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Eaton Vance Corp. (EV)
F4Q07 (Qtr End 10/31/07) Earnings Call
November 20, 2007 11.00 am ET

Executives

Dan Cataldo - Vice President of Financial Planning and Analysis
Tom Faust - Chairman & CEO
Robert Whelan - Chief Financial Officer
Laurie Hylton - Chief Accounting Officer

Analysts

Ken Worthington – JP Morgan
William Kent – Buckingham Research
Robert Lee – Keefe Bruyette Woods
Cynthia Mayer – Merrill Lynch

Presentation

Operator

Greetings and welcome to the Eaton Vance fourth quarter fiscal year 2007 earnings release conference call. At this time all the participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Dan Cataldo, Vice President of Financial Planning and Analysis. Thank you Mr Cataldo, you may begin.

Dan Cataldo

Good morning and welcome to our fourth quarter of fiscal 2007 earnings call and web cast. With me today are Tom Faust, CEO and Chairman, Bob Whelan, CFO, and Laurie Hylton, our Chief Accounting Officer. Tom and Bob will comment on the quarter and then we’ll address your questions. The full earnings release and the charts that we will be referring to during the call are available on our website, EatonVance.com, under the heading Press Releases.

Before we begin we need to start with a reminder that today’s presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our operations and business, including, but not limited to those discussed in the Company's SEC filings. These filings, including our 2006 annual report and Form 10-K, are available on our website or on request without charge. I will now turn the call over to Tom.

Tom Faust

Good morning, and thanks everyone, for joining us. For virtually every measure 2007 was an outstanding year for Eaton Vance and the clients we serve. Long-term investment performance across the broad range of asset classes continued to be excellent. Assets under management increased 25% to $161.7 billion. Gross sales and other inflows into long-term funds in separate accounts were a record $46.4 billion while net flows reached a new high of $22.9 billion.

We launched the largest ever initial public offering of a new closed-end fund in February and are positioned once again to lead our industry in closed-end fund sales for the year. We rebalanced our capital structure with the successful placement of a $500 million debt offering in September and the repurchase during the year of 10.8 million shares of the company’s stock.

Our annual revenue crossed the $1 billion mark for the first time and our quarterly dividend rate was increased 25%. Earnings per diluted share of $0.47 in the fourth quarter include approximately $0.05 per share of onetime costs associated with the previously announced reorganization of our sales company and a loss realized on an interest rate lock entered into in connection with our September debt offering. Bob Whelan will discuss these items a bit later on in the call.

The full fiscal year earnings of $1.06 per diluted share were reduced by the $0.05 just mentioned and approximately $0.65 per share of closed-end fund related expenses incurred earlier in the year. The closed-end fund expenses consisted of $90.8 million in upfront costs involved in raising the $10 billion in new closed-end fund assets brought on the books of fiscal 2007 and $52.2 million in payment made to terminate compensation agreements with certain distribution partners for closed-end funds offered in previous years. Although these items were a hit for the year’s earnings, fiscal 2008 and future years will benefit significantly through higher investment management revenues and lower expenses.

While the turmoil in the credit markets posed some challenges for us in the past quarter, our business fared well under the circumstances with positive net flows in both fund and separate accounts and for both our equity and fixed income investment disciplines.

I’d now like to refer to the PowerPoint slides to help illustrate what an exceptional year it has been. Slides one, two and three provide detail of our growth in assets under management and the breakdown among the major asset classes. While the 25% AUM growth in 2007 makes for a great year, it is only one in a string of very strong years since 1996, a period over which our assets under management have grown at a compound annual rate of 23%. As a result of strong equity flows and the healthy equity market gains over the last 12 months, equity assets have grown to represent 68% of our total AUM.

Slides four and five show gross and net flows for 2007 in the past several fiscal years. You can see that we set new record highs this year under both measures. Gross flows of $46.4 billion breakdown roughly as three quarters funds and one quarter separate accounts. Net flows of $22.9 billion for the year represent an 18% organic or internal growth rate. This was obviously helped significantly by the $10 billion of closed-end fund assets raised but the strength of our core fund and separate accounts businesses would have allowed us to achieve double-digit organic growth for the year with no contribution from closed-end fund sales. You’ll see this illustrated in slide six.

The recent turmoil in the credit markets has affected the performance and marketability of various income products including our important franchises in bank loans and municipal bonds. Although our bank loan funds experienced net redemptions approaching $700 million in the fourth fiscal quarter, we finished the year with 2% more in loan fund assets managed than we had at the beginning of the year as far as institutional bank loan funds more than offset retail fund withdrawals. Our Municipal Bond fund business experienced net inflows for the year of over $3.5 billion with positive flow trends continuing through the fourth quarter. Although the performance of many of our Muni Bonds has trailed peer group averages in the recent downturn, their long-term track record continues to be outstanding as exemplified by the fact that 86% of our Municipal Bonds maintained overall Morningstar ratings of either four or five stars or at least one share class as at the end of October.

While there’s a dislocation in the credit market that’s hardly over I am happy to report that our business thus far has not been impacted to the degree that some might have expected. This is illustrated in slide seven which shows the gross open-end fund sales by investment discipline. You will observe that the fourth quarter was down from the previous three largely as a result of a slowdown in bank loan fund sales, but it still was our best fourth quarter sales rate ever.

