(a)]
(2) Supplementary Data:
Quarterly Financial Information (Unaudited) for the years ended June 30, 2008 and 2007.
Certain financial statement schedules are omitted because the required information is provided in the Consolidated Financial Statements or the notes thereto.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of the Company is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in conformity with accounting principles generally accepted in the United States of America.
There are inherent limitations in the effectiveness of internal control over financial reporting, including the possibility that misstatements may not be prevented or detected. Accordingly, even effective internal controls over financial reporting, no matter how well designed and operated, can provide only reasonable, not absolute, assurance with respect to financial statement preparation. Furthermore, the effectiveness of internal controls can change with circumstances.
Management has assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2008 based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework. Based on that assessment, management has concluded that, as of June 30, 2008, the Company’s internal control over financial reporting is effective.
CF & Co., L.L.P., an independent registered public accounting firm, has issued an attestation report on the effective operation of Epoch Holding Corporation and Subsidiaries’ internal control over financial reporting as of June 30, 2008. As stated in their report appearing herein, CF & Co., L.L.P. has expressed an unqualified opinion on the effective operation of internal control over financial reporting as of June 30, 2008.
September 15, 2008
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of
Epoch Holding Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Epoch Holding Corporation and Subsidiaries as of June 30, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended June 30, 2008. We also have audited Epoch Holding Corporation and Subsidiaries’ internal control over financial reporting as of June 30, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Epoch Holding Corporation and Subsidiaries’ management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management report on internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Epoch Holding Corporation and Subsidiaries as of June 30, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Epoch Holding Corporation and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of June 30, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ CF & Co., L.L.P.
CF & Co., L.L.P.
Dallas, Texas
September 15, 2008
EPOCH HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
The accompanying notes are an integral part of these consolidated financial statements.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Share Data)
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 1 - Organization Business: Epoch Holding Corporation (“Epoch” or the “Company”), a Delaware corporation, is a holding company whose sole line of business is investment advisory and investment management services. The operations of the Company are conducted through its wholly-owned subsidiary, Epoch Investment Partners, Inc. (“EIP”). EIP is a registered investment adviser under the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”). EIP provides investment advisory and investment management services to retirement plans, mutual funds, endowments, foundations and high net worth individuals. Headquartered in New York, NY with an office in Sherman Oaks, CA, the Company’s current product offerings include U.S. All Cap Value, U.S. Value, U.S. Smid (small/mid) Cap Value, U.S. Small Cap Value, U.S. Choice, Global Small Cap Value, Global Absolute Return, Global Choice, Global All Cap, International Small Cap, Balanced, and Global Equity Shareholder Yield.
Unless specifically stated otherwise, references to FY 2008, FY 2007 and FY 2006 refer to the fiscal years ended June 30, 2008, June 30, 2007, and June 30, 2006, respectively.
Company Structure: Operations commenced under the Company’s existing structure on June 2, 2004 when a subsidiary of J Net Enterprises, Inc. (“J Net,” whose name was subsequently changed to Epoch Holding Corporation in November 2004), merged with EIP. EIP was formed on April 14, 2004 and did not have a predecessor business.
Business Segments: The Company’s sole line of business is the investment advisory and investment management business. There are no other operating or reportable segments.
Note 2 - Summary of Significant Accounting Policies Principles of Consolidation and Basis of Presentation: The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications have been made to prior period financial statements to conform to the current period presentation.
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions. These estimates and assumptions impact the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of these consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.
Fair Value of Financial Instruments: The carrying value of the Company’s cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses approximates fair value due to their short-term nature. Marketable securities and other investments are carried at fair value based on quoted market prices.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 2 - Summary of Significant Accounting Policies - (continued) Financial Instruments with Concentration of Credit Risk: The financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments, and marketable securities. Epoch invests its cash and cash equivalents with high-credit quality financial institutions in amounts which, at times, may be in excess of the FDIC insurance limits. Cash is also invested in various high-grade, short-term liquid investments, thereby limiting exposure to concentrations of credit risk.
Cash Equivalents: Cash equivalents are liquid investments primarily comprising money market instruments with maturities of three months or less when acquired.
Short-term Investments: Short-term investments consisted of investment grade auction-rate securities with an active resale market and could be readily converted into cash to fund current operations, or satisfy other cash requirements as needed. During August and September 2007, in response to increasing credit quality concerns present in the fixed income securities market such as increasing mortgage defaults and delinquencies, tighter lending conditions, and severely constricted liquidity in the asset-backed commercial paper market, the Company liquidated all of its short-term investments. Proceeds from these liquidations were then invested in cash and cash equivalents. No gains or losses were realized from these liquidations.
