Magellan Financial Group
Annual Report 2007

Plain-text annual report

2007 ANNUAL REPORT FOR THE YEAR ENDED 30 JUNE 2007 CONTENTS Chairman’s Letter Investment Philosophy Directors’ Report Corporate Governance Statement Income Statement Balance Sheet Statement of Changes in Equity Statement of Cash Flows Notes to the Financial Statements Directors’ Declaration Independent Audit Report Shareholder Information Corporate Directory 4 8 10 18 22 24 26 30 32 54 55 57 59 CHAIRMAN’S LETTER Dear Investor I have great pleasure in writing to you as an investor in Magellan Financial Group. Our vision is that over time Magellan will become a world class funds management business based in Australia. We will only achieve this if we achieve superior risk adjusted returns over time for investors in our funds. We are happy with Magellan’s progress since the establishment of the business in November last year. In addition to hiring an outstanding team, which I discuss below, we have:  put in place first class investment processes and procedures with an emphasis on risk management;  completed the $378 million initial public offering of our listed investment company, Magellan Flagship Fund Limited, in December 2006 and invested those funds entrusted to us in a range of what we consider to be outstanding businesses whilst maintaining significant cash reserves;  completed the recapitalisation of the Company with the Entitlements and Priority Offers in May 2007; and  launched two unlisted funds, Magellan Global Fund and Magellan Infrastructure Fund in July 2007. on three key sectors: Global Financial Services, Global Retail and Brands and Global Infrastructure. We are delighted that the vast majority of our employees have recently participated in the staff share ownership scheme. Our employees have a material investment in the company and their interests are truly aligned with all other shareholders. Chris Mackay and I would like to thank our independent directors Naomi Milgrom, Brett Cairns and Paul Lewis for their contribution and counsel this year. Each Director has a material investment in Magellan and we can assure you that they are each very committed to the success of Magellan. Chris and I firmly believe that if we and our team are disciplined in our processes we should achieve superior risk adjusted returns for the investors in Magellan’s funds. This should enable Magellan to attract significant funds under management and generate attractive returns for our shareholders. Overview of our Investment Philosophy Magellan’s investment objective is to generate superior risk adjusted returns whilst minimising the risk of permanent capital loss. While we are satisfied with our progress to date and the early response from financial planners, research houses and potential investors to the launch of our new unlisted funds, it is important to recognise that success in the funds management business is not assured and it will certainly not happen overnight. It is likely to take some years to build the Magellan brand and reputation and create an investment track record for the funds that we manage. Our investment philosophy is rational and, we believe, compelling and not practised by many in the market. Each of Magellan’s funds will seek to invest in a portfolio of outstanding global companies assessed to have highly attractive business characteristics at a discount to our assessment of their intrinsic value. We believe that investing in a portfolio of outstanding businesses purchased at attractive prices will minimise the risk of permanent capital loss for our investors. We focus on three overall objectives:  to attract, retain and develop an outstanding team;  to achieve superior risk adjusted returns for our investors whilst minimising the risk of permanent capital loss; and  to be an excellent partner for all our counterparties and intermediaries with whom we interact. We currently have 26 professionals including experienced operating, financial, legal and compliance personnel. Our 13 strong investment management team is focused We consider outstanding companies to be those that have sustainable competitive advantages which translate into returns on capital materially in excess of their cost of capital for a sustained period of time. While we are extremely focused on fundamental business value, we are not typical “value” investors. Securities that appear undervalued on the basis of a low price to earnings multiple or a price to book multiple will often prove to be poor long term investments if the underlying business is fundamentally weak and exhibits poor returns on capital. We will buy companies that have 4 MAGELLAN FINANCIAL GROUP - CHAIRMAN’S LETTER both low and higher price to earnings and price to book multiples provided that the business is outstanding and the shares are trading at an appropriate discount to our assessment of intrinsic value. Given we are seeking to buy companies at meaningful discounts to their underlying value we will often purchase companies that are “out of favour” with the investment community. Most investors do not follow such practices on a disciplined basis because it can be psychologically painful to buy “out of favour” companies even if they are outstanding. Out of favour companies sometimes fall in price after purchase but, if the analysis is correct, they usually rise in the medium term. As Benjamin Graham famously said: “In the short run, the market is a voting machine but in the long run it is a weighing machine”. We can be best described as a “value manager with a high business quality overlay”. Set out in the attachment to this Chairman’s letter is a copy of Magellan’s Investment Philosophy. Our Risk Management Approach in Current Markets The recent volatility in debt and equity markets has highlighted some very material risks in the global financial system. We do not know whether a full blown financial crisis will develop, but we do know that the risk of such an event occurring has increased materially. Given our objective of minimising the risk of permanent capital loss for our investors, we are taking a cautious stance at the moment. We are maintaining high cash balances. However, we firmly believe that the most attractive investment opportunities can arise during periods of maximum pessimism. Thus, we believe that it is possible that “very compelling” investment opportunities will become available as events unfold and we will opportunistically deploy our available cash. In the meantime we are patiently seeking opportunities for superior risk adjusted returns. Although we are absolutely focused on “bottom up” analysis of investment opportunities, we do seek to understand the context of key market events. Thus a few words on the unfolding liquidity crisis are warranted. In early September, former Federal Reserve Chairman Alan Greenspan told a group of academics in Washington, D.C. that “the behavior we are observing in the last seven weeks is identical in many respects to what we saw in 1998, what we saw in the stock market crash of 1987, I suspect what we saw in the land- boom collapse of 1837, and certainly the bank panic of 1907”, and Hank Paulson the US Treasury Secretary and former President of Goldman Sachs said that “the crisis of confidence in credit markets is likely to last longer than any of the financial shocks of the past two decades”. We believe that central bankers around the world are very concerned that the current situation has the potential to develop into a full blown financial crisis. I will attempt to outline simply what are the issues that are so concerning and how this could develop into a full blown financial crisis. Contrary to popular belief, we do not believe that the sub-prime lending crisis in the United States is the sole cause of the problem, nor the core issue the central bankers are really concerned about. A worrying but less understood issue is off-balance sheet vehicles, known as conduits and structured investment vehicles, set up by commercial and investment banks to hold assets and loans. It is estimated that there is approximately US$1,400 billion of assets held in these vehicles around the world. These vehicles have primarily been financed with short term debt known as asset backed commercial paper. Investors in the asset backed commercial paper market virtually disappeared overnight, as they have become increasingly nervous about the asset quality inside these vehicles. This has the potential to cause major liquidity issues in the financial system as commercial and investment banks are being called on to provide massive funding lines to these vehicles to replace the asset backed commercial paper or to bring these loans back on balance sheet. To preserve liquidity, banks have become very reluctant to lend to each other in the short term inter-bank market. The inter-bank lending market is an essential element of a healthy financial system. In circumstances where funding cannot be found for these vehicles, assets will need to be liquidated which is likely to push down asset prices and trigger losses across the board. Central bankers have reacted swiftly to this major issue by increasing the amount they are prepared to lend to banks on a short term basis and the United States Federal Reserve recently reduced the interest rate (known as the “Fed Discount Rate”) that they charge