Slide eight lists our top selling funds for the ten week period ending in early November. Open-end equity fund sales led by Large Cap Value, Dividend Income and Emerging Markets were just off their best quarters ever. Fixed income sales, led by Municipal Bond Funds held up very well given the current climate.

Our long-term fund performance continued to be excellent across a broad range of disciplines. This is illustrated on slide nine. As of the end of October we had 53 funds that had four or five star overall Morningstar ratings for at least one share class. Our performance as measured by Lipper is equally strong. As of the end of October, 79% of our fund assets are in funds that beat the Lipper peer group average over the past three years, 76% over the past five years and a particularly impressive 92% over the past ten years.

Slides ten and eleven drill down a bit deeper and show the three, five and ten year performance of our equity and income funds broken down by performance quintile. Over 60% of our equity fund assets have performed in either the first or second performance quintile for the past three and five years and 85% are in the first or second quintile in terms of ten year performance. Over 80% of our income fund assets were in the first or second quintile for three and ten year performance and over 70% for five year performance.

We understand that our success of the company hinges vitally on the performance of the funds and accounts that we manage. Our long-term oriented risk sensitive investment approach across equity and income disciplines is time tested and repeatable. Our investment teams are focused on the challenges at hand and committed to delivering excellence over a long-term. I’m confident that we are well positioned to keep our performance advantage through these difficult markets.

Turning to our retail managed account business; it remains strong through the fourth quarter with net flows of almost $800 million bringing the full year net flows to over $3.7 billion as shown on table four in the press release. Slides 12 and 13 show that gross retail managed accounts sales for the year were $6.2 million, up 72% and that our ending assets under management of $14.8 billion were up 53%.

We continue to see momentum building in the retail managed account business with several of our investment disciplines now ranking as top performers in their respective asset classes on a number of different sponsors’ platforms.

We had excellent performance in Eaton Vance’s Large Cap Value, Small Cap and Muni Bonds products and a strongly improving performance trend for affiliates Atlanta Capital and Fox in their flagship growth and value disciplines. Parametric’s tax-managed core and overlay products also continued to show rapid growth in the retail managed accounts market.

As you know if you have bought Eaton Vance for a long time we have made significant efforts to build out our retail managed account product line distribution platform over the past several years. We are pleased to see these efforts now paying off with strong results which we expect to carry over into fiscal 2008.

Turning to the institutional business, we are encouraged with what we are seeing, not only with Eaton Vance management institutional initiatives but also with developments at affiliates Atlanta Capital, Fox and Parametric. Consolidated net institutional flows for the quarter were solidly positive with contributions from Eaton Vance management, Parametric and Atlanta and only modest net outflows at Fox.

Lisa Jones and her team continue to make steady progress in building Eaton Vance Management Institutional business and have won over $2.3 billion in funded and pending mandates to date in calendar 2007. The number of RRPs responded to, final presentations made, and our final to win ratio are all up strongly for the year. While Bank Loans continues to be the most popular institutional asset class for us we are now starting to see meaningful new business placements in Structured Emerging Markets which is managed by Parametric and EVM’s high yield and Large Cap Value disciplines.

And through this sharply improved performance, the account withdrawals that have plagued affiliates Atlanta Capital and Fox over the last few years have now tapered off. We believe the institutional businesses of Atlanta and Fox could revert to net inflow over the coming quarters. Slides 14 and 15 break down our institutional assets under management by company and investment discipline.

There are several interesting developments in the Eaton Vance and Parametric high net worth family office channels that are worthy of comment. First, at Eaton Vance’s institutional investment counsel business we recently added three experienced investment counselors who bring a wealth of knowledge and great contacts in the investment counsel marketplace. An important part of their focus will be new business development. We are confident that a renewed focus on growth will pay dividends for our investment counsel group in fiscal 2008.

Parametric’s family office unit is one of the fasted growing parts of our overall business. Their capabilities were enhanced this year with the launch of Parametric Risk Advisors or PRA. PRA specializes in the use of options and other derivatives in the management of client investment portfolios offering managed covered call writing programs to enhance the risk and return of both concentrated stock positions and diversified equity portfolios. Since the close in May of the transaction forming PRA, it has been a major contributor to Parametric’s growth in the family office market. In fiscal 2008 we hope to expand this distribution of their capabilities to a broader range of clients and markets.

As I mentioned at the top of the call this quarter included $0.02 per share in expenses associated with the reorganization of our retail sales company Eaton Vance Distributors. You may recall that EVD has under a new leadership at play when Matt Witkos joined us from Ixis to fill the void created with the unexpected passing of Wharton Whitaker. Last month, Matt unveiled a new management structure to better align Eaton Vance Distributors with the needs of its customers. The new structure is designed to allow ourselves and marketing organizations to better serve clients, support expanded product offerings, and enhance the company’s distribution capabilities.

The new initiative integrates leadership of our sales and national account functions for the company’s major distribution channels. We are forming a new wealth management solutions group to support the marketing of the company’s specialty products and services catering to the high net worth marketplace served by financial advisors.