Marketable Securities: Marketable securities are classified as available-for-sale and are carried at fair value based upon quoted market prices, with unrealized gains or losses, net of tax, reported in Accumulated Other Comprehensive Income, a separate component of stockholders’ equity. Realized gains and losses on the sales of these securities are calculated based on an average cost basis and reported in the Statement of Operations.
Property and Equipment: The costs of leasehold improvements are capitalized and such costs are amortized on a straight-line basis over the shorter of their estimated useful lives or lease term, as applicable. All other capital assets are recorded at cost and such costs are depreciated on a straight-line basis over their estimated useful lives. Generally, the useful lives are approximately 3 to 7 years for equipment, 1 to 3 years for purchased software, and 3 to 10 years for leasehold improvements and exclude option periods, if any. Repairs and maintenance are charged to expense as incurred. Upon sale or disposition of property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in operations.
Other Investments: During the fiscal year ended June 30, 2007 the Company made an initial investment of $750 thousand split equally into each of the three Company-sponsored mutual funds-the Epoch Global Equity Shareholder Yield Fund (“EPSYX”), the Epoch U.S. All Cap Equity Fund (“EPACX”), and the Epoch International Small Cap Fund (“EPIEX”). During the quarter ended December 31, 2007 the Company also made additional investments of $500 thousand in the Epoch Global Absolute Return Fund, LLC. and $3 million in a separate account of Epoch’s Global All Cap product. The Company intends to hold these investments for a period in excess of one year.
The investments in the Company-sponsored mutual funds and the separate account of Epoch’s Global All Cap Product are treated as available-for-sale securities and are carried at fair value based upon quoted market prices. Any resulting change in market value is recorded as unrealized gain or loss in Accumulated Other Comprehensive Income, a separate component of stockholders’ equity.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 2 - Summary of Significant Accounting Policies - (continued) EIP is also the managing member of the Epoch Global Absolute Return Fund, LLC, whose underlying assets consist of marketable securities. The Company’s investment in this entity is accounted for using the equity method, under which EIP’s share of the net earnings or losses from the limited liability company is reflected in other income as earned, and any distributions are reflected as reductions from the investment.
Treasury Stock: Treasury stock is accounted for under the cost method.
Revenue Recognition: Investment advisory and management fees are recognized as services are provided, pursuant to specific terms contained in advisory or sub-advisory contracts between EIP and its clients. Such contracts generally call for revenue to be determined as a percentage of assets under management (“AUM”). Separate account fees are billed on a quarterly basis, in arrears, generally based on the account’s asset value at the end of a quarter. Fees for services performed for mutual funds under advisory and sub-advisory contracts are calculated based upon the daily net asset values of the respective fund, and are generally received in arrears. Advance payments, if received, are deferred and recognized during the periods for which services are provided.
The Company also has certain contracts which contain “incentive clauses” that allow the Company to earn performance fees in the event that investment returns meet or exceed targeted amounts specified in the contracts. Revenues for these incentives are recognized only when such performance targets are met or exceeded at the end of the contract’s year, typically at the end of each calendar year - the Company’s second fiscal quarter. Due to the inability to forecast financial markets, no revenues are recognized until the contract year ends, even when investment returns are exceeding the contractual targets within the contract year.
Share-Based Compensation: Employee and qualifying director share-based payments are accounted for in accordance with Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Compensation (“SFAS 123R”) using the fair value method. The fair value of the Company’s restricted stock awards is based on the closing price of the Company’s common stock at the grant date. Share-based compensation costs related to equity instruments are charged against income ratably over the fixed vesting period for the related equity instruments, with the initial charge generally recorded in the first full month following the grant. All outstanding stock options were fully vested prior to the adoption of SFAS 123R, accordingly there were no additional compensation costs related to any non-vested stock options required to be recorded at that time. There were no additional stock options issued for the periods presented.
Income Taxes: The Company accounts for income taxes in accordance with Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes (“SFAS 109”). SFAS 109 requires that deferred tax assets and liabilities arising from temporary differences between book and tax basis be recognized using the enacted statutory tax rates and laws that will be in effect when such differences are expected to reverse. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years. Deferred tax liabilities are recognized for temporary differences that will result in taxable income in future years. In the case of deferred tax assets, SFAS 109 requires a reduction in deferred tax assets if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
Any potential interest and penalties associated with a tax contingency, should one arise, would be included as a component of income tax expense in the period in which the assessment arises.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 2 - Summary of Significant Accounting Policies - (continued) Earnings (Loss) per Common Share: Basic earnings (loss) per share (“EPS”) is calculated by dividing net earnings (loss) applicable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted EPS includes the determinants of basic EPS and, in addition, reflects the dilutive effect, if any, of the common stock deliverable pursuant to stock options, or the common stock issuable upon the conversion of the convertible preferred stock.