to banks in order to try to ensure there is sufficient liquidity in the system. A more concerning issue is the potential for a large scale global liquidity crisis amongst non-banking financial institutions and hedge funds. In our view, a possible cause of a large scale global liquidity crisis would be an effective collective “funding run” on a number of non-banking financial institutions or hedge funds, triggered by a fall in asset prices. This would be akin to a “depositors run” on the banking system. Hedge funds in our view are vulnerable to a “funding run” as they are typically highly leveraged and they do not have a permanent equity base as their capital is usually subject to quarterly redemptions. This makes these institutions far more vulnerable than a well capitalised bank with a large depositor base. A concurrent run by investors and lenders to withdraw MAGELLAN FINANCIAL GROUP - CHAIRMAN’S LETTER 5 their funding from hedge funds around the world is likely to cause an unprecedented financial crisis and is likely to result in a very material drop in asset prices across the board. The banking system is relatively immune to a “depositors run” due to the central banks key function as the lender of last resort. Central banks do not act as lenders of last resort to non-banking financial institutions and hedge funds, and responding to such a situation would be very difficult for central banks. Cutting interest rates would do little, of itself, to alleviate such a situation, in our view. A number of market commentators have suggested that central banks should step in to act as a buyer of assets of last resort to ensure the financial system has sufficient liquidity to avert a full blown financial crisis. It is notable that the Hong Kong Government stepped in during the Asian financial crisis and bought equities across the board to provide liquidity to the market. In our view, central banks would be very reluctant to act in this capacity as they may effectively be seen as bailing out risk takers from the result of their investment decisions. While we do not know whether a full blown financial crisis will develop, we believe the risk has increased materially. Thus, we have taken a cautious approach in advance of these events unfolding with the objectives of minimising the risk of a permanent capital loss and having capital available to take advantage of opportunities that may arise. 2007 Full Year Results The reported full year profit of $3.0 million after tax for the year ended 30 June 2007 is not particularly meaningful as a predictor of the future as it included:  The results of the Company prior to the restructure and recapitalisation on 17 November 2006. Following the restructure, the Company’s activities and cost base has changed significantly;  The profit on the realisation of investments prior to the restructure and recapitalisation of the Company of $2.5 million; and  A non-cash Accounting Adjustment which increased the reported profit by approximately $4.7 million. Excluding the non-cash Accounting Adjustment (discussed below) and the re-statement of the treatment of a $0.9 million after tax gain from the liquidation of existing investments prior to the recapitalisation in November 2006, Magellan would have reported an accounting loss of $2.6 million. This compares with a forecast loss of $2.8 million to $3.0 million. The better performance primarily reflects moderately lower recruitment and employment costs than forecast. Accounting Adjustment Given the materiality of the non-cash Accounting Adjustment on our profitability and balance sheet I believe it needs some explanation and why we believe it should be excluded from our results in order to understand the true financial position of the Company. For those of you who are not “accounting minded” you may want to skip this section. The non-cash Accounting Adjustment relates to the accounting treatment for the potential issuance of Secondary Options. Under the terms of the Initial Options, an optionholder will be issued a Secondary Option upon exercise of their Initial Option. The Accounting Standards require that the Secondary Options be treated as a financial liability in the balance sheet. This accounting treatment means that we have had to record an accounting liability of $30 million on the balance sheet and an accounting profit of $4.7 million due to the decrease in the value of this liability from the date of issuance of the options to 30 June 2007. This accounting treatment is, in my view, a nonsense and makes it difficult for an investor to understand our financial statements. We discussed the issue in depth with our auditors and were informed that our financial statements would need to be qualified if we did not comply with this Accounting Standard. I can assure you we do not have an actual financial liability to any party, nor have we or will we realise a profit from the issuance of the Secondary Options. During the year Magellan raised approximately $75 million in cash from the issue of shares and options, however, in complying with this accounting standard, we recorded an increase in contributed equity of only approximately $40 million. The difference of approximately $35 million arises from the recognition of the fair value of the Secondary Options as a financial liability. A reader of our financial statements may be highly concerned that we have lost $35 million of the cash that we raised this year. I can assure you that the reduction in contributed equity is only an “accounting entry”. What is more puzzling than the “disappearing equity” is the fact that gains and losses on the fair value of these Secondary Options are required to be recorded to the profit and loss statement. For the year ended 30 June 2007 we recorded a profit of $4.7 million due to the reduction in the value of the Secondary Options from date of issue to 30 June. Had the options been valued at 28 August 2007, we would have recorded a further profit of approximately $15 million due to a further reduction in the value of the Secondary Options. This accounting treatment will continue to distort our reported profits and balance sheet for the next few periods and we will seek to provide sufficient information so that you can understand the underlying profitability and financial position of the Company. The good news is that after 30 June 2009 the financial liability component on the balance sheet will completely disappear. 6 MAGELLAN FINANCIAL GROUP - CHAIRMAN’S LETTER a public company, New Privateer Holdings Limited. We are very conscious of the legitimate interests of all parties, including the minority shareholders in New Privateer, and are hopeful that a proposal can be put forward that is fair to the shareholders of both Magellan and New Privateer. Core to any proposal will be that Chris and I forego our entitlements to any future MSA performance fees for no compensation. I would like to thank you for your interest in Magellan and I look forward to meeting you at our Annual General Meeting, which will be held at our offices at Level 7, 1 Castlereagh Street, Sydney at 12 pm on Friday 26 October, 2007. Yours sincerely Hamish M Douglass Chairman 18 September 2007 2008 Financial Outlook Given the 2007 financial results are not a meaningful predictor of the future, we have decided to provide some guidance on the 2008 outlook for the Company. For the 2008 financial year we have budgeted for a loss after tax of similar magnitude to the $2.8 million to $3.0 million loss that was forecast for 2007. This ignores the impact of any Accounting Adjustment for the Secondary Options and is before the impact of any performance fee that may be payable under the Management Services Agreement (MSA) discussed below. The budgeted loss reflects the fact that we are investing in the start up of a new business. We believe it is critical that we do not cut corners and hire an outstanding team of people in all areas of the Magellan’s business. This requires a substantial upfront investment in people and infrastructure. The budgeted total expenses for the business, including the base management fee under the MSA, are approximately $15 million. Revenue assumptions in the budget include full year investment management fees from Magellan Flagship Fund, our listed investment company, interest income on our cash balance and modest investment management fees from our new unlisted funds (Magellan Global Fund and Magellan Infrastructure Fund) launched in July 2007. We believe it is realistic to assume that investment management fees from the new unlisted funds will be modest in 2007/2008 as a whole, and particularly modest for the 6 months to 31 December 2007. The budgeted loss reflects no material contribution or losses from the Company’s investments to seed Magellan’s listed and unlisted funds or from any principal investments or investments in other fund managers. There are currently no principal investments or investments in other fund managers and none have been made since the recapitalisation of Magellan in late 2006. As discussed above in relation to our risk management, it should be no surprise that we continue to take a prudent approach to considering any potential investments. Management Services Agreement Some of you may have read that Chris and I have proposed to examine whether the MSA arrangements between