We are increasing resources devoted to the RIA sub advisory and retirement market opportunities and we are strengthening our marketing and communications and use of market data to enhance the efficiency and effectiveness of our sales efforts. We are excited about the potential for taking Eaton Vance Distributors to a higher level of performance under Matt’s leadership and of course we aren’t starting from a position of weakness. Slide 16 shows where we rank in the non proprietary channel in terms of net long-term fund sales according to strategic insights. As you can see, for the year-to-date we rank second behind only American Funds. As shown on slide 17 our share of net flows in this channel are growing and we believe have potential to continue to grow.

We are optimistic that the new management structure will help us to achieve continued strong flow results and market share gains. I would now like to turn the call over to Bob Whelan to review the financial results in more detail.

Bob Whelan

Thank you Tom and good morning everyone. As Tom has outlined, 2007 was a record year for Eaton Vance in terms of business momentum throughout our complex. I will first highlight our fourth quarter results, comment on the full year financials from both a GAAP perspective as well as from an adjusted operating basis and conclude with some highlights in terms of our balance sheet and capital spending activities.

We are reporting earnings of $0.47 per diluted share in the fourth quarter of fiscal 2007 versus $0.29 in fiscal 2006. Earnings in the quarter were reduced by approximately $0.05 due to two distinct onetime items. The first, which Tom reviewed earlier, was the reorganization of the sales company. The second was a rate lock agreement entered into in August in anticipation of our September debt offering. When we issued the $500 million of debt late September, we unwound the rate lock for a loss of approximately $6.7 million, or $0.03 per share. The $6.7 million cost of the rate lock is included in the gain and losses on investment line items, while the cost of the reorganization is captured in compensation expense.

For fourth quarter year-over-year comparison purposes, you’ll also remember that the fourth quarter 2006 EPS was reduced by approximately $0.06, as we retired our exchangeable notes or liens.

As mentioned, assets under management increased to $161.7 billion, from $128.9 billion in the fourth quarter of 2006, an increase of 25% or $32.7 billion. On an average basis, assets under management increased 26.8% from $124 billion in Q4 2006 to $156.4 billion in the fourth quarter 2007. In line with that increase, and average AUM, fourth quarter revenues increased to $293.8 million from $227.3 million, an increase of 29% quarter-over-quarter. Revenues also benefited from a positive uptake in our overall effective fee rate, which increased to approximately 75 basis points, from 73 basis points in the fourth quarter of 2006.

We continue to realize positive operating leverage in our business by growing revenues at a faster rate than total operating expenses. Operating expenses increased 21% to $188 million from $154.9 million in the fourth quarter of 2006, largely due to higher compensation expenses, higher service fees, distribution, and other expenses.

Compensation expense increased 28% to $80 million year-over-year, due to increases in staffing with the growth of the firm, higher stock base compensations, and higher operating bonus accruals. Also included in compensation expense in the fourth quarter, was $3.9 million of expense related to realignment with the Eaton Vance sales company.

Operating income increased 46% to $105.8 million in the fourth quarter of Fiscal year 2007, from $72.4 million in the fourth quarter Fiscal 2006. We also saw a significant drop in interest expense, from $11.5 million in the fourth quarter 2006 to $2.8 million in the fourth quarter 2007. The drop was largely due to the onetime cost in 2006 of retiring the company’s zero-coupon exchangeable note.

We mentioned earlier that fourth quarter earnings were impacted by the unwind of a rate lock agreement, essentially an interest rate hedge we used in anticipation of our debt offering, that resulted in a net loss of approximately $6.7 million. Within the other income expense category on the income statement, that loss is offset by approximately $2 million of gains in investments, bringing the total loss in investments for the quarter to $4.7 million.

Net income increased 59% to $61.4 million in the fourth quarter, compared to $38.5 million in the same quarter last year. Our effective tax rate for the fourth quarter was 39.7%, and 39.3% in the fourth quarter 2006. Total head count for Eaton Vance and all of our affiliates at the end of the fourth quarter was 960 employees, versus 880 last year.

Now let me summarize some key points for the full Fiscal Year. Revenues for the full year increased to just under $1.1 billion, a 26% increase over the Fiscal Year 2006, and certainly a milestone number for Eaton Vance. Fiscal 2007 investment advisory and administration fee revenue increased 30% to $773.6 million as a result of the increase in average assets under management, and improvement in our overall investment advisory in administration’s effective fee rate.

Total operating expenses including the $128 million of onetime items related to the close-end fund issuance and close-end fund terminated compensation agreements increased 43% to $851.2 million. Excluding those items would result in an increase of approximately 21%.

We think that the best measure to analyze our financial results is by looking at what we define as, adjusted operating income, a metric we use to assess the run rate of our business momentum. This is presented on slide 18. As a reminder, we start with GAAP operating income, and adjust for four items, including closed-end structuring fees, payments to terminate closed-end fund trails, stock safe compensation, and accelerated amortization or impairment.

Our adjusted operating income increased approximately 29% to $404 million from $312 million in 2006. Our adjusted operating margin increased to 37.3% in 2007 from 36.2% in 2006. The company’s effective tax rate was 39.1% for Fiscal 2007, versus 38.9% in Fiscal 2006.

