SEI Investments Co. Q3 2009 Earnings Call Transcript

Oct.21.09 | About: SEI Investments (SEIC)

SEI Investments Co. (NASDAQ:SEIC)

Q3 2009 Earnings Call

October 21, 2009 2:00 pm ET

Executives

Al West – Chairman and Chief Executive Officer

Dennis McGonigle – Chief Financial Officer

Kathy Heilig – Controller

Joe Ujobai

Wayne Withrow

[Ed Lockland]

Steve Meyer

Analysts

Glenn Greene – Oppenheimer & Company

Jeff Hopson – Stifel Nicolaus & Company

Robert Lee – Keefe, Bruyette & Woods

Tom McCrohan – Janney Montgomery Scott

[Eric Connelly - Robico]

Operator

Welcome to the SEI Third Quarter Earnings conference call. (Operator Instructions) Now I would like to turn the conference over to our host Mr. Al West, Chairman and CEO.

Al West

With me are all of our segment leader, as well as Dennis McGonigle, SEI's CFO and Kathy Heilig, SEI's Controller. Now I'll start by recapping the third quarter and then I'll turn it over to Dennis first to expand on a few financial matters and as well to cover LSV in the investment and new business segment. After that each of the business segments will comment on the results of their segments. Then finally Kathy Heilig will provide you with some important companywide statistics.

Now as usual we'll field questions at the end of each report, so let me start with the third quarter. Third quarter earnings grew by 53% from a year ago on a revenue decline of 13%. Diluted earnings per share for the first quarter of $0.27 represents a 50% increase from the $0.18 reported for the first quarter of 2008.

Now earnings for the quarter were affected by a series of one-time items which netted to a one-time increase to earnings of $4.9 million or $0.015 per share. Now Dennis will give you a more detail up date of the ebbs and flows of third quarter one-time items in a few minutes.

Now our 13% drop in revenues compared to the third quarter of 2008 is result of lower capital markets a year ago. Now since a good portion of our revenues are directly tied to assets under management and administration, lower capital market decrease our revenues. Now also during the third quarter our non-cash asset balances under management grew by $20.5 billion SEI's assets under management grew by approximately $11.5 billion during the quarter while LSV's assets under management grew by approximately $9 billion.

Now global 60/40 portfolio was up 12.9% during the quarter. In addition during the third quarter we repurchased 975,000 shares of stock at an average of just under $19 per share. Now that translates to $18.5 million of stock repurchases during the quarter.

Now while the capital markets have rebounded over the last two quarters, we continue to feel the effects of the current economic environment. Sales remain slow particularly in banking and advisor segments although activity has picked up.

Our increase in assets under management during the quarter were mostly fueled by rising capital markets. Of the $20.5 billion increase in assets under management $3.6 billion was from net cash flow. Now $1.7 billion of this was due to SEI sales and $1.9 billion were due to LSV sales.

Now we've also kept intensive pressure on cost control and our efforts during the past few quarters have resulted in a 10% reduction in our run rate operating expenses, and most of the decrease in cost came from personnel our personnel related reductions.

Now during the current crisis our strong financial condition has enabled us to continue to invest in the global web platform and its operational infrastructure is important to us because the platform is a very critical part of our future growth.

Now during the third quarter of this year we capitalized approximately $10.4 million of the global wealth platform development and amortized approximately $20 million of previously capitalized development. Now included in the $20 million figure is $7.7 million depreciation expense, which was part of a write-down of replaced software in which Dennis will explain in more detail in a few minutes.

Now also during the third quarter we accrued an additional $4 million of Encino compensation, and we expect a similar expense next quarter. Now as always we will work hard to find ways to retain clients and grow new revenues. We'll also continue our efforts to control cost and improve productivity.

In addition, we will continue to invest in areas that promise to provide long-term growth. We're firm in our belief we are on the right path to help our clients succeed and to build a strong growing company. And when we exit this crisis we feel we will be well positioned to prosper because times like these are enhancing our value propositions.

Now this concludes my remarks so now I ask Dennis McGonigle to cover some company financial issues and give you an update on LSV and the investment and new business segment. And after that I'll turn it over to the heads of the other business segments.

Dennis McGonigle

I will provide a brief update on our money market funds and SIV holdings that we have discussed at length at our prior filings and on our past earnings calls. I will then cover our third and fourth quarter accounting item. I will then cover the third quarter results for the investments in new business and LSV segments.

Going to third quarter 2009 the capital markets continued their improvement. These market conditions brought some additional stability to the market values of the collateral underlying the SIV holdings in our money market funds and on our balance sheet.

Stabilization and market values resulted in a net gain across all SIV components of approximately $14.9 million during the third quarter. As you are aware from our prior calls and filings, SEI entered into capital support agreements with three money market mutual funds back in the fourth quarter of 2007. As of today, all capital support agreements have been canceled.

SEI purchased the final remaining SIV holding from the SDIT prime obligation fund in September. We used cash on the balance sheet to fund this purchase. As a result of our recent purchase actions in total we hold $316 million of par value SIV securities directly on our balance sheet which carry a mark-to-market value of $131 million on September 30, 2009.