Comprehensive Income (Loss): Total comprehensive income (loss) is reported on the Consolidated Statement of Stockholder’s Equity and includes net income (loss) and, for investment securities available-for-sale, the change in unrealized gains (losses) and the reclassification of realized gains (losses) to net income.
Recently Issued Accounting Standards In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements. FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 at the beginning of its fiscal year commencing July 1, 2007. The adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position, results of operations, or cash flows.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier application permitted. The Company does not expect the adoption of this statement to have a material impact on its consolidated financial position, results of operations, or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits certain financial assets and financial liabilities to be measured at fair value, using an instrument-by-instrument election. The initial effect of adopting SFAS 159 must be accounted for as a cumulative effect adjustment to opening retained earnings for the fiscal year of adoption. Retrospective application to fiscal years preceding the effective date is not permitted. SFAS 159 is effective for the Company beginning July 1, 2008, although early adoption is permitted. The Company does not expect the adoption of this statement to have a material impact on its consolidated financial position, results of operations, or cash flows.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 2 - Summary of Significant Accounting Policies - (continued) In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) in EITF Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (“EITF 06-11”). EITF 06-11 requires that the realized income tax benefit from dividends paid on nonvested equity-classified employee share-based payment awards that are charged to retained earnings be recorded as an increase to additional paid-in capital, rather than a reduction to tax expense. The amount recognized in additional paid-in capital for the realized income tax benefit from dividends on those awards should be included in the pool of excess tax benefits available to absorb tax deficiencies on share-based payment awards. EITF 06-11 applies prospectively to the income tax benefits on dividends paid on unvested common shares, for fiscal years beginning after December 15, 2007, with early adoption permitted. There were no dividends declared or paid on unvested common shares prior to the ratification of EITF 06-11. The Company paid a dividend in November 2007, February 2008, and May 2008 and has declared a dividend payable in August 2008. The Company is accounting for the tax benefits on all dividends declared on unvested common shares as an increase to additional paid-in capital, in accordance with EITF 06-11. The adoption of this pronouncement did not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (“SFAS 161”), which requires enhanced disclosures about an entity’s derivative and hedging activities. The effective date of SFAS 161 is the Company’s fiscal year beginning July 1, 2009. The Company does not currently engage in hedging or derivative transactions and, accordingly, does not expect the adoption of this pronouncement to have a material impact on its consolidated financial position, results of operations, or cash flows.
In June 2008, the FASB issued FASB Staff Position (“FSP”) EITF No. 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, Earnings per Share. The FSP requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. The FSP is effective for fiscal years beginning after December 15, 2008; earlier application is not permitted. The Company does not expect the adoption of FSP EITF No. 03-6-1 to have a material effect on its results of operations or earnings per share.
Note 3 - Accounts Receivable The Company’s accounts receivable balances do not include an allowance for doubtful accounts and there have been no bad debt expenses recognized during the fiscal years ended June 30, 2008, 2007 and 2006, respectively. Management believes these receivables are fully collectible.
Significant Customers and Contracts: For the fiscal year ended June 30, 2008, CI Investments Inc. (“CI”), a Canadian-owned investment management company, accounted for approximately 16% of consolidated revenues, while Genworth Financial Asset Management, Inc. (“Genworth”), an investment adviser, through its investments in the Epoch International Small Cap Fund (“EPIEX”) and the Epoch Global Equity Shareholder Yield Fund (“EPSYX”), as well as separate account mandates, accounted for approximately 25% of consolidated revenues. The Company’s services and relationships with these clients are important to the Company’s ongoing growth strategy, and retention of these customers is significant to the ongoing results of operations of the Company.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 3 - Accounts Receivable - (continued) During FY 2007, CI accounted for approximately 17% of FY 2007 consolidated revenues while Genworth accounted for approximately 24%. During FY 2006, CI accounted for approximately 22% of FY 2006 consolidated revenues while Genworth accounted for approximately 20%
Note 4 - Property and Equipment As of June 30, 2008 and 2007, property and equipment consisted of the following (dollars in thousands):
Note 5 - Significant Transactions (a) eStara Transaction During the fiscal year ended June 30, 2000, J Net Enterprises, Inc. (“J Net”), the predecessor company to Epoch, made a $4.0 million preferred stock investment in eStara, Inc. (“eStara”), a technology-related company that provided conversion and tracking solutions to enhance on-line sales. During the fiscal years ended June 30, 2001 and 2002, the carrying value of this investment was deemed, by J Net’s management, impaired and written down. During the fiscal year ended June 30, 2003, J Net’s management concluded its ability to recover its investment was remote and wrote down the remaining carrying value to zero. On October 2, 2006, eStara’s stockholders approved the acquisition of its stock by Art Technology Group, Inc. (NASDAQ ticker symbol “ARTG”). Under the terms of the agreement, ARTG acquired all of the outstanding common stock, preferred stock, and vested and unvested stock options of eStara.