Now I’d like to highlight some of our efforts to improve our overall capital management and efficiency. As you know, we completed a very successful $500 million 10-year senior debt note offering in September, and we earmarked a portion of the proceeds of that offering for incremental share repurchases. As a result, we increased our commitment to share repurchases in the fourth quarter and purchased approximately 5.4 million shares, for $230 million in stock buybacks, at an average price of $41.57. Cash, cash equivalents and short-term investments increased to $485.1 million on October 31, 2007, from $227.4 million on October 31, 2006, reflecting the debt offering proceeds.

For the full Fiscal Year, we repurchased $442.3 million, 10.8 million shares, and we have approximately 118 million shares outstanding. Consistent with our approach to return cash to shareholders, we increased our dividend to shareholders by 25% in October. This represents the 27th consecutive year of dividend increases, and that’s indicated on slide 19. As slide 20 indicates, through the combination of dividends and share repurchases, we returned over $500 million to shareholders in Fiscal 2007.

Now I’d like to turn the call back over to Tom for some closing comments.

Tom Faust

Fiscal 2007 was a great year for Eaton Vance; the last in a series of outstanding years for the company under the leadership of my predecessor, Jim Hawks, who retired at the end of the Fiscal Year. As a leader, manager, innovator and visionary, Jim has few rivals in our industry. During his 11 years as CEO, the company’s assets under management grew nearly tenfold and our stock appreciated nearly twenty fold, achieving a total return of 31.8% per annum over the 11-year period.

The legacy of success and strong business momentum inherited by the next generation of leadership position the company well for continued strong performance. As I assume the CEO role this month, I could not be more excited about the company’s prospects. With that, we would be happy to take your questions.

Question and Answer Session

Operator

Thank you. We will now be conducting the question and answer session. (Operator instructions) Okay, thank you, our first question comes from the line of Ken Worthington, with JP Morgan. Please proceed with your question.

Ken Worthington – JP Morgan

Hi, thank you for taking my questions. First, it was a wonderful year, congratulations. In terms of the Muni bond business, can I get an update there? Performance trailed off in August, it rebounded, and it’s fallen back off again. Can you just walk through what’s happening in the funds which is causing the underperformance?

Tom Faust

The performance of our Muni funds has, in recent quarters, operated with relatively high data to the overall Muni market. So during periods where Munis have been performing well, our relative performance has been strong. So as Munis weakened over the summer, we trailed the peer group as the market rallied back. In September we did better, and in recent weeks, we’ve trailed.

A couple reasons for that, one reason is that we have longer than average call protection in our portfolios, which translates into longer than average effective durations, and therefore more overall price sensitivity. We typically hedge that in part in the taxable market, either treasury or reliable base of [flops] or futures or other hedges. And as you may know, in recent months, the Muni taxable ratio moved against the Muni market. That is Munis have under performed treasuries, so that the ratio of interest earned on Munis to taxables is now well higher than the traditional ratio, which tends to be set by the natural arbitrage of tax paying investors between taxable investments and tax-exempt investments. In fact, many investments are now paying a higher yield as municipal securities than with comparable credit taxable securities, which is something that we see as an anomaly.

But, another factor that is present in the market is that the liquidity of many municipal bonds has been substantially restricted. Because our funds have been growing, we tend to own the more liquid names, those liquid names tend to get marked down more quickly, so we think that there is a pricing effect here as well. So it’s a combination of those three things: the longer duration; the use of taxable instruments as hedges, which has worked against us in this period; and the fact that our funds, which have attracted significant cash flows, tend to own more liquid instruments. Therefore they’ve tended to be marked down more quickly in a period of weakness than perhaps less liquid securities, which trade quite infrequently, that might be owned by competitive funds.

We continue to believe that our strategy makes sense, we continue to believe that the same approach, the same team that has delivered the exceptional long-term performance results for this fund is in place, and that it is appropriate going forward, and we feel very good about our position in that business. I did mention in the prepared remarks, that a substantial majority of our municipal funds maintained four and five star ratings currently, even after this period of weakness.

Also our national municipal fund, which is really our flagship product in that area, continues to be, again after this period of weakness, the number one performer in it’s category over the last three, five and ten years. So, nobody likes to go through a period of performance weakness, but we feel like we’ve got the right team, the right approach, and that as the market goes more towards a regular equilibrium between taxable and tax-free instrument yield, that we should see more consistent performance and better performance from our group.

Ken Worthington – JP Morgan

Okay, great thank you. And then, on the outlook for sales and municipal bond business, you mentioned that they are still very highly rated by Morningstar. The near trip performances dropped off, I believe that Tom Metzold went out aggressively after the August meltdown, and convinced a lot of the brokers to sell the funds. This is really a short-term blip. What’s the outlook here for sales? Does the near trip perform? Does the fact that they are down for the year, does that matter? Should we see sales slow? Or is it the Morningstar numbers that are really going to drive sales over the next three, four, five months?

Tom Faust

Well, if you look at most municipal bond fund investors, they look first at yield, they look second at long-term performance, they look third at the consistency of the team in the process, and some were well down the list with how this particular fund performed absolute and relative to it’s peers over the last three or six months. So consistent with that, we continue to see positive flows into these funds. Clearly the whole income markets are going through periods of dislocation. It’s hard to project how that translates into sales for our products, but we continue to see positive momentum, and have no reason to believe that that will turn around any time soon.