As you know, we have been dealing with this issue for close to two years. We feel we have this issue in a very manageable position and will not look to spend much time on future calls discussing it. I encourage you to review our 10-Q filing when made and all past filings for further information.

As I mentioned during the second quarter earnings call, the next significant release of the global wealth platform release 6.0 is scheduled for the fourth quarter of this year. This release will enable SEI to run multiple clients in a single production environment or said differently on a single instance of the platform.

This will enable a more cost efficient production environment and greater operational leverage. Among the system functionality in this release is new code that will effectively replace some of the original components of the platform that we carry on our books. With the anticipation of the release of this new code into production, again expected in the fourth quarter of this year, we have taken a non-cash impairment charge of approximately $7.7 million in the third quarter of 2009.

We will take an additional $7.7 million charge in the fourth quarter of 2009. This third quarter charge is spread primarily against the banking segment $5 million, the investment of advisor segment $1.9 million and the investments in new business segment $800,000.

The fourth quarter charge will be similarity distributed. This non-cash charge reflects a write-down of the capitalized asset by the remaining book value of the component being replaced. In addition to this cost item, as we noted in the earnings release, we also incurred a $2.2 million charge associated with an operational error in our institutional segment.

So to summarize the one-time items we had a $14.9 million gain on our SIV holdings, a $7.7 million write-down associated with GWP, and a $2.2 million error in operations. All of this rounds roughly to the $4.9 million that Al discussed.

I would now like to cover the investments in new business segment and the LSV segment. I and the other business unit leaders will focus comments on 2009 quarter-to-quarter performance. I refer you to the earnings release for year-over-year comparisons.

Activities in the investments of new business segment are focused on direct marketing to ultra high net worth investors. During the quarter the I&B segment generated a loss of $2.1 million. This compares to a loss of $1.2 million for the second quarter of 2009. This increased loss is a result of the $800,000 charge related to the write-down of previously capitalized development costs on the GWP platform, as I just discussed.

The efforts in this segment are centered on our life and wealth services to the ultra high net worth segment and leveraging this capability through other parts of the company. SEI historically has used the investments in new business segment as an incubator for new initiatives. We view the losses in this segment as an investment in future market opportunities and/or services. You can expect losses in this segment to continue.

I will now turn to LSV. Earnings contribution to SEI from LSV was approximately $21.2 million in the third quarter 2009. This compares to a contribution of $17.4 million in the second quarter of 2009. Revenues from LSV for the quarter were approximately $60.2 million. This compares to revenues of $49.1 million in the second quarter of 2009.

The quarterly improvement was due to growth and assets under management for positive cash flow at market appreciation. During the third quarter, LSV's assets under management grew approximately $9.1 billion, including $1.9 billion of cash flow.

On SEI's balance sheet of our reported cash and short-term investments of approximately $507 million, $42.7 million is attributable to LSV at September 30, 2009. Of our reported receivables of $221 million, $66 million were attributable to LSV. Liabilities are affected by the debt associated with our guarantee to the LSV employee group, as well as other general liabilities. This is reflected in both current liabilities of approximately $12 million and long-term debt approximately $16 million.

Now that concludes my remarks and I'll take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Glenn Greene - Oppenheimer.

Glenn Greene – Oppenheimer & Company

Quick question for you, just on the aggregate expense level. If I adjust for all the one-time charges just sort of using $171 million expense level, which was up about call it $9 million, sequentially. I guess I was a little bit surprised of the sequential increase in expenses. I kind of thought you'd be somewhat tighter on the expense level as revenue growth improved and there'd be somewhat more margin leverage. Anything that I should be aware of or how do you think about that?

Dennis McGonigle

Well, I'll talk briefly about the increased compensation and that we felt was something we need to do and move on to begin to address in the third quarter. Also, if you remember in the institutional business, and [Ed] will talk about this a little bit, for clients, non-U.S. clients, the sub-advisor fees are an expense of the business versus an expense inside the fund.

So as assets would grow, and whether it's market-driven or whether it's cash flow driven, advisor fees would also grow. So there's a more direct correlation between revenue and expense in this business, so that's another piece of it.

Glenn Greene – Oppenheimer & Company

So $4 million of the expense increase of the incentive accrual, and is that above and beyond sort of the normal incentive level?

Dennis McGonigle

Yes, above and beyond the kind of a normal rate we were accruing in the second quarter.

Operator

Our next question comes from Jeff Hopson - Stifel Nicolaus.

Jeff Hopson – Stifel Nicolaus & Company

Dennis, can you give us an update on LSV as far as how many products are open closed or in genera give us a sense on that. And I guess the implications of $1.9 billion, is that kind of would you say some pent-up flows or can we think that maybe not that high of flows but some level of increase in positive flows from here. Any thoughts on that?

Dennis McGonigle

I don't really want to project kind of future sales activity, but I wouldn't say it's pent-up up flows because they really had kind of gotten out of marketing the firm a while back across most of their products. I wouldn't say they had marketing activity kind of ongoing while they weren't taking assets, which would result in a traffic jam, if you will.