The Company, as a holder of preferred stock of eStara, received an amount per share equal to the original issue price, plus the amount of any accrued but unpaid cumulative dividends. Additionally, the Company was entitled to its approximately 5% proportionate share of remaining merger consideration. Accordingly, the Company received 2,431,577 common shares of ARTG and $267 thousand in cash. An additional $42 thousand of cash was held in escrow and released to the Company by the first anniversary of the closing. A final $31 thousand was realized during the quarter ended March 31, 2008 pursuant to the earn-out provisions set forth in the merger agreement. The resultant shares held by the Company were classified as Marketable securities on the Consolidated Balance Sheet in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The common shares received from ARTG were subject to a lock-up agreement pursuant to which the shares were released to the Company in equal monthly installments over a period of 12 months, which commenced January 2007.
For the fiscal year ended June 30, 2008, the Company sold approximately 1.4 million shares of ARTG and recorded realized gains of approximately $3.7 million. Upon sale, these gains were reclassified, in accordance with the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” from Accumulated other comprehensive income, a separate component of stockholders’ equity, to Realized gains on investments in the Consolidated Statement of Operations. As of June 30, 2008 the Company no longer held shares of ARTG.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 5 - Significant Transactions - (continued) For the fiscal year ended June 30, 2007, realized gains of $0.2 million and dividend income of $2.4 million were recognized for cash and common shares received as payment for the cumulative dividends on the eStara preferred stock. Additionally, the Company sold approximately 1.0 million shares of ARTG and recorded realized gains of approximately $1.5 million.
(b) Strategic Data Corporation transaction During the fiscal year ended June 30, 2000, J Net, the predecessor company to Epoch, made a $1.1 million investment in Strategic Data Corp. (“SDC”), a technology-related company that specialized in advertising optimization technology. During the fiscal year ended June 30, 2001, the carrying value of this investment was deemed to be impaired by J Net’s management and written down to zero.
On February 20, 2007, SDC’s stockholders approved the acquisition of its stock by Fox Interactive Media, Inc. (“FIM”). Under the terms of the agreement, FIM acquired all of the outstanding common stock, preferred stock, and vested and unvested stock options of SDC. As a result of the merger, the Company, as a holder of preferred stock of SDC, received an initial cash payment of approximately $2.2 million on March 22, 2007, which was recorded as realized gains of $1.6 million and dividend income of $0.6 million.
The SDC merger also calls for contingent payments, upon the achievement of certain targets and milestones, payable over a period of approximately 3.5 years from the closing, as well as release of an escrow fund. The Company’s share of additional contingent payments and escrow funds stemming from the acquisition ranges from zero to approximately $15.4 million.
The first target measurement date was November 2007 and the Company accrued approximately $344 thousand at that time. The Company received those proceeds during the quarter ended March 31, 2008. The second target measurement date was June 2008 and the Company has accrued an additional $200 thousand as of June 30, 2008, with proceeds received subsequently. Both amounts have been included in Realized gains on investments in the Consolidated Statement of Operations for the year ended June 30, 2008. No further amounts related to the contingent payments or escrow fund have been accrued as of June 30, 2008, as no such amounts are readily estimable or determinable at this time.
(c) Tellme Corporation Transaction: During the fiscal year ended June 30, 2001, J Net, the predecessor company to Epoch, made a $2.0 million preferred stock investment in Tellme Networks, Inc. (“Tellme”), a technology-related company that specialized in voice technologies. The investment in Tellme was reduced from $2.0 million to $157 thousand at June 1, 2004, in connection with the Company’s acquisition of EIP.
On March 12, 2007, Tellme announced an agreement by Microsoft Corporation (“Microsoft”) to acquire all of the outstanding common stock, preferred stock, and vested and unvested stock options of Tellme. This merger closed on April 30, 2007. As a result of the merger, the Company, as a holder of preferred stock of Tellme, received a cash payment of approximately $2.0 million during the quarter ended June 30, 2007. Accordingly, approximately $1.8 million was included in Realized gains on investments in the Consolidated Statement of Operations for the fiscal year ended June 30, 2007.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 6 - Marketable Securities and Other Investments The Company’s marketable securities and other investments at June 30, 2008 and 2007 are summarized as follows (in thousands):
Investments in the Epoch mutual funds and the separate account of Epoch’s Global All Cap product are classified as available-for-sale securities. Unrealized losses on available-for-sale securities are excluded from earnings and recorded in other comprehensive income as a separate component of stockholders’ equity until realized. The investment in the Epoch Global Absolute Return Fund, LLC is accounted for using the equity method, under which the Company’s share of net realized and unrealized earnings or losses from the limited liability company is reflected in income.