Ken Worthington – JP Morgan

And then, just a couple more outlook questions; for the bank loan products, redemption to accelerated, do you expect that that will start to moderate now, or should we expect to see more of the same for that product?

Tom Faust

There are two different things happening in the two customer groups for our bank loan products. Retail investors, I think it’s fair to say, have responded negatively to the price volatility, and have been net redeemers of bank loan products. On the other hand, institutional investors have been attracted to the price weakness, the fact that they can buy into an attractive asset class, which is now on sale so to speak. There is quite a disconnect between continuing strong fundamentals and fairly significant price weakness that brought spreads out to the levels that many institutions find attractive.

We think that on the retail side, we are starting to see, or we have seen, some slowing in redemption rate. We had an initial surge in redemption back in the middle of the summer. That tailed off. I would say that on the retail side, you should expect that redemption patterns should largely follow changes in that asset. So to the extent that there are periods when bank loan prices are being marked down, that would lead me to believe that we are likely to see periods of redemption activity then, to the extent that prices are recovering, and that the volatility in the asset class is moderating. I think you should expect to see renewed retail interest in this asset class.

We’re now nicely diversified between retail funds, institutional funds, and closed-end funds, and feel that that overall business is in pretty good shape. Let me just remind you of one comment I made, which is that this price of the weakness that we had in the fourth quarter, that our overall bank loan fund to assets were up 2% year-over-year.

Ken Worthington – JP Morgan

Thanks, and then just two more categories to flush out your comments in your prepared remarks, institutional height at worth net flows had a really nice quarter. Can you just give us a little more flavor on what was behind it? I know you mentioned some of the flavor on the comments but a little bit more would be helpful and what is the outlook there?

Bob Whelan

Ken, with regard to the detail behind the numbers, the net flows were split actually fairly evenly between the high net worth business and the institutional business. The net flows and the high net worth side of the business driven largely by Parametric’s success in the family office business, and with their new PRA product. On the institutional side, as Tom mentioned in the comments box, the Atlanta business has stabilized and actually contributed modestly to the net flows and then the bulk of the contribution in the institutional was through Eaton Vance’s effort and again Parametric’s with their structure to merging markets.

Tom Faust

So I would say we’re just looking, in terms of the outlook, we’ve got a couple things going on. One is that Fox and particularly Atlanta have been a source of outflows for the last couple years and we really see that moderating with good potential for it in fact to even turn around simply because their performance has improved quite dramatically. The other thing that’s going on is that Eaton Vance’s management has been over the last two and a half years been in a build mode for our institutional group. We feel like we’re starting to get to the point where that’s really delivering for us in terms of new business and we’re pretty optimistic on both counts that the experience of the underperformers at Atlanta and Fox will turn around and continue to turn around in a year and that the momentum that’s already in place with Eaton Vance management, which by the way also represents some Parametric products in the institutional market, that that will continue and will see continued success in fiscal 2008. We are quite optimistic that it will stay continuous of the approving trend in that business.

Ken Worthington – J.P. Morgan

The last category was the managed account it’s closed sequentially to, was that just a market issue or what was – bumpy business?

Tom Faust

It tends to be a, largely an equity business. We have the small municipal business there, I would say if there was a slowing it would be – we would attribute it to market factors as opposed to anything internally, we feel very good about our prospects there. We’re growing across a wide range of products, Parametric tax-managed core, over lay business, Eaton Vance Large Cap Value, Atlanta Capital, Small Caps, Mid-Business; all of those have contributed significantly to the growth in recent quarters. No reason to think that that will turn around.

Ken Worthington – J.P. Morgan

Okay, awesome, thank you very much.

Tom Faust

Thank You.

Operator

Thank you. Our next question comes from the line of William Kent with Buckingham Research, please proceed with your question.

William Kent – Buckingham Research

Ok, thank you good morning everyone. I was just curious if we could talk a little bit about the dynamics between the revenue yield and maybe margins on a go forward basis. I guess the revenue came in a little bit in light of what many people anticipated given that you hadn’t had much of the closed-end impact from the July quarter in this quarter, but yet your revenue yield was about flattish sequentially. I was wondering if you could talk a little bit about that outlook as you think about mix and then maybe you could overlay outlook for margin, which again you seem to be highlighting more so these days, ex the comp charge, is this is this the right run rate ex-growth?

Bob Whelan

Thanks for your question Bill. One thing that definitely happens in terms of revenues each quarter is that we’re impacted by what happens in the prior quarter. I think that’s very evident in this quarter where we saw total revenues increase from $287 million to roughly $294 million in the quarter. As an example if you go back to the second quarter where we put on $10.5 billion of net flows obviously we have the big closed-end fund offering and we have $3.5 billion of market action. So, $15 billion between those two categories really impacted the third quarter because if you times that by the effective fee rate, you get a pretty big impact and that was larger than the $27 million there. The $5 million increase was really impact because we had net flows in Q3 of 4.3, but that was off-set by $1.9 billion of market, a much different quarter sequentially. If I look at the fourth quarter now, I look at $2.2 billion of net flows and I look at market action, which was very significant in the quarter, almost $7.2 billion. So, when you combine those at roughly $9.4 billion, think about the effective fee rate to apply to that, that’s a pretty big annualized number and obviously a big quarterly number. I think it comes out to $16-$17 million. So there’s a lag in terms of what happens in one quarter vs. the other.