Magellan and NPH Funds Pty Limited (NPH Funds) can be restructured to an achieve an outcome that benefits Magellan’s future development. Chris and I believe that it is in the interests of all shareholders to restructure the MSA arrangements. In order to achieve an outcome that benefits all Magellan shareholders, we have proposed to the Board that we will forego our entitlement to any future performance fees for no compensation. While on its face this may appear relatively straightforward, it is complicated, primarily because the ownership of NPH Funds includes MAGELLAN FINANCIAL GROUP - CHAIRMAN’S LETTER 7 INVESTMENT PHILOSOPHY Investment Objectives The Magellan Funds have two principal Investment Objectives:  to achieve superior risk adjusted investment returns over the medium to long-term; and  to minimise the risk of permanent capital loss. Investment Philosophy Our Investment Philosophy is simple to state. We aim to find outstanding companies at attractive prices. We consider outstanding companies to be those that have sustainable competitive advantages which translate into returns on capital materially in excess of their cost of capital for a sustained period of time. While we are extremely focused on fundamental business value, we are not typical “value” investors. Securities that appear undervalued on the basis of a low price to earnings multiple or a price to book multiple will often prove to be poor investments if the underlying business is fundamentally weak and exhibits poor returns on capital. We will buy companies that have both low and higher price to earnings and price to book multiples provided that the business is outstanding and the shares are trading at an appropriate discount to our assessment of intrinsic value. An outstanding company will usually have some or (ideally) all of the following characteristics: Wide Economic moat An economic moat refers to the protection around an economic franchise which enables a company to earn returns materially in excess of the cost of capital for a sustained period of time. Outstanding companies are unusual as capitalism is very efficient at competing away excess returns, in most cases. A company’s economic moat will usually be a function of some form of sustainable competitive advantage. A strong indicator as to whether a company possesses an economic moat is the historical returns on capital (both including and excluding intangible assets) it has achieved. If a company has earned returns materially above the cost of its capital for a sustained period, it is a good indication that a company may have an economic moat. In some cases, a company may be developing a strong economic moat, but its historical returns on 8 MAGELLAN FINANCIAL GROUP - INVESTMENT PHILOSOPHY capital are low reflecting the investment in building a business with long-term sustainable competitive advantages. The key lesson is that historical returns on capital do not necessarily indicate whether a business has a wide economic moat and it is critical to fully understand the competitive advantages and threats which protect and threaten a company’s economic franchise. Identification of companies with wide economic moats involves consideration and assessment of the barriers to entry, the risks of substitutes, the negotiating power of buyers and suppliers to a company and intensity of rivalry amongst competitors. The following are illustrations of sustained competitive advantages:  Where it is very expensive for consumers to shift from the incumbent provider (that is, where there is a low threat of substitutes) because of, for example, cost, inconvenience and/or regulatory restrictions.  Where the leading market participant has material economies of scale which gives it a significant cost advantage over competitors or new entrants.  Where the business has a strong and unique brand name or is protected by long-term intellectual property rights such as copyright, patents, trademarks and/or regulatory approvals.  Where a company has a very strong network (ideally monopoly or proprietary). For example, where it is the vital intermediary between buyers and sellers, a market maker or even a ring road that tolls workers and businesses use as they move people and goods. We are particularly interested in networks where access, pricing and volume are subject to market forces and are not regulated in a materially adverse manner.  Where the use of psychological imperatives (such as, safety, exclusivity and quality) drives customer loyalty and enables companies to charge a premium for their products or services. Each of these sustained competitive advantages is relatively unusual and it is particularly valuable where a strong competitive advantage prevails over a long period of time. Market-based monopolies and proprietary networks can provide the strongest and most sustainable competitive advantages, but are extraordinarily rare. Re-investment Potential We seek companies that have a moderate to high potential to continue to re-invest capital into the business at high incremental returns. We believe that conventional investment analysis fails to properly assess the potential of a business to deploy material amounts of additional capital into the business at attractive rates of return. This is a fundamental driver of value over time. The most attractive types of companies are either:  companies with wide economic moats which can continue to grow materially with very limited additional capital. These companies will exhibit rising returns on capital employed. These types of businesses are extraordinarily rare and extremely valuable; and  companies with wide economic moats which have opportunities to deploy material amounts of capital into the business at high incremental rates of return. Examples include a strong retail franchise with substantial roll-out opportunity, or a retail banking or financial services franchise that can continue to grow its lending activities at attractive margins. These types of businesses are rare and can be very valuable compounding machines”. It is more usual to find businesses with wide economic moats which can only deploy very modest amounts of capital and exhibit modest growth potential. These businesses, while attractive, are less likely to be “compounding machines” than those with material high return re-investment opportunities. We are therefore very focused on assessing a company’s ability to continue to re-invest free cash flow at high rates of return. It is factors such as, store roll out potential, global expansion potential, the size of the market and market share potential, and market growth rates, which will drive this re-investment potential. We judge re-investment potential as low, medium or high depending on the level of re-investment over the medium term as a percentage of net income, and the rate of return expected to be achieved. Low business risks The purpose of assessing business risk is to determine the predictability of cash flow and earnings projections. Businesses which are difficult to predict or could exhibit large variations in cash flows and earnings have high inherent business risk. We assess business risk taking into account factors such as cyclicality, operating leverage, operating margin, financial leverage, competitive strength, regulatory and political environment and profitability. We assign each company a risk assessment: low, medium and high. This is not an attempt to measure the volatility of the shares, but rather the predictability and strength of the underlying business. Low agency risk We term the risk surrounding the deployment of the free cash flow generated by a business as ‘agency risk’. A fundamental assumption inherent in a standard discounted cash flow valuation (DCF) is that free cash flows are returned to shareholders or are re-invested at the cost of capital. The reality is that this assumption is often flawed as free cash flow is often not returned to shareholders but, rather, cash is re-invested by companies at returns below the cost of capital. In these cases, businesses can end up being worth substantially less than implied by a DCF analysis. We term the risk surrounding the deployment of the free cash flow generated by a business as “agency risk”. A company which can deploy a substantial amount of free cash flow back into the business at attractive returns for a sustained period of time will almost certainly carry lower agency risk than a company which has limited opportunities to re-invest capital at attractive returns, unless the company is explicit about returning excess cash flow to shareholders via dividends and/or share buy-backs. In assessing agency risk, we look at factors, including the structure and level of incentives offered to senior management, the level of share ownership by senior management and directors, the track record of management in pursuing acquisitions, the desire of management to grow their empire and the track record of management and the Board in acting in a shareholder friendly manner, including returning free cash flow to shareholders via share buy-backs and/or dividends. The assessment criteria we apply in evaluating potential investments are depicted in the diagram below. An ideal investment will normally have a number of combined favourable attributes operating together which would illustrate what