Proceeds from the sale of available-for-sale securities totaled $5.1 million and $6.2 million for the years ended June 30, 2008 and 2007, respectively.
Note 7 - Accounts Payable and Accrued Liabilities Accounts payable and accrued liabilities consisted of the following (in thousands):
Note 8 - Commitments and Contingencies Employment Agreements: The Company entered into a three-year employment agreement with its Chief Executive Officer in November 2007, effective January 1, 2008. The agreement calls for a base annual salary of $350 thousand and bonus compensation in accordance with the Company’s bonus and incentive compensation plans then in effect. The agreement was reviewed and approved by the Company’s Compensation Committee and the Board of Directors.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 8 - Commitments and Contingencies - (continued) There are no employment contracts with any other employees or officers of the Company. There are written agreements with certain employees, which provide for sales commissions or bonuses, subject to the attainment of certain performance criteria or continuation of employment. Such commitments under the various agreements total approximately $1.6 million at June 30, 2008. Of this amount, approximately $0.9 million is included in accrued compensation and benefits in the Consolidated Balance Sheet at June 30, 2008. An additional $0.2 million will be accrued during the fiscal year ended June 30, 2009. Approximately $0.5 million represents restricted stock awards to be issued during the fiscal year ending June 30, 2009.
Common Stock Repurchase Plan: On June 24, 2008, the Company’s Board of Directors approved the repurchase of up to a maximum of 250,000 shares, or just over 1% of the Company’s fully diluted outstanding common stock. The repurchase plan calls for the repurchases to be made in the open market and/or in privately negotiated transactions from time to time in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended, subject to prevailing market and business conditions. The plan does not obligate the Company to purchase any particular number of shares, and may be suspended or discontinued at any time. The repurchase plan will expire on June 30, 2009. During the fiscal year ended June 30, 2008, the Company repurchased 8,900 shares at a weighted average price of $9.25.
Legal Matters: From time to time, the Company or its subsidiaries may become parties to claims, legal actions and complaints arising in the ordinary course of business. Management is not aware of any matters which would have a material adverse effect on its consolidated financial statements.
Leases: The Company’s primary headquarters and operations are located in New York, NY. Business is conducted at a location with approximately 10,000 square feet under a long-term lease that expires in September 2015. To accommodate for the growth in business, the Company entered into a sublease agreement for an additional 3,100 square feet at its Company headquarters effective February 1, 2007. This lease expires in June 2010.
The Company is also the primary party to another lease in New York, NY with approximately 8,500 square feet, which expires in November 2010. This property is subleased to an unrelated third party. While the Company remains responsible for obligations under the lease, the sublease income, net of profit sharing with the landlord, more than offsets the Company’s obligations under this lease. The subtenant has performed its obligations under the sublease agreement and the Company is not aware of any credit issues with the subtenant. As of June 30, 2008, the remaining future minimum payments under this lease total $1.2 million. Future minimum receipts from the subtenant, net of profit sharing with the landlord, slightly exceed $1.2 million as of June 30, 2008.
The Company also has an office lease in Sherman Oaks, CA with an annual option to renew. The obligations under this lease are minimal.
Total rental expenses for the Company’s continuing operations were $1.4 million, $1.2 million and $1.1 million for the fiscal years ended June 30, 2008, 2007 and 2006, respectively. Rental income under the sublease, net of profit sharing expenses with the primary landlord were $545 thousand, $559 thousand and $570 thousand for the fiscal years ended June 30, 2008, 2007 and 2006, respectively.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 8 - Commitments and Contingencies - (continued) The following table outlines the minimum annual office lease obligations of the Company and related sub-lease receipts (dollars in thousands):
Investment Management Contracts: Most of the Company’s revenues are derived pursuant to written investment advisory and management agreements. These agreements may be terminated by either party with notice or terminated in the event of an “assignment” (as defined in the Investment Company Act of 1940 as amended (the “1940 Act”)). Generally, any change in control of the Company would constitute an “assignment” under the 1940 Act. Additionally, mutual fund agreements generally must be approved and renewed annually.
Note 9 - Preferred Stock On November 6, 2006, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with General American Investors Company, Inc. (“GAM” or the “Purchaser”), whereby GAM invested $10 million in Epoch and Epoch issued GAM 10,000 shares of Series A Convertible Preferred Stock (the “Series A Preferred Stock”).