We did see to the second part, we did see some jump in our margin. If we look at our adjusted operating margin in the first half of the year, it hovered either side of 35%, if you look at that margin now it’s closer to 39%. We’re definitely seeing the benefit of having put on $10 billion in closed-end funds throughout the year that has an effective fee rate of between 90 and 100 basis points. But I think in general to your question we look at our effective fee rate and we look at running our businesses profitably and we’re very prudent with expense management and if you can do those two things, that translates into improved margins.

William Kent – Buckingham Research

Okay, Tom you’d mentioned earlier that you’d spent a lot of time building up the institutional business. I’m just sort of curious as you look to reposition the retail sales effort here, is this a new leg of incremental expense growth?

Tom Faust

No, we wouldn’t expect it to be that, as I think you know this is largely a commissioned based sales and marketing organization. Most of their expenses follow the sales trend. We had an enormous sales year obviously with the $10 billion of closed-end fund assets. We do think that as part of the repositioning of Eaton Vance Distributors, our retail marketing arm, there are opportunities for enhanced efficiencies and certainly one of the metrics we look at is the cost of sales and we certainly would hope to improve on that over time. So, no we don’t get this as a big spending item, this is a very much a scale business, we’re not looking to build something new, we’re looking to take a fully functioning, fully staffed sales and marketing organization and move it to a higher level of performance by changing the emphasis and changing the way we do certain things and also a new leadership in different positions.

William Kent – Buckingham Research

Okay, just a few final questions, unrelated. Just in terms of capital management there does seem to be a significant step-up in terms of buy back. Buy-back represented about half the full-year activity, I’m sort of curious, is this sort of onetime in nature or has there been a philosophical change in how you’re thinking about free cash flow, and the other question totally unrelated, could you talk a little bit about the impact on the Muni business from what’s going on with the guarantors?

Bob Whelan

Let me take the first part of that question. We definitely look at share repurchases in terms of an ongoing plan where we’ve repurchased shares to offset the impacted dilution by issuing shares. With the debt offering we entered into a more than incremental program and we started that program in the third quarter, actually well in advance of raising the debt. So if you look at the third quarter there was, as you know, there was a step up in terms of share repurchases and it was a pretty significant step-up in the fourth quarter up to just under $240 million and there’s probably a little bit more to do in terms of that incremental program and we’re probably in that 70% complete. But, once that’s complete we’ll go back to a more normalized rate of share repurchases.

Tom Faust

And regarding the municipal bond insurers and the impact on our businesses there’s no outside exposure that we have relative to competitors vs. the market in general. We do have obviously a pretty good-sized immunity business and this is an issue that that market has focused on increasingly in recent weeks. We, as we have for years, analyzed the financial health of the insurers as part of the evaluation of the bonds that they insure and in many cases we see bonds that are today trading at levels below where they would be on an uninsured basis. So, to the extent that insurance in some cases is literally for free you don’t see a lot of downsizing in terms of most bonds.

Remember that for losses to be incurred here, not only do the insurers have to encounter financial distresses in that they can’t meet their financial obligations, but also the initial bond issuer has to see what levels of similar financial distress and from where we sit today we certainly don’t see a significant likelihood that there these bonds will not do them any good. But having said that, obviously there is some concern about the potential for downgrade in some of these issues that we invest that the insurers and whose bonds we invest will not be downgraded and that there will be a capital made available to the extent necessary to maintain current rate.

William Kent – Buckingham Research

Okay thanks for taking all my questions.

Operator

Thank you, our next question comes from the line of Robert Lee with KBW, please proceed with your question.

Robert Lee – KBW

Thanks, good morning everyone, a couple of quick questions. First one, maybe to follow up a little bit on new initiatives. If you look historically, guide into the [mesh] account business that was earlier in the decade, a long time ago already, maybe invested in the institutional business a couple of years ago, that’s starting, seeming that’s starting to ramp up. If you look ahead, where do you think sort of the next area, in the next place, you need to sort of ramp up your investment? Is it going to be in the international exposure and are you thinking of that in sort of the next kind of year or two or something like that?

Tom Faust

Good question. I think you’re right on that there remains a significant opportunity for events outside of the United States, both in terms of spanning our investment capability involving non-US securities and also in distributing to the 95% or so of the world’s population that resides outside the United States. We do have an international fund business that is small. We sold this year – do you have the number there handy? - I think it’s along the order of $2 billion of sales for the year in our international fund, which is up approximately 100%, while small two out of overall sales of 45 billion or so, nonetheless its among our fastest growing businesses

If you think about Eaton Vance’s product platform, our product line that we offered back three, four, five years ago we’ve had a large exposure to tax managed equity, we’ve had a significant exposure to municipal bonds, we’ve had a large presence in bank loans. None of those products at that time were significant businesses forged outside of the United States. And indeed the opportunity for tax managed and municipal investment on a non-US basis is quite limited. These products are created with fewer tax laws in mind and don’t necessarily travel well internationally. But as our product line has expanded and we’ve developed market leading franchises and Large Cap Value and Equity Income and High Yield and Emerging Markets. We suddenly have a product line that travels very well and our success internationally today reflects a good sale of those types of products.

