Affiliated Managers Group, Inc. Annual Report 2008 A f f i l i a t e d M a n a g e r s G r o u p , I n c . Affiliated Managers Group, Inc. (NYSE: AMG) is an asset management company which operates through a diverse group of high quality boutique asset management firms (its “Affiliates”). AMG’s unique partnership approach with its Affiliates preserves the entrepreneurial orientation that distinguishes the most successful investment management firms. AMG promotes the continued growth and strong performance of its Affiliates by: • Maintaining and enhancing Affiliate managers’ equity incentives in their firms; • Preserving each Affiliate’s distinct culture and investment focus; and, • Leveraging AMG’s scale to expand the product offerings and distribution capabilities of its Affiliates, and to provide its Affiliates access to the highest quality operations, compliance and technology resources. AMG seeks to achieve earnings growth through the internal growth of its Affiliates, development initiatives designed to enhance its Affiliates’ businesses, and investments in new Affiliates. Pro forma for a pending investment, AMG’s Affiliates collectively manage approximately $174 billion (as of December 31, 2008) in more than 300 investment products across the institutional, mutual fund and high net worth distribution channels for investors around the world. AMG has achieved strong long-term growth in earnings, with compound annual growth in Cash Earnings Per Share of approximately 17 percent since its initial public offering in 1997. Contents Financial Highlights and Quarterly Earnings Letter to Shareholders AMG Overview Financial Information Endnotes Corporate Data 1 2 6 17 79 80 Unless otherwise noted, data presented is as of December 31, 2008. F i n a n c i a l H i g h l i g h t s (in millions, except as indicated and per share data) 2006 2007 2008 Years ended December 31, Operating Results Revenue Net Income Cash Net Income(1) EBITDA(2) Earnings Per Share – diluted Cash Earnings Per Share – diluted(3) Balance Sheet Data Total Assets Senior Indebtedness Mandatory Convertible Securities Junior Convertible Securities Stockholders’ Equity Other Financial Data $ 1,170.4 $ 1,369.9 $ 1,158.2 151.3 222.5 342.1 3.70 5.68 $ 182.0 258.7 418.2 4.55 6.65 $ $ 2,665.9 $ 3,395.7 778.9 300.0 300.0 499.2 897.6 300.0 800.0 469.2 23.2 222.0 335.3 0.57 5.49 $ $ 3,246.4 740.7 0.0 730.8 1,092.6 Assets Under Management (at period end, in billions) $ 241.1 $ 274.8 $ 170.1 Average Shares Outstanding – diluted Average Shares Outstanding – adjusted diluted(4) 43.7 39.2 42.4 38.9 40.9 40.5 *For the notes referenced above, please see page 79. Q u a r t e r l y E a r n i n g s $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 4Q 97 4Q 98 4Q 99 4Q 00 4Q 01 4Q 02 4Q 03 4Q 04 4Q 05 4Q 06 4Q 07 ** 4Q 08 **AMG’s results for the fourth quarter of 2008 presented above exclude a non-cash charge of $150.0 million, which is discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Cash Earnings Per Share Earnings Per Share (diluted) 1 T o O u r S h a r e h o l d e r s Against a backdrop of global asset declines and extreme Since our founding, we have consistently executed our financial market volatility in 2008, AMG produced stable strategy of partnering with outstanding boutique firms in the results, demonstrating the strength of our business model and most profitable areas of the investment management industry, the quality and diversity of our Affiliate group. For the year, and leveraging our scale to support and enhance their growth. we generated Cash Earnings Per Share of $5.49, a decline of Our unique partnership approach maintains our Affiliates’ 17 percent over the prior year, compared to declines of 37 distinctive cultures and the entrepreneurial focus that percent in the S&P 500 Index and 40 percent for the MSCI distinguishes the most successful investment management World Index, respectively. Our ability to navigate through this firms. By providing key principals with operational autonomy period reflects the strength of our Affiliates — leading boutique and meaningful equity ownership, our investment structure asset management firms widely recognized for their strong creates a powerful incentive for our Affiliates to efficiently long-term performance records and superior client service. manage their businesses and focus on long-term growth. Given our high quality group of Affiliates, complemented by a In addition, our investment structure generally provides our strong capital position, our business is well positioned to Affiliates with the operating leverage in their firms, which weather these difficult times and to generate growth for our benefits our Affiliate partners as margins expand with the shareholders when financial markets stabilize. AMG Executive Management Sean M. Healey President and Chief Executive Officer Nathaniel Dalton Executive Vice President and Chief Operating Officer Darrell W. Crate Executive Vice President and Chief Financial Officer John Kingston, III Executive Vice President and General Counsel Jay C. Horgen Executive Vice President, New Investments 2 growth of their firms and protects AMG’s earnings from specialist BlueMountain continued to produce strong margin compression during periods of declining markets and investment performance and meaningful performance fees decreasing revenues. The strength of our investment approach from a number of products, such as multi-strategy, currency is demonstrated by the substantial growth generated by our and market-neutral strategies. Looking ahead, with more Affiliates over the long term — even after recent market declines, than 300 distinct products across a diverse mix of strategies, our largest Affiliates’ assets under management have grown an weighted toward international equities, we are in a strong average of over 70% since the time of our initial investment. position to generate significant growth as markets recover and In 2008, our largest Affiliates continued to distinguish investors reallocate to return-oriented products. themselves as industry leaders by outperforming peers and While AMG is dedicated to maintaining our Affiliates’ benchmarks across an array of investment styles, asset classes, autonomy, we have successfully implemented scalable multi- and geographies. In recognition of its outstanding relative Affiliate initiatives that enhance revenue growth and performance, Tweedy, Browne was nominated by Morningstar operational efficiency. We have leveraged our holding for both Domestic- and International-Stock Manager of the company resources to implement distribution initiatives that Year awards while Third Avenue received a Morningstar complement the focused marketing efforts of our boutique Manager of the Year nomination for its impressive near- and Affiliates both within the U.S. and around the world. long-term International Value performance record. Affiliates such as quantitative manager First Quadrant and credit T o O u r S h a r e h o l d e r s c o n t i n u e d Domestically, our Managers Investment Group platform has regarded manager of municipal and taxable bond products as expanded our Affiliates’ access to mutual fund and separately well as multi- and small-cap equity products, to our Affiliate managed accounts in a broad range of intermediary channels. group. While market volatility limited our new investment Through our global distribution platform, we meaningfully activity in 2008, we are encouraged by positive trends in the extended our Affiliates’ international reach by focusing on transaction environment. We continue to see a number of markets where investors appreciate and seek the specialized investment opportunities from large financial services firms investment styles of boutique asset managers. With offices in which are reassessing and divesting of non-core business lines, Canada, Australia and, in 2008, the opening of our London including asset management subsidiaries, and we expect this office servicing Europe and the Middle East, our growing trend to continue in 2009 and beyond. At the same time, we international client base includes non-U.S. clients from expect transaction activity among boutique firms facing 25 countries, and accounts for approximately 30 percent of succession-oriented issues to increase as markets stabilize, and AMG’s assets under management. our track record of successful investments and reputation as an In addition to the strong long-term growth of our Affiliates, AMG’s business model provides a unique opportunity for growth through accretive new investments. In 2008, we were pleased to welcome Gannett Welsh & Kotler, a highly innovative and supportive partner to our Affiliates continues to make us the partner of choice among boutique firms, their clients, and consultants. We remain disciplined and selective in AMG Board of Directors Sean M. Healey President and Chief Executive Officer William J. Nutt Chairman Patrick T. Ryan Former Chief Executive Officer, PolyMedica Corporation Jide J. Zeitlin Former General Partner, Goldman, Sachs & Co. Richard E. Floor Partner, Goodwin Procter LLP Rita M. Rodriguez Former Director, Export-Import Bank of the United States Harold J. Meyerman Former Senior Executive, The Chase Manhattan Bank and First Interstate Bank, Ltd. 4 assessing these new investment prospects, focusing on high accretive new investments. We are well positioned to weather quality businesses with proven records of outstanding the ongoing challenges of this extraordinary market investment performance and client service. environment and we look ahead with optimism at our Even in this challenging environment, our business generates strong recurring cash flow that is supported by a robust and stable capital base with substantial liquidity and no net debt. Currently, we have approximately $175 million in available cash and an undrawn revolving credit facility of nearly $800 million — a ready source of capital to finance future multi- Affiliate initiatives and new investments. We are confident in our ability to generate incremental returns by opportunistically deploying our cash flow, executing timely stock repurchases and making accretive investments in new Affiliates. In closing, we remain focused on the execution of our proven growth strategy of partnering with outstanding Affiliates, enhancing the growth of our existing Affiliates, and making prospects to generate long-term growth and create shareholder value. We are grateful to our Affiliates, our employees, the members of our Board of Directors and our service providers for their contributions to our ongoing success, and to our shareholders for their support. Sean M. Healey President and Chief Executive Officer 5 Earnings Contribution Earnings Contribution By Product Category By Product Category International Equities 35% U.S. Growth Equities 30% U.S. Value Equities 15% Alternative Products 15% Fixed Income 5% A M G O v e r v i e w AMG follows a proven, disciplined are leading investors in their disciplines, strategy for growing its business: invest in with years of successful application of excellent boutique asset management their investment processes demonstrated businesses; allow management to retain through their outstanding long-term equity in their firm as a powerful incentive performance records. for growth through a partnership structure that preserves the unique culture and approach that has led to their success; and then provide these Affiliates with a range of growth and development initiatives designed to enhance their businesses. AMG’s Affiliates predominantly offer active portfolio management of domestic and international equities, which gives AMG a significant presence in some of the most dynamic and profitable areas of the investment management industry. AMG’s success in executing its business Approximately 35 percent of AMG’s strategy has established a strong founda- EBITDA is derived from global, interna- tion for continued growth. With the tional and emerging markets equity diversity and strong performance of products, 45 percent from domestic equity AMG’s Affiliates, a proven ability and products, including both growth and value capacity to execute its growth initiatives, styles, and 15 percent from alternative and AMG’s established position as a products. The remaining five percent is leading institutional partner for boutique derived from fixed income products. This asset management firms, AMG is diverse array of products enables AMG to well-positioned to continue to generate participate broadly in the most attractive shareholder value in the future. segments of the investment management industry, while generating incremental growth by introducing Affiliate products into additional distribution channels. Investment Products AMG’s Affiliates include some of the highest quality boutique investment management firms in the industry. As a group, AMG Affiliates manage more than 300 investment products across a broad array of investment styles. AMG’s Affiliates 6 Global, International and Emerging Markets Equities Third Avenue’s international value equity portfolios seek long-term capital apprecia- Earnings Contribution Earnings Contribution By Product Category By Product Category AMG’s Affiliates include leading boutique tion by investing in the securities of firms which manage global, international well-financed, well-managed foreign and emerging markets equities across a companies believed to be priced below wide variety of products with distinct their intrinsic values. Third Avenue also investment styles. Some of AMG’s received a Morningstar International-Stock Affiliates with particularly strong track Manager of the Year nomination in records in this area include Tweedy, 2008 for the impressive near- and long- Browne Company, Third Avenue term performance record of the firm’s Management, Genesis Investment International Value fund. Management, AQR Capital Management, and Foyston, Gordon & Payne. Genesis is a specialist manager of emerg- ing markets equities for institutional Tweedy, Browne’s Global Value product clients. The firm aims to identify growing is among the largest and most distin- companies which are most undervalued guished global value equity products, and compared to their long-term potential. follows a diversified, Graham and Dodd approach to global investing. The Global Value fund has an excellent long-term track record and continues to generate strong results for its investors. In 2008, Tweedy, Browne was nominated by Morningstar for the International-Stock Manager of the Year award in recognition of its impressive investment performance record. Tweedy, Browne’s Worldwide High Dividend Yield Value fund has also per- formed well since its inception in 2007. Third Avenue also applies a disciplined value philosophy to investing in interna- tional equities. The firm has generated outstanding long-term results utilizing its “safe and cheap” investment approach. AQR employs a disciplined and systematic global research process to develop diver- sified global and international equity portfolios that are overweight on cheap (and, in turn, underweight on expensive) international securities, countries and currencies to achieve long-term success in both investment performance and risk management. AQR manages international products on behalf of a wide range of lead- ing global institutional investors through collective investment vehicles and separate accounts, and has generated strong results in this area. International Equities 35% 7 Earnings Contribution Earnings Contribution By Product Category By Product Category U.S. Growth Equities 30% A M G O v e r v i e w c o n t i n u e d Foyston, Gordon & Payne manages E channel, as well as in the retail and defined value equity products for institutional contribution channels through AMG’s and private clients. Foyston’s investment Managers Investment Group platform. products — Canadian equities, U.S. equities and international equities — have each generated strong long-term invest- ment results, significantly outperforming their respective peers and benchmarks. U.S. Growth Equity TimesSquare is among the industry’s leading growth equity managers, specializ- ing in small-, small/mid-, and mid-cap strategies. The firm has achieved excellent long-term returns for its investors through its proprietary research driven, bottom-up AMG’s Affiliates are among the leading process of selecting companies that boutique managers in the active meet its definition of superior growth management of U.S. equities. Among the businesses. Company’s larger Affiliates providing growth equity expertise, Friess Associates, TimesSquare Capital Management, Frontier Capital Management and Renaissance Investment Management have strong market positions and are well-respected as leading growth investors. Friess uses a time-tested investment strategy that relies on exhaustive, company-by-company research to identify companies with promising earnings growth potential that have yet to be recognized by the broader investment community. Friess’ highly rated Brandywine mutual fund family is one of the most well-respected families of mutual funds. Friess has also expanded its distri- bution internally in the institutional Frontier offers a wide range of high qual- ity investment products, including strategies focused on small-, small/mid-, mid-, and large-cap growth equities. The firm uses a highly disciplined stock selec- tion process driven by intensive internal research to generate excellent returns for its clients. Renaissance employs disciplined, systematic investment processes in the management of small-, mid-, and large- cap growth stocks. Renaissance’s portfolios follow specific investment disciplines designed to maximize return and control risk, and have generated strong long-term results for the firm’s clients. 8 U.S. Value Equity investment philosophy focuses on AMG’s Affiliates also include some of the identifying companies that exhibit a industry’s most experienced and respected combination of attractive valuation practitioners of value investing, such as and a positive earnings catalyst. Tweedy, Browne, Third Avenue and Systematic Financial Management. AMG’s domestic value equity products span a wide range of market capitalizations and include many of the industry’s most highly rated investment products. Alternative Products AMG’s diverse alternative product set includes several strategies that are not correlated with equity markets and a range of Affiliates offer investment prod- ucts with performance fee components. Tweedy, Browne, a renowned practitioner AMG’s Affiliates have broad expertise in of deep value investing, manages U.S. their respective investment disciplines, equity products including the Tweedy, and the Company realized a material Browne Value Fund, as well as individual contribution to its earnings from perform- accounts for institutional and high net ance fees in 2008. worth investors. In 2008, the firm was nominated for Morningstar’s Domestic- Stock Manager of the Year award. Tweedy, Browne’s research seeks to appraise the intrinsic value of a company, and uses a disciplined buy and sell process to guide its investment decisions. AMG has substantial breadth and diversity in its alternative product offerings through investments in leading firms such as First Quadrant, AQR, BlueMountain Capital Management, Genesis, Third Avenue, and ValueAct Capital. Overall, the Company offers more than 40 distinct Third Avenue is among the leading value investment strategies, including distressed managers in the investment management securities, quantitative global macro, industry, with strong-performing products active value and credit alternatives. including the Third Avenue Value and Third Avenue Small-Cap Value mutual funds. The firm seeks to invest in securi- ties and companies at a deep discount to the intrinsic value of their assets, and has created superior returns for its investors over the long term. First Quadrant offers investment manage- ment strategies in two main areas, equities and global macro, while paying close attention to risk management. In addition, First Quadrant’s Global Alternatives mutual fund offers retail investors access to the firm’s proven global asset allocation Systematic specializes in the management strategies focused on uncorrelated alpha of value equity portfolios across the sources across the globe. market capitalization spectrum. The firm’s Earnings Contribution Earnings Contribution By Product Category By Product Category E U.S. Value Equities 15% Alternative Products 15% 9 A M G O v e r v i e w c o n t i n u e d AQR employs a disciplined, multi-asset, Third Avenue applies its disciplined value global research process. The firm employs approach to products investing in real more than 20 distinct investment strate- estate securities, as well as distressed gies in managing its portfolios, and offers securities and other special situations. For products ranging from aggressive high example, the highly rated Third Avenue volatility, market-neutral hedge funds to Real Estate Value Fund invests primarily low volatility, benchmark-driven tradi- in equity and debt securities of companies tional portfolios. BlueMountain, a global credit alternatives manager, specializes in relative value strategies in the corporate loan, bond, credit and equity derivatives markets. The firm identifies investment strategies using a combination of fundamental research and quantitative and technical analysis. BlueMountain’s investment team operates in the real estate industry or related indus- tries, using bottom-up, fundamental analysis to identify undervalued securities. Third Avenue also has a long history of including investments in distressed debt securities within its equity mutual funds and has extended this expertise to investing in distressed and other special situations through private investment partnerships. in a highly integrated manner, with risk ValueAct Capital establishes substantial management as a key element of the firm’s ownership positions in companies it investment process. believes to be fundamentally undervalued, Genesis, a leading investment firm in emerging markets equities, delivers strong long-term returns for its clients by identi- fying underpriced companies through independent research and disciplined and then works with the company’s management and board of directors to implement business strategies that enhance shareholder value and create a return independent of the market. analysis. The Genesis Smaller Companies Fixed Income Fund invests primarily in equity securities In addition to their specialized expertise of firms that operate in emerging markets in equity and alternative products, a and have market capitalizations of less number of AMG’s Affiliates, including than $1 billion. Gannett Welsh & Kotler, Chicago Equity Partners, Beutel, Foyston and Managers Investment Group, offer fixed income and other products to their institutional, mutual fund and high net worth clients. Together, these products account for approximately five percent of AMG’s EBITDA. Earnings Contribution Earnings Contribution By Product Category By Product Category Fixed Income 5% 10 Growth and Development Initiatives AMG’s growth and development strategy is focused on preserving each Affiliate’s distinct operating and investment culture while offering Affiliates the advantages of scale. While AMG’s Affiliates have independ- ently demonstrated an ability to achieve strong organic growth, AMG has imple- mented a number of strategic initiatives to further enhance the growth and profita- bility of its Affiliates’ businesses. AMG makes available to its Affiliates a broad array of opportunities and services, includ- ing initiatives designed to expand an Affiliate’s product offerings and distribution capabilities, as well as multi- Affiliate initiatives that enable Affiliates to streamline operations and obtain high quality services at cost-effective rates. While Affiliates maintain the flexibility and freedom to determine their participa- tion, nearly all have elected to participate in one or more of these initiatives. Multi-Affiliate Distribution Platforms AMG’s Affiliates, like other high quality boutique asset managers, integrate their specific investment process in every func- tion of the firm, including both sales and client service, which provides these firms with competitive advantages in bringing their products and services to certain distribution channels in the marketplace, such as direct or consultant-driven institu- tional channels. In other channels, which require a breadth of product offerings and depth of marketing capacity, AMG has created distribution platforms that offer Affiliates the benefits of scale where they exist, while preserving each Affiliate’s distinct operating and investment culture, as well as its unique set of relationships and marketing expertise. More than half of AMG’s Affiliates, including most of its largest Affiliates, use AMG as part of their product distribution strategy. As institutional investors worldwide increasingly seek high quality investment managers, AMG has identified a number of opportunities to meet the global demand for boutique asset managers. AMG has offices located in Sydney and London to provide its Affiliates with access to institutional investors in Australia, Europe and the Middle East. AMG’s experienced professionals have broad expertise in serving these markets and a demonstrated capacity to provide superior execution in sales, client service and support. By providing its Affiliates with efficient and superior distribution capabili- ties for international investors in these regions, AMG expects to generate signifi- cant incremental client cash flows over time. AMG continues to identify markets where its high quality investment products appeal to sophisticated institutional Diverse International Client Base $55 Billion in Non-U.S. Clients Non-U.S. AUM 11 A M G O v e r v i e w c o n t i n u e d investors, and expects to further develop knowledge and experience of senior this platform in other regions around AMG attorneys and compliance profes- the world. In the United States, AMG’s Managers Investment Group distribution platform offers Affiliates the opportunity to mean- ingfully expand their product offerings sionals to its Affiliates, AMG provides industry expertise and robust, leading-edge compliance capabilities at a level well beyond that which would be typically available to mid-sized firms. and distribution capabilities through Ongoing Succession Planning intermediaries in the retail marketplace, AMG works closely with its Affiliates to where scale and quality of execution in maintain and enhance the equity incen- sales, client service, support and back- tives that are critical to each Affiliate’s office requirements are essential for continued growth. AMG engages in an success. With a team of experienced sales ongoing process with its Affiliates to professionals, the Managers platform manage each firm’s succession and transi- services and distributes single- and multi- tion process, with a focus on ensuring manager Affiliate mutual fund and that equity incentives are properly allo- separate account products to intermedi- cated and aligned among key members aries, including broker-dealers, banks and of each firm. independent advisors. In addition, the Managers Investment Group platform distributes Affiliate mutual funds in the defined contribution marketplace. Investments in New Affiliates Legal and Compliance Resources In addition to the strong organic growth AMG has also leveraged the benefits of scale to offer Affiliates cost-effective access to high quality resources in areas such as compliance and technology. As the regulatory climate in the investment management industry continues to create complexity, Affiliates can take advantage of AMG’s centralized resources as a source of support, providing a full range of customized assistance across the universe of requirements. By bringing the of AMG’s existing Affiliates, AMG has generated substantial growth through accretive investments in additional high quality boutique firms. AMG’s investment strategy provides Affiliate managers with direct equity in their firm, creating a powerful incentive for long-term growth and investment 12 performance. This approach preserves the Financial Strength entrepreneurial culture that characterizes the best boutique asset management firms, while also providing access to the resources and distribution capabilities of a larger asset management company. AMG’s investment structure is attractive to successful asset managers who value their autonomy and continued participation in their firm’s future growth. AMG’s operations generate strong and recurring free cash flow, and the Company’s broad exposure across various investment styles and distribution chan- nels provides balance and stability to this cash flow. AMG takes a disciplined approach to investing its free cash flow, and adheres to well-defined return objec- tives in making investments in growth AMG continues to identify and develop initiatives for existing Affiliates, as well as relationships with high quality domestic making investments in new Affiliates. AMG supports its growth strategy by maintaining a strong balance sheet and diverse sources of long-term capital. The Company maintains an investment grade rating, and strives to maintain substantial liquidity and financial flexibility. AMG manages its capital resources and cash flow to achieve superior long-term results for shareholders by financing new invest- ments, repaying existing indebtedness, and repurchasing its stock, when appropriate. and international boutique firms (both independent managers and subsidiaries of larger financial services companies), and is well positioned to execute new invest- ments, having established relationships with many of the best firms in the indus- try. Within its target universe, AMG is widely recognized as the partner of choice for owners, clients and employees of firms that seek to facilitate ownership transitions, while maintaining their unique culture and approach and providing next generation management with key growth incentives through direct equity ownership. With a proven track record of value creation, a disciplined investment strategy, and a strong, flexible balance sheet to support further growth, AMG has excellent prospects for continued success in executing accretive investments in new Affiliates. 