Stock issuance costs of $89 thousand were for legal and accounting services. No placement or other broker fees were paid in connection with this transaction.
The Series A Preferred Stock had an annual cumulative cash dividend of 4.60%, payable semi-annually on June 30 and December 31, commencing December 31, 2006. These securities were convertible, in whole or in part at any time, into shares of the Company’s common stock at a fixed conversion price of $6.00 per share, or 1,666,667 common shares in total.
The conversion price of $6.00 per common share contained a beneficial conversion feature of $0.42 per share to the November 6, 2006 closing price of $6.42. This beneficial conversion feature of $0.7 million, which is the difference between the above closing price and the conversion price, was fully amortized through Retained earnings (accumulated deficit) at the date of closing. A corresponding amount was credited to Additional paid-in capital.
The holders of the Series A Preferred Stock had voting rights equivalent to the holders of the Company’s common stock, and were entitled to vote on an as-converted basis (1,666,667 shares) with the holders of the common stock together as a single class. The Series A Preferred Stock also provided for customary preference upon a Liquidation, as defined in the Certificate of Designation.
On July 1, 2008, the holder converted the Preferred Stock to 1,666,667 shares of Common Stock. Accordingly, the Series A Convertible Preferred Stock has been cancelled and the conversion eliminates the holder’s rights to receive the semi-annual dividends on the Preferred Stock.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 9 - Preferred Stock - (continued) Prior to conversion, the number of shares of common stock issuable upon the conversion of the Series A Preferred Stock has no effect on the Company’s basic earnings per share calculation, but is included in its diluted earnings per share calculation. Upon conversion, the issuable shares of common stock shall be included in the calculation of both the basic and diluted earnings per share.
Note 10 - Long-Term Incentive Compensation 2004 Omnibus Long-Term Incentive Compensation Plan: At the annual meeting of shareholders on November 18, 2004, stockholders approved the 2004 Omnibus Long-Term Incentive Compensation Plan (the “2004 Plan”). The 2004 Plan allows the Company to issue 3,000,000 shares of common stock subject to stock options, restricted stock awards or other share-based compensation. The Plan terminates at the earliest of (a) the time no shares remain available for issuance under the Plan, (b) the Plan is terminated by the Board, or (c) the tenth anniversary of the Effective Date. Awards outstanding upon expiration of the Plan remain in effect until they have been exercised or terminated, or have expired. Restricted stock awards issued to employees under the 2004 Plan vest at the rate of 12.5% immediately and remaining amounts vest at the rate of 12.5%, 25%, and 50% upon the completion of the first, second, and third years of service, respectively. During fiscal year ended June 30, 2008, a total of 491,528 shares of restricted stock were issued to employees of the Company under the Company’s 2004 Plan at a weighted average price of $11.47, while 695,893 and 838,906 shares, respectively were issued during fiscal years ended June 30, 2007 and 2006 at weighted average prices of $6.13 and $4.64 per share, respectively. At June 30, 2008 there were 2,335,174 shares issued and 664,826 shares available for issuance under this Plan.
Subsequent to June 30, 2008, the Company granted 190,605 shares of restricted stock to employees at a weighted average price of $11.45 per share.
In FY 2008, non-employee directors received $80,000 for their services. Non-employee director compensation is paid with a minimum of $60,000 in stock and a maximum of $20,000 in cash, at the election of the director. Total shares issued to non-employee directors for FY 2008 were 35,604 shares at a weighted average price of $13.39. These shares vest fully in one year. For FY 2007, non-employee directors of the Company received common stock equal to $50,000 for their services. Total shares issued to non-employee directors for FY 2007 were 66,228 shares at a weighted average price of $5.08.
Subsequent to June 30, 2008, 38,620 shares were issued to non-employee directors at a weighted average price of $9.10 in advance of FY 2009 services.
A summary of the status of the Company’s nonvested shares under the 2004 Plan and the Merger Agreement, as of June 30, 2008, 2007, and 2006 respectively, as well as changes during the years ended June 30, 2008, 2007, and 2006 is presented below (shares in thousands):
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 10 - Long-Term Incentive Compensation - (continued) As of June 30, 2008, there was $5.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 2.1 years. The total intrinsic value of restricted stock awards vested during the years ended June 30, 2008, 2007 and 2006 was $5.9 million, $1.3 million and $0.6 million, respectively. Total compensation cost for restricted stock awards recognized in income during the years ended June 30, 2008, 2007 and 2006, was $4.2 million, $6.3 million and $4.7 million, respectively.