They weren't in that situation. They really didn't get back to marketing until the beginning of this year. Most of their but not all of their products generally are open for assets in the market. I guess that's the good news or the good news in a down market is that it gives your capacity.

Jeff Hopson – Stifel Nicolaus & Company

Okay, any new products?

Dennis McGonigle

No, nothing of note that are really driving – have driven the asset growth.

Operator

Our next question comes from Robert Lee - KBW.

Robert Lee – Keefe, Bruyette & Woods

A couple of quick questions, the first I just want to make sure, I actually want to clarify one of Al's comments about the amortization. I guess as you flip the switch maybe on release 6.0, obviously you have that write-off but should I take it just that there's another $13 million of amortization that you'll start to kind of be normal amortization or am I misunderstanding the comment?

Dennis McGonigle

I'd say outside the 7.7 if you take that out of the 20 that's our current amortization rate. Now when we release 6.0 there'll be a slight uptick in amortization because we're bringing more capitalized code into production.

Robert Lee – Keefe, Bruyette & Woods

Okay, and just on the balance sheet a little bit, I mean you you've got all the SIVs now on the balance sheet, and obviously you have the positive mark here. And I know you've been thinking about different ways to kind of, I guess we'll call it maximize it, whether it's sell it off, do something structured to kind of – can you maybe update us on any of those activities, or is there anything coming in the next quarter or two, in terms of a large pay down because if I remember correctly, your intention is to also use some of the proceeds from that to kind of pay down the related debt?

Dennis McGonigle

Now, the latter parts correct. We really are looking at the SIV holdings kind of [inaudible]. We've really tried to be and frankly we're fortunate to have the financial strength to be patient with this issue and let it run a full cycle and it seems like we are in more of a recovery cycle now. Now that certainly doesn't – I certainly don't expect the recovery means getting all the way back to par.

We feel we can continue to be patient with this. We're not fore sellers. The market from a buying standpoint or from a liquidity standpoint hasn't I would say returned to any kind of normal state where there's a lot of demand out there for this type of paper.

We will use cash flows off these structures to pay down the debt over time and we are still in the process of trying to find the right kind of advisor possibly to work with on the outside that then can take the underlying collateral and begin to liquefy some of that, as it makes sense. I would say we're in no – we don't feel any sense of urgency to do anything in the near-term. We've got a great bid if you know somebody who's looking to put a great bid out there, we would certainly be all ears.

Robert Lee – Keefe, Bruyette & Woods

I'm not sure it'd be a great bid. So just to follow up on that, the little bit of a decrease in debt sequentially that could just as much been just, as you said, kind of the cash flows coming off the portfolio. They just kind of immediately apply.

Dennis McGonigle

Is it really also in that debt number is the LSV debt, and that gets paid down also.

Operator

Our next question comes from Tom McCrohan - Janney Montgomery and Scott.

Tom McCrohan – Janney Montgomery Scott

Dennis, when you put the new version in that single instance, is there any corresponding cost saving benefit that's now you're just running everything on one version of the software?

Dennis McGonigle

I'd say certainly as the business builds we will get leverage and scale out of our production environment. Right now we're running I guess three instances of the software for different clients and we will consolidate that down to one during the course of the first half of next year.

And so there is the possibility that we would get some benefit immediately, but for sure the benefit we will get is as the business builds and we can run any new client that comes along on the same instance as all the other clients, and that's a big advantage. That's similar to Trust 3000, frankly, and that's how we get scale and leverage in the production environment on Trust 3000 and have for 30 years.

Operator

At this time there is no further questions.

Al West

I'm now going to turn it over to Joe Ujobai to discuss our private banking segment.

Joe Ujobai

Today, I would like to view our financials and give you an update on our market activity for the private banking segment. As a financial update, I will focus my comments on a comparison to the second quarter of this year.

For the quarter, revenue of approximately $88.5 million increased slightly by $2 million or 2.2% from the second quarter. In the private banking segment, we have three main drivers of revenue. Number one, wealth processing. Revenue from our wealth processing business has grown slightly by 4% as we converted our second client to the Global Wealth Platform, and we have seen an increase in one- time or professional service fees in the U.S.

I would like to remind you of the loss of a large U.S. bank client that we announced in the fourth quarter of 2006. This loss was the result of M&A activity. We retained that business longer than initially announced through 2009. We expect to see an approximate quarterly revenue loss of $2.2 million starting the first quarter of 2010.

Our second area of revenue is asset management. Ending assets in our wealth management programs primarily from global distributors was $12.3 billion versus $10.7 billion in Q2. This reflects approximately $1.7 million in market appreciation and no significant net client redemptions. This is the first quarter that we have not seen substantial outflows from this program since 2007.

In the U.S., we've experienced a decline in our cash management assets as our U.S. banking clients moved away from money market funds given the current yield environment. The third lever of revenue is brokerage and transaction services and our revenue in this solution decreased modestly by 3%.

Expenses for the quarter increased by 12% largely driven by, number one, a $5 million DWP impairment charge and we expect to see a similar charge in the fourth quarter. Number two, other costs associated with the rollout of additional Global Wealth Services functionality. And number three, additional workforce costs associated with incentive compensation and increased sales efforts as we strengthen the worldwide sales and relationship teams.