Charlie Munger of Berkshire Hathaway describes as a “Lollapalooza” effect (which is a term for factors which will reinforce and greatly amplify each other). Margin of Safety We will only purchase an investment when there is a sufficient “margin of safety”. The margin of safety is the discount we require before buying shares of a company. The bigger the assessed discount, the wider is our margin of safety. The available margin of safety, we believe, is driven, in part, by prevailing market psychology. While not a driver of a company’s quality or intrinsic value, the markets can have a profound, albeit rarely long-term, effect on the pricing of a company’s shares. When short-term issues or concerns are worrying investors or other factors are resulting in excess enthusiasm (that is, irrational exuberance), shares will often be mis- priced relative to intrinsic value. While our process can make us appear to be out of step with trends, investing contrary to consensus thinking has the potential to provide investment opportunities. Understanding where current market sentiment lies and assessing the company within the context of whether the concern or excitement is being appropriately priced, is an important step in investing. There are some exceptional businesses where the “Lollapalooza” effect is truly at work and the moat is so wide and the risks are so low that we will invest with a very modest margin of safety. It is more usual to find companies which do not have all the reinforcing factors at play which results in a higher level of risk and requires a higher margin of safety. MAGELLAN FINANCIAL GROUP - INVESTMENT PHILOSOPHY 9 DIRECTORS’ REPORT The Directors of Magellan Financial Group Limited (the “Company”) submit their report for the Company, its controlled entities and Magellan Financial Group Trust (the “Trust”) which together form the consolidated entity (the “Group”) in respect of the year ended 30 June 2007. Directors The following persons were Directors of the Company during the year and up to the date of this report unless otherwise stated. Name Directorship Appointed Resigned Hamish Douglass Chairman and Executive Director Chris Mackay Deputy Chairman and Executive Director Naomi Milgrom Non-executive Director Paul Lewis Brett Cairns Roger Davis Non-executive Director Non-executive Director Non-executive Director & Chairman Mark Beames Non-executive Director Dean Smorgon Non-executive Director Russel Pillemer Executive Director Damien Hatfield Executive Director Corporate Information 21 November 2006 21 November 2006 20 December 2006 20 December 2006 22 January 2007 - - - - - - - - - - 20 December 2006 21 November 2006 21 November 2006 21 November 2006 21 November 2006 The Company is limited by shares and incorporated in Australia. The shares and options of the Company are publicly traded on the Australian Securities Exchange (ASX) – ASX Code: MFG and MFGOA. Recapitalisation and De-stapling The Company was previously called Pengana HedgeFunds Limited and the Trust was previously called Pengana HedgeFunds Trust. The names of the Company and the Trust were changed on 21 November 2006 following a meeting of shareholders to approve the recapitalisation of the Company and the introduction of new management led by Mr Douglass (the Chairman of the Company) and Mr Mackay (the Deputy Chairman of the Company). The recapitalisation involved the Company issuing approximately 77.4 million shares via a placement of approximately 38.4 million shares in November 2006 and the issuance of approximately 39.0 million shares in May 2007 pursuant to an Entitlements Offer to shareholders and a Priority Offer to certain other parties. On 22 March 2007, shareholders of the Company and unitholders in the Trust voted to simplify the Group by de-stapling and winding up the Trust. From 22 March 2007, shares in the Company remained listed on the ASX as individual securities and units in the Trust were de-listed. The net assets of the Trust at the date of the de-stapling were nil. The Trust was wound up on 29 June 2007. Principal Activity The primary business activity of the Group is to establish a funds management business with an objective to offer international investment funds to Australian and New Zealand investors. Since the recapitalisation of the Company on 21 November 2006 the Company has:  hired an outstanding team of 26 professionals, including a 13 strong investment management team;  moved into offices at 1 Castlereagh Street, Sydney and established a presence in New York;  completed the $378 million initial public offering of a listed investment company, Magellan Flagship Fund Limited (the Flagship Fund), in December 2006; 10 MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT  launched two unlisted funds, Magellan Global Fund and Magellan Infrastructure Fund in July 2007;  simplified the Group structure by de-stapling and winding up the Trust; and  completed the recapitalisation of the Company with the Entitlements and Priority Offers in May 2007. Trading Results The Group’s net operating loss after tax and minority interest and before the AASB 132 Accounting Adjustment (refer below) for the year ended 30 June 2007 was $1,694,000 (2006: $2,567,000 profit). The Group’s total revenues were approximately $7.1 million, total expenses were $9.2 million and the income tax benefit was $0.9 million. Net operating loss attributable to members of the Company after tax and before AASB 132 Accounting Adjustment AASB 132 Accounting Adjustment attributable to members of the Company * Net profit attributable to members of the Company after AASB 132Accounting Adjustment * The AASB 132 Accounting Adjustment discussion (below) provides further information. 2007 $’000 (1,694) 4,681 2,987 2006 $’000 2,567 - 2,567 The revenues of the Group for the year ending 30 June 2007 of $7.1 million include:  Investment management fees of $2.6 million which primarily reflects investment management fees earned from the managed listed investment company from launch in December 2006 to 30 June 2007.  Interest income of $1.9 million on cash held by the Group which reflects that the majority of this cash was raised in May 2007. As at 30 June 2007 the Group held $74.4 million in cash, the majority of which was raised in May 2007.  Non-recurring gains of $2.5 million arising from the liquidation of existing investments of the Group prior to the recapitalisation in November 2006. The expenses of the Group for the year ending 30 June 2007 of $9.2 million include:  Employment and recruitment costs of $5.6 million. The majority of our team members were hired in the second half of the 2007 financial year and therefore there was little or no off-setting revenue. As at 30 June 2007 the Group had 26 employees.  Base fees of $1.55 million paid to NPH Funds Pty Ltd (NPH Funds) under the Management Services Agreement for the 7 month period from recapitalisation of the Company to 30 June 2007.  Legal and professional fees of $0.3 million associated with the launch of the Magellan Global Fund and Magellan Infrastructure Fund and the de-stapling and winding up of the Trust The Group’s full year results are not directly comparable to those of the prior period due to activities undertaken as part of the recapitalisation of the business in November 2006 and the establishment of its globally focussed funds management business. AASB 132 Accounting Adjustment As part of the recapitalisation, the Company has issued options (Initial Options) to subscribe in shares of the Company. The total number of Initial Options on issue at 30 June 2007 was 28,334,066 (2006: nil). Upon exercise of an Initial Option, the option holder will be issued with one new ordinary share in the Company and one additional option (Secondary Option). Note 13 provides further information. Australian Accounting Standard AASB 132 Financial Instruments: Presentation determines that the Initial Options are compound financial instruments comprising both an option on a share and an option on an option. AASB 132 further determines that the option on a share is an equity instrument and that the option on an option is a financial liability. The financial liability component is valued at the date that the Initial Options were issued and at each subsequent reporting date. The financial liability is recognised on the Balance Sheet with subsequent changes in fair value recognised through the Income Statement. Note 2(i) to the financial statements provides further information on the recognition and measurement of the financial liability component of the Initial Option. In the Directors’ opinion this accounting treatment of the Initial Options should be supplemented with the inclusion of the additional explanations in this section of the Directors’ Report and in note 2(i) to the financial statements in order to provide users of the financial report with the more useful information. The Directors have formed this view after considering:  the inconsistent approach required by AASB 132 in treating the option on a share as an equity instrument and the option on an option as a financial liability; MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT 11  at the time the Initial Options are either exercised by, or expire on, 30 June 2009 the financial liability component recognised in the Balance Sheet will cease to exist;  the Company will