The aggregate intrinsic value of nonvested shares at June 30, 2008 was $11.2 million.
Expired Stock Option Plans: On January 12, 1993, J Net’s stockholders approved the 1992 Incentive and Non-qualified Stock Option Plan (the “1992 Plan”). On August 17, 1994, the Board adopted certain amendments (the “Amendments”) to the 1992 Plan which were approved by J Net’s stockholders on January 10, 1995. The Amendments increased the number of shares of J Net’s common stock authorized for issuance pursuant to the 1992 Plan from 1,045,000 to 2,545,000. The 1992 Plan terminated in accordance with its terms on September 30, 2002. Options outstanding at the termination date totaled 877,500. Although the 1992 Plan has expired, the issued and outstanding options remain in force until they are exercised, cancelled or expire. Options outstanding under the 1992 stock option plan are summarized below as follows (shares in thousands):
The intrinsic value of options exercised during FY 2007 and FY 2006 was approximately $0.3 million and $22 thousand, respectively.
The following table summarizes information about the 1992 Plan stock options outstanding at June 30, 2008 (shares in thousands):
The intrinsic value of outstanding options under the above plan at June 30, 2008 was $0.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 10 - Long-Term Incentive Compensation - (continued) Other Nonqualified Stock Options: On September 14, 1999, nonqualified stock options to purchase an aggregate of 140,000 shares of common stock were granted to the J Net Board of Directors and a non-employee then serving as the Secretary at an exercise price of $9.00 per share, the fair market value on the date of grant. The options vested 50% on each of the first and second anniversaries of the date of grant and expire ten years from the date of grant. On October 31, 2001, a total of 30,000 options were cancelled as a result of a director’s resignation.
On June 21, 2000, nonqualified stock options to purchase an aggregate of 500,000 shares of common stock were granted to the former President and Chief Operating Officer and the former Executive Vice President and Chief Financial Officer at an exercise price of $13.13 per share, the fair market value on the date of the grant. The options vested in thirds on each of the first, second and third anniversaries of the date of grant and expire ten years from the date of the grant. As of June 30, 2003, all the options were exercisable. On June 21, 2003, the former President and Chief Operating Officer and the former Executive Vice President and Chief Financial Officer’s employment contracts expired and were not renewed. The expiration of those contracts did not affect the expiration of the options, which expire on June 21, 2010.
There were no nonqualified options granted during the fiscal years ended June 30, 2008, 2007 and 2006, respectively.
Changes in nonqualified options outstanding are summarized below (shares in thousands):
The following table summarizes information about the nonqualified stock options outstanding at June 30, 2008 (shares in thousands):
The intrinsic value of outstanding options under the above plan at June 30, 2008 was $8 thousand.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 11 - Defined Contribution Plan The Company sponsors a defined contribution plan (the “Plan”) for all of its employees. The Plan qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Plan, participating employees may defer up to 60% of their pre-tax gross wages, subject to annual Internal Revenue Code contribution limits. Employees vest immediately in their contributions. The Plan allows the Company to make discretionary contributions. The Company made contributions of approximately $123 thousand and $84 thousand, respectively, to the Plan during FY 2008 and FY 2007. These annual Company contributions vest immediately. The Company intends to contribute to the Plan on an annual basis.
Note 12 - Other Income In November 2000, J Net, the predecessor company to Epoch, recorded an accrued liability related to a sale of certain assets to an unrelated third party. The recorded amount of $950 thousand represented management’s best estimate of additional settlement amounts due. In late November 2006, a final assessment was made by management which resulted in the reversal of the previously recorded accrual. This amount is included in “Interest and other income” on the statement of operations for FY 2007.
Note 13 - Income Taxes The Company files a consolidated U.S. federal income tax return reflecting the income (loss) of Epoch Holding Corporation and its subsidiaries. The components of the provision for (benefit from) income tax are as follows (dollars in thousands):
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 13 - Income Taxes - (continued) The Company’s effective income tax rate for the years ended June 30, 2008, 2007 and 2006 differs from the amount computed using income before income taxes and applying the U.S. federal income tax rate to such amounts because of the effect of the following items:
In accordance with SFAS 109, deferred tax assets should be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The future realization of the Company’s deferred tax assets depends upon the availability of sufficient future taxable income. In making this determination, the Company considers all available positive and negative evidence. The Company considers, among other things, the overall business environment, the Company’s historical earnings including significant pretax losses since inception, and industry outlook.
The Company released a valuation allowance during the current fiscal year against certain deferred tax assets, primarily deferred stock compensation expense and compensation accruals, as management estimates that these benefits can, more likely than not, be utilized in the future. As a result of the Company’s limited earnings history, a valuation allowance remains on certain other deferred tax assets. The Company will assess the need for a deferred tax asset valuation allowance on an ongoing basis considering the factors mentioned above as well as other relevant criteria.