Margin for the quarter was 10% versus 18% in the second quarter. Margin, excluding the one-time DWP impairment event, would have been 16%. As mentioned during previous calls, I expect that our margin will remain bumpy as we transition our business to the Global Wealth Services Solution.

But where the market activity update, we are focused on the following growth areas. First, the continued rollout of Global Wealth Services enabled by the Global Wealth Platform. After the conversion of our second client this summer, we now process in excess of 40,000 accounts on the platform which is a significant milestone for our business.

We continue our focus on the IWA business model, as most U.K. banks are still determining the way forward. The Global Wealth Services offering has been well received by the IWA firms wanting to transfer their business from transaction lead to device and fee-based solutions due to the changing regulatory environment, the volatility in the capital markets, and changing end consumer needs. We will convert tenant financial service to the platform during the fourth quarter. Business development efforts remain focused on similar firms.

Next, a renewed focus on the U.S. opportunity based on current market conditions. In the U.S., we are focused on selling new local or community banks our Global Wealth Services Solution that includes asset management and wealth processing.

Community banks are seeing a renewed opportunity to grow their wealth management business as individual investors re-evaluate current providers. Since we re-launched our efforts in this market last year we have closed eight new clients. We have momentum and in the third quarter we added additional sales and marketing resources.

We will also launch a targeted marketing campaign to over 250 prospects later this month. With our current U.S. clients, we are focused on three areas. First, cross-selling existing clients. Regarding recurring fees, we are focused on opportunities related to the key macro issues of the industry such as the heightened regulatory environment and the increased communication via the Webbed-based services.

Over the past few years, we have built new solutions in these areas and are using these services to add additional client revenue and enhance the re-contracting process. We are also seeing some increased client discretionary or one-time spend for professional service projects.

Secondly, we are engaged in significant re-contracting activity. We are trying to help our clients manage their expenses during these difficult times. We do this by helping reduce their overall operating spend while extending the term of our contracts. So far overall re-contracting rates this year are similar to previous years. Year-to-date, we have re-contracted 12 clients with an average re-contract term of 4.5 years.

Third, we are working to extend our outsourcing reach. We see more banks considering outsourcing, although this decision process is slower than we'd like. We continue to focus on flipping some of our larger technology only outsource clients or ASP clients with full investment processing outsourcing or BSP.

We are also promoting selective outsourcing such as mutual fund processing and employee benefit reporting. By outsourcing to SEI, we believe that we can provide substantial savings to our clients and increased revenue to SEI.

Finally, we continue to support our global asset management distribution footprint. In the third quarter, we began to see evidence of improvement in individual investor sentiment, although regional differences remain. As we mentioned, we have stabilized this business and are turning towards net asset growth both with current distributors and key prospects.

In conclusion, I expect the foreseeable future to be challenging. We will grow this business in the short-term by focusing on the opportunities for change in the marketplace while we continue to invest in our longer term future and the rollout of Global Wealth Services. Our strategy is compelling and our activity is generating additional sale agendas.

At this point, I'd like to open it up to any questions.

Operator

(Operator Instructions) Our first question comes from Tom McCrohan - Janney, Montgomery Scott.

Tom McCrohan - Janney, Montgomery Scott

Money market mutual fee waivers, is that impacting your business at all?

Joe Ujobai

Yes, two things. Our revenue in our cash management programs are down because we've seen some asset redemption as banks have moved into longer term assets and in many cases they're managing the money themselves, and the waivers have also affected the revenue in the liquidity area.

Tom McCrohan - Janney, Montgomery Scott

And is there a number you can throw out there to help us quantify the impact from that?

Joe Ujobai

Yes, I think for the quarter we were down in revenue about $1.1 million in revenue quarter-over-quarter and probably 60% of that actually came from the waivers and the other 40% came from redemptions.

Tom McCrohan - Janney, Montgomery Scott

You say quarter-over-quarter, year-over-year?

Joe Ujobai

I don't have the year-over-year number, but I just have the quarter-over-quarter. Sequentially, yes.

Tom McCrohan - Janney, Montgomery Scott

And the community banks that you signed, the eight new clients, I thought the last time you talked about that, it was three community banks year-to-date. So did you sign five new ones this quarter alone?

Joe Ujobai

No, this is since we re-launched our activities in the community bank space, so this includes when we started sort of middle of the year last year and this year. So since we started to focus more again on community banks and we put a sales team very specifically against that effort, we've closed a total of eight banks.

Tom McCrohan - Janney, Montgomery Scott

Do you have the number for this particular quarter?

Joe Ujobai

There were no additional banks signed in this quarter.

Operator

Our next question comes from Jeff Hopson - Stifel Nicolaus.

Jeff Hopson - Stifel Nicolaus & Company

In terms of Global Wealth Platform being fully operational in the U.S., can you remind us when kind of that timeframe is? And then looking at some of the larger banks in the U.S., are they still, would you say, highly distracted at this point or can you give us any sense of what's happening in the larger bank market?