13 A M G D i s t r i b u t i o n C h a n n e l s Earnings Contribution By Distribution Channel Institutional 55% Mutual Fund 35% High Net Worth 10% Institutional Distribution Channel AMG’s Affiliates offer approximately 200 investment products across more than 50 different investment styles in the institutional distribution channel, including small-, small/mid-, mid-, and large-cap value, growth equity and emerging markets. In addition, AMG’s Affiliates offer quantitative, alternative, credit arbitrage and fixed income products. AMG’s Affiliates manage assets for foundations and endowments, defined benefit and defined contribution plans for corporations and municipalities, and Taft-Hartley plans, with disciplined and focused investment styles that address the specialized needs of institutional clients. AMG’s institutional investment products are distributed by over 70 sales and marketing professionals at its Affiliates who develop new institutional business through direct sales efforts and established relationships with pension consultants. AMG works with its Affiliates in executing and enhancing their marketing and client service initiatives, with a focus on ensuring that its Affiliates’ products and services successfully address the specialized needs of their clients and are responsive to the evolving demands of the marketplace. In addition, AMG provides its Affiliates with resources to improve sales and marketing materials, network with the pension consultant and plan sponsor communities, and further expand and establish new distribution alternatives. AMG has also worked with its Affiliates in executing and enhancing their marketing and client service initiatives by expanding its global distribution platform to serve institutional investors in Australia, Europe and the Middle East. Through offices in Sydney and London, AMG provides investors in these international marketplaces a single point of contact to access a broad range of investment products offered by its Affiliates. 14 Mutual Fund Distribution Channel AMG has a strong presence in the mutual fund channel, with Affiliates providing advisory or sub-advisory services to more than 100 mutual funds. These funds are distributed to retail and institutional clients directly and through intermediaries, including independent investment advisors, retirement plan sponsors, broker-dealers, major fund marketplaces and bank trust departments. By utilizing the distribution, sales, client service and back-office capabilities of Managers Investment Group, AMG Affiliates are provided access to the mutual fund distribution channel and wrap sponsor platforms. Managers offers Affiliates a single point of contact for retail intermediaries such as banks, brokerage firms and other sponsored platforms. Within this distribution channel, Managers is presently servicing and distributing approximately 35 mutual funds managed by nine Affiliates. High Net Worth Distribution Channel AMG’s Affiliates serve two principal client groups in the high net worth distribution channel. The first group consists principally of direct relationships with high net worth individuals and families and charitable foundations. For these clients, AMG’s Affiliates provide investment management or customized investment counseling and fiduciary services. The second group consists of individual managed account client relationships established through intermediaries, which are generally brokerage firms or similar sponsors. AMG’s Affiliates provide investment management services through approximately 100 managed account and wrap programs. AMG has undertaken several initiatives to provide its Affiliates with enhanced managed account distribution and administration capabilities. Through Managers Investment Group, AMG is presently distributing approximately 35 investment products managed by eight Affiliates. Managers distributes single and multi-manager separate account products and mutual funds through brokerage firms. 15 16 F i n a n c i a l S e c t i o n 18 Management’s Discussion and Analysis of Financial Condition and Results of Operations 43 Selected Financial Data 44 Management’s Report on Internal Control Over Financial Reporting 45 Report of Independent Registered Public Accounting Firm 46 Consolidated Financial Statements 50 Notes to Consolidated Financial Statements 78 Common Stock and Corporate Organization Information 17 Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements When used in this Annual Report and in our other filings with the United States Securities and Exchange Commission, in our These factors (as well as those discussed above under “Risk Factors”) could affect our financial performance and cause actual results to differ materially from historical earnings press releases and in oral statements made with the approval of and those presently anticipated and projected. We will not an executive officer, the words or phrases “will likely result,” undertake and we specifically disclaim any obligation to release “are expected to,” “will continue,” “is anticipated,” “may,” publicly the result of any revisions which may be made to any “intends,” “believes,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among others, the following: forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of events, whether or not anticipated. In that respect, we wish to caution readers not to place undue reliance on any such for- ward-looking statements, which speak only as of the date made. our performance is directly affected by changing conditions in global financial markets generally and in the equity markets particularly, and a decline or a lack of sustained Overview growth in these markets may result in decreased advisory We are an asset management company with equity in- fees or performance fees and a corresponding decline (or lack vestments in a diverse group of boutique investment of growth) in our operating results and in the cash flow distributable to us from our Affiliates; management firms (our “Affiliates”). We pursue a growth strategy designed to generate shareholder value through we cannot be certain that we will be successful in finding or the internal growth of our existing business, additional investing in additional investment management firms on investments in boutique investment management firms favorable terms, that we will be able to consummate and strategic transactions and relationships structured to announced investments in new investment management firms, or that existing and new Affiliates will have favor- able operating results; we may need to raise capital by making long-term or short-term borrowings or by selling shares of our common enhance our Affiliates’ businesses and growth prospects. Through our Affiliates, we manage approximately $170.1 billion in assets (as of December 31, 2008) in more than 300 investment products across a broad range of asset stock or other securities in order to finance investments in classes and investment styles in three principal distribution additional investment management firms or additional channels: Mutual Fund, Institutional and High Net investments in our existing Affiliates, and we cannot be sure that such capital will be available to us on acceptable terms, if at all; and Worth. We believe that our diversification across asset classes, investment styles and distribution channels helps to mitigate our exposure to the risks created by changing those certain other factors discussed under the caption market environments. The following summarizes our “Risk Factors.” operations in our three principal distribution channels: 18 Our Affiliates provide advisory or sub-advisory services We operate our business through our Affiliates in our three to more than 100 mutual funds. These funds are dis- principal distribution channels, maintaining each Affiliate’s tributed to retail and institutional clients directly and distinct entrepreneurial culture and independence through through intermediaries, including independent invest- our investment structure. In making investments in ment advisors, retirement plan sponsors, broker/dealers, boutique asset management firms, we seek to partner with major fund marketplaces and bank trust departments. the highest quality firms in the industry, with outstanding In the Institutional channel, our Affiliates offer approx- imately 200 investment products across approximately 50 different investment styles, including small, small/mid, mid and large capitalization value, growth equity and emerging markets. In addition, our management teams, strong long-term performance records and a demonstrated commitment to continued growth and success. Fundamental to our investment approach is the belief that Affiliate management equity ownership (along with AMG’s ownership) aligns our interests and provides Affiliate managers with a powerful incentive to continue to Affiliates offer quantitative, alternative, credit arbitrage grow their business. Our investment structure provides a and fixed income products. Through this distribution degree of liquidity and diversification to principal owners of channel, our Affiliates manage assets for foundations boutique investment management firms, while at the same and endowments, defined benefit and defined contri- time expanding equity ownership opportunities among the bution plans for corporations and municipalities, and firm’s management and allowing management to continue Taft-Hartley plans, with disciplined and focused to participate in the firm’s future growth. Our partnership investment styles that address the specialized needs of approach also ensures that Affiliates maintain operational institutional clients. The High Net Worth distribution channel is comprised broadly of two principal client groups. The first group consists principally of direct relationships with high net worth individuals and families and charitable foundations. For these clients, our Affiliates provide investment management or customized investment autonomy in managing their business, thereby preserving their firm’s entrepreneurial culture and independence. Although the specific structure of each investment is highly tailored to meet the needs of a particular Affiliate, in all cases, AMG establishes a meaningful equity interest in the firm, with the remaining equity interests retained by the management of the Affiliate. Each Affiliate is organized counseling and fiduciary services. The second group as a separate firm, and its operating or shareholder consists of individual managed account client relation- agreement is structured to provide appropriate incentives ships established through intermediaries, which are for Affiliate management owners and to address the generally brokerage firms or other sponsors. Our Affiliate’s particular characteristics while also enabling us Affiliates provide investment management services to protect our interests, including through arrangements through approximately 100 managed account and such as long-term employment agreements with key wrap programs. members of the firm’s management team. 19 In most cases, we own a majority of the equity interests of Our minority investments are also structured to align our a firm and structure a revenue sharing arrangement, in interests with those of the Affiliate’s management through which a percentage of revenue is allocated for use by shared equity ownership, as well as to preserve the Affiliate’s management of that Affiliate in paying operating expenses entrepreneurial culture and independence by maintaining of the Affiliate, including salaries and bonuses. We call this the Affiliate’s operational autonomy. In cases where we the “Operating Allocation.” The portion of the Affiliate’s hold a minority interest, the revenue sharing arrangement revenue that is allocated to the owners of that Affiliate generally allocates a percentage of the Affiliate’s revenue to (including us) is called the “Owners’ Allocation.” Each us. The remaining revenue is used to pay operating expenses Affiliate allocates its Owners’ Allocation to its managers and profit distributions to the other owners. and to us generally in proportion to their and our respective ownership interests in that Affiliate. Certain of our Affiliates operate under profit-based arrangements through which we own a majority of the One of the purposes of our revenue sharing arrangements is equity in the firm and receive a share of profits as cash to provide ongoing incentives for Affiliate managers by flow, rather than a percentage of revenue through a typical allowing them to participate in the growth of their firm’s revenue sharing agreement. As a result, we participate fully revenue, which may increase their compensation from both in any increase or decrease in the revenue or expenses of the Operating Allocation and the Owners’ Allocation. such firms. In these cases, we participate in a budgeting These arrangements also provide incentives to control process and generally provide incentives to management operating expenses, thereby increasing the portion of the through compensation arrangements based on the perform- Operating Allocation that is available for growth initiatives ance of the Affiliate. and compensation. As one measure of these incentives, in 2008, approximately $381.8 million of compensation and We are focused on establishing and maintaining long- profits were allocated to our Affiliate managers (reported term partnerships with our Affiliates. Our shared equity in Compensation expense and Minority interest). An Affiliate’s Operating Allocation is structured to cover its operating expenses. However, should actual operating expenses exceed the Operating Allocation, our contractual share of cash under the Owners’ Allocation generally has ownership gives both AMG and our Affiliate partners meaningful incentives to manage their businesses for strong future growth. From time to time, we may consider changes to the structure of our relationship with an Affiliate in order to better support the firm’s growth strategy. priority over the allocations and distributions to the Through our affiliated investment management firms, Affiliate’s managers. As a result, the excess expenses first we derive most of our revenue from the provision of reduce the portion of the Owners’ Allocation allocated to investment management services. Investment management the Affiliate’s managers until that portion is eliminated, fees (“asset-based fees”) are usually determined as a percentage before reducing the portion allocated to us. Any such fee charged on periodic values of a client’s assets under reduction in our portion of the Owners’ Allocation is management; most asset-based advisory fees are billed by required to be paid back to us out of the portion of future our Affiliates quarterly. Certain clients are billed for all Owners’ Allocation allocated to the Affiliate’s managers. or a portion of their accounts based upon assets under 20 management valued at the beginning of a billing period (including their revenue) in our Consolidated Statements (“in advance”). Other clients are billed for all or a portion of Income. Our share of these firms’ profits (net of of their accounts based upon assets under management intangible amortization) is reported in “Income from valued at the end of the billing period (“in arrears”). Most equity method investments,” and is therefore reflected in client accounts in the High Net Worth distribution our Net Income and EBITDA. As a consequence, increases channel are billed in advance, and most client accounts in or decreases in these firms’ assets under management the Institutional distribution channel are billed in arrears. (which totaled $44.2 billion as of December 31, 2008) will Clients in the Mutual Fund distribution channel are billed not affect reported revenue in the same manner as changes based upon average daily assets under management. in assets under management at our other Affiliates. Advisory fees billed in advance will not reflect subsequent changes in the market value of assets under management for that period but may reflect changes due to client Our Net Income reflects the revenue of our consolidated Affiliates and our share of income from Affiliates which we withdrawals. Conversely, advisory fees billed in arrears account for under the equity method, reduced by: will reflect changes in the market value of assets under management for that period. In addition, over 50 Affiliate alternative investment and equity products, representing approximately $28.6 billion of assets under management (as of December 31, 2008), also bill on the basis of absolute or relative investment performance (“performance fees”). These products, which are primarily in the Institutional distribution channel, are often structured to have returns that are not directly correlated to changes in broader equity indices and, if earned, the performance fee component is typically billed less frequently than an asset-based fee. Although performance fees inherently depend on investment results and will vary from period to period, we anticipate per- formance fees to be a recurring component of our revenue. We also anticipate that, within any calendar year, the majority of performance fees will typically be realized in the fourth quarter. our expenses, including the operating expenses of our consolidated Affiliates; and the profits allocated to managers of our consolidated Affiliates (i.e., minority interest). As discussed above, for consolidated Affiliates with revenue sharing arrangements, the operating expenses of the Affiliate as well as its managers’ minority interest generally increase (or decrease) as the Affiliate’s revenue increases (or decreases) because of the direct relationship established in many of our agreements between the Affiliate’s revenue and its Operating Allocation and Owners’ Allocation. At our consolidated profit-based Affiliates, expenses may or may not correspond to increases or decreases in the Affiliates’ revenues. Our level of profitability will depend on a variety of factors, including: For certain of our Affiliates, generally where we own a those affecting the global financial markets generally and minority interest, we are required to use the equity method the equity markets particularly, which could potentially of accounting. Consistent with this method, we have result in considerable increases or decreases in the assets not consolidated the operating results of these firms under management at our Affiliates; 21 the level of Affiliate revenue, which is dependent on the Assets under Management ability of our existing and future Affiliates to maintain or increase assets under management by maintaining their existing investment advisory relationships and fee structures, marketing their services successfully to new clients and obtaining favorable investment results; our receipt of Owners’ Allocation from Affiliates with revenue sharing arrangements, which depends on the ability of our existing and future Affiliates to maintain certain levels of operating profit margins; the increases or decreases in the revenue and expenses of Affiliates that operate on a profit-based model; the availability and cost of the capital with which we finance our existing and new investments; our success in making new investments and the terms upon which such transactions are completed; the level of intangible assets and the associated amortiza- tion expense resulting from our investments; the level of our expenses, including compensation for our employees; and the level of taxation to which we are subject. Results of Operations The following tables present our Affiliates’ reported assets under management by operating segment (which are also referred to as distribution channels in this Annual Report). Statement of Changes (in billions) December 31, 2005 Net client cash flows New investments(1) Investment performance Other(2) December 31, 2006 Net client cash flows New investments(1) Investment performance Other(2) December 31, 2007 Net client cash flows New investments(1) Investment performance Other(2) Mutual Fund $50.3 0.4 0.6 6.9 — 58.2 (0.2) — 4.6 (0.4) 62.2 (4.1) — (23.0) (0.4) Institutional High Net Worth $109.3 18.5 11.1 16.1 (0.3) $24.7 0.5 0.2 3.4 (0.6) 154.7 0.7 8.8 15.9 0.3 180.4 (14.3) 0.8 (53.4) (4.1) 28.2 (0.9) 2.0 3.9 (1.0) 32.2 (1.4) 6.6 (9.8) (1.6) Total $184.3 19.4 11.9 26.4 (0.9) 241.1 (0.4) 10.8 24.4 (1.1) 274.8 (19.8) 7.4 (86.2) (6.1) December 31, 2008 $34.7 $ 109.4 $26.0 $ 170.1 (1) In 2006, we completed a new Affiliate investment in Chicago Equity Partners. In 2007, we completed new investments in ValueAct and BlueMountain. In 2008, we completed a new investment in Gannett Welsh and Kotler. (2) Other includes assets under management attributable to Affiliate product closings and transfers of our interest in certain Affiliated investment management firms. The operating segment analysis presented in the following table is based on average assets under management. For the Mutual Fund distribution channel, average assets under management generally represent an average of the daily net assets under management. For the Institutional and High Net Worth distribution channels, average assets under management represents an average of the assets at the beginning and end of each calendar quarter during the applicable period. We believe that this analysis more closely correlates to the billing cycle of each distribution channel and, as such, provides a more meaningful relation- ship to revenue. 22 (in millions, except as noted) 2006 2007 % Change 2008 % Change Average assets under management (in billions)(1) Mutual Fund Institutional High Net Worth Total Revenue(2) Mutual Fund Institutional High Net Worth Total Net Income(2) Mutual Fund Institutional High Net Worth Total EBITDA(2)(3) Mutual Fund Institutional High Net Worth Total $ 54.4 125.1 26.8 $ 61.9 168.9 30.5 $ 206.3 $ 261.3 $ 501.7 514.8 153.9 $1,170.4 $ 68.0 65.8 17.5 $ 558.3 645.6 166.0 $1,369.9 $ 72.5 87.9 21.6 $ 151.3 $ 182.0 $ 138.2 162.3 41.6 $ 342.1 $ 153.9 211.3 53.0 $ 418.2 14% 35% 14% 27% 11% 25% 8% 17% 7% 34% 23% 20% 11% 30% 27% 22% $ 50.8 148.8 28.5 $ 228.1 $ 456.2 559.8 142.2 $1,158.2 $ 45.6 (21.0) (1.4) $ 23.2 $ 110.9 183.0 41.4 $ 335.3 (18)% (12)% (7)% (13)% (18)% (13)% (14)% (15)% (37)% (124)% (106)% (87)% (28)% (13)% (22)% (20)% (1) Assets under management attributable to investments that were completed during the relevant periods are included on a weighted average basis for the period from the closing date of the respective investment. Average assets under management includes assets managed by affiliated investment management firms that we do not consolidate for financial reporting purposes of $39.1 billion, $53.7 billion and $59.6 billion for 2006, 2007 and 2008, respectively. (2) Note 27 to the Consolidated Financial Statements describes the basis of presentation of the financial results of our three operating segments. As discussed in Note 1 to the Consolidated Financial Statements, we are required to use the equity method of accounting for certain investments and as such do not consolidate their revenue for financial reporting purposes. Our share of profits from these investments is reported in “Income from equity method investments” and is therefore reflected in Net Income and EBITDA. (3) EBITDA represents earnings before interest expense, income taxes, depreciation and amortization. As a measure of liquidity, we believe that EBITDA is useful as an indicator of our ability to service debt, make new investments and meet working capital requirements. EBITDA is not a measure of liquidity under generally accepted accounting principles and should not be considered an alternative to cash flow from operations. EBITDA, as calculated by us, may not be consistent with computations of EBITDA by other companies. Our use of EBITDA, including a reconciliation to cash flow from operations, is discussed in greater detail in “Liquidity and Capital Resources.” 23 Revenue assets under management resulted principally from positive Our revenue is generally determined by the level of our assets under management, the portion of our assets investment performance. across our products and three operating segments, which Institutional Distribution Channel realize different fee rates, and the recognition of any The decrease in revenue of $85.8 million (or 13%) in the performance fees. Institutional distribution channel in 2008 from 2007 resulted principally from a 12% decrease in average assets Our revenue decreased $211.7 million (or 15%) in 2008 under management. The decrease in average assets under from 2007, primarily as a result of a 13% decrease in management resulted principally from investment perform- average assets under management. The decrease in aver- ance and negative net client cash flows. age assets under management resulted principally from investment performance and negative net client cash flows. Our revenue increased $130.8 million (or 25%) in 2007 from 2006, primarily as a result of a 35% increase in The increase in revenue of $199.5 million (or 17%) in average assets under management. The increase in average 2007 from 2006 resulted principally from a 27% increase assets under management resulted principally from positive in average assets under management. The increase in investment performance in 2006 and 2007, net client cash average assets under management resulted principally from flows in 2006 and, to a lesser extent, our 2006 investment positive investment performance in 2006 and 2007, net in a new Affiliate. The increase in revenue was propor- client cash flows in 2006 and, to a lesser extent, our 2006 tionately less than the increase in assets under management investment in a new Affiliate. The increase in revenue primarily as a result of our equity method investments, as was proportionately less than the growth in assets under we do not consolidate revenue or expenses of such management primarily as a result of our equity method Affiliates. investments, as we do not consolidate the revenue or expenses of these Affiliates. High Net Worth Distribution Channel The following discusses the changes in our revenue by operating segments. Mutual Fund Distribution Channel The decrease in revenue of $23.8 million (or 14%) in the High Net Worth distribution channel in 2008 from 2007 resulted principally from a 7% decrease in average assets under management. The decrease in average assets under management resulted principally from investment per- The decrease in revenue of $102.1 million (or 18%) in formance, partially offset by our 2008 investment in a new the Mutual Fund distribution channel in 2008 from 2007 Affiliate. The decrease in revenue was proportionately resulted from an 18% decrease in average assets under greater than the decrease in assets under management as management. The decrease in average assets under manage- a result of our equity method investments, as we do not ment resulted principally from investment performance. consolidate the revenue or expenses of these Affiliates. The increase in revenue of $56.6 million (or 11%) in 2007 Our revenue increased $12.1 million (or 8%) in 2007 from from 2006 resulted principally from a 14% increase in 2006 primarily as a result of a 14% increase in average average assets under management. The increase in average assets under management. The increase in average assets 24 under management resulted principally from positive investments, as we do not consolidate the revenue or investment performance. The increase in revenue was expenses of these Affiliates, and increases in assets under proportionately less than the increase in assets under management that realize a comparatively lower fee rate. management primarily as a result of our equity method Operating Expenses The following table summarizes our consolidated operating expenses: (in millions) Compensation and related expenses Selling, general and administrative Amortization of intangible assets Depreciation and other amortization Other operating expenses Total operating expenses 2006 $ 472.4 184.0 27.4 8.7 23.9 $ 716.4 2007 % Change 2008 % Change $ 579.4 198.0 31.7 10.4 18.8 $ 838.3 23% 8% 16% 20% (21)% 17% $ 516.9 200.1 33.9 12.8 26.4 $ 790.1 (11)% 1% 7% 23% 40% (6)% The substantial portion of our operating expenses is primarily a result of the relationship between revenue and incurred by our Affiliates, the majority of which is incurred operating expenses at our Affiliates with revenue sharing by Affiliates with revenue sharing arrangements. For arrangements, which experienced aggregate decreases in Affiliates with revenue sharing arrangements, an Affiliate’s revenue and accordingly, reported lower compensation Operating Allocation percentage generally determines its expense. This decrease was also attributable to a $5.8 million operating expenses. Accordingly, our compensation expense decrease in holding company incentive compensation. is generally impacted by increases or decreases in each These decreases were partially offset by an increase in Affiliate’s revenue and the corresponding increases or share-based compensation of $44.9 million, including decreases in their respective Operating Allocations. During $38.7 million related to senior management’s surrender of 2008, approximately $216.6 million, or about 42% of our stock options for no consideration (accounting standards consolidated compensation expense, was attributable to require that, although no benefits were realized by senior our Affiliate managers. The percentage of revenue allocated management in connection with the option surrender, the to operating expenses varies from one Affiliate to another remaining Black-Scholes compensation expense associated and may vary within an Affiliate depending on the source with these options must be reported in the period they or amount of revenue. As a result, changes in our aggregate were forfeited). revenue may not impact our consolidated operating expenses to the same degree. Compensation and related expenses decreased 11% in 2008 The increase in 2007 was primarily a result of the rela- tionship between revenue and operating expenses at our Affiliates with revenue sharing arrangements, which and increased 23% in 2007. The decrease in 2008 was experienced aggregate increases in revenue and accord- 25 ingly, reported higher compensation expense. The increase from the transfer of our interests in certain Affiliates during was also related to a $13.4 million increase in aggregate 2006 and 2007. Affiliate expenses from our new investment. In 2007, the increase in compensation was proportionately Amortization of intangible assets increased 7% in 2008 and greater than the increase in revenue because of an 16% in 2007, principally from an increase in definite-lived increase in revenue at Affiliates with higher Operating intangible assets resulting from our investments in new and Allocations. Unrelated to the changes in revenue, the existing Affiliates in recent periods. increase was also attributable to a $7.4 million increase in share-based compensation. Depreciation and other amortization increased 23% in 2008 and 20% in 2007. These increases were principally Selling, general and administrative expenses were essentially flat in 2008. Increases of $13.8 million attributable to one- attributable to spending on depreciable assets in recent periods, as well as our investments in new Affiliates. time Affiliate expenses were offset by Affiliate cost-cutting initiatives and a $10.3 million decrease in sub-advisory and Other operating expenses increased 40% in 2008, principally distribution expenses attributable to a decline in assets as a result of a loss realized on the transfer of Affiliate under management at our Affiliates in the Mutual Fund interests, partially offset by an increase in income from distribution channel. Selling, general and administrative Affiliate investments in marketable securities. Other expenses increased 8% in 2007. This increase was principally operating expenses decreased 21% in 2007 principally as a result of the growth in assets under management at our a result of a gain realized upon the transfer of Affiliate Affiliates in the Mutual Fund distribution channel. Selling, interests during 2007 as well as a $0.8 million recovery general and administrative expenses also increased in 2007 of Affiliate expenses that previously reduced our share of as a result of $1.0 million of expenses related to our global Owners’ Allocation. These decreases were partially offset distribution initiatives. These increases were partially offset by a $0.7 million increase in aggregate Affiliate expenses by a $6.7 million decrease in aggregate Affiliate expenses from our 2006 investment in Chicago Equity Partners. Other Income Statement Data The following table summarizes non-operating income and expense data: (in millions) Income (loss) from equity method investments Investment and other income Investment income (loss) from Affiliate investments in partnerships Minority interest in Affiliate investments in partnerships Minority interest Interest expense Income tax expense (1) Percentage change is not meaningful. 