We also believe that there’s the potential to sell bank loans, not on a retail basis through a usage vehicle, but on a high net worth basis with a higher minimum in Euro, which would be a new market for us we hope in 2008. So, we’ve seen very good momentum in that business. We think that it will continue to be a strong grower for us as we take our US based investment capabilities and operate around the world. We are also in the process of expanding our investment capabilities outside the United States. We have a small office in London that focuses on investing in bank loans in the European market. We are expanding our capabilities to invest globally in equity markets primarily from a base here in Boston, but certainly view becoming a more international company in terms of both distribution and management capabilities as an important priority not just for 2008, but really I would say over the next half dozen to a dozen years. We won’t get there overnight, but I certainly believe that a dozen years from now we will be a dramatically more international company, more global company than we are today.

I don’t think however that there is significant spending required to get there. Obviously, if we expand our investment capabilities, that requires investment in new analysts and traders and portfolio managers potentially in more locations around the world. On the distribution side we largely see that there is a self-funded effort where we don’t see the need given our distribution model for that business to put out armies of people to serve that market. Rather it’s a quasi institutional sale that a relatively small number of people can service our customers there effectively. But, we think it’s a great opportunity there for us and one that increasingly fits well with our product line and our skill fit on the investment side.

Robert Lee - KBW

And maybe just a follow up question to that. A lot of your competitors have spoken a lot about the opportunity created by all the recent pension reform in the DC business, and I know you’ve restructured your distribution and one of the areas you mentioned was that, but could you maybe bring us up to speed on what your strategy is, if any, to take advantage of some of the those opportunities or are you going to have to come out with your own version of target based products, for example?

Tom Faust

Well, the answer there may be surprising; it’s very similar to the answer on the international side. Our accent to domestic products didn’t fit well with the retirement market in the same way that they didn’t fit well with international. So to the extent that we now have a broader product line that includes large value, high yield, equity income, a range of other equity strategies including emerging markets. So they’re also things that fit very well with the retirement market. For the most part that is a sub advisory or take a sleeve of a multimanager portfolio who is similar to international, it’s an institutional type sale with a vehicle often being a fund product, but nonetheless a sale made at a relatively high level where our disciplined investment processes, our consistency of our investment teams, where in certainly our strong performance in risk adjusted performance fits very well.

As I mentioned in the call, certainly one of our priorities in repositioned Eaton Vance Distributors is to go after that opportunity on a more focused basis because we think it fits well with, not only our skills, but also obviously there is a large and growing market opportunity there. So we think that as we look for growth areas, where can Eaton Vance grow, we’ve $160 billion in change, have we reached our limits? We think not, and one of the reasons that we believe that is the substantial opportunities that we have in areas likes international, in sub advisory, in retirement, and then in serving the registered investment advisory market, all of which Eaton Vance has historically had a very, very small market share in, and we are certainly devoting resources within our distribution company to try and address those opportunities. We think there’s some low hanging fruit out there that we can readily exploit in the next couple of years.

Robert Lee - KBW

Okay, just two quick modeling questions for Bob. Should I assume that with Jim and company retiring that we won’t see the same seasonality in comp costs in Q1 that we have the last year or two?

Bob Whelan

Yes

Robert Lee - KBW

Okay, so then this quarter should be, obviously, after getting merit increases and what not, it should be a reasonably good run rate to start from?

Bob Whelan

In terms of compensation?

Robert Lee - KBW

Yeah, I mean next to seventh.

Bob Whelan

I’m looking at compensation, just below all four quarters of this year, and they’ve ranged from when you carve out the one time that we had a missed quarter on the closed-end compensation costs because of the closed-end funds, they range between $71 and $77 million so we’re keeping compensation pretty constant.

Tom Faust

You have that phenomenon of the accelerated top phase comp expense for the same degree that we’ve had in the first quarter.

Robert Lee - KBW

Right, okay, and lastly, just the tax rate. Looking ahead, should we continue to assume the tax rate will run somewhere around the mid-low 39 range?

Tom Faust

Yes.

Robert Lee - KBW

That’s it, thank you very much.

Operator

Thank you, our next question comes from the line of Cynthia Mayer with Merrill Lynch, please proceed with your question.

Cynthia Mayer – Merrill Lynch

Hi, good morning. Just a couple of questions. I guess on a follow up to Bill’s question on the average fee rate. Given that the retail fund flows and the closed-end fund flows have tailed off for now, but the managed accounts and the tax overlay and the institutional bank loans are pretty resilient. What’s the outlook for the average fee rate you think, and is there any reason you wouldn’t experience some pressure there?

Bob Whelan

You know, it’s a good question Cynthia, and it’s not an exact science to predict this. We definitely saw the effective fee rate increase in the second half slightly; we saw the effective fee rate for advisor and administration bump up pretty significantly in the second half. It’s at a great level right now; it’s at very strong historical levels. You know if there’s any easing it would be slight, but I think we’re optimistic that the mix of business with the closed-end funds coming on this year is a positive. We’ll benefit slightly from some fee waivers coming off in ’08. I’m not sure you’ll see too much of a decline, it’s probably going to be a pretty constant number.