Joe Ujobai

Yes, so we plan to rollout Global Wealth Services in the U.S. initially with our advisors, as well as some community banks in sort of the late 2011 timeframe. I would say that larger banks are still distracted but we're starting to see the organizations figure out the way forward and we're beginning to have increased conversations, particularly in the U.S. with our current clients as they think about how they would grow their business in the future. And they want to get a better understanding of how Global Wealth Services can help them.

Operator

Our next question comes from Glenn Greene – Oppenheimer.

Glenn Greene – Oppenheimer & Company

I guess the first question is just the status of the sales activity, pipeline activity, what you're kind of seeing out in the market, the reception from prospects and to the extent you think where we might expand this beyond sort of the three clients that we know about.

Joe Ujobai

Well, we have been very focused in the U.K. on the IWA space, which we call independent wealth advisors. And we see opportunities with firms similar to [Tenan] and [Towie Law] and you'll certainly be the first to know when we sign more contracts and announce those.

So I feel good about our focus in that space and we've mentioned a couple of times why we like that space. Those funds are often owner occupied so we're able to discuss the ability to transform the business and grow the business given the capabilities of global wealth platform with the owners of that business. We see the regulatory environment tightening and we could expect that some of the built-in regulatory compliant functionality is certainly of interest.

The concept of moving towards a centralized investment process resonating so that the firm would have an investment process versus the individual relationship managers. So we stay focused in that space. We see good activity around business and services discovery, and we're as anxious to get a few more clients as you are. So we'll keep you up-to-date on that.

Glenn Greene – Oppenheimer & Company

And then just quickly on the trend in margins, it looked like your revenue did improve a little bit. Maybe it was partly the discretionary parts of your business or maybe the asset sensitive parts of your business improving, but the margins deteriorated. So I was a little confused by that trend.

Joe Ujobai

Well, we had a few things that caused margin deterioration. One being we took $5 million of this impairment charge, so that affected our margin. So we were about 18% margin last quarter and we dropped down about 16.

We also have accrued for additional intensive compensation, like Al and Dennis mentioned. We have some additional expense associated with the conversion of the second client on the platform in the June/July timeframe, mostly because we're offering additional services.

So for example, the second client tends to add a fair number of new accounts. And so we've increased some services around account open, around asset transfer from other investment providers. So as we added some additional services, we have increased some costs in the underlying operations area for the platform. So that's what affected the additional margin pressure outside of the $5 million of the impairment charge.

Just my other point, we're also using this market opportunity to, I would say, add some additional strength to our sales force. So we're using the fact that there are people available to move more people towards, to hire some additional sales people, both in the U.S., Canada and in Europe.

Operator

At this time, there are no further questions.

Al West

Our next segment is investment advisors and Wayne Withrow will cover this segment.

Wayne Withrow

While the advisor segment has not yet returned to being the growth engine it has been in the past and I expect it to be in the future, we did continue to make progress in recovering from the market meltdown of the last 12 months. During the quarter, we achieved improved revenues, profits, margins and cash flow.

Revenues in the quarter increased almost $4 million or 9.8% from the second quarter of 2009. This increase was driven by market appreciation. While we did experience negative cash flow, we continued to trend back to positive growth.

Net negative cash flow during the quarter was $225 million, which was an improvement from the negative $555 million in the second quarter and the negative $905 million we experienced in the first quarter of this year.

Assets under management during the quarter increased from $26.8 billion to $29.5 billion. As assets under management have increased, so has the average basis points earned on assets. During the third quarter, we earned 56 basis points on managed assets, a 1.4 basis point increase from the second quarter. This built upon the 1.5 basis point increase we achieved in the second quarter. To put this in historical perspective, we earned 58.9 basis points on assets under management during fiscal 2008.

Profits for the quarter were $15.5 million. This was a 13.4% increase from the $13.6 million we earned in the second quarter. These profits reflected our revenue increase and tight expense management. As Dennis mentioned, we wrote off a portion of the global wealth platform during the quarter and $1.9 million of this write-off is reflected in the advisor segment. Absent this write-off, expenses would have been essentially flat in the second quarter as we have worked hard to ensure that our revenue increases drop to the bottom line.

This write-off also impacted margins, and while our reported margins improved to 35.6% from 34.5%, our margins would have been 40% absent this write-off. Please keep in mind that the profits in this segment are highly leveraged to changes in revenue due to market valuations. As valuations increase, we can with reasonable expense controls, drop a portion of the revenue increase to the bottom line.

On the new business front, we recruited 67 new advisors during the quarter. This brings our total for the year to 158 new advisors, which puts us on pace to exceed the 175 new advisors we recruited in all of 2008. Our pipeline of qualified prospects remains getting stronger. The large new advisors sales team we put in place at the beginning of the year is beginning to get traction.

As we sprint to the end of 2009, it appears that the worst is behind us and most of what I consider leading indicators items like new advisor signings, margin expansions and net cash flow are all moving in the right direction, although not as quickly as I would like.

I welcome any questions you may have.

Operator

(Operator Instructions). Our first question comes from Jeff Hopson – Stifel Nicolaus.