In the prior fiscal year, the Company reversed a valuation allowance primarily as a result of the application of net operating loss carryfowards, to reduce current taxable income to zero, as well as to reflect changes in other temporary items.
InterWorld Corporation, an inactive subsidiary, completed bankruptcy proceedings in FY 2006. This investment had been written down to zero in prior years for financial reporting purposes. For tax purposes, this built-in loss was recognized at the time of bankruptcy completion in FY 2006. A significant portion of the built-in loss resulting from this bankruptcy is disallowed under section 382 of the Internal Revenue Code (“IRC”).
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 13 - Income Taxes - (continued) Deferred income taxes are provided for the effects of temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements. These temporary differences will result in future income or deductions for income tax purposes and are measured using the federal enacted rate together with the state and local enacted tax rates, net of federal benefit that will be in effect when such items are expected to reverse. The Company has recorded a valuation allowance for certain deferred tax assets, as, based upon currently available evidence, it is more likely than not that these tax benefits may not be realized. Significant components of the Company’s deferred income tax assets and liabilities are as follows (dollars in thousands):
The Company has $10.9 million of acquired NOLs which expire between 2022 and 2026, arising from the reverse merger business combination with EIP on June 2, 2004. As a result of a greater than 50% change in ownership, the ability to utilize certain NOLs became limited. These limitations are covered by Section 382 of the IRC. IRC Section 382 limits the annual utilization of NOLs accumulated prior to the ownership change to a percentage of the acquired entity’s fair value at the time of the change in ownership. Such NOLs can be utilized by the Company against taxable income only at a rate of approximately $600 thousand per year due to the these limitations. The Company also has $1.2 million of acquired alternative minimum tax credits from the reverse merger.
Certain tax benefits associated with the Company’s employee share-based compensation are recorded directly in Stockholders’ equity. Stockholders’ equity increased by approximately $1.6 million as a result of these tax benefits for the fiscal year ended June 30, 2008. No such benefits were realized for fiscal years ended June 30, 2007 and 2006, respectively.
The Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, on July 1, 2007, which sets forth a specific method for the financial statement measurement of a tax position taken or expected to be taken on a tax return. The adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position, results of operations, or cash flows.
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 14 - Earnings (Loss) per Share Basic earnings (loss) per share is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during each period.
Diluted earnings per share is computed by dividing net earnings, adjusted for the effect of dilutive securities, by the weighted average number of common and common equivalent shares outstanding during the period. The Company had 1,035,000, 1,035,000 and 1,130,000 issued and outstanding stock options at June 30, 2008, 2007, and 2006 respectively. The calculation of earnings (loss) per share excluded 510,000, 960,000 and 1,130,000 issued and outstanding stock options, at June 30, 2008, 2007, and 2006, respectively as the exercise price of these options was higher than the average market price of the common stock, for the respective periods presented. The conversion of those particular options, whose exercise price was higher than the average market price of the common stock during the respective period, would have an anti-dilutive effect.
The 1,666,667 shares of common stock issuable upon conversion of the preferred stock has no effect on basic earnings per share, but has been included in the calculation of diluted earnings per share for the fiscal year ended June 30, 2008. Upon conversion, the issuable shares of common stock will be included in the calculation of both basic and diluted earnings per share.
The table below presents the computation of basic and diluted earnings (loss) per share for the years ended June 30 2008, 2007, and 2006 respectively:
(In Thousands Except per Share Data)
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 15 - Subsequent Events On July 1, 2008, the holder of the 10,000 shares of Series A Convertible Preferred Stock (“the Preferred Stock”) outstanding, with a face value of $10,000,000, converted the Preferred Stock to 1,666,667 shares of Common Stock. Accordingly, the Series A Convertible Preferred Stock has been cancelled and the conversion eliminates the holder’s rights to receive the semi-annual dividends on the Preferred Stock. See Note 9.
On July 9, 2008, the Company declared a quarterly cash dividend of $0.03 per share on common stock payable on August 15, 2008 to all shareholders of record at the close of business on July 31, 2008. The total dividend paid was approximately $665 thousand.
Note 16 - Quarterly Financial Data (Unaudited) The table below presents selected quarterly financial data for fiscal years ended June 30, 2008 and 2007, respectively. The data presented should be read in conjunction with the consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein (in Thousands, Except per Share and AUM Data);
EPOCH HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended June 30, 2008, 2007, and 2006 Note 16 - Quarterly Financial Data (Unaudited) - (continued)