2006 $ 38.3 16.9 3.4 3.4 212.5 58.8 86.6 2007 % Change 2008 % Change $ 58.2 17.1 52% 1% $ (97.1) 43.7 N.M.(1) 156% 38.9 1,044% (63.4) N.M.(1) 38.1 242.0 76.9 106.9 1,021% 14% 31% 23% (60.5) 193.7 73.9 20.9 N.M.(1) (20)% (4)% (80)% 26 Income (loss) from equity method investments consists of in partnerships was $(63.4) million and $38.9 million, our share of income (loss) from Affiliates that are accounted respectively, which was principally attributable to investors for under the equity method of accounting, net of any who are unrelated to us. related intangible amortization. Income (loss) from equity method investments decreased substantially in 2008, Minority interest decreased 20% in 2008 and increased principally as a result of a $150.0 million non-cash charge 14% in 2007. These changes were principally as a result of to reduce the carrying value of certain Affiliates accounted the previously discussed changes in revenue. In 2008, the for under the equity method of accounting to their fair value, as well as decreases in assets under management and revenue attributable to Affiliates that are accounted for under the equity method of accounting. Income from equity method investments increased 52% in 2007 principally as a result of increases in assets under management and revenue attributable to Affiliates that are accounted for under the equity method of accounting, including invest- ments in new Affiliates. Investment and other income increased 156% in 2008, principally from a net gain of $43.3 million realized on the repurchase of a portion of our junior convertible trust preferred securities and a gain of $8.2 million realized on the settlement of interest rate derivative contracts. These gains were partially offset by a decrease in Affiliate investment earnings as well as $2.0 million of expenses incurred from the settlement of our 2004 mandatory convertible securities and the conversion of our floating rate senior convertible securities. Investment and other income increased 1% in 2007, principally from an increase in Affiliate investment earnings. As discussed in Note 1 to the Consolidated Financial Statements, Investment income (loss) from Affiliate invest- ments in partnerships and Minority interest in Affiliate investments in partnerships relate to the consolidation of certain investment partnerships in which our Affiliates decrease in minority interest was proportionately greater than the decrease in revenue as a result of the decrease in Affiliate investment income. Interest expense decreased 4% in 2008, principally attributable to a $25.9 million decrease resulting from the conversion of our floating rate senior convertible securities and the settlement of our mandatory convertible securi- ties and a $7.7 million decrease in the cost of our senior bank debt resulting from a decline in LIBOR interest rates. These decreases were partially offset by a $19.9 million increase from the issuance of our junior convertible trust preferred securities in 2007, and a $7.2 million increase from the issuance of our 2008 senior convertible notes. Interest expense increased 31% in 2007, principally from an increase of $11.5 million related to higher outstanding borrowings under our senior bank debt, $5.4 million from the October 2007 issuance of $500 million of junior convertible trust preferred securities and $3.5 million from the April 2006 issuance of $300 million of junior convertible trust preferred securities. These increases were partially offset by a $3.1 million decrease in interest expense from repayment of our senior notes due 2006. Income taxes decreased 80% in 2008 principally as a result of the decrease in net income before taxes of 85%. This decrease was partially offset by an increase in income serve as the general partner. We are required to consolidate taxes of $5.3 million related to the one-time revaluation of certain Affiliate investment partnerships (including interests our deferred tax liabilities as a result of new Massachusetts in the partnerships in which we do not have ownership tax legislation. Income taxes increased 23% in 2007 rights) in our consolidated financial statements. For 2008 principally as a result of the increase in net income before and 2007, the income (loss) from Affiliate investments taxes of 21%. 27 Net Income The following table summarizes Net Income for the past three years: tax expenses that are unlikely to reverse, we add back these non-cash expenses to Net Income to measure operating performance. We add back amortization attributable to acquired client relationships because this expense does not (in millions) 2006 2007 % Change 2008 % Change correspond to the changes in value of these assets, which do Net Income $151.3 $182.0 20% $23.2 (87)% not diminish predictably over time. The portion of deferred taxes generally attributable to intangible assets (including Net Income decreased 87% in 2008, after increasing 20% goodwill) that we no longer amortize but which continues in 2007. The decrease in 2008 was principally as a result of to generate tax deductions is added back, because these the decrease in revenue and the loss from equity method accruals would be used only in the event of a future sale of investments, and was partially offset by an increase in an Affiliate or an impairment charge, which we consider investment and other income as well as decreases in reported unlikely. We add back the portion of consolidated operating, minority interest and tax expenses, as described depreciation expense incurred by our Affiliates because above. The increase in 2007 was principally as a result of under our Affiliates’ operating agreements we are generally increases in revenue and income from equity method not required to replenish these depreciating assets. investments, partially offset by increases in reported Conversely, we do not add back the deferred taxes relating operating, interest, minority interest and tax expenses, as to our floating rate senior convertible securities or other described above. Supplemental Performance Measure As supplemental information, we provide a non-GAAP performance measure that we refer to as Cash Net Income. This measure is provided in addition to, but not as a substitute for, Net Income. Cash Net Income is defined as Net Income plus amortization and deferred taxes related to intangible assets plus Affiliate depreciation. We consider Cash Net Income an important measure of our financial performance, as we believe it best represents operating performance before non-cash expenses relating to our acquisition of interests in our Affiliates. Cash Net Income is used by our management and Board of Directors as a principal performance benchmark, including as a measure for aligning executive compensation with stockholder value. Since our acquired assets do not generally depreciate or require replacement by us, and since they generate deferred depreciation expenses. We intend to modify our definition of Cash Net Income in 2009 to add back non-cash Affiliate equity expense and non-cash interest expense related to FASB Staff Position APB 14-1 (which is effective in 2009). The following table provides a reconciliation of Net Income to Cash Net Income: (in millions) 2006 2007 2008 Net Income Intangible amortization Intangible amortization— $151.3 27.4 $182.0 31.6 $ 23.2 33.9 equity method investment(1) Intangible—related deferred taxes Affiliate depreciation 9.3 28.8 5.7 10.4 28.6 6.1 170.7 (12.8) 7.0 Cash Net Income $222.5 $258.7 $222.0 (1) As discussed in Note 1 to the Consolidated Financial Statements, we are required to use the equity method of accounting for certain of our investments and, as such, do not separately report these Affiliates’ revenues or expenses (including intangible amortization expenses) in our income statement. Our share of these investments’ amortization is reported in “Income (loss) from equity method investments.” 28 Cash Net Income decreased 14% in 2008 primarily as a internal leverage ratio. We also view our leverage on a “net result of the decreases in revenue, partially offset by an debt” basis by deducting from our debt balance holding increase in investment and other income as well as decreases company cash (including prospective proceeds from the in reported operating, minority interest and tax expenses, settlement of our forward equity sale agreement). As of as described above. Cash Net Income increased 16% in December 31, 2008, our internal leverage ratio was 1.3:1. 2007, primarily as a result of the previously described factors’ effect on Net Income. Liquidity and Capital Resources Under the terms of our credit facility we are required to meet two financial ratio covenants. The first of these covenants is a maximum ratio of debt to EBITDA (the “bank leverage ratio”) of 3.5x. The calculation of our The following table summarizes certain key financial data bank leverage ratio is generally consistent with our internal relating to our liquidity and capital resources: leverage ratio approach. The second covenant is a minimum (in millions) 2006 Balance Sheet Data Cash and cash equivalents $ 201.7 365.5 Senior bank debt 2008 senior convertible notes — Zero coupon convertible notes 113.4 Floating rate convertible securities 300.0 Mandatory convertible securities Junior convertible trust preferred securities Cash Flow Data Operating cash flows Investing cash flows Financing cash flows EBITDA(1) 300.0 300.0 301.0 (165.1) (75.1) 342.1 December 31, 2007 2008 $ 223.0 519.5 $ 396.4 233.5 EBITDA to cash interest expense ratio of 3.0x (our “bank interest coverage ratio”). For the purposes of calculating these ratios, share-based compensation expense is added back to EBITDA. — 78.1 300.0 300.0 800.0 326.7 (580.8) 272.5 418.2 460.0 47.1 — — 730.8 255.7 (189.4) 109.7 335.3 As of December 31, 2008, we were in full compliance with the terms of our credit facility. While continued material declines in the equity markets could negatively impact our EBITDA and, in turn, our ability to comply with our covenants, our holding company cash resources are sufficient to repay the balance outstanding under our credit facility. We are rated BBB- by Standard & Poor’s. A downgrade of our credit rating, either as a result of industry or company- specific considerations, would not have a material financial effect on any of our agreements or securities (or otherwise (1) The definition of EBITDA is presented in Note 3 on page 23. trigger a default). We view our ratio of debt to EBITDA (our “internal leverage In addition to borrowings available under our $770 million ratio”) as an important gauge of our ability to service debt, revolving credit facility, our current liquidity is augmented make new investments and access additional capital. by approximately $320 million of holding company cash Consistent with industry practice, we do not consider (including prospective proceeds from the forward equity mandatory convertible securities or junior trust preferred settlement) and the free cash flow generated by our business. securities as debt for the purpose of determining our We have no near-term debt maturities. 29 Supplemental Liquidity Measure As supplemental information, we provide information regarding our EBITDA, a non-GAAP liquidity measure. This measure is provided in addition to, but not as a sub- stitute for, cash flow from operations. EBITDA represents earnings before interest expense, income taxes, depreciation and amortization. EBITDA, as calculated by us, may not be consistent with computations of EBITDA by other companies. As a measure of liquidity, we believe that EBITDA is useful as an indicator of our ability to service debt, make new investments and meet working capital requirements. We further believe that many investors use this information when analyzing the financial position of companies in the investment management industry. debt and the issuance of convertible securities and common stock. Our principal uses of cash were to settle convertible securities, repurchase shares of our common stock, make investments in new and existing Affiliates, repay senior debt and make distributions to Affiliate managers. We expect that our principal uses of cash for the foreseeable future will be for investments in new and existing Affiliates, distributions to Affiliate managers, payment of principal and interest on outstanding debt, the repurchase of debt securities, the repurchase of shares of our common stock and for working capital purposes. The following table summarizes our debt obligations and convertible securities as of December 31, 2008: The following table provides a reconciliation of cash flow (in millions) Maturity Date Form of Repayment from operations to EBITDA: (in millions) Cash Flow 2006 2007 2008 from Operations $ 301.0 $ 326.7 $255.7 Interest expense, net of non-cash items(1) Current tax provision Income from equity method investments, net of distributions(2) Changes in assets and liabilities and other adjustments(3) 53.6 55.2 70.9 74.6 68.5 51.7 1.6 15.0 (6.9) Amount $ 233.5 — 47.1 460.0 Senior Bank Debt Term Loan Revolver Zero Coupon Senior Convertible Notes 2008 Senior Convertibles Notes Junior Convertible Trust Preferred Securities (1) Settled in cash. 2012 2012 2021 2038 (1) (1) (2) (3) (4) 730.8 2036/2037 (2) Settled in cash or common stock at our election if holders exercise their May 2011 or 2016 put rights, and in common stock if the holders exercise their conversion rights. EBITDA(4) $ 342.1 $ 418.2 (69.3) (69.0) (33.7) $335.3 (3) Settled in cash if holders exercise their August 2013, 2018, 2023, 2028 or 2033 put rights, and in cash or common stock at our election if the holders exercise their conversion rights. (1) Non-cash items represent amortization of issuance costs and interest accretion ($5.2, $6.0 and $5.4 million in 2006, 2007 and 2008, respectively). (4) Settled in cash or common stock at our election if the holders exercise their conversion rights. (2) Distributions from equity method investments were $46.0, $53.6 and $80.5 million for 2006, 2007 and 2008, respectively. Senior Bank Debt (3) Other adjustments include stock option expenses, tax benefits from stock options and other adjustments to reconcile Net Income to cash flow from operating activities. (4) The definition of EBITDA is presented in Note 3 on page 23. On November 27, 2007, we entered into an amended and restated credit facility (the “Facility”). During the third quarter of 2008, we increased our borrowing capacity to $1.01 billion, comprised of a $770 million revolving credit In 2008, we met our cash requirements primarily through facility (the “Revolver”) and a $240 million term loan cash generated by operating activities, borrowings of senior (the “Term Loan”). All other terms of the Facility remain 30 unchanged. We pay interest on these obligations at specified repurchase the securities with cash, shares of our common rates (based either on the LIBOR rate or the prime rate as stock or some combination thereof. We have the option in effect from time to time) that vary depending on our to redeem the securities for cash at their accreted value. credit rating. The Term Loan requires principal payments Under the terms of the indenture governing the zero at specified dates until maturity. Subject to the agreement coupon convertible notes, a holder may convert such of lenders to provide additional commitments, we have security into common stock by following the conversion the option to increase the Facility by up to an additional procedures in the indenture; subject to changes in the price $175 million. of our common stock, the zero coupon convertible notes may not be convertible in certain future periods. The Facility will mature in February 2012, and contains financial covenants with respect to leverage and interest In 2006, we amended the zero coupon convertible notes. coverage. The Facility also contains customary affirmative Under the terms of this amendment, we paid interest and negative covenants, including limitations on through May 7, 2008 at a rate of 0.375% per year on the indebtedness, liens, cash dividends and fundamental principal amount at maturity of the notes in addition to corporate changes. Borrowings under the Facility are the accrual of the original issue discount. collateralized by pledges of the substantial majority of our capital stock or other equity interests owned by us. As of 2008 Senior Convertible Notes December 31, 2008, we had $233.5 million outstanding under our Facility. Zero Coupon Senior Convertible Notes In August 2008, we issued $460 million of senior convertible notes due 2038 (“2008 senior convertible notes”). The 2008 senior convertible notes bear interest at 3.95%, payable semi-annually in cash. Each security is convertible In 2001, we issued $251 million principal amount at into 7.959 shares of our common stock (at an initial maturity of zero coupon senior convertible notes due 2021 conversion price of $125.65) upon the occurrence of (“zero coupon convertible notes”), with each note issued at certain events. Upon conversion, we may elect to pay or 90.50% of such principal amount and accreting at a rate of deliver cash, shares of common stock, or some combination 0.50% per year. As of December 31, 2008, $50.1 million thereof. The holders of the 2008 senior convertible notes principal amount at maturity remain outstanding. Each may require us to repurchase the notes in August of 2013, security is convertible into 17.429 shares of our common 2018, 2023, 2028 and 2033. We may redeem the notes for stock (at a current base conversion price of $53.95) upon cash at any time on or after August 15, 2013. the occurrence of certain events, including the following: (i) if the closing price of a share of our common stock is The 2008 senior convertible notes are considered contingent more than a specified price over certain periods (initially payment debt instruments under federal income tax $62.36 and increasing incrementally at the end of each regulations. These regulations require us to deduct interest calendar quarter to $63.08 in April 2021); (ii) if the credit in an amount greater than our reported interest expense, rating assigned by Standard & Poor’s to the securities is which will result in annual deferred tax liabilities of below BB-; or (iii) if we call the securities for redemption. approximately $9.6 million. These deferred tax liabilities The holders may require us to repurchase the securities will be reclassified directly to stockholders’ equity if our at their accreted value in May 2011 and 2016. If the common stock is trading above certain thresholds at the holders exercise this option in the future, we may elect to time of the conversion of the notes. 31 Junior Convertible Trust Preferred Securities 0.25 shares of our common stock, which represents a In 2006, we issued $300 million of junior subordinated convertible debentures due 2036 to a wholly-owned trust simultaneous with the issuance, by the trust, of $291 million of convertible trust preferred securities to investors. The junior subordinated convertible debentures and convertible trust preferred securities (together, the “2006 junior convertible trust preferred securities”) have substantially the same terms. The 2006 junior convertible trust preferred securities bear interest at 5.1% per annum, payable quarterly in cash. Each $50 security is convertible, at any time, into 0.333 shares of our common stock, which represents a conversion price of $150 per share (or a 48% premium to the share price of $101.45 at the time of issuance). Upon conversion, investors will receive cash or shares of our common stock (or a combination of cash and common stock) at our election. The 2006 junior convertible trust preferred securities may not be redeemed by us prior to April 15, 2011. On or after April 15, 2011, they may be redeemed if the closing price of our common stock exceeds $195 per share for a specified period of time. The trust’s only assets are the junior convertible subordinated debentures. To the extent that the trust has available funds, we are obligated to ensure that holders of the 2006 junior convertible trust preferred securities receive all payments due from the trust. conversion price of $200 per share (or a 53% premium to the share price of $130.77 at the time of issuance). Upon conversion, investors will receive cash or shares of our common stock (or a combination of cash and common stock) at our election. The 2007 junior convertible trust preferred securities may not be redeemed by us prior to October 15, 2012. On or after October 15, 2012, they may be redeemed if the closing price of our common stock exceeds $260 per share for a specified period of time. The trust’s only assets are the 2007 junior convertible subordinated debentures. To the extent that the trust has available funds, we are obligated to ensure that holders of the 2007 junior convertible trust preferred securities receive all payments due from the trust. The 2006 and 2007 junior convertible trust preferred securities are considered contingent payment debt instruments under the federal income tax regulations. We are required to deduct interest in an amount greater than our reported interest expense. In 2009, these deductions will generate deferred taxes of approximately $8.8 million. In November 2008, we repurchased $69.2 million aggregate principal amount of the 2007 junior convertible trust preferred securities. We realized a gain of $43.3 million on this transaction, which was reported in Investment and other income. Following the repurchase, these securities In October 2007, we issued an additional $500 million of junior subordinated convertible debentures due 2037 to a wholly-owned trust simultaneous with the issuance, by were cancelled and retired. Purchases of Affiliate Equity the trust, of $500 million of convertible trust preferred Many of our Affiliate operating agreements provide our securities to investors. The junior subordinated convertible Affiliate managers the conditional right to require us to debentures and convertible trust preferred securities purchase their retained equity interests at certain intervals. (together, the “2007 junior convertible trust preferred These agreements also provide us a conditional right to securities”) have substantially the same terms. require Affiliate managers to sell their retained equity The 2007 junior convertible trust preferred securities termination of employment and provide Affiliate managers bear interest at 5.15% per annum, payable quarterly in a conditional right to require us to purchase such retained cash. Each $50 security is convertible, at any time, into equity interests upon the occurrence of specified events. interests to us upon their death, permanent incapacity or 32 These purchases may occur in varying amounts over a period securities ($300 million) in 2003 and the 2004 PRIDES of approximately 15 years (or longer), and the actual timing ($300 million) in 2004. and amounts of such purchases (or the actual occurrence of such purchases) generally cannot be predicted with any In February 2008, we called the outstanding floating rate certainty. These purchases are generally calculated based convertible securities for redemption at their principal upon a multiple of the Affiliate’s cash flow distributions at amount plus accrued and unpaid interest. In lieu of the time the right is exercised, which is intended to represent redemption, substantially all of the holders elected to fair value. As one measure of the potential magnitude of convert their securities. Pursuant to these conversions such purchases, in the event that a triggering event and and other privately negotiated exchanges, we issued resulting purchase occurred with respect to all such approximately 7.0 million shares of common stock and retained equity interests as of December 31, 2008, the the floating rate convertible securities were cancelled aggregate amount of these payments would have totaled and retired. approximately $806.5 million. In the event that all such transactions were consummated, we would own the cash The floating rate convertible securities were considered flow distributions attributable to the additional equity contingent payment debt instruments under federal interests purchased from our Affiliate managers. As of income tax regulations that required us to deduct interest in December 31, 2008, this amount would represent an amount greater than our reported interest expense. approximately $111.0 million on an annualized basis. We Because the trading price of our common stock exceeded may pay for these purchases in cash, shares of our common $60.90 at the time of the conversions described above, stock or other forms of consideration. Affiliate management $18.3 million of deferred tax liabilities attributable to partners are also permitted to sell their equity interests to these securities was reclassified to stockholders’ equity other individuals or entities in certain cases, subject to our when the securities were retired. approval or other restrictions. These potential purchases, combined with our other cash needs, may require more In March 2008, we repurchased the outstanding senior cash than is available from operations, and therefore, we notes component of the 2004 PRIDES. The repurchase may need to raise capital by making borrowings under proceeds were used by the original holders to fulfill their our Facility, by selling shares of our common stock or obligations under related forward equity purchase contracts. other equity or debt securities, or to otherwise refinance a Pursuant to the settlement of the forward equity purchase portion of these purchases. Although the timing and contracts and other privately negotiated exchanges, we amounts of these purchases are difficult to predict, we issued approximately 3.8 million shares of common stock expect to repurchase approximately $50 million of Affiliate and the 2004 PRIDES were cancelled and retired. equity during 2009 and, in such event, will own the cash flow associated with the equity repurchased. Derivatives Other Convertible Securities In 2006, we entered into a series of contracts that provided the option, but not the obligation, to repurchase 0.9 million In the first quarter of 2008, we retired two issues of shares of our common stock. Upon exercise, we could convertible securities, our floating rate senior convertible elect to receive the intrinsic value of a contract in cash or securities due 2033 (“floating rate convertible securi- common stock. During 2007, we exercised our option, ties”) and mandatory convertible securities (“2004 which had an intrinsic value of $21.1 million. We elected PRIDES”). We issued the floating rate convertible to receive approximately 0.1 million shares of common 33 stock and used the remaining proceeds, $6.8 million, to In accordance with EITF 04-05, we consolidated $68.8 enter into a series of contracts to repurchase up to 0.8 and $134.7 million of client assets held in partnerships million shares. These options expired during the first controlled by our Affiliates as of December 31, 2008 and quarter of 2008. 