Jeff Hopson – Stifel Nicolaus & Company

In terms of the new advisors that you're recruiting, how does that show up in the cash flows? So if you recruit them this quarter, I guess, would that be reflected in the cash flows as far as clients coming over, would that show up then in the following quarters, I guess?

Wayne Withrow

It's simple and it's complicated. Net cash flow is exactly that. It's the net cash flow from all advisors, new and old. But with new advisors, one thing to keep in mind is we recruit, sometimes if we recruit a new advisor, we count them when they get to a certain level as a new advisor.

Generally, those new advisors then would either convert their book of business over to us, which could take anywhere from three to six months. So if we sign them this quarter into converting, we may not see the assets come over for another six months or during that six month period.

Other advisors that we sign into new advisors give us selected accounts then they continue to produce new accounts for us. We expect to see them in the future. But when they give us the assets, when they actually give us they assets, they are in the net cash flow numbers.

Jeff Hopson – Stifel Nicolaus & Company

Okay, and given kind of, I guess, industry mutual fund flows that generally have been moving in the right direction, but selectively perhaps. Can you give us any sense of maybe what happened in September and to the extent that you're still seeing outflows, what are the types of products? Where are they going? Why are they still moving negative, I guess?

Wayne Withrow

I think that we see two things. One, you see and continue to see sort of the consumer preference for less risky asset classes and perhaps guarantees. So you see our products moving that way. You also see in the advisor segment, and considering that many of these advisors are small businesses.

There is a shift to more commission based products around some of the advisors because their revenues took such a significant hit, they're looking more on building revenue today as opposed to the longer term impact of having fee based revenue. I think you're seeing sort of commission based and loaded products doing better then perhaps fee based products.

Jeff Hopson – Stifel Nicolaus & Company

So would that include something I guess a variable annuity which do you guys not participate in that sale?

Wayne Withrow

The drain of assets out of programs like us in the variable annuities is at issue.

Operator

There are no further questions at this time.

Al West

Our next segment is the institutional investment segment. I'm going to turn it over to [Ed Lockland] to discuss this segment.

[Ed Lockland]

Good afternoon everyone. With the continued capital market improvement during the quarter, the customary year ago comparisons are not meaningful. So I'm going to focus my remarks also on the financial results and progress we've made during the third quarter compared to the second quarter.

Third quarter revenues of $47 million increased 13%. Positive capital markets and net new client funding had the most significant impact on our revenue growth. Operating profits of $20 million increased 6% for the quarter. A one-time expense of $2.2 million due to an operational error was a drag on quarterly profits.

Variable direct costs were sub-advisor and referral fees associated with improved revenue also increased accordingly. Margins decreased slightly to 42% for the quarter compared to the second quarter. This resulted from a one-time error expense primarily. Quarter-end active balances were $49 billion reflecting a $7 billion increase compared to the second quarter of 2009.

Net new client funding during the second quarter or during the third quarter, I'm sorry, was $933 million. The backlog of committed but unfunded sales was $200 million at the end of the quarter. Client signings for the third quarter were $425 million and totaled $2.8 billion year-to-date through September.

Client decision making continues to be prolonged but it is showing some signs of improvement. New client appointments and RFP activity are healthy signs that contribute to improved pipelines and support future sales results. The uncertain market conditions have not altered global plans sponsors desires to manage the volatility that pension funding can cause to corporate business results. An SEI solution enables clients to successfully manage their entire pension program.

However, many plan sponsors are more focused on the sluggish economy and its impact on a core business in making changes to their pension program. We're optimistic though that as market conditions improve prospective clients will again return to a more normal decision making timeline and sales results will increase again. As institutional investors reflect on the capital markets over the last two years many will look to outsourcing as a solution, and SEI is well positioned to capitalize on this growing trend.

This concludes my prepared remarks and I'm happy to entertain any questions you may have.

Operator

(Operator Instructions) Our first question comes from Jeff Hopson.

Jeff Hopson – Stifel Nicolaus & Company

Not to put words in your mouth, but it almost sounds like there's a potential in your mind for an accelerated activity level at some point in the future because the changes have had a profound impact on pensions, and it seems like if anything the need is greater to do something. So how would you respond to that?

[Ed Lockland]

I would say you stated better than I could.

Jeff Hopson – Stifel Nicolaus & Company

So maybe as we move into next year hopefully things will pick up in terms of activity, decision making, etc., is that a reasonable thought?

[Ed Lockland]

Yes, I mean I think we're optimistic about that. We have I think we have pipeline certainly that can support decisions at a higher sales result level. We just have to get the planned sponsors focused on that being an important priority to kind of complete the due diligence and make a decision.

Operator

Our next question comes from Robert Lee - KBW.

Robert Lee – Keefe, Bruyette, & Woods

Just a quick question and I apologize if maybe you covered this I had to step away for a second. But some traditional asset managers, I guess maybe most notable BlackRock, have been kind of making efforts to kind of get into the fiduciary management business, they talk about it fair amount.

I mean are you seeing them in your segment of the market more, or is it really kind of much larger kind of even larger pensions then you're looking at, or I mean do you see that affecting the playing field at all?

