Business Context and Reporting Period
SEI Investments Company provides investment processing, investment management and investment operations solutions to financial institutions, advisors, institutional investors, investment managers and ultra-high-net-worth families globally. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
As of September 30, 2017, SEI managed, advised or administered approximately $845.2 billion of client assets, including $325.0 billion under management and $515.6 billion under administration. LSV Asset Management, an unconsolidated affiliate, accounted for $101.9 billion of assets under management.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | Change | Nine Months 2017 | Nine Months 2016 | Change |
|---|---|---|---|---|---|---|
| Total revenue | $386.0 million | $354.6 million | +9% | $1,118.3 million | $1,032.7 million | +8% |
| Income from operations | $99.2 million | $97.2 million | +2% | $290.0 million | $277.6 million | +4% |
| Net income | $101.7 million | $86.7 million | +17% | $282.2 million | $245.2 million | +15% |
| Diluted EPS | $0.63 | $0.53 | +19% | $1.74 | $1.49 | +17% |
| Operating margin | 25.7% | 27.4% | Down 170 bps | 25.9% | 26.9% | Down 100 bps |
| Net margin | 26.4% | 24.5% | Up 190 bps | 25.2% | 23.7% | Up 150 bps |
Revenue growth was led by asset management, administration and distribution fees, which increased 10% in the third quarter and 10% for the nine-month period. Information processing and software servicing fees increased 6% in the third quarter and 4% year to date. Transaction-based and trade execution fees declined 17% and 20%, respectively.
Equity in earnings of LSV increased 21% to $39.3 million in the third quarter and 19% to $109.2 million for the first nine months. The nine-month effective tax rate declined to 30.2% from 34.7%, primarily because of the adoption of ASU 2016-09 and the expiration of certain tax statutes of limitation.
Cash Flow, Liquidity and Capitalization
- Operating cash flow was $316.4 million for the first nine months of 2017, compared with $289.4 million in the prior-year period.
- Investing cash flow used $148.1 million, including $80.1 million of net cash paid for the Archway acquisition and $48.6 million of capitalized software development.
- Financing cash flow used $193.7 million, including $186.5 million for share repurchases and $88.9 million of dividends, partially offset by $40.0 million of revolving-credit borrowings and $41.6 million of stock-option proceeds.
- Cash and cash equivalents were $685.0 million at September 30, 2017, compared with $695.7 million at December 31, 2016.
- Revolving-credit borrowings were $40.0 million at September 30, 2017. The facility provides total capacity of $300.0 million and expires in June 2021. After a $10.0 million repayment in October 2017, $270.0 million was available for general corporate purposes as of October 19, 2017.
- Management reported $284.9 million of cash that was free and immediately accessible for general corporate purposes as of October 19, 2017. Certain subsidiary and foreign cash balances may be restricted or less readily available.
- SEI repurchased 3.5 million shares for $188.3 million during the first nine months. The repurchase authorization was increased by $200.0 million on October 24, 2017, leaving approximately $230.5 million available.
Material Changes Versus the Prior Comparable Period
- Assets under management, advisement and administration increased 12% year over year to $845.2 billion at September 30, 2017. Average assets under management, advisement and administration increased 14% for the first nine months.
- Investment Advisors revenue increased 13% year to date and operating profit increased 17%, supported by higher assets and positive client flows.
- Investment Managers revenue increased 18% year to date and operating profit increased 18%, including $5.0 million of third-quarter revenue from Archway.
- Private Banks operating profit declined 67% year to date and its operating margin fell to 3% from 9%, primarily because of higher Wealth Platform maintenance, support, personnel and amortization costs, lower trade-execution fees and client losses.
- Institutional Investors operating profit increased 3% year to date, while its operating margin declined to 50% from 51% because of higher direct and personnel costs and lower average basis points earned.
- Stock-based compensation expense increased to $19.5 million from $12.0 million for the first nine months, primarily reflecting awards granted in late 2016.
- SEI acquired Archway Technology Partners and related entities on July 3, 2017, for $81.5 million in cash consideration, with up to $8.0 million of contingent consideration. The purchase accounting remains preliminary.
- The prior-year period included a $2.8 million gain from the final contingent payment related to the sale of SEI Asset Korea; no comparable gain was recorded in 2017.
Guidance, Outlook, Commentary and Risks
The filing does not provide formal quantitative earnings or revenue guidance. Management expressed a favorable view of the SEI Wealth Platform, citing market acceptance of its full-service outsourcing and software-as-a-service offerings. Regions Bank began operating on the Platform in early October 2017, and the Wells Fargo conversion was reported to be progressing as expected.
SEI was reassessing the useful lives of certain Platform components. Based on its preliminary assessment, quarterly amortization expense related to components already in use was expected to decline by approximately $3.0 million to $5.0 million beginning in the fourth quarter of 2017. This estimate excludes $27.3 million of in-progress Platform software costs.
Management expects to adopt the revenue recognition standard, ASU 2014-09, in the first quarter of 2018, with significant effects on disclosures, business processes and internal controls. The timing of recognition for implementation, fund conversion and ancillary fees remained under evaluation, and the filing states that contract costs may be capitalized and amortized under the new standard.
- Revenue and earnings remain sensitive to capital-market levels, asset flows, investment performance and the results of LSV.
- Foreign currency movements affect reported results; approximately 9% of nine-month revenue came from foreign operations, and SEI does not hedge foreign currency exposure.
- Regulatory examinations, changing financial-services regulations, cybersecurity, operational and third-party service-provider risks could increase costs or adversely affect results.
- Seven Louisiana lawsuits related to Stanford Trust Company remain unresolved. The company states that it has valid defenses but cannot reasonably estimate a potential loss.
- A Belgian claim seeking approximately $84 million against multiple defendants, including two SEI subsidiaries, had its appeal dismissed in October 2017; SEI states that ultimate loss cannot be estimated.
- The credit facility contains financial and operational covenants that could restrict dividends and repurchases upon default, although SEI reported compliance during the period.
Most Important Facts to Verify
- Whether Wealth Platform investment, maintenance costs and amortization continue to pressure Private Banks margins.
- The final useful-life determination for the Wealth Platform and the resulting amortization reduction.
- Archway’s revenue contribution, integration costs and potential contingent consideration payments.
- The sustainability of LSV earnings and distributions, which contributed materially to pre-tax income and operating cash flow.
- The effect of ASU 2014-09 adoption on revenue timing, contract-cost capitalization, disclosures and internal controls.
- Developments and potential exposure in the Stanford-related litigation and the Belgian claim.
- Capital allocation following the expanded share-repurchase authorization and the planned repayment of the revolving-credit balance.