Tom Faust

One second. The point is, Cynthia, if you look at our current sales mix at five seven, you see a fairly dramatic shift in terms of in the mix away from income products and towards equity products just in our core fund sales as there’s been the turmoil in the income markets. And that’s a factor that I think would logically, you would expect would put upward pressure on fee rates because our equity fee rates in that business are higher than our income rates and I think that would mitigate to a significant degree some of the effects that you correctly identified as pushing abreast and the other way at the margin.

Cynthia Mayer – Merrill Lynch

Okay, great. And in terms of the Munis and the market turmoil, do the Muni portfolios in managed accounts, is their performance also similar to the funds?

Tom Faust

It’s really pretty different. You mean in terms of our relative positioning in that business? Is that what you mean?

Cynthia Mayer – Merrill Lynch

The longer duration and the…

Bob Whelan

No, these are pretty tightly prescriptive duration buckets. They tend to be also, we don’t use, there are no derivatives, there are no hedges involved, the nature of those is that the relatively small number of bonds, they tend to be all Triple A or insured bonds, and so our competitive profile there is quite dissimilar from our competitive profile in the fund business. In normal times, we would say we have less ability to add value through management in the SMA channels just because we’re got fewer management levers in that business, in the short fun that’s helped us because some of those levers has worked against us near term, helped us in the SMA business versus our fund business performance.

Tom Faust

In fact, Cynthia, our relative Muni bond performance, in the managed account business, has actually improved quite significantly, to the point where we’re now at the top of the list.

Cynthia Mayer – Merrill Lynch

Okay, interesting. And I guess, just a couple of more questions on closed-ends, obviously it’s pretty slow right now but can you tell us what you’re incubating?

Tom Faust

Well, we have two funds that have been filed, and one of them is a credit opportunities fund designed to take advantage of the obvious turmoil and dislocation in the income market. That has been filed for a number of months. We have no current plan to offer that, no monthly time slot assigned to that product, for the reasons that you identified, pretty weak market conditions currently.

The other product that we have filed is a successor to our July offering, which is a risk managed equity fund, that is different from most other options based income products, uses the purchase of index put options to give a measure of down side protection. That fund was successfully launched in July, there’s a follow up product with a different mix of stocks and a different mix of options that we would hope to launch, but again due to weak market conditions we do not have a particular marketing spot in mind for that. So those are the two things that we can talk about that have been filed. Obviously we consider it. We continue to think about other ideas that will fit well with this particular product category.

Cynthia Mayer – Merrill Lynch

Any thoughts on when conditions will improve?

Tom Faust

Well, this is a market that historically, because it’s retail dominated, tends to sell off in the fourth quarter. And if history is a guide we would hope after the first of the year to see substantially better after market trading for existing products in the market and also significantly expanded opportunity to do new offerings.

Cynthia Mayer – Merrill Lynch

Okay, and just one more question. How do you view your exchange fund business at this point, because looking at the flows it seems as though you had, at least based on strategic insight, like a billion in outflows in the fiscal year versus just nominal outflows the previous two years. I’m wondering if you view it as something that could pick up if the tax flows are changed or if it’s at this point static.

Tom Faust

It’s a relatively mature business. We’ve offered similar products for approximately a decade now through primarily the same distribution channels. You point out an external factor that could accelerate momentum which would be a change or an anticipated change in the tax law to raise capital gains rate.

We’re also in the midst of internal changes. I mentioned in my remarks of a wealth management solutions group which has really combined what were separate units internally, one focusing on the retail managed account business and the other on the exchange fund opportunity and to put those into one expanded unit that focuses on these types of specialty and other specialty products. So the hope is, the expectation is, that the internal attention devoted to this product area will improve and that even if the external environment doesn’t change that we’ll see improvement in that business.

There’s also another factor that affects the net flows, is that there’s a natural lifetime to an exchange fund, and for many investors there’s a redemption acceleration after approximately seven to eight years from the issuance. And if you think back to what was going on the market seven years ago, it was a pretty good environment for selling strategies like this, that were designed to diversify stock positions. So, since we’re seven years or so beyond the peak market conditions of ’99, 2000, 2001, it’s reasonable to assume that we’re about seven years beyond peak sales of these funds, and that as we start [inaudible] years like 2001, 2002, 2003 when sales were less we would expect less redemptions pressure on the back end. So we’re hopeful that between the stronger focus on sales and the less, the falling off of redemptions due to the factor I just described, that the net trend here should improve over the next couple of years.

Cynthia Mayer – Merrill Lynch

Great, thank you.

Operator

Thank you. There are no further questions at this time. I would like to turn the call back over to management for closing comments.

Bob Whelan

Thank you for joining us this morning. I hope you agree that it’s been a great year and we look forward to continued success under our new leadership. Thanks for joining us.

Operator

This concludes today’s conference. (Operator instructions)

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Source: Eaton Vance Corp. F4Q07 (Qtr End 10/31/07) Earnings Call Transcript
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