[Ed Lockland]

We certainly see more of them in so far as their presence in the marketplace. I would say right now where we see them probably most visible would be in the Netherlands and outside of the U.S. then we see them here in the U.S., but I think that's probably just a matter of time before they kind of cover everything kind of on a global basis.

So, yes, they definitely are much more visible. I don't know that they're going after a different segment per se then we are, that part would be unclear to me because I really haven't seen them necessarily post a lot of wins that they've talked about.

Robert Lee – Keefe, Bruyette, & Woods

I mean to the extent they've won any business, is it possible to talk a little bit about how maybe you kind of would differentiate, besides the multi manager approach, obviously, but if there's anything else that may different in your approach or their approach that makes you pretty comfortable that you're really not going to lose share or anything to them.

[Ed Lockland]

Well, I think the difference you pointed out as far as the multi manager I think is one. I think the other that we probably shouldn't lose sight of this, I mean we have 600 clients worldwide that we're providing fiduciary management services to, and we've done it for the last 15 years. So we have a pretty extensive client base.

I think that gives us the ability to be able to be able to go back and point to how we've been able to guide these clients throughout the years to make changes to their portfolio and align that portfolio to their corporate finance strategies. So I think from a reference perspective just from a breadth of the different type of client relationships that we've had, we're a decent sized player in this particular space.

I'm not sure that the multi manager is the only differentiation that I would point to. I think that they're going to use a lot of their own proprietary product as well. As opposed to ourselves using what we think to be independent, if you will, separate from SEI. So we're giving access to a lot more talented managers then just a single proprietary type of a firm.

Operator

There are no questions left in queue.

Al West

And our final segment today is investment managers and I'm going to turn it over to Steve Meyer to discuss this segment.

Steve Meyer

Good afternoon everyone. As usual I will briefly cover the financials of the segment for the third quarter and then cover our new sales and a brief look at the market. For the financials I will compare our third quarter results to that of this year's second quarter. For the third quarter of 2009, revenues for the segment totaled $35.2 million, which was a $1.9 million increase or 5.5% higher than our revenues for the second quarter of 2009.

Our quarterly profit for this segment of $12.2 million was up approximately $1.1 million or a 9.3% increase over the second quarter of 2009 profit. This quarter-over-quarter increase in profit was due primarily to a $1.9 million increase in revenue offset by an $800,000 increase in expenses primarily in our compensation expense and investment spent.

Our third party asset balances at the end of third quarter of 2009 were $216.2 billion or $2.3 billion higher than at the end of the second quarter of 2009. The main driver of this asset increase was market appreciation of approximately $7.8 billion offset by net negative cash flows of $5.5 billion.

Similar to the second quarter these negative net cash flows were mainly concentrated in a few of our traditional manager client products mainly lower fee stable asset and liquidity funds. Only approximately a half a billion of these negative flows were attributable to hedge fund redemptions.

During the third quarter of 2009, the segment had new business sales events totaling $7.3 million in annualized revenue consisting of $5.4 million in events from the alterative segment and $1.9 million in events from traditional managers. I would describe this quarter's sales activity as strong, but we hope to increase our quarterly sales as decisions cycles continue to progress.

Overall the market continues to strengthen and provide a more stable foundation for investment manager decision making. However, I believe we still see most investment managers in the cautiously optimistic camp waiting for more assurances and solid fundamentals in the market. So while we continue to see increased activity and agendas progress, we also remain cautiously optimistic as managers reassess their business models and enter into longer decision cycles.

We believe that longer sales cycles will be the norm as first time outsourcers combined with more rigorous and detailed selection processes increase. Ultimately, we feel well positioned for these new market realities and processes and are encouraged as we look forward toward 2010 and beyond. So as 2009 starts to wind down, we continue to focus on our key agendas and growth plans setting the stage for 2010 and executing for our long-term growth.

I'll now turn it over for any questions you have.

Operator

(Operator Instructions) Our first question comes from Glenn Greene - Oppenheimer.

Glenn Greene - Oppenheimer & Company

I just want to drill down a little bit more on the outflow trends, not only this quarter but really year-to-date and just want to understand a little bit more what kind of funds these are. Why the fee structure is so low and it doesn't seem to really be impacting your revenue. So just want a little bit more color on what exactly is happening there.

Steve Meyer

Well, I think we're probably not the only ones in this boat, but if you look across the industry the products I'm talking about are liquidity products such as money market funds, GIC, stable valued products. And I think what you're seeing and I think what you saw across the industry in Q3 there was a pickup in redemption withdrawals from those types of products.

Obviously, for us on an outsourcing standpoint they tend to be those products, they tend to be stable value or stable NEV products and they're typically lesser of a fee-based products for us than others say other equity or hedge fund products.

So I think that's why it's not impacting our revenue to a great deal. But I think what you're seeing in some ways a positive sign for the market I think some of these monies coming out are going from liquidity funds into other investment products either at that investment manager shop or somewhere else.

Glenn Greene - Oppenheimer & Company

The other part is the sales activity the $7.3 million which you characterize as strong but tempered by the environment. I mean do you think this is kind of a baseline level that things should get better from here?