not be required to settle the financial liability component with cash. To the extent that the Initial Options are exercised it will be settled with the issue of a Secondary Option which will be treated as an equity instrument; and  the fair value of the financial liability will change with movements in the prices of the Company’s securities. Movements in the fair value are required to go through the Income Statement. To illustrate, the Directors determined that the fair value of the financial liability at 30 June 2007 was $1.06 per Initial Option. Applying the same valuation methodology to the relevant valuation inputs as at 28 August 2007, the value was $0.52 giving a total value of the financial liability of $14,734,000 (30 June 2007 $30,033,000). The impact of the AASB 132 Accounting Adjustment on the capital and reserves of the Company is as follows: Contributed equity Retained earnings Reserves Balance before AASB 132 Accounting Adjustment $’000 Impact of AASB 132 Accounting Adjustment $’000 Per Balance Sheet 30 June 2007 $’000 103,080 (2,394) (1,203) 99,483 (37,715) 4,681 - (30,034) 68,365 2,287 (1,203) 69,449 Dividends and Distributions The Group paid a Company dividend of 5.39 cents (fully franked) and a Trust distribution of 1.61 cents for a total of 7.0 cents per stapled security in December 2006. No other amounts have been declared by the Directors and none have been paid or are payable during the year and to the date of this report. Changes in the State of Affairs There were significant changes in the state of affairs of the Group that occurred during the year. These changes have been disclosed in this report or the financial statements. Events Subsequent to the end of the Financial Year On 3 July 2007, the Company subscribed for $15m and $5m respectively of units in the Magellan Global Fund and Magellan Infrastructure Fund, two new unlisted investment trusts of which Magellan Asset Management Limited (MAM), a controlled entity, is the Responsible Entity and Investment Manager. There is a Management Services Agreement (MSA) between the Company and NPH Funds Pty Ltd (NPH Funds), details of which are set out in note 17. NPH Funds is 40% owned by a company controlled by Hamish Douglass, the Chairman of the Company, and 60% owned by New Privateer Holdings Limited (NPH) an ASX listed company in which Chris Mackay, the Deputy Chairman of the Company, has a 36% shareholding (approximately 55% on a fully diluted basis). Since the end of the financial year, Hamish Douglass and Chris Mackay have advised the Boards of the Company and NPH that they do not wish to participate in any possible performance fees that may arise under the management services agreement between the Company and NPH Funds. Messrs Douglass and Mackay will examine whether, if they do not participate in any possible performance fees that may become payable, the arrangements, between the Company, NPH Funds, NPH and themselves can be restructured to achieve an outcome that benefits the Company’s future development. The Directors are not aware of any other matter or circumstance not otherwise dealt with in this report or in the financial statements that has significantly or may significantly affect the operations of the Group, the result of those operations or the state of affairs of the Group in subsequent financial periods. Likely Developments and Expected Result of Operations The Group will continue to pursue its financial objective which is to increase the profitability of the Company over time by increasing the value and performance of funds under management and by containing costs. The methods of operating the Group are not expected to change in the foreseeable future. Rounding Off of Amounts The Group is of a kind referred to in the Australian Securities & Investments Commission’s Class Order 98/0100 (as amended) and consequently amounts in the Directors’ Report and financial statements have been rounded off to the nearest thousand dollars in accordance with that Class Order, unless otherwise indicated. 12 MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT Environmental Regulation The Group is not subject to any particular or significant environmental regulation under Commonwealth, State or Territory legislation. Auditor Ernst & Young (the “Auditor”) continues in office in accordance with section 307C of the Corporation Act 2001. Audit and Non-audit Services Details of the amounts paid or payable to the Auditor for audit and non-audit services provided during the period are set out below. The Directors, in accordance with advice received from the Audit Committee, are satisfied that the provision of those non-audit services during the period by the Auditor is compatible with the general standard of independence for auditors imposed by the Corporations Act 2001. The Directors are satisfied, considering the nature and quantum of the non-audit services that the provision of non-audit services by the Auditor, as set out below, did not compromise the Auditor independence requirements of the Corporations Act 2001. Audit services: Auditors of the Company – Ernst & Young Audit and review of the annual financial report Other services: Other regulatory audit services (AFSL) Auditors’ Independence Declaration 2007 $ 2006 $ 112,412 72,148 9,000 - A copy of the Auditors’ Independence Declaration as required under section 307C of the Corporations Act 2001 is set out on page 17. Information on Directors Hamish Douglass Chairman and Executive Director, and member of the Audit and Risk Committee Mr Douglass has more than 15 years experience in financial services and has advised on some of the largest corporate transactions in Australia. Mr Douglass was formerly the Co-head of Global Banking at Deutsche Bank, Australasia. Mr Douglass is a Non-executive director of Magellan Flagship Fund Limited, Managing Director of NPH Funds Pty Limited and a Non-executive director of Catalyst Investment Managers Pty Limited. Mr Douglass is a member of the Australian Takeovers Panel. Chris Mackay Deputy Chairman and Executive Director Mr Mackay has considerable experience in business management, business assessment, capital allocation, risk management and investment. Mr Mackay is the Chief Investment Officer of the Company, a Non-executive director of Magellan Flagship Fund Limited, Chairman of New Privateer Holdings Limited and a Director of Publishing & Broadcasting Limited. Mr Mackay retired as Chairman of UBS Australasia in March 2006, having previously been its Chief Executive Officer. Mr Mackay is a member of the Federal Treasurer’s Financial Sector Advisory Council and a former member of the Business Council of Australia and Director of the International Banks & Securities Association. Naomi Milgrom Non-executive Director Naomi Milgrom is the Executive Chair and CEO of Australia’s largest speciality women’s fashion retailer, the Sussan Group - comprising Sussan, Suzanne Grae and Sportsgirl. One of Australia’s top business entrepreneurs, Ms Milgrom has combined business leadership with leadership in the arts, sciences and women’s health, as Chair of the Australian Centre for Contemporary Art (ACCA), Chair of the Melbourne Fashion Festival, and Director of the Howard Florey Institute. Ms Milgrom was the first woman to deliver the Batman Oration on Australia Day 2006. The Centenary of Federation Medal was awarded to Ms Milgrom for her outstanding contribution to business and the fashion industry. Paul Lewis Non-executive Director and member of the Audit and Risk Committee Mr Lewis was Managing Partner and Chief Executive – Asia, based in Hong Kong from 1992 – 2004, for PA Consulting Group, at the conclusion of which PA had offices in Hong Kong, Beijing, Tokyo, Bangalore, Singapore, Kuala Lumpur and Jakarta. MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT 13 Mr Lewis led major assignments in financial services – retail banking, life insurance and stock exchanges, energy, manufacturing, telecommunications, rail, air, container shipping and government. Mr Lewis also served on senior advisory panels with ministerial representation in Hong Kong, Malaysia and Indonesia. Mr Lewis is currently an Emeritus Partner with PA Consulting Group, and holds a number of senior advisory roles with British Telecom, namely, being on the Asia Pacific Advisory Board since 2003, the Global Advisory Board since 2005 and in senior advisory roles including local Chairman for Australia and New Zealand. He is a council member for the Australian British Chamber of Commerce and a director of PA Consulting Group’s Asia businesses. Brett Cairns Non-executive Director and Chairman of the Audit and Risk Committee Mr Cairns is co-head of the Capital Markets Group within Structured Finance at Babcock & Brown, which he joined in 2002. Mr Cairns was a former Managing Director and Head of Debt Capital Markets for Merrill Lynch in Australia where he worked from 1994 to 2002. Prior to joining Merrill Lynch, Mr Cairns spent 3 years with Credit Suisse Financial Products, the then derivatives bank of the Credit Suisse group. David Simpson Company Secretary Mr Simpson is the Company’s General Counsel and Company Secretary of the Group and of the Flagship Fund and is General Counsel of MAM. Mr Simpson has over 20 years of experience as a corporate lawyer, specialising in large scale mergers and acquisitions, both