2007, respectively. Sales of client assets generated $6.0 and $12.8 million of operating cash flow in 2008 and During the first quarter of 2008, we entered into a series 2007, respectively. of treasury rate lock contracts with a notional value of $250 million. These contracts were settled in the second Investing Cash Flow quarter of 2008, and we received $8.2 million. Each Changes in net cash flow used in investing activities result contract was designated and qualified as a cash flow primarily from our investments in new and existing hedge under Statement of Financial Accounting Standard Affiliates. Net cash flow used to make investments was No. 133, “Accounting for Derivative Instruments and $171.4 million, $556.7 million and $123.3 million for Hedging Activities” (“FAS 133”). We documented our the years ended December 31, 2008, 2007 and 2006, hedging strategies and risk management objectives for respectively. These investments were primarily funded with these contracts. We assessed and documented, both at borrowings under our credit facility and existing cash. inception and on an ongoing basis, whether these hedging contracts were highly effective in offsetting changes in cash flows associated with the hedge items. During the fourth quarter of 2008, we concluded that it was probable that the hedged transaction would not occur and the gain was reclassified from accumulated other comprehensive income to Net Income. Operating Cash Flow In January 2009, we announced an agreement to restructure and postpone our previously announced transaction with Harding Loevner LLC (“Harding Loevner”). The amended agreement provides Harding Loevner the option to complete the transaction during the second half of 2009 on terms substantially consistent with the original agreement. Under past acquisition agreements, we are contingently Cash flow from operations generally represents Net Income liable, upon achievement of specified financial targets, to plus non-cash charges for amortization, deferred taxes, make payments of up to $232 million through 2012. In equity-based compensation and depreciation, as well as 2009, we expect to make total payments of approximately increases and decreases in our consolidated working capital. $100 million to settle portions of these contingent obligations, our purchase of Affiliate equity (as discussed above) and our The decrease in cash flow from operations in 2008 as potential investment in Harding Loevner. compared to 2007 resulted principally from decreased minority interest of $150.9 million and $70.4 million from Financing Cash Flow settlements of liabilities, partially offset by $138.8 million from the collection of accounts receivable. The increase in cash flow from operations for the year ended 2007 as Net cash flows from financing activities decreased $162.8 million in 2008 as compared to 2007, primarily as a result of a net repayment of senior bank debt of $286.0 million compared to 2006 resulted principally from increased Net combined with $208.7 million settlement of convertible Income of $30.7 million and increased minority interest securities, partially offset by a $370.5 million decrease in of $29.1 million, partially offset by a $44.8 million increase the repurchases of common stock. In addition, we issued in settlements of liabilities. $460 million of senior convertible notes in 2008 and 34 repurchased $69.2 million aggregate principal amount of 3.8 million shares of common stock to settle the forward our junior convertible trust preferred securities for $24.2 equity purchase contracts. million. The increase in cash flows used in financing activities in 2007 from 2006 was primarily as a result of our $500 million issuance of junior convertible trust preferred securities and a net increase in borrowings under our revolver of $154.0 million, partially offset by $436.0 million of repurchases of our common stock. As more fully discussed in Liquidity and Capital Resources, during 2008, we retired the outstanding floating rate convertible securities and issued approximately 7.0 million shares of common stock. Additionally, we repurchased the outstanding senior notes component of our 2004 PRIDES. The repurchase proceeds were used by the In May 2008, we entered into a forward equity sale agreement under which we may sell up to $200 million of our common stock to a major securities firm, with the timing of sales at our discretion. Through February 25, 2009, we have agreed to sell approximately $144.3 million under this agreement at a weighted average price of $81.31. We can settle these forward sales at any time prior to December 19, 2009. In accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”), beginning in 2006, certain tax benefits associated with stock options have been reported as financing cash flows in the amount of $11.1 million and original holders to fulfill their obligations under the related $36.5 million as of December 31, 2008 and 2007, forward equity purchase contracts. We issued approximately respectively. Contractual Obligations The following table summarizes our contractual obligations as of December 31, 2008: (in millions) Senior bank debt(1) Senior convertible securities(1) Junior convertible trust preferred securities(1)(2) Leases Other liabilities(3) Total Total $ 233.5 1,066.9 1,824.9 97.3 28.4 $ 3,251.0 Payments Due 2009 2010–2011 2012–2013 Thereafter $ 25.9 18.5 37.5 19.3 26.2 $127.4 $103.8 36.3 75.0 31.8 2.2 $249.1 $103.8 36.3 75.0 22.3 — $237.4 $ — 975.8 1,637.4 23.9 — $2,637.1 (1) The timing of debt payments assumes that outstanding debt is settled for cash or common stock at the applicable maturity dates. The amounts include the cash payment of fixed interest. (2) As more fully discussed on page 29, consistent with industry practice, we do not consider our junior convertible trust preferred securities as debt for the purpose of determining our leverage ratio. (3) Other liabilities reflect amounts payable to Affiliate managers related to our purchase of additional Affiliate equity interests. This table does not include liabilities for uncertain tax positions ($21.9 million as of December 31, 2008) as we cannot predict when such liabilities will be paid. 35 Market Risk Our revenue is derived primarily from fees which are based on the market values of assets under management. Such values are affected by changes in financial markets, and accordingly declines in the financial markets will negatively impact our revenue and Net Income. The broader financial markets are affected, in part, by changing interest rates. We cannot predict the effects that interest rates or changes in interest rates may have on either the broader financial markets or our Affiliates’ assets under management and associated fees. We operate primarily in the United States, and accordingly most of our consolidated revenue and associated expenses are denominated in U.S. dollars. We also provide services and earn revenue outside of the United States; therefore, the portion of our revenue and expenses denominated in foreign currencies may be impacted by movements in currency exchange rates. The valuations of our foreign Affiliates are impacted by fluctuations in foreign exchange rates, which could be recorded as a component of stock- holders’ equity. To illustrate the effect of possible changes in currency exchange rates, as of December 31, 2008, we estimate that a 1% change in the Canadian dollar to U.S. dollar exchange rate would result in approximately a $2.9 We pay a variable rate of interest on our credit facility million change to stockholders’ equity and a $0.4 million ($233.5 million outstanding as of December 31, 2008) change to income before income taxes. During 2008, and, until February 2008, paid a variable rate of interest on changes in currency exchange rates decreased stockholders’ our floating rate senior convertible securities. We have fixed equity by $68.3 million. rates of interest on our zero coupon senior convertible notes, our 2008 senior convertible notes and on both of our junior convertible trust preferred securities. Recent Accounting Developments From time to time, we seek to manage our exposure to In September 2006, the FASB issued FAS No. 157, “Fair Value changing interest rates by entering into interest rate hedging Measurements” (“FAS 157”) which defines fair value, contracts. For example, through February 2008, we were a establishes a framework for measuring fair value in accord- party to interest rate hedging contracts with a $150 million ance with generally accepted accounting principles, and notional amount, which fixed the interest rate on a portion requires expanded disclosure about fair value measurements. of our floating rate senior convertible securities to a weighted As described in Note 5 of our Consolidated Financial average interest rate of approximately 3.28% for the period Statements, we adopted this standard in the first quarter from February 2005 to February 2008. We estimate that a 100 basis point (1%) change in interest rates would result in a net annual change to interest expense related to our variable rate borrowings of approximately $2.3 million. While a change in market interest rates would not affect the interest expense incurred on our of 2008 for our financial assets and liabilities that are measured at fair value on a quarterly basis. For all other nonfinancial assets and liabilities, FAS 157 is effective in the first quarter of 2009. The standard is not expected to have a material impact on our consolidated financial statements, but will require certain additional disclosures. fixed rate securities, such a change may affect the fair In February 2007, the FASB issued FAS No. 159, “The value of these securities. We estimate that a 100 basis point Fair Value Option for Financial Assets and Financial (1%) change in interest rates would result in a net change Liabilities—Including an amendment of FASB Statement in the value of our fixed rate securities of approximately No. 115” (“FAS 159”). FAS 159 permits companies to $10.8 million. measure many financial instruments and certain other 36 items at fair value. We adopted FAS 159 in the first the equity interests held by our Affiliates described in quarter of 2008; as we did not apply the fair value option Note 17 to the Consolidated Financial Statements, to be to any of our outstanding instruments, FAS 159 did not recorded outside of permanent equity at their current have an impact on our consolidated financial statements. redemption value, and the interests should be adjusted to In December 2007, the FASB issued FAS No. 141 (revised 2007), “Business Combinations” (“FAS 141R,” which is effective in the first quarter of 2009). FAS 141R will require acquirors to measure identifiable assets and liabilities at their full fair values on the acquisition date. FAS 141R will also change the treatment of contingent consideration, contingencies, acquisition costs, and restructuring costs. FAS 141R will be applied to future acquisitions, and its impact will depend on the nature and volume of those transactions. Upon adoption, FAS 141R will be retrospec- tively applied to acquisition costs previously deferred, and we anticipate that 2007 and 2008 earnings will be adjusted by $0.7 million and $6.1 million, respectively. In December 2007, the FASB issued FAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“FAS 160”). FAS 160 will change the accounting and reporting for minority or noncontrolling interests. Upon adoption, these interests and transactions between controlling interest and minority interest holders may be accounted for within stockholders’ equity. FAS 160 also requires an entity to present Net Income and consolidated comprehensive income attributable to the parent and the minority interest separately in the consolidated financial statements. We will adopt FAS 160 in the first quarter of 2009. their current redemption value at each balance sheet date. Adjustments to the carrying amount of a noncontrolling interest from the application of Topic D-98 are recorded to stockholders’ equity. We will adopt this guidance in 2009, resulting in our recording the current redemption value of our redeemable non-controlling interests with a corresponding adjustment to stockholders’ equity in the consolidated balance sheets. In March 2008, the FASB issued FAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“FAS 161”). FAS 161 requires enhanced disclosures regarding the impact of derivatives on our financial position, financial performance, and cash flows. We will adopt FAS 161 in the first quarter of 2009 and do not expect this standard to have a material effect on the consolidated financial statements. In May 2008, the FASB issued FASB Staff Position APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”), which applies to all convertible debt instruments that may be settled either wholly or partially in cash upon conversion. FSP APB 14-1 requires issuers to separately account for the liability and equity components of convertible debt In March 2008, the SEC announced revisions to EITF instruments in a manner reflective of the issuer’s noncon- Topic D-98, “Classification and Measurement of vertible debt borrowing rate. Previous guidance required Redeemable Securities” (“Topic D-98”), which provides these types of convertible debt instruments to be accounted SEC registrants guidance on the financial statement classi- for entirely as debt. FSP APB 14-1 is effective in the first fication and measurement of equity securities that are quarter of 2009 and will be retrospectively applied to prior subject to mandatory redemption requirements or whose periods. We expect that FSP APB 14-1 will increase interest redemption is outside the control of the issuer. The revised expense for our convertible securities by approximately Topic D-98 requires redeemable minority interests, such as $14 million in 2009. 37 In June 2008, the FASB ratified EITF No. 07-5, In November 2008, the FASB ratified EITF 08-7, “Determining Whether an Instrument (or Embedded “Accounting for Defensive Intangible Assets” (“EITF 08-7”). Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 08-7 applies to defensive assets which are acquired EITF 07-5 provides guidance for determining whether an intangible assets which the acquirer does not intend to equity-linked financial instrument, or embedded feature, is actively use, but intends to hold to prevent its competitors indexed to an entity’s own stock. We will adopt EITF 07-5 from obtaining access to the asset. EITF 08-7 clarifies that in the first quarter of 2009 and do not expect the adoption defensive intangible assets are separately identifiable and to change the classification or measurement of our financial should be accounted for as a separate unit of accounting in instruments. In October 2008, the FASB issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial accordance with FAS 141R and FAS 157. EITF 08-7 is effective for intangible assets acquired in 2009. We are assessing the potential impact, if any, of the adoption of EITF 08-7 on our consolidated results of operations and Asset When the Market for that Asset is Not Active” financial condition. (“FSP FAS 157-3”), which applies to financial assets that are required or permitted to be measured at fair value in accordance with FAS 157. FSP FAS 157-3 clarifies the application of FAS 157 and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that asset is not active. The adoption did not have a significant impact on our financial position or results of operations, nor did it have a significant impact on the valuation techniques we used in measuring the fair value of our financial assets. In December 2008, the FASB issued FASB Staff Position FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). This guidance increases disclosure requirements for public entities involved in securitization or asset-backed financing arrangements and variable interest entities. We adopted FSP FAS 140-4 and FIN 46(R)-8 in the fourth quarter of 2008 and such adoption did not have a significant impact on our consolidated financial In November 2008, the FASB ratified EITF 08-6, “Equity statements. Method Investment Accounting Considerations” (“EITF 08-6”). EITF 08-6 clarifies that the initial carrying value of an equity method investment should be determined in accordance with FAS 141R and other-than-temporary Critical Accounting Estimates and Judgments impairments of equity method investments should be The preparation of financial statements and related disclosures recognized in accordance with APB Opinion No. 18, in conformity with accounting principles generally accepted “Accounting by an Investor for Its Proportionate Share of in the United States requires us to make judgments, Accumulated Other Comprehensive Income of an Investee assumptions, and estimates that affect the amounts Accounted for under the Equity Method in Accordance reported in the Consolidated Financial Statements and with APB Opinion No. 18 upon a Loss of Significant accompanying notes. Note 1 to the Consolidated Financial Influence.” EITF 08-6 is effective on a prospective basis beginning in the first quarter of 2009. We are assessing Statements describes the significant accounting policies and methods used in the preparation of the Consolidated the potential impact, if any, of the adoption of EITF 08-6 Financial Statements. We consider the accounting policies on our consolidated results of operations and financial described below to be our critical accounting estimates condition. and judgments. These policies are affected significantly by 38 judgments, assumptions, and estimates used in the preparation circumstances suggest fair value has declined below the of the Consolidated Financial Statements and actual results related carrying amount. could differ materially from the amounts reported based on these policies. Valuation In allocating the purchase price of our investments and test- ing our assets for impairment, we make estimates and assumptions to determine the value of our acquired client relationships, operating segments, and equity method investments. We also assess the value of minority interests held by our Affiliate managers in establishing the terms for their transfer. In these valuations, we make assumptions about the growth rates and useful lives of existing and prospective client accounts, as well as future earnings, valuation multiples, tax benefits and discount rates. We consider the reasonableness of our assumptions by comparing our valuation conclusions to market transactions, and in certain instances engage third party consultants to perform independent evaluations. If we used different assumptions, the effect may be material to our financial statements, as the carrying value of our equity method investments and intangible assets (and related amortization) could be stated differently and our impairment conclusions could be modified. The use of different assumptions to value our minority interests could change the amount of compensation expense, if any, we report upon their transfer. Goodwill For purposes of the impairment test of goodwill, the fair value of each reporting unit is measured by applying a fair value multiple to the run rate cash flow of the reporting unit. The key valuation inputs are the levels of asset under management, their related fee rates, and expenses attributable to each reporting unit. Changes in the estimates used in this test could materially affect our impairment conclusion. In each of the third and fourth quarters of 2008, we performed our impairment test, and no impairments were identified. Indefinite-Lived Intangible Assets As of December 31, 2008, the carrying values of indefinite- lived intangible assets were $267.8 million. Indefinite-lived intangible assets are comprised of investment advisory contracts with registered investment companies that are sponsored by our Affiliates. We do not amortize our indefinite- lived acquired client relationships because we expect these contracts will contribute to our cash flows indefinitely. Each quarter, we assess whether events and circumstances have occurred that indicate these relationships might have a definite life. We perform indefinite-lived intangible asset impairment tests annually, or more frequently should circumstances suggest fair value has declined below the related carrying amount. In this test we compare the carrying amount of each asset to its fair value, measuring value through a dis- counted cash flow analysis. The key valuation assumptions As of December 31, 2008, the carrying value of goodwill include current and projected levels of assets under manage- was $1,243.6 million. Goodwill represents the excess of the ment in the relevant registered investment company, purchase price of acquisitions over the fair value of identi- fied assets and liabilities. Goodwill impairment tests are expenses attributable to these contracts and discount rates. performed annually at the reporting unit level (in our case, In the fourth quarter of 2008, we performed our annual our three operating segments), or more frequently, should impairment test, and no impairments were identified. 39 Definite-Lived Intangible Assets impairment charge is recognized to reduce the carrying As of December 31, 2008, the carrying values of definite- lived intangible assets were $223.6 million. Definite-lived intangible assets are comprised of investment advisory contracts acquired in an Affiliate investment. We monitor the useful lives of these assets and revise them, if necessary. We review historical and projected attrition rates and other events that may influence our projections of the future economic benefit that we will derive from these relationships. Significant judgment is required to estimate the period that these assets will contribute to our cash value of the investment to its fair value. We measure the fair value of each of our equity method investments by applying a fair value multiple to estimates of the run rate cash flow. Our fair value multiples are supported by observed transactions and discounted cash flow analyses which reflect assumptions of current and projected levels of Affiliate assets under management, fee rates and estimated expenses. Changes in estimates used in these valuations could materially affect the impairment flows and the pattern over which these assets will be conclusions. consumed. A change in the remaining useful life of any of these assets could have a material impact on our amorti- zation expense. For example, if we reduced the weighted average remaining life of our definite-lived acquired client relationships by one year; our amortization expense would increase by approximately $6.0 million per year. In the fourth quarter of 2008, we completed our evaluation of investments accounted for under the equity method and concluded a decline in the market value of our recent investments in ValueAct and BlueMountain was other- than-temporary. Accordingly, we reduced the carrying value of these investments by $150 million. We perform definite-lived intangible asset impairment tests annually, or more frequently should circumstances Income Taxes suggest fair value has declined below the related carrying amount. We assess each of our definite-lived acquired client relationships for impairment by comparing their carrying value to the projected undiscounted cash flows of the acquired relationships. In the fourth quarter of 2008, we performed our annual impairment test, and no impairments were identified. Our overall tax position requires analysis to estimate the expected realization of tax assets and liabilities. Tax regu- lations often require income and expense to be included in our tax returns in different amounts and in different periods than are reflected in the financial statements. Additionally, we must assess whether to recognize the benefit of an uncertain tax position, and, if so, the appropriate amount of the benefit. Equity Method Investments Deferred taxes are established to reflect the differences in As of December 31, 2008, the carrying values of equity timing between the inclusion of items of income and method investments were $679 million. Our equity method expense in the financial statements and their reporting on investments are in Affiliates in which we own a minority our tax returns. Our deferred tax liabilities are generated interest and have the ability to participate in decision primarily from tax-deductible intangible assets and convert- making. We evaluate these investments for impairment by ible securities. We generally believe that our intangible- assessing whether the fair value of the investment has related deferred taxes are unlikely to reverse, and that our declined below its carrying value for a period we consider deferred tax liabilities for convertible securities may not other-than-temporary. If we determine that a decline in fair reverse. As such, we currently believe the economic benefit value below our carrying value is other-than-temporary, an we realize from these sources may be permanent. 