Steve Meyer

I wouldn't exactly say that, as Al is elbowing me. What I would say is I think it was a strong quarter. I still think we have a very strong pipeline. I think in relation to our pipeline I would hope that the quarterly sales were a little stronger and I think there's opportunity for that.

Similar to [Ed] and what he said, but obviously very more articulate than I, I think our biggest challenge is having these managers go through the process and make the decision so it becoming a focal point. In some ways the market recovering has allowed managers to delay their decisions a little bit more. So we're kind of looking for that point when the decision cycles again progressing but fall a little bit more so we can see that increase activity hit the bottom line.

Operator

Our next question comes from Jeff Hopson - Stifel Nicolaus.

Jeff Hopson - Stifel Nicolaus & Company

It seems like hedge fund flows in the industry have improved I'll say considerably here in the third quarter. It sounds like you're seeing the same as well. Any thoughts on kind of where we go from here?

Steve Meyer

Specific to hedge funds, Jeff?

Jeff Hopson - Stifel Nicolaus & Company

Yes.

Steve Meyer

Well, I think third quarter I think across the industry you saw net inflows there were minor net inflows but they outpaced for the first time in awhile the outflows. However, there were still a good portion of net outflows in the fund there just happened to be a little bit more net inflows across the industry again. I do think what we are seeing is kind of the rush to the doors caused by the market crisis and some of the other scandals out there like Madoff.

I think those kind of panic withdrawals we're seeing and have seen the end of, however, I do believe there is a new norm in hedge funds. If you think of what the industry has gone through and before there used to be longer lockup periods with investors, this really is we're looking at as the error of the investor and many investors now have renegotiated their deals with many of these managers, have less term or less lockup.

And while I think we're seeing better performance and more stability in the industry, I don't believe that hedge fund redemptions are done completely. I think they're going to be a normal pace of them but not an extreme case that we saw.

Operator

Our next question comes from [Eric Connelly - Robico].

[Eric Connelly - Robico]

The move toward more separate accounts or tri-party prime brokerage made a noticeable difference in the sales pipelines yet, and would you expect it to in the future?

Steve Meyer

Yes. I think specifically with more and more people having to have more parties at the table so more prime brokerage more and more firms are using traditional custodians to do certain parts of their business. What that requires is there's more sophisticated and complication in investment manager shop and it requires someone to be the integrator of all of these parties.

That is where our sweet spot is. We are the integrator, especially in the operates and outsourcing, and I think that phenomena going on in the market has started to show an uptick in our pipeline and I think will continue to be one of the growth engines for us.

[Eric Connelly - Robico]

But nothing you could relate to us in numbers?

Steve Meyer

No, I would say that is one of – I can't break it down specifically on how much our pipelines attributable to that. I would say that combined with the other things we've talked about first time people have typically in sourced now looking and being mandated by their investors to be outsource.

Kind of the uncertainty but the acknowledgement that there is going to be more regulation and control in this in this investment management marketplace combined with managers really having to after they've come out of this market crisis focus on their core investment expertise in their clients and really have to partner with someone very strong to take care of their operational infrastructure. I think all of those combined are driving the pipeline, but I couldn't put specific numbers on one or two of those.

Operator

There are no further questions.

Al West

I would now like Kathy Heilig to give you a few companywide statistics.

Kathy Heilig

Good afternoon everyone. I have some additional corporate information about this quarter. Third quarter cash flow from operations was $102 million or $0.53 per share. Year-to-date cash flow from operations $235.7 million or $1.24 per share.

The third quarter free cash flow $86 million and year-to-date free cash flow $180 million. Third quarter capital expenditures, which excludes the capitalize software, were $2.4 million which brings year-to-date capital expenditures to $9 million and we would expect about another $4 million in the fourth quarter.

The tax rate for the third quarter 2009 was 37% very similar to the tax rate that we had in the second quarter, which was 36.7%. And we would expect it to be in the same range for the fourth quarter, although because we had such a low tax rate in the first quarter our annual rate will be somewhere between 33% and 34%.

The accounts payable balance at September 30 was $11.8 million. We also would like to remind you that many of our comments are forward-looking statements and are based upon assumptions that involve risks and the financial information presented in our release and on this call is unaudited.

Future revenues and income could differ from expected results. We have no obligation to publicly update or correct any statements herein as a result of future developments. You should refer to our periodic SEC filings for a description of various risks and uncertainties that could affect our future financial results.

And now please feel free to ask any other questions that you may have.

Operator

(Operator Instructions) There are no questions.

Al West

So ladies and gentleman, despite some of the external uncertainties we face and its impact on our results the strength of our company is allowing us to stay the course on our transformation. Now we have made important strides and definitely feel our efforts will eventually be rewarded and, as I mentioned before, times like these enhance the value of our business proposition. So now if there are any other question please ask them at this time.

Operator

(Operator Instructions) There are no further questions.

Al West

Thank you very much, and thank you everybody for your attendance and we appreciate that and have a great afternoon.

Operator

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Once again ladies and gentlemen, if you would like to listen to the replay of this conference the dial-in numbers are 1-800-475-6701 or 320-365-3844 with the access code of 119321. This does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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