public and private, and international offerings of debt and equity securities. Mr Simpson was a partner in Freshfields Bruckhaus Deringer (“Freshfields”), one of the world’s largest law firms, and before that was a partner in one of Australia’s leading law firms, Allen Allen & Hemsley (now Allens Arthur Robinson). From 1991 to 2004, Mr Simpson was based in Asia, living and working as a corporate lawyer in Indonesia from 1991 to 1997 and Singapore from 1997 to 2004. Mr Simpson was the managing partner of both the Allens Arthur Robinson and Freshfields offices in Singapore. Directors’ Meetings The following table sets out the number of meetings of the Company’s Directors held during the year ended 30 June 2007 and attended by each Director. Board Meetings Audit & Risk Committee Meetings Held Attended Held Attended While a Director While a member 6 6 5 5 4 4 3 3 3 3 6 6 4 5 4 4 2 3 3 3 1 1 1 1 1 1 1 1 - - 1 1 1 1 1 1 1 1 - - Hamish Douglass Chris Mackay Naomi Milgrom Paul Lewis Brett Cairns Roger Davis* Mark Beames* Dean Smorgon* Russel Pillemer* Damien Hatfield* * resigned during the year Remuneration Report This report details the policy for determining the remuneration of Directors and Executives and provides specific detail of their remuneration. Remuneration of Non-executive Directors The Executive Directors review and determine the remuneration of the Non-executive Directors and may utilise the services of external advisors. It is the policy of the Board to remunerate at market rates commensurate with the responsibilities borne by the Non-executive Directors. The remuneration of the Non-executive Directors is not linked to the performance of the Group. Remuneration of Executive Directors The Executive Directors were not remunerated in relation to acting as Directors or as Executives of the Group. 14 MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT Remuneration of Executives (iv) the aggregate maximum number of shares issued under The remuneration policy is designed to attract and retain appropriately experienced, skilled and qualified executives in order to achieve the Group’s objectives. Executive remuneration is a combination of fixed and variable remuneration that takes into account the executives experience, abilities and achievements. The fixed compensation is structured as a total employment cost package, which the executive may elect to receive as a combination of cash, non-cash benefits and superannuation contributions. There are no guaranteed increases to the fixed remuneration, however it is reviewed annually to ensure that it is competitive and reasonable. The variable compensation is performance related and is determined by the Board after consideration of the Executives skills and contributions to the achievement of the Group’s objectives as measured by such indicators as the performance of the Group and the performance of the Flagship Fund, the Magellan Global Fund and the Magellan Infrastructure Fund as appropriate. The Directors do not consider it appropriate to assess Executive performance solely against short term indicators. A focus on short term indicators may encourage performance that is not in the best interests of the Group and its shareholders. The Directors are more concerned that the Executives are motivated to build shareholder wealth over the long term. Share Purchase Plan The Group has put in place a Share Purchase Plan for its employees and Non-executive Directors (Participants). The plan will provide assistance to Participants to invest in shares in the Company in order to more closely align the interests of Participants with the interests of the shareholders of the Group. Employees will be invited to apply for a specified number of fully paid ordinary shares in the Company once a year. The number of Company shares that may be offered is limited to: (a) for the initial offer of Shares, after release of the Group’s full year 30 June 2007 financial results in September 2007: (i) shares with a market value equal to a multiple of four times the employee’s after-tax bonus for the year ending 30 June 2007; and (ii) such further number of plan shares as approved by the Board; (b) for any subsequent offer of shares: (i) shares with a market value equal to a multiple of one times the employee’s after-tax bonus for the financial year (ending 30 June) prior to the financial year in which the subsequent offer is made; and (ii) such further number of shares as requested and approved by the Board, and, in each case: each subsequent offer under the Share Purchase Plan will not exceed 5% of the total number of shares on issue at the time of the offer provided that the Company may issue additional Company shares in any subsequent offer up to, but not exceeding, the number of shares that it has bought back in the period since the last offer of shares under the Share Purchase Plan. Participating Non-executive Directors will be invited to apply for up to 1,000,000 shares on a once only basis. No performance hurdles will attach to the invitation to participate in, or the issue of shares under, the Share Purchase Plan. The Directors can resolve to vary the timing of these invitations. The issue price for the shares will be the fair market value of the shares at the offer date. This will ordinarily be calculated using the volume weighted average price of traded shares in the 5 business days prior to the offer date. Participants will be required to pay an amount equal to 25% of the issue price at the time of issue. The remaining 75% of the issue price will be funded by way of a full recourse interest free loan from the Company. Employees will be required to apply 25% of their after tax annual bonus each year to repay the loan until the loan has been fully repaid. The maximum term of the loan for employees is 10 years. Any outstanding balance at the end of 10 years must be repaid by the employee. Employees will not be entitled to repay their loan early. Participating Non-executive Directors will be required to repay the loan on the fifth anniversary of the date of issue of their shares. Participating Non-executive Directors will be entitled to repay their loan early. Loans to Participants under the plan will be secured on the shares issued to that Participant. The shares will not be transferable until the loan is fully paid. Once the loan has been fully repaid, the shares will be freely transferable. Dividends will be payable on the shares issued under the Share Purchase Plan on the same basis as all other issued fully paid ordinary shares, and will be applied to repay the loan until the loan has been fully repaid. The plan shares will have the same rights to participate in any entitlements or bonus issues and will otherwise rank equally with all other issued ordinary shares. Directors’ fees The Non-executive Directors’ base remuneration is reviewed annually. Retirement benefits for Directors No retirement benefits (other than superannuation) are provided to Directors. (iii) subject to a maximum of $750,000 worth of shares per employee in each financial year, other than in the case of a new employee where the Board may resolve, in its absolute discretion, to initially offer additional shares to the new employee; and Details of Remuneration The Executive Directors have not been remunerated by the Group in relation to acting as Directors of the Group or, in the case of Mr Douglass, as a member of the Audit and Risk Committee. MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT 15 Only the Non-executive Directors of the Company were remunerated by the Company and received the following amounts during the year: Directors Naomi Milgrom Paul Lewis Brett Cairns Roger Davis Mark Beames Dean Smorgon Short Term Benefits Post Employment Benefits Primary Salary Superannuation $ 10,477 10,000 8,333 51,253 1,274 40,973 $ 927 - - 2,064 37,750 1,377 Total $ 11,404 10,000 8,333 53,317 39,024 42,350 In addition to the Executive Directors, the remuneration of the Key Management Personnel is shown below: Key Management Personnel Short Term Benefits Post Employment Commencement Date Salary Cash Bonus Superannuation Total $ $ $ $ N Campbell Chief Financial Officer and Chief Operating Officer D Simpson General Counsel and Company Secretary D Barkas Group Financial Controller 6 July 2006 200,314 200,000 12,686 413,000 10 November 2006 133,517 110,000 8,458 251,975 23 April 2007 31,103 20,000 2,424 53,527 Service Agreements Remuneration and other terms of employment for the Non-executive Directors are formalised in service agreements. The Executive Directors (Messrs Douglass and Mackay) do not have employment agreements and are not remunerated by the Group. All other employees have employment agreements. Messrs Douglass and Mackay have a financial interest in NPH Funds which has entered into a Management Services Agreement with the Company (details on the fees payable under the Management Services Agreement are set out in note 17 to the financial statements). There are no fixed term agreements between the Group and its employees. Employment may be terminated with three months notice by either the Group or its employees. There are no provisions for any termination payments other than for unpaid remuneration and accrued annual leave. Directors’ Interests in Contracts No Director has or has had any interest in a contract entered into