40 Most of our intangible assets are tax-deductible because in the financial statements is the benefit expected to be we generally structure our Affiliate investments as cash realized upon the ultimate settlement with the tax authority. transactions that are taxable to the sellers. We record For tax positions not meeting this threshold, no benefit is deferred taxes because a substantial majority of our recognized. intangible assets do not amortize for financial statement purposes, but do amortize for tax purposes, thereby creating Changes in our tax position could have a material impact tax deductions that reduce our current cash taxes. These on our earnings. For example, a 1% increase to our statutory liabilities will reverse only in the event of a sale of an tax rate attributable to our deferred tax liabilities would Affiliate or an impairment charge. Under current accounting result in an increase of approximately $6.2 million in our rules, we are required to accrue the estimated cost of such a tax expense in the period of such determination. reversal as a deferred tax liability. As of December 31, 2008, our estimate of the tax liability associated with such a sale or impairment charge was approximately $204 million. During 2008, our convertible securities generated deferred taxes of approximately $8.3 million because our interest deductions for tax purposes are greater than our reported interest expense. We believe that some or all of these deferred tax liabilities may be reclassified to equity when the securities convert to common stock. We also regularly assess our deferred tax assets, which consist primarily of tax loss carryforwards, in order to determine the need for valuation allowances. In our assessment we make assumptions about future taxable income that may be generated to utilize these assets, which have limited lives. If we determine that we are unlikely to realize the benefit of a deferred tax asset, we establish a valuation allowance that would increase our tax expense in the period of such determination. As of December 31, 2008, we had a valuation allowance for all Share-Based Compensation We have share-based compensation plans covering senior management, employees and directors. Prior to 2006, we accounted for share-based compensation using the intrinsic value method described in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations. Accordingly, prior to 2006, no compensation expense was recognized from share-based compensation plans as the exercise price of all stock options granted equaled the market price of the underlying stock on the grant date of the award. In 2006, we adopted the fair value recognition provisions of FAS 123R which requires a company to recognize share- based compensation, based on the fair value of the awards on the grant date. As a result, compensation is recognized in the financial statements for all share-based payments granted after the date of adoption, and for all awards that of our loss carryforwards. In the event that Massachusetts are unvested after that date. adopts certain income tax regulations (which were recently released in proposed form), we could potentially reverse Under FAS 123R, we estimate the fair value of stock approximately $3 million of our valuation allowance on option awards using the Black-Scholes option pricing net operating losses. model. The Black-Scholes model requires us to make assumptions about the volatility of our common stock In our assessment of uncertain tax positions, we consider and the expected life of our stock options based on past the probability that a tax authority would sustain our tax experience and anticipated future exercise behavior. We position in an examination. For tax positions meeting a consider both the historical volatility of our common “more-likely-than-not” threshold, the amount recognized stock and the implied volatility from traded options in 41 determining expected volatility. Given unprecedented Economic and Market Conditions market volatility during the latter part of 2008, we did not include the trading activity for the three months preceding International Operations our fourth quarter award in calculating the fair value of our In connection with our international distribution initiatives, stock options. we have offices in Sydney, Australia and London, England. In addition, we have international operations through Our options typically vest and become fully exercisable Affiliates who provide some or a significant part of their over three to five years of continued employment and investment management services to non-U.S. clients. In the do not include performance-based or market-based vest- future, we may open additional offices, or invest in other ing conditions. For grants that are subject to graded vesting investment management firms which conduct a significant over a service period, we recognize expense net of expected part of their operations outside of the United States. forfeitures on a straight-line basis over the requisite service There are certain risks inherent in doing business interna- period for the entire award. As of December 31, 2008, we had $16.9 million in remaining unrecognized compensation cost related to stock option grants, which will be recognized over a weighted-average period of approximately four years (assuming no forfeitures). Revenue Recognition tionally, such as changes in applicable laws and regulatory requirements, difficulties in staffing and managing foreign operations, longer payment cycles, difficulties in collecting investment advisory fees receivable, different and in some cases, less stringent, regulatory and accounting regimes, political instability, fluctuations in currency exchange rates, expatriation controls, expropriation risks and potential adverse tax consequences. There can be no assurance that one or more of such factors will not have a material adverse The majority of our consolidated revenue represents effect on our international operations or our affiliated advisory fees (asset-based and performance-based). Our investment management firms that have international Affiliates recognize asset-based advisory fees quarterly as they render services to their clients. In addition to generating asset-based fees, over 50 Affiliate products, representing approximately $28.6 billion of assets under management, also bill on the basis of absolute investment performance (“performance fees”). These products, which are primarily in the Institutional distribution channel, are generally structured to have returns that are not directly correlated to changes in broader equity indices and, if earned, the performance fee component is typically billed less fre- quently than the asset-based fee. Our Affiliates recognize performance fees when they are earned (i.e., when they become billable to customers) based on the contractual terms of agreements and when collection is reasonably operations or on other investment management firms in which we may invest in the future and, consequently, on our business, financial condition and results of operations. Inflation We do not believe that inflation or changing prices have had a material impact on our results of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Risk.” Quantitative and Qualitative Disclosures About Market Risk assured. Although performance fees inherently depend on For quantitative and qualitative disclosures about how we investment results and will vary from period to period, we are affected by market risk, see “Management’s Discussion anticipate performance fees to be a recurring component and Analysis of Financial Condition and Results of of our revenue. Operations—Market Risk.” 42 Selected Financial Data Set forth below are selected financial data for the last five years. This data should be read in conjunction with, and is qualified in its entirety by reference to, the Consolidated Financial Statements and accompanying notes included elsewhere in this Annual Report. (in thousands, except as indicated and per share data) 2004 2005 2006 2007 2008 For the Years Ended December 31, Statement of Income Data Revenue Net Income Earnings per share—diluted(1) Average shares outstanding—diluted Other Financial Data Assets under Management (in millions) Cash flow from (used in): Operating activities Investing activities Financing activities EBITDA(2) Cash Net Income(3) Balance Sheet Data Total assets(4) Intangible assets(4) Equity investments in Affiliates(4) Affiliate investments in partnerships(5) Minority interest in $ 659,997 77,147 2.02 39,645 $ 916,492 119,069 2.81 44,690 $ 1,170,353 151,277 3.70 43,670 $ 1,369,866 181,961 4.55 42,399 $ 1,158,217 23,170 0.57 40,873 $ 129,802 $ 184,310 $ 241,140 $ 274,764 $ 170,145 $ 177,886 (478,266) 215,243 186,434 126,475 $ 204,078 (82,029) (122,267) 267,463 186,103 $ 301,003 (165,079) (75,082) 342,118 222,454 $ 326,654 (580,755) 272,548 418,229 258,749 $ 255,676 (189,411) 109,747 335,311 221,962 $ 1,933,421 1,328,976 252,597 4,594 $ 2,321,636 1,576,941 301,476 5,079 $ 2,665,920 1,679,293 293,440 108,350 $ 3,395,705 1,726,989 842,490 134,657 $ 3,246,370 1,734,991 678,887 68,789 Affiliate investments in partnerships(5) Senior debt(6) Senior convertible securities(7) Mandatory convertible securities Junior convertible trust preferred securities(8) Other long-term obligations(9) Stockholders’ equity(10) — 126,750 423,958 300,000 — 155,565 707,692 — 241,250 424,232 300,000 — 202,772 817,381 104,096 365,500 413,358 300,000 300,000 229,793 499,222 127,397 519,500 378,083 300,000 800,000 290,538 469,202 65,465 233,514 507,146 — 730,820 258,843 1,092,560 (1) Earnings per share—diluted for 2006 and 2007 are $0.04 and $0.03 lower, respectively, than amounts previously reported as the anti-dilutive effect of certain convertible securities had been incorrectly included in prior calculations. These changes were not material to our financial position or results of operations. (2) The definition of EBITDA is presented in Note 3 on page 23. Our use of EBITDA, including a reconciliation to cash flow from operations, is dis- cussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” (3) Cash Net Income is defined as Net Income plus amortization and deferred taxes related to intangible assets plus Affiliate depreciation. We consider Cash Net Income an important measure of our financial performance, as we believe it best represents operating performance before non-cash expenses relating to the acquisition of interests in our affiliated investment management firms. Cash Net Income is not a measure of financial performance under generally accepted accounting principles and, as calculated by us, may not be consistent with computations of Cash Net Income by other companies. Our use of Cash Net Income, including a reconciliation of Cash Net Income to Net Income, is discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” (4) Total assets, Intangible assets and Equity investments in Affiliates have increased as we have made new or additional investments in affiliated investment management firms. (5) In 2006, we implemented Emerging Issues Task Force Issue 04-05, “EITF 04-05” (see Note 1 to the Consolidated Financial Statements). In accordance with EITF 04-05, we have consolidated client assets held in partnerships controlled by our Affiliates. These assets are reported as “Affiliate investments in partnerships”; a majority of these assets are held by investors that are unrelated to us, and are reported as “Minority interest in Affiliate investments in partnerships.” (6) Senior debt consists of outstanding borrowings under our credit facility and, through November 2006, our senior notes due 2006. (7) Senior convertible securities consists of our zero coupon senior convertible notes, our floating rate senior convertible securities (through February 2008) and our 2008 senior convertible notes, which were issued in August 2008. (8) In 2006 and 2007, we completed private placements of junior convertible trust preferred securities of $300 million and $500 million, respectively. (9) Other long-term obligations consist principally of deferred income taxes and payables to related parties. (10) During 2006 and 2007, we repurchased $537,777 and $426,479 of our common stock, respectively. 43 Management’s Report on Internal Control Over Financial Reporting Management of Affiliated Managers Group, Inc. (the reasonable assurance regarding prevention or timely “Company”), is responsible for establishing and maintain- detection of unauthorized acquisition, use or disposition of ing adequate internal control over financial reporting. The the Company’s assets that could have a material effect on Company’s internal control over financial reporting our financial statements. processes are designed under the supervision of the Company’s chief executive and chief financial officers As of December 31, 2008, management conducted an to provide reasonable assurance regarding the reliability assessment of the effectiveness of the Company’s internal of financial reporting and the preparation of the control over financial reporting based on the framework Company’s financial statements for external reporting established in Internal Control—Integrated Framework purposes in accordance with accounting principles generally issued by the Committee of Sponsoring Organizations of accepted in the United States. the Treadway Commission (“COSO”). Based on this assess- ment, management has determined that the Company’s The Company’s internal control over financial reporting internal control over financial reporting as of December 31, includes policies and procedures that pertain to the main- 2008 was effective. tenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; The Company’s internal control over financial report- provide reasonable assurances that transactions are recorded ing as of December 31, 2008 has been audited by as necessary to permit preparation of financial statements in PricewaterhouseCoopers LLP, an independent registered accordance with accounting principles generally accepted public accounting firm, as stated in their report appearing in the United States, and that receipts and expenditures on page 45, which expresses an unqualified opinion on the are being made only in accordance with authorizations of effectiveness of the firm’s internal control over financial management and the directors of the Company; and provide reporting as of December 31, 2008. 44 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Affiliated Managers Group, Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Affiliated Managers Group, Inc. (the “Company”) at December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial report- ing, included in Management’s Report on Internal Control Over Financial Reporting appearing on page 44 of this Annual Report. Our responsibility is to express opinions on these financial statements, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transac- tions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstate- ments. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Boston, Massachusetts March 2, 2009 45 Consolidated Statements of Income (dollars in thousands, except per share data) Revenue Operating expenses: Compensation and related expenses Selling, general and administrative Amortization of intangible assets Depreciation and other amortization Other operating expenses Operating income Non-operating (income) and expenses: Investment and other income (Income) loss from equity method investments Investment (income) loss from Affiliate investments in partnerships Interest expense Income before minority interest and income taxes Minority interest Minority interest in Affiliate investments in partnerships Income before income taxes Income taxes—current Income taxes—intangible-related deferred Income taxes—other deferred Net Income Earnings per share—basic Earnings per share—diluted Average shares outstanding—basic Average shares outstanding—diluted Supplemental disclosure of total comprehensive income: Net Income Other comprehensive income (loss) Total comprehensive income (loss) The accompanying notes are an integral part of the Consolidated Financial Statements. For the Years Ended December 31, 2006 2007 2008 $ 1,170,353 $ 1,369,866 $ 1,158,217 472,400 184,019 27,378 8,763 23,880 716,440 453,913 (16,943) (38,318) (3,400) 58,800 139 453,774 (212,523) (3,364) 237,887 55,267 28,779 2,564 579,365 197,967 31,653 10,444 18,822 838,251 531,615 (17,133) (58,197) (38,877) 76,919 (37,288) 568,903 (241,987) (38,089) 288,827 74,634 28,576 3,656 $ 151,277 $ 181,961 $ $ 4.83 3.70 $ $ 6.18 4.55 $ $ $ 516,895 200,072 33,854 12,767 26,511 790,099 368,118 (43,654) 97,142 63,410 73,891 190,789 177,329 (193,728) 60,504 44,105 51,758 (12,776) (18,047) 23,170 0.61 0.57 31,289,005 43,669,991 29,464,764 42,398,686 38,211,326 40,872,656 $ 151,277 (2,090) $ 181,961 50,071 $ 149,187 $ 232,032 $ $ 23,170 (68,818) (45,648) 46 Consolidated Balance Sheets (in thousands) Assets Current assets: Cash and cash equivalents Investment advisory fees receivable Affiliate investments in partnerships Affiliate investments in marketable securities Prepaid expenses and other current assets Total current assets Fixed assets, net Equity investments in Affiliates Acquired client relationships, net Goodwill Other assets Total assets Liabilities and Stockholders’ Equity Current liabilities: Accounts payable and accrued liabilities Payables to related party Total current liabilities Senior debt Senior convertible securities Mandatory convertible securities Junior convertible trust preferred securities Deferred income taxes Other long-term liabilities Total liabilities Commitments and contingencies (Note 16) Minority interest Minority interest in Affiliate investments in partnerships Stockholders’ equity: Common stock ($.01 par value; 153,000 shares authorized; 39,024 shares outstanding in 2007 and 45,795 outstanding in 2008) Additional paid-in capital Accumulated other comprehensive income (loss) Retained earnings Less: treasury stock, at cost (10,865 shares in 2007 and 6,296 shares in 2008) Total stockholders’ equity Total liabilities and stockholders’ equity The accompanying notes are an integral part of the Consolidated Financial Statements. December 31, 2007 2008 $ 222,954 237,636 134,657 21,237 33,273 649,757 69,879 842,490 496,602 1,230,387 106,590 $ 396,431 131,099 68,789 10,399 34,603 641,321 71,845 678,887 491,408 1,243,583 119,326 $ 3,395,705 $ 3,246,370 $ 246,400 69,952 $ 186,385 26,187 316,352 519,500 378,083 300,000 800,000 257,022 33,516 212,572 233,514 507,146 — 730,820 228,429 30,414 $ 2,604,473 — 194,633 127,397 $ 1,942,895 — 145,450 65,465 390 662,454 64,737 836,426 458 939,540 (4,081) 859,596 1,564,007 (1,094,805) 1,795,513 (702,953) 469,202 1,092,560 $ 3,395,705 $ 3,246,370 47 Consolidated Statements of Changes in Stockholders’ Equity (dollars in thousands) December 31, 2005 Stock issued under option and other incentive plans Tax benefit of option exercises Issuance of Affiliate equity interests Cost of call spread option agreements Conversion of zero coupon convertible notes Repurchase of common shares Net Income Other comprehensive income December 31, 2006 Stock issued under option and other incentive plans Tax benefit of option exercises Issuance of Affiliate equity interests Settlement of call spread agreements Cost of call spread option agreements Conversion of zero coupon convertible notes Repurchase of common shares, including prepaid forward purchase contracts Net Income Other comprehensive income December 31, 2007 Stock issued under option and other incentive plans Tax benefit of option exercises Issuance costs Issuance of Affiliate equity interests Settlement of mandatory convertible securities Conversion of floating rate Common Shares Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Treasury Shares Treasury Shares at Cost 39,023,658 $ 390 $ 593,090 $ 16,756 $ 503,188 (5,424,950) $ (296,043) — — — — — — — — — — — — — — — — (991) 28,529 2,031 (13,290) — — — — — — — — — 1,263,873 — — 42,694 — — — — — — — — — — (2,090) — 215,350 — (5,482,047) — — 151,277 — 11,458 (537,777) — — 39,023,658 $ 390 $ 609,369 $ 14,666 $ 654,465 (9,427,774) $ (779,668) — — — — — — — — — — — — — — — — — — (23,443) 42,308 27,508 15,564 (6,800) — (2,052) — — — — — — — — — 1,504,143 — — 84,333 — — — — — (115,789) (8,764) — — — — 667,826 35,773 — — 50,071 — (3,493,605) — — 181,961 — (426,479) — — 39,023,658 $390 $ 662,454 $64,737 $ 836,426 (10,865,199) $(1,094,805) — — — — 2,605,118 — — — — 26 42 — — — — — 1,215 13,868 (951) 6,444 213,939 50,288 18,291 (26,008) — — — — — — — — — — — — — — 760,937 — — 64,941 — — — — — 1,183,202 85,484 — 2,839,779 249,637 — — — — — — (68,818) — 580,681 — (795,400) — — 23,170 — 57,280 (65,490) — — senior convertible securities 4,166,595 Tax benefit related to conversion of floating rate senior convertible securities Conversion of zero coupon convertible notes Repurchase of common shares Net Income Other comprehensive income — — — — — December 31, 2008 45,795,371 $458 $939,540 $ (4,081) $ 859,596 (6,296,000) $ (702,953) The accompanying notes are an integral part of the Consolidated Financial Statements. 48 Consolidated Statements of Cash Flows (in thousands) Cash flow from operating activities: Net Income Adjustments to reconcile Net Income to net cash flow from operating activities: Amortization of intangible assets Amortization of issuance costs Depreciation and other amortization Deferred income tax provision (benefit) Accretion of interest (Income) loss from equity method investments, net of amortization Distributions received from equity method investments Tax benefit from exercise of stock options Stock option expense Affiliate equity expense Other adjustments Changes in assets and liabilities: (Increase) decrease in investment advisory fees receivable Decrease in Affiliate investments in partnerships (Increase) decrease in prepaids and other current assets (Increase) decrease in other assets Increase (decrease) in accounts payable, accrued liabilities and other long-term liabilities Increase (decrease) in minority interest Cash flow from operating activities Cash flow used in investing activities: Cost of investments in Affiliates, net of cash acquired Purchase of fixed assets Purchase of investment securities Sale of investment securities Cash flow used in investing activities Cash flow from (used in) financing activities: Borrowings of senior bank debt Repayments of senior bank debt Issuance of senior convertible notes Settlement of convertible securities Issuance of junior convertible trust preferred securities Repurchase of junior convertible trust preferred securities Repayments of senior debt Issuance of common stock Repurchase of common shares, including prepaid forward purchase contracts Issuance costs Excess tax benefit from exercise of stock options Cost of call spread option agreements Settlement of derivative contracts Note payments Redemptions of Minority interest—Affiliate investments in partnerships Cash flow from (used in) financing activities Effect of foreign exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Supplemental disclosure of cash flow information: Interest paid Income taxes paid Supplemental disclosure of non-cash financing activities: Stock issued for conversion of floating rate senior convertible securities Stock issued in settlement of mandatory convertible securities Stock issued for conversion of zero coupon senior convertible note Payables recorded for Affiliate equity purchases The accompanying notes are an integral part of the Consolidated Financial Statements. For the Years Ended December 31, 2007 2006 2008 $ 151,277 $ 181,961 $ 23,170 27,378 2,862 8,763 31,343 2,360 (38,318) 46,033 5,482 1,654 924 7,604 (52,281) 7,707 150 3,159 65,814 29,092 301,003 (123,262) (21,510) (29,522) 9,215 (165,079) 602,000 (412,000) — — 300,000 — (65,750) 52,765 (536,478) (9,982) 23,047 (13,290) — (7,687) (7,707) (75,082) 464 61,306 140,423 $ 201,729 31,653 3,250 10,444 32,232 2,772 (58,197) 53,612 5,780 9,039 8,109 (2,130) (35,963) 12,766 (4,722) (3,178) 21,035 58,191 326,654 (556,683) (16,821) (13,648) 6,397 (580,755) 727,000 (573,000) — — 500,000 — — 53,324 (435,997) (19,999) 36,528 — — (2,542) (12,766) 272,548 2,778 21,225 201,729 $ 222,954 33,854 4,726 12,767 (30,823) 686 97,142 80,487 2,767 53,968 13,948 (33,209) 102,788 6,045 19,640 9,770 (49,315) (92,735) 255,676 (171,400) (9,554) (33,613) 25,156 (189,411) 366,000 (651,986) 460,000 (208,730) — (24,213) — 238,814 (65,490) (28,859) 11,101 — 8,154 5,628 (672) 109,747 (2,535) 173,477 222,954 $ 396,431 $ 59,526 29,003 $ 77,735 30,243 $ 63,987 45,279 — — 11,458 36,736 — — 35,773 18,308 299,970 93,750 31,272 23,655 49 Notes to Consolidated Financial Statements 1 Business and Summary of Significant Accounting Policies (a) Organization and Nature of Operations Affiliated Managers Group, Inc. (“AMG” or the “Company”) is an asset management company with equity investments in a diverse group of boutique investment management firms (“Affiliates”). AMG’s Affiliates currently provide investment management services globally to mutual funds, institutional clients and high net worth individuals. Fees for services are largely asset-based and, as a result, the Company’s revenue may fluctuate based on the performance of financial markets. Affiliates are either organized as limited partnerships, limited liability partnerships, limited liability companies, or corporations. AMG generally has contractual arrangements with its Affiliates whereby a percentage of revenue is customarily allocable to fund Affiliate operating expenses, including compensation (the “Operating Allocation”), while the remaining portion of revenue (the “Owners’ Allocation”) is allocable to AMG and the other partners or members, generally with a priority to AMG. In certain other cases, the Affiliate is not subject to a revenue sharing arrangement, but instead operates on a profit-based model. In these cases, AMG participates fully in any increase or decrease in the revenue or expenses of such firms. In situations where AMG holds a minority equity interest, the revenue sharing arrangement generally allocates to AMG a (b) Principles of Consolidation The Company evaluates the risk, rewards, and significant terms of each of its Affiliate and other investments to determine the appropriate method of accounting. Majority- owned or otherwise controlled investments are consolidated. In many of its Affiliate investments, AMG is, directly or indirectly, the sole general partner (in the case of Affiliates which are limited partnerships), managing partner (in the case of Affiliates which are limited liability partnerships), sole manager member (in the case of Affiliates which are limited liability companies) or principal shareholder (in the case of Affiliates which are corporations). As a result, the Company generally consolidates its Affiliate investments. Investments that are determined to be Variable Interest Entities as defined by FASB Interpretation No. 46 (revised), “Consolidation of Variable Interest Entities” (“FIN 46R”), are consolidated if AMG or a consolidated Affiliate is the primary beneficiary of the investment. For Affiliate operations consolidated into these financial statements, the portion of the income allocated to owners other than AMG is included in Minority interest in the Consolidated Statements of Income. As Affiliates are generally structured as pass-through entities for tax pur- poses, minority interest has been presented before income taxes in the Consolidated Statements of Income. Minority interest on the Consolidated Balance Sheets includes capital and undistributed income owned by the managers of the consolidated Affiliates. All material intercompany percentage of the Affiliate’s revenue. The remaining revenue balances and transactions have been eliminated. is used to pay operating expenses and profit distributions to the other owners. AMG applies the equity method of accounting to investments where AMG or an Affiliate does not hold a The financial statements are prepared in accordance with majority equity interest but has the ability to exercise accounting principles generally accepted in the United significant influence (generally at least a 20% interest or States (“U.S. GAAP”). All dollar amounts, except per share a general partner interest) over operating and financial data in the text and tables herein, are stated in thousands matters. AMG or an Affiliate also applies the equity unless otherwise indicated. Certain reclassifications have method when their minority shareholders or partners been made to prior years’ financial statements to conform have certain rights to remove their ability to control the to the current year’s presentation. entity or rights to participate in substantive operating 50 decisions (e.g. approval of annual operating budgets, major (d) Affiliate Investments in Partnerships financings, selection of senior management, etc.). For equity method investments, AMG’s or the Affiliate’s portion of income before taxes is included in Income from equity method investments. Other investments in which AMG or an Affiliate own less than a 20% interest and does not exercise significant influence are accounted for under the cost method. Under the cost method, income is recognized as dividends when, and if, declared. Effective January 1, 2006, the Company implemented Emerging Issues Task Force Issue 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Assets of consolidated partnerships are reported as “Affiliate investments in partnerships.” A majority of these assets are held by investors that are unrelated to the Company, and reported as “Minority interest in Affiliate investments in partnerships.” Income from these partnerships is presented as “Investment (income) loss from Affiliate investments in partnerships” in the consolidated statements of income. The portion of this income or loss that is attributable to investors that are unrelated to the Company is reported as a “Minority interest in Affiliate investments in partnerships.” (e) Affiliate Investments in Marketable Securities Entity When the Limited Partners Have Certain Rights” Affiliate investments in marketable securities are classified (“EITF 04-5”). Under EITF 04-5, the Company or an as either trading or available-for-sale and carried at fair Affiliate consolidates any partnership that it controls, value. Unrealized holding gains or losses on investments including those interests in the partnerships in which the classified as available-for-sale are reported net of Company does not have ownership rights. A general deferred tax as a separate component of accumulated partner is presumed to control a partnership unless the other comprehensive income in stockholders’ equity until limited partners have certain rights to remove the general realized. If a decline in the fair value of these investments is partner or other substantive rights to participate in partner- determined to be other than temporary, the carrying ship operations. Partnerships that are not controlled by amount of the asset is reduced to its fair value, and the the Company or an Affiliate are accounted for using the difference is charged to income in the period incurred. equity method of accounting. The effect of any changes in the Company’s equity interests in its Affiliates resulting from the issuance of an Affiliate’s equity by the Company or one of its Affiliates is included as a component of stockholders’ equity, net of the related income tax effect in the period of the change. (c) Cash and Cash Equivalents (f) Fixed Assets Fixed assets are recorded at cost and depreciated using the straight-line method over their estimated useful lives. The estimated useful lives of office equipment and furniture and fixtures range from three to ten years. Computer software developed or obtained for internal use is amortized using the straight-line method over the estimated useful life of the software, generally three years or less. Leasehold The Company considers all highly liquid investments, improvements are amortized over the shorter of their including money market mutual funds, with original maturities of three months or less to be cash equivalents. estimated useful lives or the term of the lease, and the building is amortized over 39 years. The costs of improve- Cash equivalents are stated at cost, which approximates ments that extend the life of a fixed asset are capitalized, market value due to the short-term maturity of these while the cost of repairs and maintenance are expensed investments. as incurred. Land is not depreciated. 51 (g) Leases The Company and its Affiliates currently lease office space and equipment under various leasing arrangements. As these leases expire, it can be expected that in the normal course of business they will be renewed or replaced. All leases and subleases are accounted for under Statement of Financial Accounting Standard (“FAS”) No. 13, “Accounting for Leases.” These leases are classified as either capital leases or operating leases, as appropriate. Most lease agreements classified as operating leases contain renewal options, rent escalation clauses or other induce- ments provided by the landlord. Rent expense is accrued to recognize lease escalation provisions and inducements provided by the landlord, if any, on a straight-line basis over the lease term. (h) Equity Investments in Affiliates The Company periodically evaluates its equity method investments for impairment. In such impairment evalua- tions, the Company assesses if the value of the investment has declined below its carrying value for a period considered to be other than temporary. If the Company determines that a decline in value below the carrying value of the investment is other than temporary, then the reduction in carrying value would be recognized in (Income) loss from equity method investments in the Consolidated Statements of Income. (i) Acquired Client Relationships and Goodwill The purchase price for the acquisition of interests in Affiliates is allocated based on the fair value of net assets acquired, primarily acquired client relationships. In deter- mining the allocation of the purchase price to acquired client relationships, the Company analyzes the net present value of each acquired Affiliate’s existing client relationships For equity method investments, the Company’s portion of based on a number of factors including: the Affiliate’s income or loss before taxes is included in (Income) loss historical and potential future operating performance; the from equity method investments. The Company’s share of Affiliate’s historical and potential future rates of attrition income taxes incurred directly by Affiliates accounted for among existing clients; the stability and longevity of under the equity method are recorded within Income existing client relationships; the Affiliate’s recent, as well taxes—current in the Consolidated Statements of Income as long-term, investment performance; the characteristics because these taxes generally represent the Company’s share of the firm’s products and investment styles; the stability of the taxes incurred by the Affiliate. Deferred income taxes and depth of the Affiliate’s management team and the incurred as a direct result of the Company’s investment in Affiliate’s history and perceived franchise or brand value. Affiliates accounted for under the equity method have been included in Income taxes—intangible-related deferred in the Consolidated Statements of Income. The associated deferred tax liabilities have been classified as a component of deferred income taxes in the Consolidated Balance Sheet. The Company has determined that certain of its mutual fund acquired client relationships meet the indefinite life criteria outlined in FAS No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”), because the Company expects both the renewal of these contracts and the cash As is consistent with the equity method of accounting, flows generated by these assets to continue indefinitely. for one of its equity method Affiliates based outside the United States, the Company has elected to record financial Accordingly, the Company does not amortize these intangible assets, but instead reviews these assets at least results one quarter in arrears to allow for the receipt of annually for impairment. Each reporting period, the financial information. The Company converts the financial Company assesses whether events or circumstances have information of foreign investments to U.S. GAAP. occurred which indicate that the indefinite life criteria 52 are no longer met. If the indefinite life criteria are no longer minority interest owners. Resulting payments made to such met, the Company assesses whether the carrying value of owners are generally considered purchase price for these the assets exceeds its fair value, and an impairment loss acquired interests. would be recorded in an amount equal to any such excess. As of December 31, 2008, the cost assigned to all other acquired client relationships was being amortized over a weighted average life of approximately 10 years. The expected useful lives of acquired client relationships are analyzed each period and determined based on an analysis of the historical and projected attrition rates of each Affiliate’s existing clients, and other factors that may influence the expected future economic benefit the Company will derive from the relationships. The Company tests for the possible impairment of definite-lived intangi- ble assets annually or more frequently whenever events or changes in circumstances indicate that the carrying amount of the asset is not recoverable. If such indicators exist, the Company compares the undiscounted cash flows related to the asset to the carrying value of the asset. If the carrying value is greater than the undiscounted cash flow amount, an impairment charge is recorded in the Consolidated Statements of Income for amounts necessary to reduce the (j) Revenue Recognition The Company’s consolidated revenue primarily represents advisory fees billed monthly, quarterly and annually by Affiliates for managing the assets of clients. Asset-based advisory fees are recognized monthly as services are ren- dered and are based upon a percentage of the market value of client assets managed. Any fees collected in advance are deferred and recognized as income over the period earned. Performance-based advisory fees are generally assessed as a percentage of the investment performance realized on a client’s account, generally over an annual period. Performance-based advisory fees are recognized when they are earned (i.e., when they become billable to customers) based on the contractual terms of agreements and when collection is reasonably assured. Also included in revenue are commissions earned by broker dealers, recorded on a trade date basis, and other service fees recorded as earned. carrying value of the asset to fair value. (k) Issuance Costs The excess of purchase price for the acquisition of interests in Affiliates over the fair value of net assets acquired, including acquired client relationships, is reported as goodwill within the operating segments in which the Affiliate operates. Goodwill is not amortized, but is instead reviewed for impairment. The Company assesses goodwill for impairment at least annually, or more frequently whenever events or circumstances occur indicating that the recorded goodwill may be impaired. Fair value is determined for each operating segment primarily based on price-earnings multiples. If the carrying amount of goodwill exceeds the fair value, an impairment loss would be recorded. Issuance costs incurred in securing credit facility financing are amortized over the remaining term of the credit facility. Costs incurred to issue the zero coupon senior convertible securities, the floating rate senior convertible securities, the 2008 senior convertible notes and the junior convertible trust preferred securities are amortized over the earlier of the period to the first investor put date or the stated term of the security. Costs incurred to issue the Company’s mandatory convertible securities were allocated between the senior notes and the purchase contracts based upon the relative cost to issue each instrument separately. Costs allocated to the senior notes were recognized as interest expense over the period of the forward equity purchase contract component of such securities. Costs associated with financial instruments that are not required to be As further described in Note 17, the Company periodically accounted for separately as derivative instruments are purchases additional equity interests in Affiliates from charged directly to stockholders’ equity. 53 (l) Derivative Financial Instruments The Company is exposed to interest rate risk inherent in its variable rate debt obligations. The Company’s risk manage- ment strategy may utilize financial instruments, specifically interest rate derivative contracts to hedge certain interest rate exposures. For example, the Company may agree with a counter party (typically a major commercial bank) to exchange the difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed notional principal amount. In entering into these contracts, the Company intends to offset cash flow gains and losses that occur on its existing debt obligations with cash flow gains and losses on the contracts hedging these obligations. In measuring the amount of deferred taxes each period, the Company must project the impact on its future tax payments of any reversal of deferred tax liabilities (which would increase the Company’s tax payments), and any use of its state and foreign carryforwards (which would decrease its tax payments). In forming these estimates, the Company makes assumptions about future federal, state and foreign income tax rates and the apportionment of future taxable income to jurisdictions in which the Company has operations. An increase or decrease in federal or state income tax rates could have a material impact on the Company’s deferred income tax liabilities and assets and would result in a current income tax charge or benefit. The Company records all derivatives on the balance sheet The Company recognizes the financial statement benefit at fair value. If the Company’s derivatives qualify as cash of an uncertain tax position only after considering the flow hedges, the effective portion of the unrealized gain or probability that a tax authority would sustain the position loss is recorded in accumulated other comprehensive in an examination. For tax positions meeting a “more- income as a separate component of stockholders’ equity likely-than-not” threshold, the amount recognized in the and reclassified into earnings when periodic settlement of financial statements is the benefit expected to be realized variable rate liabilities are recorded in earnings. Hedge upon settlement with the tax authority. For tax positions effectiveness is generally measured by comparing the not meeting the threshold, no financial statement benefit is present value of the cumulative change in the expected recognized. As allowed by FIN 48, the Company recognizes future variable cash flows of the hedged contract with the interest and other charges relating to unrecognized tax present value of the cumulative change in the expected benefits as additional tax expense. future variable cash flows of the hedged item. To the extent that the critical terms of the hedged item and the derivative are not identical, hedge ineffectiveness would be reported in earnings as interest expense. Hedge ineffectiveness was not material in 2006, 2007 or 2008. (m) Income Taxes In the case of the Company’s deferred tax assets, the Company regularly assesses the need for valuation allowances, which would reduce these assets to their recoverable amounts. In forming these estimates, the Company makes assumptions of future taxable income that may be generated to utilize these assets, which have The Company accounts for income taxes using the liability limited lives. If the Company determines that these assets method. Under this method, deferred taxes are recognized will be realized, the Company records an adjustment to for the expected future tax consequences of temporary the valuation allowance, which would decrease tax expense differences between the book carrying amounts and tax in the period such determination was made. Likewise, bases of the Company’s assets and liabilities. Historically, should the Company determine that it would be unable deferred tax liabilities have been attributable to intangible to realize additional amounts of deferred tax assets, an assets and convertible securities. Deferred tax assets have adjustment to the valuation allowance would be charged been attributable to state and foreign loss carryforwards, to tax expense in the period such determination was made. deferred revenue, and accrued liabilities. For example, if the Company was to make an investment 54 in a new Affiliate located in a state where it has operating net of tax, was $5,694 and $33,460 for the years ended loss carryforwards, the projected taxable income from the December 31, 2007 and 2008, respectively. This additional new Affiliate could be offset by these operating loss carry- compensation expense decreased basic and diluted earnings forwards, justifying a reduction to the valuation allowance. per share by $0.19 and $0.13, respectively, for the year (n) Foreign Currency Translation The assets and liabilities of Affiliates that are not based in the United States are translated into U.S. dollars using exchange rates in effect as of the balance sheet date. The revenue and expenses of these Affiliates are translated into U.S. dollars using average exchange rates for the relevant period. Because of the permanent nature of the Company’s investments, net translation exchange gains and losses are excluded from Net Income but are recorded in other comprehensive income. Foreign currency transaction gains and losses are reflected in Investment and other income. (o) Share-Based Compensation Plans Effective January 1, 2006, the Company adopted the fair value recognition provisions of FAS No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”). FAS 123R revises FAS No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). FAS 123R requires as an expense the cost of all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values over the requisite service period. In addition, FAS 123R requires unrecognized costs related to options vesting after the date of initial adoption to be recognized as an expense in the financial statements over the remaining requisite service period. ended December 31, 2007, and $0.88 and $0.82, respec- tively, for the year ended December 31, 2008. FAS 123R also requires the Company to report any tax benefits realized upon the exercise of stock options that are in excess of the expense recognized for reporting purposes as a financing activity in the Company’s consol- idated statement of cash flows. Prior to the adoption of FAS 123R, these tax benefits were presented as operating cash flows in the consolidated statements of cash flows. If the tax benefit realized is less than the expense, the tax shortfall is recognized in stockholders’ equity. To the extent the expense exceeds available windfall tax benefits, it is recognized in the Consolidated Statements of Income. Under FAS 123R, the Company was permitted to calculate its cumulative windfall tax benefits for the purposes of accounting for future tax shortfalls. The Company elected to apply the long-form method for determining the pool of windfall tax benefits. (p) Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts included in the financial statements and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. (q) Recent Accounting Developments In September 2006, the FASB issued FAS No. 157, “Fair The Company adopted FAS 123R using the modified Value Measurements” (“FAS 157”), which defines fair value, prospective transition method. Under this method, com- establishes a framework for measuring fair value in pensation expense includes: (i) an expense for all unvested accordance with generally accepted accounting principles, options outstanding on January 1, 2006, and (ii) an and requires expanded disclosure about fair value meas- expense for all options granted subsequent to January 1, urements. As described in Note 5, the Company adopted 2006. Compensation expense recognized under FAS 123R, this standard in the first quarter of 2008 for its financial 55 assets and liabilities that are measured at fair value on a income attributable to the parent and the minority interest quarterly basis. For all other nonfinancial assets and separately in the consolidated financial statements. The liabilities, FAS 157 is effective in the first quarter of 2009. Company will adopt FAS 160 in the first quarter of 2009. The standard is not expected to have a material impact on the Company’s consolidated financial statements, but In March 2008, the SEC announced revisions to will require certain additional disclosures. EITF Topic D-98 “Classification and Measurement of Redeemable Securities” (“Topic D-98”), which provides In February 2007, the FASB issued FAS No. 159, “The SEC registrants guidance on the financial statement Fair Value Option for Financial Assets and Financial classification and measurement of equity securities that are Liabilities—Including an amendment of FASB Statement subject to mandatory redemption requirements or whose No. 115” (“FAS 159”). FAS 159 permits companies to meas- ure many financial instruments and certain other items at redemption is outside the control of the issuer. The revised Topic D-98 requires redeemable minority interests, such as fair value. The Company adopted FAS 159 in the first the equity interests held by the Company’s Affiliates quarter of 2008; as it did not apply the fair value option to described in Note 16, to be recorded outside of permanent any of its outstanding instruments, FAS 159 did not have equity at their current redemption value, and the interests an impact on its consolidated financial statements. should be adjusted to their current redemption value at each balance sheet date. Adjustments to the carrying In December 2007, the FASB issued FAS No. 141 (revised amount of a noncontrolling interest from the application 2007), “Business Combinations” (“FAS 141R,” which is of Topic D-98 are recorded to stockholders’ equity. The effective in the first quarter of 2009). FAS 141R will require Company will adopt this guidance in 2009, resulting in its acquirors to measure identifiable assets and liabilities at recording the current redemption value of its redeemable their full fair values on the acquisition date. FAS 141R will noncontrolling interests with a corresponding adjustment also change the treatment of contingent consideration, to stockholders’ equity in the consolidated balance sheets. contingencies, acquisition costs, and restructuring costs. FAS 141R will be applied to future acquisitions, and its In March 2008, the FASB issued FAS No. 161, impact will depend on the nature and volume of those “Disclosures about Derivative Instruments and Hedging transactions. Upon adoption, FAS 141R will be retrospec- Activities—an amendment of FASB Statement No. 133” tively applied to acquisitions costs previously deferred, and (“FAS 161”). FAS 161 requires enhanced disclosures the Company anticipates that 2007 and 2008 earnings will regarding the impact of derivatives on its financial position, be adjusted by $700 and $6,100, respectively. financial performance, and cash flows. The Company will adopt FAS 161 in the first quarter of 2009 and does not In December 2007, the FASB issued FAS No. 160, expect this standard to have a material effect on the con- “Noncontrolling Interests in Consolidated Financial solidated financial statements. Statements, an amendment of ARB No. 51” (“FAS 160”). FAS 160 will change the accounting and reporting for In May 2008, the FASB issued FASB Staff Position APB minority or noncontrolling interests. Upon adoption, these interests and transactions between controlling interest and 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including minority interest holders may be accounted for within Partial Cash Settlement)” (“FSP APB 14-1”), which applies stockholders’ equity. FAS 160 also requires an entity to to all convertible debt instruments that may be settled present Net Income and consolidated comprehensive either wholly or partially in cash upon conversion. FSP 56 APB 14-1 requires issuers to separately account for the accordance with FAS 141R and other-than-temporary liability and equity components of convertible debt instru- impairments of equity method investments should be ments in a manner reflective of the issuer’s nonconvertible recognized in accordance with APB Opinion No. 18, debt borrowing rate. Previous guidance required these “Accounting by an Investor for Its Proportionate Share of types of convertible debt instruments to be accounted for Accumulated Other Comprehensive Income of an Investee entirely as debt. FSP APB 14-1 is effective in the first Accounted for under the Equity Method in Accordance quarter of 2009 and will be retrospectively applied to prior with APB Opinion No. 18 upon a Loss of Significant periods. The Company expects that FSP APB 14-1 will Influence.” EITF 08-6 is effective on a prospective basis increase interest expense for its convertible securities by beginning in the first quarter of 2009. The Company is approximately $14,000 in 2009. assessing the potential impact, if any, of the adoption of EITF 08-6 on its consolidated results of operations and In June 2008, the FASB ratified EITF No. 07-5, financial condition. “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 provides guidance for determining whether an In November 2008, the FASB ratified EITF 08-7, equity-linked financial instrument, or embedded feature, is “Accounting for Defensive Intangible Assets” (“EITF indexed to an entity’s own stock. The Company will adopt 08-7”). EITF 08-7 applies to defensive assets which are EITF 07-5 in the first quarter of 2009 and does not expect acquired intangible assets which the acquirer does not the adoption to change the classification or measurement intend to actively use, but intends to hold to prevent its of its financial instruments. competitors from obtaining access to the asset. EITF 08-7 clarifies that defensive intangible assets are separately In October 2008, the FASB issued FASB Staff Position identifiable and should be accounted for as a separate unit No. FAS 157-3, “Determining the Fair Value of a Financial of accounting in accordance with FAS 141R and FAS 157. Asset When the Market for that Asset is Not Active” (“FSP EITF 08-7 is effective for intangible assets acquired in FAS 157-3”), which applies to financial assets that are 2009. The Company is assessing the potential impact, if required or permitted to be measured at fair value in any, of the adoption of EITF 08-7 on its consolidated accordance with FAS 157. FSP FAS 157-3 clarifies the results of operations and financial condition. application of FAS 157 and provides an example to illus- trate key considerations in determining the fair value of a financial asset when the market for that asset is not active. In December 2008, the FASB issued FASB Staff Position The adoption did not have a significant impact on the FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Company’s financial position or results of operations, nor Entities (Enterprises) about Transfers of Financial Assets did it have a significant impact on the valuation techniques and Interests in Variable Interest Entities” (“FSP FAS 140- the Company used in measuring the fair value of its 4 and FIN 46(R)-8”). This guidance increases disclosure financial assets. requirements for public entities involved in securitization or asset-backed financing arrangements and variable In November 2008, the FASB ratified EITF 08-6, “Equity interest entities. The Company adopted FSP FAS 140-4 Method Investment Accounting Considerations” (“EITF and FIN 46(R)-8 in the fourth quarter of 2008 and 08-6”). EITF 08-6 clarifies that the initial carrying value of such adoption did not have a significant impact on its an equity method investment should be determined in consolidated financial statements. 57 2 Concentrations of Credit Risk 4 Affiliate Investments in Marketable Securities Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments. The Company maintains cash and cash equivalents, investments and, at times, certain financial instruments with various financial institutions. These financial institutions are typically located in cities in which AMG and its Affiliates operate. For AMG and certain Affiliates, cash deposits at a financial institution may exceed Federal Deposit Insurance Corporation insurance limits. 3 Affiliate Investments in Partnerships Purchases and sales of investments (principally equity securities) and gross client subscriptions and redemptions relating to Affiliate investments in partnerships were as follows: The cost of Affiliate investments in marketable securities, gross unrealized gains and losses were as follows: At December 31, 2007 2008 Cost of Affiliate investments in marketable securities $ 20,272 $ 14,984 Gross unrealized gains 1,866 36 Gross unrealized losses (901) (4,621) 5 Fair Value Measurements Effective January 1, 2008, the Company adopted FAS 157, for all financial instruments and non-financial instruments that are measured at fair value on a quarterly basis. For At December 31, all other non-financial assets and liabilities, FAS 157 2007 2008 is effective on January 1, 2009. FAS 157 defines fair Purchase of investments $ 285,001 $ 617,339 Sale of investments Gross subscriptions Gross redemptions 295,799 623,384 4,523 17,289 4,562 5,234 Management fees earned by the Company on partnership assets were $1,309 and $1,169 for the years ended December 31, 2007 and 2008, respectively. value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and requires expanded disclosure about fair value measure- ments. Fair value is determined based on the price that would be received for an asset or paid to transfer a liability in the most advantageous market, utilizing a hierarchy of three different valuation techniques: As of December 31, 2007 and December 31, 2008, the markets; Level 1— Quoted market prices for identical instruments in active Company’s investments in partnerships that are not controlled by its Affiliates were $19,799 and $10,221, respectively. These assets are reported within “Other assets” in the consolidated balance sheet. The income or loss related to these investments is classified within “Investment Level 2— Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in mar- kets that are not active; and model-derived valuations whose inputs, or significant value drivers, are observable; and and other income” in the consolidated statement of Level 3— Prices reflecting the Company’s own assumptions income. concerning unobservable inputs to the valuation model. 58 The following table summarizes the Company’s financial 6 Fixed Assets and Lease Commitments assets that are measured at fair value on a quarterly basis: Fixed assets consisted of the following: Fair Value Measurements December 31, 2008 Level 1 Level 2 Level 3 Financial Assets Affiliate investments in partnerships Affiliate investments in marketable securities $ 68,789 $ 64,524 $ 80 $ 4,185 10,399 9,081 1,318 — Substantially all of the Company’s Level 3 instruments consist of Affiliate investments in partnerships. Changes in the fair value of these investments are presented as “Investment (income) loss from Affiliate investments in partnerships” in the consolidated statements of income. However, the portion of this income or loss that is attributable to investors that are unrelated to the Company is reported as “Minority interest in Affiliate investments in partnerships.” The following table presents the changes in Level 3 assets or liabilities for the year ended December 31, 2008: Building and leasehold improvements $ 50,903 $ 52,919 At December 31, 2007 2008 Office equipment Furniture and fixtures Land and improvements Computer software Fixed assets, at cost Accumulated depreciation and amortization Fixed assets, net 30,468 14,741 14,056 9,314 30,210 14,645 13,582 15,857 119,482 127,213 (49,603) (55,368) $ 69,879 $ 71,845 The Company and its Affiliates lease office space and computer equipment for their operations. At December 31, 2008, the Company’s aggregate future minimum payments for operating leases having initial or noncancelable lease terms greater than one year are payable as follows: Required Minimum Payments Balance, January 1, 2008 Realized and unrealized gains (losses) Purchases, issuances and settlements Transfers in and/or out of Level 3 Balance, December 31, 2008 2009 2010 2011 2012 2013 $ 4,731 (641) 95 — $ 4,185 Thereafter $19,299 17,323 14,501 11,889 10,375 23,882 Amount of total gains (losses) included in Net Income attributable to unrealized gains (losses) from assets still held at December 31, 2008 Consolidated rent expense for 2006, 2007 and 2008 was $ (1) $19,574, $20,283 and $20,861, respectively. 59 7 Accounts Payable and Accrued Liabilities directors of the Company the opportunity to voluntarily Accounts payable and accrued liabilities consisted of the following: At December 31, 2007 2008 Accrued compensation $ 169,382 $ 100,959 Accrued professional fees Accrued interest Accrued expense reimbursements Accrued income taxes Accounts payable Other 10,978 12,542 — 16,671 11,260 25,567 15,431 15,373 11,971 10,597 8,909 23,145 $ 246,400 $ 186,385 defer base salary, bonus payments and director fees, as applicable, on a pre-tax basis, and invest such deferred amounts in one or more specified measurement funds. While the Company has no obligation to do so, the Deferred Compensation Plan also provides the Company the opportunity to make discretionary contributions; in the event any such contributions are made, contributed amounts will be subject to vesting and forfeiture provisions. Consolidated expenses related to the Company’s benefit plans in 2006, 2007 and 2008 were $10,943, $11,420 and $12,103, respectively. 9 Senior Bank Debt 8 Benefit Plans On November 27, 2007, the Company entered into an The Company has three defined contribution plans amended and restated credit facility (the “Facility”). consisting of a qualified employee profit-sharing plan During the third quarter of 2008, the Company increased covering substantially all of its full-time employees and its borrowing capacity to $1,010,000, comprised of a several of its Affiliates, and non-qualified plans for certain $770,000 revolving credit facility (the “Revolver”) and senior employees. AMG’s other Affiliates generally have a $240,000 term loan (the “Term Loan”). All other terms separate defined contribution retirement plans. Under each of the Facility remain unchanged. The Company pays of the qualified plans, AMG and each participating interest on these obligations at specified rates (based either Affiliate, as the case may be, are able to make discretionary on the Eurodollar rate or the prime rate as in effect from contributions for the benefit of qualified plan participants time to time) that vary depending on the Company’s credit up to IRS limits. The Company’s non-qualified Executive Retention Plan (the “ERP”) is designed to work in concert with the Company’s rating. The Term Loan requires principal payments at specified dates until maturity. Subject to the agreement of lenders to provide additional commitments, the Company has the option to increase the Facility by up to stockholder-approved Long-Term Executive Incentive Plan, an additional $175,000. providing a trust vehicle for long-term compensation awards based upon the Company’s performance and growth. The The Facility will mature in February 2012, and contains ERP permits the Compensation Committee to make awards financial covenants with respect to leverage and interest that may be invested by the recipient in the Company’s coverage. The Facility also contains customary affirmative common stock, in Affiliate investment products, and in and negative covenants, including limitations on indebted- cash accounts, in each case subject to vesting and forfeiture ness, liens, cash dividends and fundamental corporate provisions. The Company’s contributions to the ERP are changes. Borrowings under the Facility are collateralized irrevocable. In addition, the Company has established a by pledges of the substantial majority of capital stock or Deferred Compensation Plan that provides officers and other equity interests owned by the Company. The 60 Company had outstanding borrowings under the Facility of liabilities will be reclassified directly to stockholders’ equity $519,500 and $233,514 at December 31, 2007 and if the Company’s common stock is trading above certain December 31, 2008, respectively. The Company pays a thresholds at the time of the conversion of the notes. quarterly commitment fee on the daily unused portion of the Facility, which amounted to $602, $443 and $799 in Zero Coupon Senior Convertible Notes 2006, 2007 and 2008, respectively. 