up to the date of this Directors’ Report with the Company or any related entity other than as disclosed in note 17 to the financial statements. Indemnification and Insurance of Directors and Officers The Group has paid premiums to insure each of its Directors and Officers in office against liabilities for costs and expenses incurred by them in defending any legal proceedings arising out of their conduct while acting in the capacity of Directors and Officers of the Group, other than conduct involving a wilful breach of duty in relation to the Group. This report is made in accordance with a resolution of the Directors. Hamish Douglass Chairman Sydney 30 August 2007 16 MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT MAGELLAN FINANCIAL GROUP - DIRECTORS’ REPORT 17 CORPORATE GOVERNANCE STATEMENT Magellan Financial Group Limited (the “Company”) is a listed company. The Board recognises the importance of good corporate governance. The Company’s corporate governance framework, policies and practices are designed to ensure the effective management and operation of the Company, and will remain under regular review. The Board The Board is responsible for the overall operation and stewardship of the Company and is responsible for its overall success and long-term growth and corporate governance. The Board will act in the best interests of the Company to ensure the business of the Company is properly managed. Board Composition and Independence There must be a minimum of three Directors and a maximum of ten Directors. The Board has a majority of independent Non-executive Directors. The Board comprises: periodically and its independence, and that of the individual Directors, will be assessed as part of those reviews. Board Charter The Company’s corporate governance policies revolve around a Charter the purpose of which is to:  promote high standards of corporate governance;  clarify the role and responsibilities of the Board; and  enable the Board to provide strategic guidance for the Company and effective operational oversight. The Charter will apply subject to applicable legal and regulatory requirements, including duties and obligations imposed on the directors by statute and general law. The Board may review and amend the Charter at any time. The Board is responsible for:  approving the appointment and removal of the Chairman and the Company Secretary;  assessing the Company’s overall performance;  establishing committees of the Board and, in relation to each committee appointing the members and the Chairman, setting committee charters and delegating authority to relevant committees;  subject to the law and the Company’s Constitution, determining the remuneration of the Non-executive directors (including the members of all committees of the Board);  nominating candidates for election to the Board by shareholders;  reporting to shareholders;  reviewing and having input into overall target portfolio  Directors with an appropriate range of skills, experience composition; and expertise; and  recommending to shareholders any increase or decrease  Directors who can understand and competently deal with in the share capital of the Company; current and emerging business issues.  issuing, allotting, granting options over, offering or The Board currently comprises five Directors, three of whom are Independent Non-executive Directors. A Director must retire from office no later than the longer of the third annual general meeting of the Company or three years, following that Director’s last election or appointment. An independent Non-executive Director is a Non-executive Director who is independent of the Company and free of any business or other relationship that could materially interfere with, or could reasonably be perceived to materially interfere with, the exercise of their unfettered and independent judgment. The Board is confident that each of the Directors will bring skills and qualifications to the Company which will enable them to effectively discharge their individual and collective responsibilities as Directors of the Company. The Board considers that the number of Directors is sufficient to enable it to effectively discharge its responsibilities. However, the composition of the Board will be reviewed otherwise dealing with or disposing of unissued shares in the capital of the Company or rights to subscribe for or convert any security into shares in the capital of the Company in accordance with the Company’s Constitution. The Directors, however, will not, in the absence of extraordinary circumstances, do so without the approval of the Company’s shareholders obtained in general meeting, unless such issue, allotment, grant of offer is made pro- rata to all of the Company’s shareholders;  making calls in respect of any money unpaid on shares and forfeiting or accepting surrender of shares in accordance with the Company’s Constitution;  approving an appropriate debt/equity ratio limit for the Company;  approving material funding facilities for the Company;  approving by the end of June of each year an operating budget for the Company, for the financial year ahead;  approving the transfer or transmission of shares in accordance with the Company’s Constitution, provided that such power may be delegated to a share registrar; 18 MAGELLAN FINANCIAL GROUP - CORPORATE GOVERNANCE STATEMENT  approving the financial markets on which the Company’s securities, including its shares, will be listed;  approving any notifications to the relevant exchanges for listings, suspensions, delistings or relistings;  declaring the amount of profits available for payment of dividends, to fix the amount of a dividend to be recommended to shareholders, and to declare and make arrangements for the payment of interim dividends in accordance with the Company’s Constitution;  approving the establishment of a dividend re-investment plan;  approving the giving of guarantees and letters of comfort by the Company;  approving any security, mortgage or other pledge given over any of the Company’s assets or revenues;  approving the Company’s annual financial statements and reports to shareholders;  approving the Company’s half year financial statements and reports to shareholders;  authorising charitable contributions by the Company;  continuing the Board policy that the Company does not make donations to any political parties;  reporting as appropriate, that the business is a going concern, with supporting assumptions or qualifications as necessary;  on advice from the Audit & Risk Committee of the Board, approving the Company’s accounting policies;  approving the appointment and removal of the external auditors of the Company;  considering and, if appropriate, accepting external audit reports, including management letters;  reviewing any recommendation from the Audit & Risk Committee of the Board arising from internal audit reports;  reviewing reports and appraisals from the Audit & Risk Committee of the Board on market and operational controls;  reviewing and overseeing the implementation of a Code of Conduct;  monitoring and ensuring compliance with legal and regulatory requirements and ethical standards and policies;  approving any material conflict of interest that the Company or a Director may have prior to relevant transactions being entered into. Subject to legal or regulatory requirement and the Company’s Constitution, the Board may delegate any of the above powers to individual Directors, or committees of the Board. Any such delegation shall be in compliance with the law and the Company’s Constitution. Non-executive Directors’ Remuneration Structure The Non-executive Directors’ fees are in each case $20,000 per annum plus reimbursement of expenses such as travelling expenses. The Executive Directors, Chris Mackay and Hamish Douglass, will not receive any fees in relation to acting as Directors of the Company, nor will Hamish Douglass receive any fee as a member of the Audit & Risk Committee. Two of the Non-executive Directors are entitled to participate in the Company’s Share Purchase Plan, but no determination of the details of their participation was made in the reporting period. Board Committees The Board may from time to time establish committees to assist it in the discharge of its responsibilities. The Board has established the Audit & Risk Committee and the Investment Committee. Other committees may be established by the Board as and when required. Membership of Board committees will be based on the needs of the Company, relevant legislative and other requirements and the skills and experience of individual Directors. The Board expects that, over time, the Directors will rotate on and off various committees. Committee members will be appointed for a three year term of office with staggered anniversary dates. A Nomination and Remuneration Committee is not required given the size and nature of the Company. Performance of all committee members will be reviewed periodically by the Board.  