10 Senior Convertible Securities The components of senior convertible securities are as follows: At December 31, 2007 2008 2008 senior convertible notes $ — $ 460,000 Zero coupon senior convertible notes 78,083 47,146 Floating rate senior convertible securities 300,000 — Total senior convertible securities $ 378,083 $ 507,146 2008 Senior Convertible Notes In 2001, the Company issued $251,000 of principal amount at maturity of zero coupon senior convertible notes due 2021 (“zero coupon convertible notes”), with each note issued at 90.50% of such principal amount and accreting at a rate of 0.50% per year. As of December 31, 2008, $50,135 principal amount at maturity remains outstanding. Each security is convertible into 17.429 shares of the Company’s common stock (at a current base conversion price of $53.95) upon the occurrence of certain events, including the following: (i) if the closing price of a share of its common stock is more than a specified price over certain periods (initially $62.36 and increasing incre- mentally at the end of each calendar quarter to $63.08 in April 2021); (ii) if the credit rating assigned by Standard & In August 2008, the Company issued $460,000 of senior Poor’s to the securities is below BB-; or (iii) if the Company convertible notes due 2038 (“2008 senior convertible calls the securities for redemption. The holders may require notes”). The 2008 senior convertible notes bear interest the Company to repurchase the securities at their accreted at 3.95%, payable semi-annually in cash. Each security is value in May 2011 and 2016. If the holders exercise this convertible into 7.959 shares of the Company’s common option in the future, the Company may elect to repurchase stock (at an initial conversion price of $125.65) upon the securities with cash, shares of its common stock or the occurrence of certain events. Upon conversion, the some combination thereof. The Company has the option to Company may elect to pay or deliver cash, shares of its redeem the securities for cash at their accreted value. Under common stock, or some combination thereof. The holders the terms of the indenture governing the zero coupon of the 2008 senior convertible notes may require the convertible notes, a holder may convert such security into Company to repurchase the notes in August of 2013, 2018, common stock by following the conversion procedures in 2023, 2028 and 2033. The Company may redeem the the indenture. Subject to changes in the price of the notes for cash at any time on or after August 15, 2013. Company’s common stock, the zero coupon convertible notes may be convertible in certain future periods. The 2008 senior convertible notes are considered contin- gent payment debt instruments under federal income tax In 2006, the Company amended the zero coupon convertible regulations. These regulations require the Company to notes. Under the terms of this amendment, the Company deduct interest in an amount greater than its reported paid interest through May 7, 2008 at a rate of 0.375% per interest expense, which will result in annual deferred year on the principal amount at maturity of the notes in tax liabilities of approximately $9,600. These deferred tax addition to the accrual of the original issue discount. 61 Floating Rate Senior Convertible Securities In the first quarter of 2008, the Company called its floating rate senior convertible securities due 2033 (“floating rate convertible securities”) for redemption at their principal amount plus accrued and unpaid interest. In lieu of redemption, substantially all of the holders elected to convert their securities. The Company issued approxi- mately 7.0 million shares of common stock to settle these conversions and other privately negotiated exchanges. All of the Company’s floating rate convertible securities have been cancelled and retired. In connection with these transactions, the Company incurred $1,151 of expenses, which were reported in “Investment and other (income) loss” and reclassified $18,291 of deferred tax liabilities to stockholders’ equity. 11 Mandatory Convertible Securities In the first quarter of 2008, the Company repurchased the outstanding senior notes component of its mandatory convertible securities (“2004 PRIDES”). The repurchase proceeds were used by the original holders to fulfill their obligations under the related forward equity purchase contracts. Pursuant to the settlement of the forward equity purchase contracts and other privately negotiated exchanges, the Company issued approximately 3.8 million shares of common stock. All of the 2004 PRIDES have been cancelled and retired. In connection with these transactions, the Company incurred $825 of expenses which were reported in “Investment and other (income) loss” and reclassified $4,461 of deferred tax liabilities to current liabilities through the income tax provision. investors. The junior subordinated convertible debentures and convertible trust preferred securities (together, the “2006 junior convertible trust preferred securities”) have substantially the same terms. The 2006 junior convertible trust preferred securities bear interest at a rate of 5.1% per annum, payable quarterly in cash. Each $50 security is convertible, at any time, into 0.333 shares of the Company’s common stock, which represents a conversion price of $150 per share (or a 48% premium to the then prevailing share price of $101.45). Upon conversion, investors will receive cash or shares of the Company’s common stock (or a combination of cash and common stock) at the election of the Company. The 2006 junior convertible trust preferred securities may not be redeemed by the Company prior to April 15, 2011. On or after April 15, 2011, they may be redeemed if the closing price of the Company’s common stock exceeds $195 per share for a specified period of time. The trust’s only assets are the junior convertible subordinated debentures. To the extent that the trust has available funds, the Company is obligated to ensure that holders of the 2006 convertible trust preferred securities receive all payments due from the trust. In October 2007, the Company issued an additional $500,000 of junior subordinated convertible debentures which are due 2037 to a wholly-owned trust simultaneous with the issuance, by the trust, of $500,000 of convertible trust preferred securities to investors. The junior subor- dinated convertible debentures and convertible trust preferred securities (together, the “2007 junior convertible trust preferred securities”) have substantially the same terms. 12 Junior Convertible Trust Preferred Securities The 2007 junior convertible trust preferred securities bear interest at 5.15% per annum, payable quarterly in In 2006, the Company issued $300,000 of junior subordi- cash. Each $50 security is convertible, at any time, into nated convertible debentures due 2036 to a wholly-owned 0.25 shares of the Company’s common stock, which trust simultaneous with the issuance, by the trust, of represents a conversion price of $200 per share (or a 53% $291,000 of convertible trust preferred securities to premium to the then prevailing share price of $130.77). 62 Upon conversion, investors will receive cash or shares of The components of income before income taxes consisted the Company’s common stock (or a combination of cash of the following: and common stock) at the election of the Company. The 2007 junior convertible trust preferred securities may not be redeemed by the Company prior to October 15, 2012. On or after October 15, 2012, they may be redeemed if the closing price of the Company’s common stock exceeds Domestic International $260 per share for a specified period of time. The trust’s only assets are the 2007 junior convertible subordinated Year Ended December 31, 2006 2007 2008 $ 186,249 $ 221,798 $(15,147) 51,638 67,029 59,252 $ 237,887 $ 288,827 $ 44,105 debentures. To the extent that the trust has available The Company’s effective income tax rate differs from the funds, the Company is obligated to ensure that holders amount computed by using income before income taxes of the convertible trust preferred securities receive all and applying the U.S. federal income tax rate to such payments due from the trust. amount because of the effect of the following items: In November 2008, the Company repurchased $69,180 aggregate principal amount of the 2007 junior convertible trust preferred securities. The Company realized a gain of $43,275 on this transaction, which was reported in Investment and other income. Following the repurchase, these securities were cancelled and retired. 13 Income Taxes Year Ended December 31, 2006 2007 2008 35.0% 35.0% 35.0% Tax at U.S. federal income tax rate State income taxes, net of federal benefit Non-deductible expenses Valuation allowance 2.2 0.0 0.8 1.6 0.2 1.3 Effect of foreign operations (1.6) (1.1) (26.3) 3.0 30.0 (1.9) A summary of the provision for income taxes is as follows: Effect of changes in tax law, rates — 36.4% — 7.7 37.0% 47.5% Current: Federal State Foreign Deferred: Federal State Foreign Year Ended December 31, 2006 2007 2008 $ 38,971 $ 52,012 $ 31,076 6,344 9,952 33,261 1,900 8,124 14,498 33,582 1,954 (3,818) (3,304) In July 2008, the state of Massachusetts enacted legislation that will require combined tax reporting for the Company and all its subsidiaries beginning in 2009. The tax provision for the year ended December 31, 2008 includes a deferred tax expense of $5,256 resulting from the revaluation of 5,454 15,228 (28,751) the Company’s deferred taxes under the new legislation. The 2,310 (4,382) legislation changed the methodology for measuring net operating losses, resulting in a state tax benefit and a $ 86,610 $106,866 $ 20,935 corresponding valuation allowance increase. 63 The components of deferred tax assets and liabilities are December 31, 2007 and December 31, 2008 are principally as follows: At December 31, 2007 2008 Deferred assets (liabilities): Intangible asset amortization $ (193,275) $ (185,376) Convertible securities interest (28,215) (18,222) Non-deductible intangible amortization State net operating loss carryforwards Deferred compensation Fixed asset depreciation Accrued expenses Capital loss carryforwards Deferred income Valuation allowance (26,668) (18,277) 18,023 (8,005) (3,562) 2,196 — 507 31,259 (9,443) (3,626) 3,304 922 3,211 (238,999) (196,248) (18,023) (32,181) Net deferred income taxes $ (257,022) $ (228,429) Deferred tax liabilities are primarily the result of tax deductions for the Company’s intangible assets and con- vertible securities. The Company amortizes most of its intangible assets for tax purposes only, reducing its tax basis below its carrying value for financial statement related to the uncertainty of the realization of the loss carryforwards, which realization depends upon the Company’s generation of sufficient taxable income prior to their expiration. The change in the valuation allowance for the year ended December 31, 2008 is principally attributable to state net operating losses during this period and a provision for loss carryforwards that the Company does not expect to realize. In the event that Massachusetts adopts certain income tax regulations (which were recently released in proposed form), the Company could potentially reverse approximately $3,000 of its valuation allowance on net operating losses. On December 31, 2007, the Company carried a liability for uncertain tax positions of $22,506, including $3,877 for interest and related charges. On December 31, 2008, this liability was $21,881, including interest and related charges of $4,223. These liabilities at December 31, 2007 and December 31, 2008 included $12,619 and $13,925, respectively, for tax positions that, if recognized, would affect the Company’s effective tax rate. The Company does not anticipate that this liability will change signifi- cantly over the next twelve months. A reconciliation of the beginning and ending amount of unrecognized tax benefits purposes and generating deferred taxes each reporting is as follows: period. In contrast, the intangible assets associated with the Company’s Canadian Affiliates are not deductible for tax 2007 2008 purposes, but certain of these assets are amortized for Balance as of January 1 $ 21,315 $ 22,506 book purposes. As such, at the time of its investment, the Additions based on tax positions Company recorded a deferred tax liability that represents the tax effect of the future book amortization of these assets. The Company’s junior convertible trust preferred securities and 2008 senior convertible notes also generate tax deductions that are higher than the interest expense recorded for financial statement purposes. related to current year 4,381 4,493 Additions based on tax positions of prior years Reductions for tax provisions of prior years Settlements Reductions related to lapses of statutes of limitations 116 — — 346 — — (3,306) (4,313) At December 31, 2008, the Company had state net Reductions related to operating loss carryforwards that expire over a 15-year foreign exchange rates — (1,151) period beginning in 2008. The valuation allowances at Balance as of December 31 $ 22,506 $ 21,881 64 The Company or its subsidiaries files income tax returns in 15 Comprehensive Income federal, various state, and foreign jurisdictions. With few exceptions, the Company is no longer subject to income tax examinations by any tax authorities for years before 2005. A summary of comprehensive income, net of applicable taxes, is as follows: As more fully discussed in Note 10 above, the Company Year Ended December 31, 2006 2007 2008 retired its floating rate convertible securities and 2004 Net Income $ 151,277 $ 181,961 $ 23,170 PRIDES in the first quarter of 2008. The retirement of these securities reduced the Company’s deferred tax liabili- ties related to convertible securities interest. Deferred tax liabilities of $18,291 associated with the floating rate convertible securities were reclassified to stockholders’ equity and deferred tax liabilities of $4,461 associated with the 2004 PRIDES were reversed through the income tax provision. 14 Derivative Financial Instruments The Company periodically uses interest rate hedging contracts to manage market exposures associated with changing interest rates. Through February 2008, the Company was a party to interest rate hedging contracts with a $150,000 notional amount, which fixed the interest rate on a portion of the floating rate senior con- Foreign currency translation adjustment Change in net unrealized loss on derivative securities Change in net unrealized gain (loss) on investment securities Comprehensive income (loss) (1,832) 51,475 (68,277) (358) (1,328) (180) 100 (76) (361) $ 149,187 $ 232,032 $(45,648) The components of accumulated other comprehensive income, net of taxes, were as follows: Foreign currency At December 31, 2007 2008 vertible securities to a weighted average interest rate of translation adjustments $ 64,556 $(3,721) approximately 3.28%. During the first quarter of 2008, the Company entered into a series of treasury rate lock contracts with a notional value of $250,000. Each contract was designated and qualified as a cash flow hedge under Statement of Financial Accounting Standard No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). These Unrealized gain on derivative securities Unrealized gain on investment securities Accumulated other 180 1 — (360) comprehensive income (loss) $ 64,737 $(4,081) 16 Commitments and Contingencies contracts were settled in the second quarter of 2008, and The Company and its Affiliates are subject to claims, legal the Company received $8,154. During the fourth quarter proceedings and other contingencies in the ordinary course of 2008, the Company concluded that it was probable that of their business activities. Each of these matters is subject to the hedged transaction would not occur and the gain was various uncertainties, and it is possible that some of these reclassified from accumulated other comprehensive matters may be resolved in a manner unfavorable to the income to Net Income. Company or its Affiliates. The Company and its Affiliates 65 establish accruals for matters for which the outcome is In November 2007, the Company acquired a minority probable and can be reasonably estimated. Management interest in ValueAct Capital (“ValueAct”), a San Francisco– believes that any liability in excess of these accruals upon the based alternative investment firm that establishes ownership ultimate resolution of these matters will not have a material interests in undervalued companies and works with each adverse effect on the consolidated financial condition or company’s management and Board of Directors to results of operations of the Company. implement business strategies that enhance shareholder Certain Affiliates operate under regulatory authorities which under the Company’s credit facility. require that they maintain minimum financial or capital requirements. Management is not aware of any violations In 2006, the Company expanded its product offerings in the of such financial requirements occurring during the period. Institutional distribution channel through the acquisition value. This transaction was financed through borrowings 17 Business Combinations of a majority equity interest in Chicago Equity Partners, LLC (“Chicago Equity”), which manages a wide range of U.S. equity and fixed income products across multiple The Company’s Affiliate investments totaled $144,580, capitalization sectors and investment styles. The transaction $610,235 and $130,231 in the years ended December 31, was financed through borrowings under the Company’s 2006, 2007 and 2008, respectively. These investments were credit facility. made pursuant to the Company’s growth strategy designed to generate shareholder value by making investments in The assets and liabilities of the investments in acquired boutique investment management firms and other strategic businesses are accounted for under the purchase method of transactions designed to expand the Company’s participa- accounting and recorded at their fair values at the dates tion in its three principal distribution channels. of acquisition. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded In 2008, the Company acquired Gannett Welsh & Kotler, as an increase in goodwill. The results of operations of LLC (“GW&K”), an investment management unit of acquired businesses have been included in the Consolidated The Bank of New York Mellon specializing in intermediate Financial Statements beginning as of the date of acquisition. duration municipal bonds, multi-cap and small-cap The following table summarizes net Affiliate investments equities, and core taxable fixed income investments. during the years ended December 31, 2007 and 2008: In December 2007, the Company acquired a minority interest in BlueMountain Capital Management (“BlueMountain”), a leading global credit alternatives manager specializing in relative value strategies in the corporate loan, bond, credit and equity derivatives markets. BlueMountain has offices in New York and London, and manages assets on behalf of predominantly institutional and high net worth clients. This transaction was financed through borrowings under the Company’s credit facility. Current assets Fixed assets Definite-lived acquired client relationships Indefinite-lived acquired client relationships Equity investments in Affiliates Goodwill Current liabilities Net assets acquired $ 2007 — — 2008 $ 2,778 5,992 19,876 32,865 4,577 541,377 18,262 — $ 584,092 4,344 10,478 61,601 (2,883) $ 115,175 66 The Company’s purchase price allocation for its investment interests to the Company at certain intervals and upon their in GW&K is subject to the finalization for the valuations of death, permanent incapacity or termination of employment acquired client relationships and computer software. As a and provide Affiliate managers a conditional right to result, these preliminary amounts may be revised in future require the Company to purchase such retained equity periods. In 2008, the Company completed its purchase interests upon the occurrence of specified events. The price allocation for its investments in ValueAct and purchase price of these conditional purchases are generally BlueMountain. calculated based upon a multiple of the Affiliate’s cash flow distributions, which is intended to represent fair Under past acquisition agreements, the Company is con- value. As one measure of the potential magnitude of such tingently liable, upon achievement of specified financial purchases, in the event that a triggering event and resulting targets, to make payments of up to $232,000 through 2012. In 2009, the Company expects to make payments purchase occurred with respect to all such retained equity interests as of December 31, 2008, the aggregate amount of approximately $100,000 to settle portions of these of these payments would have totaled approximately contingent obligations, the purchase of Affiliate equity $806,500. In the event that all such transactions were (as described below) and its potential investment in closed, AMG would own the prospective cash flow distri- Harding Loevner. In addition to the investments described above, in the years butions of all equity interests that would be purchased from the Affiliate managers. As of December 31, 2008, this amount would represent approximately $111,000 on ended December 31, 2006, 2007 and 2008, the Company an annualized basis. completed additional investments in existing Affiliates and transferred interests in certain affiliated investment management firms. 18 Goodwill and Acquired Client Relationships Many of the Company’s operating agreements provide In 2007 and 2008, the Company acquired interests from, Affiliate managers a conditional right to require AMG to made additional purchase payments to and transferred purchase their retained equity interests at certain intervals. interests to Affiliate management partners. Most of the Certain agreements also provide AMG a conditional right goodwill acquired during the year is deductible for tax to require Affiliate managers to sell their retained equity purposes. The following table presents the change in goodwill during 2007 and 2008: Balance, as of December 31, 2006 Goodwill acquired, net Foreign currency translation Balance, as of December 31, 2007 Goodwill acquired, net Foreign currency translation Balance, as of December 31, 2008 Mutual Fund $ 454,561 3,881 15,893 474,335 9,901 (20,815) Institutional $ 504,068 9,604 15,523 529,195 50,646 (20,330) High Net Worth $218,598 2,715 5,544 226,857 1,055 (7,261) Total $ 1,177,227 16,200 36,960 1,230,387 61,602 (48,406) $ 463,421 $ 559,511 $220,651 $ 1,243,583 67 The following table reflects the components of intangible assets of the Company’s Affiliates that are consolidated as of December 31, 2007 and 2008: Amortized intangible assets: Acquired client relationships Non-amortized intangible assets: 2007 2008 Carrying Amount Accumulated Amortization Carrying Amount Accumulated Amortization $ 389,346 $156,182 $ 399,886 $176,261 Acquired client relationships—mutal fund management contracts Goodwill 263,438 1,230,387 — — 267,783 1,243,583 — — For the Company’s Affiliates that are consolidated, definite- duration of the decline as well as the Company’s ability lived acquired client relationships are amortized over their and intent to hold the investment. The Company derives expected useful lives. As of December 31, 2008, these rela- the fair value of each of its equity method investments tionships were being amortized over a weighted average based on price-earnings multiples and discounted cash flow life of 10 years. The Company estimates that its consoli- analyses. The valuation analysis reflects assumptions of dated annual amortization expense will be approximately the growth rates of the assets, discount rates and other $33,600 for the next five years, assuming no useful life factors including recent financial results and operating changes or additional investments in new or existing trends, implied values from any recent comparable trans- Affiliates. actions and other conditions that may affect the value of the investments. During the third and fourth quarters of 2008, the Company completed impairment assessments for its goodwill and amortized and non-amortized acquired client relationships, and no impairments were identified. 19 Equity Investments in Affiliates Certain of the Company’s Affiliates are accounted for During 2008, the Company concluded a decline in the market value of its recent investments in ValueAct and BlueMountain was other-than-temporary. Because the market values had declined below the carrying value of these investments, the Company reduced the carrying value of these investments by $150,000. under the equity method of accounting. These Affiliates’ The definite-lived acquired client relationships attributable financial position and results of operations are more fully to the Company’s equity method investments are amortized described in Note 26. In accordance with Accounting over their expected useful lives. As of December 31, 2008, Principles Board Opinion No. 18, “The Equity Method of these relationships were being amortized over approximately Accounting for Investments in Common Stock” (“APB 18”), 12 years. Amortization expense for these relationships was the Company periodically evaluates these investments to $10,386 and $20,694 for 2007 and 2008, respectively. The assess whether the value of the investment has declined Company estimates that the annual amortization expense below its carrying value for a period considered to be attributable to its current equity-method Affiliates will be other-than-temporary. This evaluation consists of several approximately $23,500 for the next five years assuming no qualitative and quantitative factors regarding the severity and useful life changes. 68 20 Minority Interest Minority interest in the Consolidated Statements of Income includes the income allocated to owners of consolidated in March 2006 in connection with the issuance of the 2006 junior convertible trust preferred securities, up to an additional 4,000,000 shares of common stock; Affiliates, other than AMG. For the years ended December in July 2006, up to an additional 1,516,943 shares of 31, 2006, 2007 and 2008, this income was $212,523, common stock; $241,987 and $193,728, respectively. Minority interest on the Consolidated Balance Sheets includes capital and undistributed profits owned by the managers of the consol- idated Affiliates (including profits allocated to managers from the Owners’ Allocation and Operating Allocation). For the years ended December 31, 2006, 2007 and 2008, profit distributions to management owners were $287,899, $321,505 and $322,927, respectively. 21 Stockholders’ Equity Preferred Stock The Company is authorized to issue up to 5,000,000 shares of Preferred Stock in classes or series and to fix the designations, powers, preferences and the relative, participating, optional or other special rights of the shares of each series and any qualifications, limitations and restrictions thereon as set forth in the stock certificate. Any in February 2007, up to an additional 3,000,000 shares of common stock; and in October 2007, in connection with the issuance of the 2007 junior convertible trust preferred securities, up to an additional 2,500,000 shares pursuant to a prepaid forward purchase contract which the Company may elect to settle on or before October 15, 2012. The timing and amount of purchases are determined at the discretion of AMG’s management. In the year ended December 31, 2007, the Company repurchased 3,609,394 shares of common stock at an average price of $120.59 per share (including 1,578,300 shares through a forward equity purchase contract and 115,789 shares of common stock upon the settlement of certain call spread option agreements). In the year ended December 31, 2008, the Company repurchased 795,400 shares of common stock at an average price of $82.34 per share. As of December 31, 2008, the Company had the ability to acquire up to such Preferred Stock issued by the Company may rank 1,084,706 shares of common stock under its authorized prior to common stock as to dividend rights, liquidation share repurchase program. preference or both, may have full or limited voting rights and may be convertible into shares of common stock. In the first quarter of 2008, the Company issued an Common Stock The Company’s Board of Directors has authorized the issuance of up to 150,000,000 shares of Voting Common aggregate of approximately 11,000,000 shares of voting common stock in connection with certain private exchanges and conversions of its floating rate convertible securities and certain private exchanges and the settlement of the forward equity purchase contracts related to its Stock and 3,000,000 shares of Class B Non-Voting 2004 PRIDES. Common Stock. In recent periods, the Company’s Board of Directors has sale agreement under which it may sell up to $200,000 of authorized the following share repurchase programs: its common stock to a major securities firm, with the timing In May 2008, the Company entered into a forward equity 69 of sales at the Company’s discretion. Through February 25, Stock Option and Incentive Plans 2009, the Company has agreed to sell approximately The Company established the 1997 Stock Option and $144,300 under this agreement at a weighted average price Incentive Plan (as amended and restated, the “1997 Plan”), of $81.31. The Company can settle these forward sales at under which it is authorized to grant options to employees any time prior to December 19, 2009. Financial Instruments The Company’s 2004 PRIDES contained freestanding forward equity contracts that required holders to purchase shares of the Company’s common stock in February 2008. Additionally, the Company’s zero coupon convertible notes, floating rate convertible securities, 2008 senior convertible notes and junior convertible trust preferred securities contain an embedded right for holders to receive shares of the Company’s common stock under certain conditions. All of these arrangements, the forward equity sale agree- ment, the forward equity purchase contract and call spread option agreements meet the definition of equity under FASB Emerging Issues Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” and are not required to be accounted for separately as derivative instruments. In 2006, the Company entered into a series of contracts that provided the option, but not the obligation, to repurchase 0.9 million shares of its common stock. Upon exercise, the Company could elect to receive the intrinsic value of a contract in cash or common stock. During and directors. In 2002, stockholders approved an amend- ment to increase the number of shares of common stock authorized for issuance under this plan to 7,875,000. In 2002, the Company’s Board of Directors established the 2002 Stock Option and Incentive Plan (as amended and restated, the “2002 Plan”), under which the Company is authorized to grant non-qualified stock options and certain other awards to employees and directors. This plan requires that the majority of grants under the plan in any three-year period must be issued to employees of the Company who are not executive officers or directors of the Company. This plan was approved by the Company’s Board of Directors. There are 3,375,000 shares of the Company’s common stock authorized for issuance under this plan. In December 2003, the Board of Directors approved an amendment to each of the 1997 Plan and 2002 Plan to accelerate the vesting of the then-outstanding unvested options (other than options granted to directors). The shares issuable upon the exercise of the accelerated options remain subject to restrictions on transfer which lapse according to specified schedules, for so long as the option holder remains employed by the Company. In the event the option holder ceases to be employed by the Company, the transfer restrictions will remain outstanding until the later of 2007, the Company exercised its option, which had an December 2010, or seven years after the date of grant. intrinsic value of $21,100. The Company elected to receive approximately 0.1 million shares of common stock and In May 2006, the stockholders of the Company ap- used the remaining proceeds, $6,800, to enter into a series proved the 2006 Stock Option and Incentive Plan (the of contracts to repurchase up to 0.8 million shares. These “2006 Plan”), under which the Company is authorized options expired during the first quarter of 2008. to grant stock options and stock appreciation rights to 70 senior management, employees and directors. There are As of December 31, 2008, the intrinsic value of options 3,000,000 shares of the Company’s common stock outstanding was $12,338. authorized for issuance under this plan. The plans are administered by a committee of the Board of received and the actual tax benefit recognized for options Directors. Under the plans, options generally vest over a exercised were $32,564 and $13,868, respectively. During During the year ended December 31, 2008, the cash period of three to five years and expire seven to ten years after the grant date. All options have been granted with exercise prices equal to the fair market value of the Company’s common stock on the date of grant. The following table summarizes the transactions of the Company’s stock option and incentive plans: the year ended December 31, 2008, the excess tax benefit classified as a financing cash flow was $11,101. During the year ended December 31, 2007, the cash received and the actual tax benefit recognized for options exercised were $52,417 and $42,308, respectively. During the year ended December 31, 2007, the excess tax benefit classified as a financing cash flow was $36,528. Stock Options Weighted Average Exercise Price Weighted Average Remaining Contractual Life (years) Unexercised options outstanding— January 1, 2008 Options granted Options exercised 7,180,786 $ 66.59 1,048,303 (760,457) 49.98 43.09 Options forfeited (2,218,495) 109.89 Unexercised options outstanding— December 31, 2008 Exercisable at 5,250,137 48.38 December 31, 2008 4,103,183 46.52 4.5 4.3 Exercisable and free from restrictions on transfer at December 31, 2008 During the year ended December 31, 2008, the Company’s employees voluntarily surrendered 2,099,597 stock options for no consideration. Accordingly, the unrecognized compensation expense related to these stock options of $38,742 was recognized as compensation expense. The Company’s Net Income for the year ended December 31, 2008 includes $33,460 of compensation expense net of $20,508 of income tax benefits, related to the share-based compensation arrangements. The Company’s Net Income for the year ended December 31, 2007 includes $9,039 of compensation expense net of $3,345 of income tax benefits, related to the share-based compensation arrangements. The Company’s Net Income for the year ended December 31, 2006 includes $1,654 of compensation expense net of 3,754,954 44.76 3.6 $612 of income tax benefits, related to the share-based compensation arrangements. As of December 31, 2008, The Company generally uses treasury stock to settle stock there was $16,936 of deferred compensation expense option exercises. The total intrinsic value of options related to stock options which will be recognized over a exercised during the years ended December 31, 2006, 2007 weighted average period of approximately four years and 2008 was $78,371, $115,568 and $39,782, respectively. (assuming no forfeitures). 71 The fair value of options granted is estimated using the Black-Scholes option pricing model. The weighted average fair value of options granted during the years ended December 31, 2006, 2007 and 2008 was $28.66, $26.88 and $13.58 per option, respectively, based on the assump- tions stated below. Year Ended December 31, Dividend yield Expected volatility(1) Risk-free interest rate(2) Expected life of options (in years)(3) Forfeiture rate(3) 2006 0.0% 22.6% 4.9% 4.4 5.0% 2007 0.0% 23.8% 3.1% 3.8 5.0% 2008 0.0% 30.5% 2.0% 4.0 5.0% (1) Based on the historical and implied volatility of the Company’s common stock. Given unprecedented market volatility during the latter part of 2008, the Company did not include the trading activity for the three months preceding its fourth quarter award in calculating the fair value of its 2008 stock options. (2) Based on the U.S. Treasury yield curve in effect at the date of grant. (3) Based on historical data and expected exercise behavior. The Company periodically issues Affiliate equity interests to certain Affiliate employees. The estimated fair value of Year Ended December 31, 2006(1) 2007(1) 2008 $ 151,277,000 $ 181,961,000 $ 23,170,000 10,297,000 10,780,000 279,000 $ 161,574,000 $ 192,741,000 $ 23,449,000 31,289,005 29,464,764 38,211,326 Numerator: Net Income Interest expense on convertible securities, net of taxes Net Income, as adjusted Denominator: Average shares outstanding— basic Effect of dilutive instruments: Stock options 2,542,878 2,117,478 1,326,696 Senior convertible securities Mandatory convertible securities Average shares outstanding— diluted 9,238,255 9,276,218 1,238,736 599,853 1,540,226 95,898 43,669,991 42,398,686 40,872,656 equity granted in these awards, net of estimated forfeitures, is recorded as compensation expense over the service period (1) Certain interest expense and share amounts have been revised as the anti-dilutive effect of certain convertible securities had been incor- rectly included in amounts previously reported. as Affiliate equity expense. 22 Earnings Per Share The calculation of basic earnings per share is based on the weighted average number of shares of the Company’s common stock outstanding during the period. Diluted earnings per share is similar to basic earnings per share, As more fully discussed in Notes 10, 11 and 12, the Company had certain convertible securities outstanding during the periods presented and is required to apply the if-converted method to these securities in its calculation of diluted earnings per share. Under the if-converted method, shares that are issuable upon conversion are deemed outstanding, regardless of whether the securities are but adjusts for the dilutive effect of the potential issuance contractually convertible into the Company’s common of incremental shares of the Company’s common stock. stock at that time. For this calculation, the interest expense The following is a reconciliation of the numerator and (net of tax) attributable to these dilutive securities is added denominator used in the calculation of basic and diluted back to Net Income (reflecting the assumption that the earnings per share available to common stockholders. securities have been converted). Issuable shares for these Unlike all other dollar amounts in these Notes, the securities and related interest expense are excluded from the amounts in the numerator reconciliation are not presented calculation if an assumed conversion would be anti-dilutive in thousands. to diluted earnings per share. 72 The calculation of diluted earnings per share for 2006, effects of master netting agreements. The Company 2007 and 2008 excludes the potential exercise of options generally does not give or receive collateral on interest rate to purchase approximately 0.9, 2.3 and 1.3 million derivatives because of its own credit rating and that of common shares, respectively, because their effect would its counter parties. be anti-dilutive. In addition, the calculation of diluted earnings per share excludes the effect of the outstanding Interest Rate Risk Management call spread option agreements for all periods presented because their effect would be anti-dilutive. For the years ended December 31, 2006, 2007 and 2008, the Company repurchased approximately 5.5, 3.6 and 0.8 million shares of common stock, respectively, under various stock repurchase programs. 23 Financial Instruments and Risk Management The Company is exposed to market risks brought on by changes in interest and currency exchange rates. The Company has not entered into foreign currency transac- tions or derivative financial instruments to reduce risks associated with changes in currency exchange rates. The Company uses derivative financial instruments to reduce risks associated with changes in interest rates. Notional Amounts and Credit Exposures of Derivatives The notional amount of derivatives does not represent From time to time, the Company enters into derivative financial instruments to reduce exposure to interest rate risk. The Company does not hold or issue derivative finan- cial instruments for trading purposes. Derivative financial instruments are intended to enable the Company to achieve a level of variable-rate or fixed-rate debt that is acceptable to management and to limit interest rate exposure. The Company agrees with another party to exchange the difference between fixed-rate and floating rate interest amounts calculated by reference to an agreed notional principal amount. Fair Value Financial Accounting Standard No. 107 (“FAS 107”), “Disclosures about Fair Value of Financial Instruments,” requires the Company to disclose the estimated fair values for certain of its financial instruments. Financial instru- ments include items such as loans, interest rate contracts, notes payable and other items as defined in FAS 107. amounts that are exchanged by the parties, and thus are not Fair value of a financial instrument is the amount at a measure of the Company’s exposure. The amounts which the instrument could be exchanged in a current exchanged are calculated on the basis of the notional or transaction between willing parties, other than in a forced contract amounts, as well as on other terms of the interest or liquidation sale. Quoted market prices are used when rate derivatives and the volatility of these rates and prices. available; otherwise, management estimates fair value based on prices of financial instruments with similar The Company would be exposed to credit-related losses characteristics or by using valuation techniques such as in the event of nonperformance by the counter parties discounted cash flow models. Valuation techniques involve that issued the financial instruments, although the uncertainties and require assumptions and judgments Company does not expect that the counter parties to regarding prepayments, credit risk and discount rates. interest rate derivatives will fail to meet their obligations, Changes in these assumptions will result in different given their typically high credit ratings. The credit exposure valuation estimates. The fair value presented would not of derivative contracts is represented by the positive fair necessarily be realized in an immediate sale nor are there value of contracts at the reporting date, reduced by the typically plans to settle liabilities prior to contractual 73 maturity. Additionally, FAS 107 allows companies to use a wide range of valuation techniques; therefore, it may be difficult to compare the Company’s fair value information to other companies’ fair value information. The carrying amount of cash, cash equivalents and short- term investments approximates fair value because of the short-term nature of these instruments. The carrying value of notes receivable approximate fair value because interest rates and other terms are at market rates. The carrying value of notes payable approximates fair value principally because of the short-term nature of the notes. The carrying value of senior bank debt approximates fair value because the debt is a credit facility with variable interest based on selected short-term rates. The fair market value of the zero coupon senior convertible securities, the senior convertible securities, and the junior convertible trust preferred securities at December 31, 2008 was $36,239, $288,512 and $237,353, respectively. 2008 First Quarter Second Quarter Third Quarter Fourth Quarter $335,034 115,411 $ 308,964 103,981 $ 290,824 102,755 $223,395 45,971 52,028 32,778 56,025 35,295 48,554 24,848 (112,502) (69,751) Revenue Operating income Income (loss) before income taxes Net Income (loss) Earnings per share—diluted(1) $ 0.83 $ 0.83 $ 0.59 $ (1.76) (1) For periods from the second quarter of 2006 through the second quarter of 2008, the Company’s quarterly and annual reports incorrectly included the anti-dilutive effect of certain convertible securities and thus overstated diluted earnings per share. Management has concluded that the anti-dilution resulting from this error was not material. All diluted earnings per share numbers for these periods that are disclosed above have been revised. Additionally, in the fourth quarter of 2008, the Company reported a non-cash expense of $150,000 to reduce the carrying value of certain investments accounted for under the equity method of accounting to their fair value, which reduced Operating income, Income before taxes, Net Income and Earnings per share—diluted. 24 Selected Quarterly Financial Data (Unaudited) 25 Related Party Transactions The following is a summary of the quarterly results of oper- ations of the Company for the years ended December 31, 2007 and 2008. 2007 First Quarter Second Quarter Third Quarter Fourth Quarter Revenue $309,837 $ 331,464 $ 345,605 $ 382,960 Operating income 112,302 123,944 127,620 167,749 The Company periodically records amounts receivable and payable to Affiliate partners in connection with the transfer of Affiliate equity interests. As of December 31, 2007 and 2008, the total receivable was $35,510 and $56,103, respectively. The total payable as of December 31, 2007 was $70,915, of which $69,952 is included in current liabilities. The total payable as of December 31, 2008 was $28,241, of which $26,187 is included in current liabilities. Income before income taxes Net Income Earnings per 58,130 36,622 66,487 41,887 67,596 42,585 96,614 60,867 In certain cases, Affiliate management owners and Com- pany officers may serve as trustees or directors of certain mutual funds from which the Affiliate earns advisory share—diluted(1) $ 0.92 $ 1.03 $ 1.06 $ 1.53 fee revenue. 74 26 Summarized Financial Information of Equity Method Affiliates The following table presents summarized financial information for Affiliates accounted for under the equity method. 2006 2007 2008 Revenue(1)(2) Net Income $ 748,024 $ 910,708 $ 495,262 458,819 230,922 175,660 Current assets(2) Noncurrent assets Current liabilities Noncurrent liabilities 2007 2008 $9,094,573 $ 6,453,256 178,022 136,334 2,485,882 1,965,773 and Minority interest(2) 6,379,647 4,302,461 (1) Revenue includes advisory fees for asset management services, in- vestment income and dividends from consolidated investment partnerships. (2) In the 2007 investments in BlueMountain and ValueAct, the Company acquired a share of revenue but no portion of the assets held by investors that are unrelated to the Company (which include consolidated investment partnerships). The Company’s share of undistributed earnings from equity method investments totaled $18,461 as of December 31, 2008. 27 Segment Information Financial Accounting Standard No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“FAS 131”), establishes disclosure requirements relating to operating segments in annual and interim financial statements. Management has assessed the requirements of FAS 131 and determined that the Company operates in three business segments representing the Company’s three Revenue in the Mutual Fund distribution channel is earned from advisory and sub-advisory relationships with all domestically registered investment products as well as non-institutional investment products that are registered abroad. Revenue in the Institutional distribution channel is earned from relationships with foundations and endowments, defined benefit and defined contribution plans and Taft-Hartley plans. Revenue in the High Net Worth distribution channel is earned from relationships with wealthy individuals, family trusts and managed account programs. Revenue earned from client relationships managed by Affiliates accounted for under the equity method is not consolidated with the Company’s reported revenue but instead is included (net of operating expenses, including amortization) in “Income from equity method investments,” and reported in the distribution channel in which the Affiliate operates. Income tax attributable to the profits of the Company’s equity method Affiliates is reported within the Company’s consolidated income tax provision. In firms with revenue sharing arrangements, a certain percentage of revenue is allocated for use by management of an Affiliate in paying operating expenses of that Affiliate, including salaries and bonuses, and is called an “Operating Allocation.” In reporting segment operating expenses, Affiliate expenses are allocated to a particular segment on a pro rata basis with respect to the revenue generated by that Affiliate in such segment. Generally, as revenue increases, additional compensation is typically paid to Affiliate management partners from the Operating Allocation. As a result, the contractual expense allocation pursuant to a revenue sharing arrangement may result in the characterization of any growth in profit margin beyond the Company’s Owners’ Allocation as an operating expense. All other operating expenses (excluding intangible principal distribution channels: Mutual Fund, Institutional amortization) and interest expense have been allocated to and High Net Worth, each of which has different client segments based on the proportion of cash flow distributions relationships. reported by Affiliates in each segment. 75 2006 Revenue Operating expenses: Depreciation and other amortization Other operating expenses Operating income Non-operating (income) and expenses: Investment and other income Income from equity method investments Investment income from Affiliate investments in partnerships Interest expense Income before minority interest and income taxes Minority interest Minority interest in Affiliate investments in partnerships Income before income taxes Income taxes Net Income Total assets Goodwill 2007 Revenue Operating expenses: Depreciation and other amortization Other operating expenses Operating income Non-operating (income) and expenses: Investment and other income Income from equity method investments Investment income from Affiliate investments in partnerships Interest expense Income before minority interest and income taxes Minority interest Minority interest in Affiliate investments in partnerships Income before income taxes Income taxes Net Income Total assets Goodwill 2008 Revenue Operating expenses: Depreciation and other amortization Other operating expenses Operating income Non-operating (income) and expenses: Investment and other income (Income) loss from equity method investments Investment loss from Affiliate investments in partnerships Interest expense Income before minority interest and income taxes Minority interest Minority interest in Affiliate investments in partnerships Income before income taxes Income taxes Net Income Total assets Goodwill 76 Mutual Fund Institutional High Net Worth Total $ 501,739 $ 514,761 $ 153,853 $ 1,170,353 6,734 291,571 298,305 203,434 (7,088) (1,087) — 24,360 16,185 187,249 (80,333) — 106,916 38,869 $ 68,047 $ 898,150 $ 454,561 22,511 295,733 318,244 196,517 (6,584) (34,503) — 27,606 (13,481) 209,998 (106,536) — 103,462 37,715 65,747 $ $ 1,279,981 $ 504,068 6,896 92,995 99,891 53,962 (3,271) (2,728) (3,400) 6,834 (2,565) 56,527 (25,654) (3,364) 27,509 10,026 $ 17,483 $ 487,789 $ 218,598 36,141 680,299 716,440 453,913 (16,943) (38,318) (3,400) 58,800 139 453,774 (212,523) (3,364) 237,887 86,610 $ 151,277 $ 2,665,920 $ 1,177,227 $ 558,257 $ 645,613 $ 165,996 $ 1,369,866 10,356 317,582 327,938 230,319 (7,121) (1,651) — 28,317 19,545 210,774 (95,720) — 115,054 42,570 $ 72,484 $ 986,308 $ 474,335 23,543 381,165 404,708 240,905 (6,587) (51,214) (10) 38,772 (19,039) 259,944 (120,506) (10) 139,428 51,589 87,839 $ $ 1,832,951 $ 529,195 8,198 97,407 105,605 60,391 (3,425) (5,332) (38,867) 9,830 (37,794) 98,185 (25,761) (38,079) 34,345 12,707 $ 21,638 $ 576,446 $ 226,857 42,097 796,154 838,251 531,615 (17,133) (58,197) (38,877) 76,919 (37,288) 568,903 (241,987) (38,089) 288,827 106,866 $ 181,961 $ 3,395,705 $ 1,230,387 $ 456,187 $ 559,801 $ 142,229 $ 1,158,217 10,037 279,769 289,806 166,381 (7,539) (2,575) 445 24,724 15,055 151,326 (75,559) 227 75,994 30,430 $ 45,564 $ 993,955 $ 463,421 28,648 369,639 398,287 161,514 (27,755) 82,252 1,856 40,150 96,503 65,011 (96,706) 1,382 (30,313) (9,336) (20,977) $ $ 1,752,387 $ 559,511 7,936 94,070 102,006 40,223 (8,360) 17,465 61,109 9,017 79,231 (39,008) (21,463) 58,895 (1,576) (159) $ (1,417) $ 500,028 $ 220,651 46,621 743,478 790,099 368,118 (43,654) 97,142 63,410 73,891 190,789 177,329 (193,728) 60,504 44,105 20,935 23,170 $ $ 3,246,370 $ 1,243,583 As of December 31, 2006, equity method investments of $6,451, $273,170 and $13,819 are included in the total assets of the Mutual Fund, Institutional and High Net Worth segments, respectively. As of December 31, 2007, equity method investments of $8,704, $755,107 and $78,679 are included in the total assets of the Mutual Fund, Institutional and High Net Worth segments, respectively. As of December 31, 2008, equity method investments of $8,807, $609,956 and $60,124 are included in the total assets of the Mutual Fund, Institutional and High Net Worth segments, respectively. 77 Common Stock and Corporate Organization Information Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Issuer Purchases of Equity Securities Our common stock is traded on the New York Stock Exchange (symbol: AMG). The following table sets forth the high and low prices as reported on the New York Stock Exchange composite tape since January 1, 2007 for the periods indicated. Period October 1–31, 2008 November 1–30, 2008 December 1–31, 2008 Total Number of Shares Purchased 190,000 — — Average Price Paid Per Share $ 57.58 — — Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1) Maximum Number of Shares that May Yet Be Purchased Under Outstanding Plans or Programs(2) 190,000 1,084,706 — 1,084,706 — 1,084,706 2007 First Quarter Second Quarter Third Quarter Fourth Quarter 2008 First Quarter Second Quarter Third Quarter Fourth Quarter High Low $ 119.78 $ 103.00 131.84 135.02 136.51 106.70 98.67 114.15 Total 190,000 $ 57.58 190,000 1,084,706 (1) Notes 21 and 22 to the Consolidated Financial Statements provide additional detail with respect to our share repurchase programs. (2) As of February 25, 2009, there were 1,084,706 shares that could be purchased under our share repurchase programs. Employees and Corporate Organization $ 118.36 $ 77.59 80 persons and our Affiliates employed approximately 1,600 As of December 31, 2008, we employed approximately 108.36 114.91 85.00 88.42 72.51 17.93 persons, the substantial majority of which were full-time employees. Neither we nor any of our Affiliates is subject to any collective bargaining agreements, and we believe that our labor relations are good. We were formed in 1993 as The closing price for a share of our common stock as a corporation under the laws of the State of Delaware. reported on the New York Stock Exchange composite tape on February 25, 2009 was $38.30. As of February 25, 2009, there were 26 stockholders of record. We have not declared a cash dividend with respect to the periods presented. We do not anticipate paying cash dividends on our common stock as we intend to retain earnings to finance investments in new Affiliates, repay indebtedness, pay interest and income taxes, repurchase debt securities and shares of our common stock when appropriate, and develop our existing business. Further- more, our credit facility prohibits us from making cash dividend payments to our stockholders. 78 Endnotes Notes to Financial Highlights (1) Cash Net Income is defined as Net Income plus amortization and deferred taxes related to intangible assets plus Affiliate depreciation. AMG’s use of Cash Net Income, including a reconciliation to Net Income, is discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” (2) Earnings before interest expense, income taxes, depreciation and amortization. (3) Cash Net Income (as described in Note 1, above) divided by the adjusted diluted average shares outstanding (see Note 4 below). (4) In the calculation of adjusted diluted average shares outstanding, the potential share issuance in connection with the Company’s convertible securities measures net shares using a “treasury stock” method. Under this method, only the net number of shares of common stock equal to the value of the contingently convertible securities and the junior convertible trust preferred securities in excess of par, if any, are deemed to be outstanding. The Company believes the inclusion of net shares under a treasury stock method best reflects the benefit of the increase in available capital resources (which could be used to repurchase shares of common stock) that occurs when these securities are converted and the Company is relieved of its debt obligation. This method does not take into account any increase or decrease in the Company’s cost of capital in an assumed conversion. Other Investment product and performance information has been provided by each Affiliate to AMG, and is provided in this Annual Report for reference purposes only and not for investment or solicitation purposes. The investment performance of Affiliate products is compared to benchmarks deemed by the Affiliates and AMG to be the appropriate benchmarks for such products. 79 Corporate Data Corporate Offices Affiliated Managers Group, Inc. 600 Hale Street Prides Crossing, Massachusetts 01965 617 747 3300 www.amg.com Stock Exchange Listing New York Stock Exchange Ticker Symbol: AMG This Annual Report contains forward-looking statements. There are a number of important factors that could cause AMG’s actual results to differ materially from those indicated by such forward-looking statements including, but not limited to, those listed elsewhere in this Annual Report and in the Section titled “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission. 80 Board of Directors Richard E. Floor Partner, Goodwin Procter LLP Sean M. Healey President and Chief Executive Officer Harold J. Meyerman Former Senior Executive, The Chase Manhattan Bank and First Interstate Bank, Ltd. William J. Nutt Chairman Rita M. Rodriguez Former Director, Export-Import Bank of the United States Patrick T. Ryan Former Chief Executive Officer, PolyMedica Corporation Jide J. Zeitlin Former General Partner, Goldman, Sachs & Co. Executive Officers Sean M. Healey President and Chief Executive Officer Darrell W. Crate Executive Vice President and Chief Financial Officer Nathaniel Dalton Executive Vice President and Chief Operating Officer Jay C. Horgen Executive Vice President, New Investments John Kingston, lll Executive Vice President and General Counsel Affiliated Managers Group, Inc. 600 Hale Street Prides Crossing, MA 01965 617 7 47 3300 www.amg.com