monitoring and ensuring compliance with best practice Audit & Risk Committee corporate governance requirements; The Audit & Risk Committee must comprise:  ensuring the risk management systems, including internal controls, operating systems and compliance processes, are operating efficiently and effectively;  convening meetings of shareholders (including the annual general meeting) and exercising all other powers relating to shareholders’ meetings given to directors in the Company’s Constitution;  approving all resolutions being put and matters concerned with a notice of general meeting or annual general meeting;  approving the Company’s Continuous Disclosure Policy and monitoring compliance with this policy;  approving the establishment of overseas branch registers of the Company;  approving any material related party transaction and any transaction that any Director would directly benefit from; and  at least three Directors; and  a majority of Independent Directors. The Chairman of the Audit & Risk Committee is an Independent Non-executive Director and is not the Chairman of the Board. The objective of the Audit & Risk Committee is to assist the Board to discharge its responsibilities in relation to:  effective management of financial and operational risks;  compliance with laws and regulations;  accurate management and financial reporting;  maintenance of an effective and efficient audit; and  high standards of business ethics and corporate governance. MAGELLAN FINANCIAL GROUP - CORPORATE GOVERNANCE STATEMENT 19 The Audit & Risk Committee will endeavour to:  maintain and improve the quality, credibility and objectivity of the financial accountability process; with the objective that no Director or employee will contravene the requirements of the Corporations Act 2001, the ASX Listing Rules or any other applicable law.  promote a culture of compliance within the Company;  ensure effective communication between the Board and the Company’s senior financial and compliance management;  ensure effective audit functions and communications between the Board and the Company’s auditor;  ensure that compliance strategies and compliance functions are effective; and  ensure that Directors are provided with financial and non- financial information that is of high quality and relevant to the judgments to be made by them. Key Policies and Procedures The Company acts in accordance with the following policies and procedures: Continuous Disclosure Policy The Company is committed to complying with its continuous disclosure obligations under the Corporations Act 2001 and the Listing Rules and releasing relevant information to the market and shareholders in a timely and direct manner and to promoting investor confidence in the Company and its securities. The Company:  as a minimum complies with its continuous disclosure obligations under the Corporations Act 2001 and the ASX Listing Rules;  provides shareholders and the market with timely, direct and equal access to information issued by it; and This is designed to protect the reputation of the Company and to ensure that such reputation is maintained or perceived to be maintained by persons external to the Company. An overriding principle is that the Directors and employees who possess non-public price sensitive information must not deal in the Company’s securities. Conflicts of Interest Policy A ‘conflict of interest’ may arise where the Company makes internal decisions that may materially impact shareholders or other stakeholders. The Company takes conflicts seriously, as they have the potential to impact adversely on the Company’s business, its obligations under the law, its ethical standards and its reputation. The Company is committed to maintaining high moral and business ethics and ensuring that the conduct of all of its officers is exemplary, at all times. The Company sets itself high standards, and has implemented policies and procedures to achieve its aim. The Company:  addresses and resolves conflicts of interest as necessary precursor to the maintenance of the Company’s ethics;  wants to ensure that the quality of its business is not compromised by conflicts of interest;  wants to ensure that adequate conflicts of interest management procedures are in place to minimise any adverse impact on shareholders and other stakeholders.  ensures that information which is not generally available Related Party Transaction Policy and which may have a material effect on the price or value of the Company securities (price sensitive information), is identified and appropriately considered by the Directors and senior executives for disclosure to the market. The Company adheres to procedures which must be followed in relation to releasing announcements to the market and discussions with analysts, the media or shareholders. The Company’s market announcements will also be available on its website (www.magellangroup.com.au) after they are released to ASX. Trading Policy All Directors and employees of the Company may deal in:  the Company’s securities, which includes any shares in the Company, debentures (including convertible notes) issued by the Company, units of shares in the Company and options to acquire or subscribe for shares in the Company; and  other financial products, which includes any shares, options, derivatives (including market index derivatives), debentures any other financial product able to be traded of any company, trust or other organisation, local domestic and international, in which the Company invests or proposes to invest, The Company has established a protocol for officers of the Company in negotiating and entering into transactions between the Company and related parties. This is directed at ensuring compliance with the law and the ASX Listing Rules when contracting with parties which are related parties of the Company. Procedures are followed when negotiating and entering into arrangements between the Company and related parties, aimed at ensuring that at all times the best interests of the Company are paramount without regard to the interests of related parties. Corporate Reporting In respect of the year ending 30 June 2007 the Chairman and Chief Financial Officer have certified to the Board that:  the financial records of the Company for the financial period have been properly maintained in accordance with section 286 of the Corporations Act 2001 (Act);  the financial statements and notes referred to in paragraph 295(3)(b) of the Act for the financial period comply with the accounting standards;  the financial statements and notes, including the additional disclosures relating the AASB 132 Financial Instruments: Presentation Accounting Adjustment for the financial period give a true and fair view (as per section 297 of the Act); 20 MAGELLAN FINANCIAL GROUP - CORPORATE GOVERNANCE STATEMENT  any other matters that are prescribed by the Corporations Regulations 2001 in relation to the financial statements and the notes for the financial period are satisfied;  the integrity of the Company’s financial statements is founded on a sound system of risk management and internal compliance and control which implements the policies adopted by the Board; and  the Company’s risk management and internal compliance and control system is operating efficiently and effectively in all material respects. MAGELLAN FINANCIAL GROUP - CORPORATE GOVERNANCE STATEMENT 21 INCOME STATEMENT FOR THE YEAR ENDED 30 JUNE 2007 Note 3 4a 4b Revenue Management fee revenue Dividend income Interest income Revaluation of financial assets Net gains on sale of financial assets Other revenue Total revenue Expenses Employee benefits expense Depreciation and amortisation Rental expense Audit fees Legal and professional fees Management fee expense Other operating expenses Finance costs Total expenses Operating (loss) / profit before income tax Income tax benefit / (expense) 5 Net operating (loss) / profit before AASB 132 Accounting Adjustment AASB 132 Accounting Adjustment Net profit after AASB 132 Accounting Adjustment Deduct net profit / (loss) attributable to minority interests: - Magellan Financial Group Trust - External minority interests Net profit / (loss) attributable to members of the parent after AASB 132 Accounting Adjustment Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 2006 $’000 2,568 - 1,866 - 2,493 148 7,075 5,622 36 208 121 320 1,678 1,172 - 9,157 (2,082) 937 (1,145) 4,681 3,536 471 549 - 149 203 1,928 1,686 76 4,042 - - - 72 113 332 711 89 1,317 2,725 (529) 2,196 - 2,196 - (371) - - 1,713 - (59) 89 1,743 - - - 77 130 1,678 329 - 2,214 (471) 141 (330) 4,681 4,351 - - - - 105 - 4,913 226 5,244 - - - 45 81 298 450 - 874 4,370 (905) (3,645) - 3,465 - - 2,516 2,567 4,351 3,465 1 As explained in note 2(i), the AASB 132 Accounting Adjustment arises from the requirement to recognise one element of the capital structure of the Company as a financial liability rather than as an equity instrument and to recognise changes in fair value of this financial liability in the Income Statement. 22 MAGELLAN FINANCIAL GROUP - INCOME STATEMENT Operating (loss) / profit attributable to stapled security holders before AASB 132 Accounting Adjustment represented by: - Magellan Financial Group Limited - Magellan Financial Group Trust Operating (loss) / profit attributable to stapled security holders before AASB 132 Accounting Adjustment represented by: - Magellan Financial Group Limited - Magellan Financial Group Trust Earnings per stapled security Earnings attributable to stapled security holders after AASB 132 accounting adjustment Basic earnings per stapled security Diluted (loss) /earnings per security Earnings attributable to stapled security holders before AASB 132 accounting adjustment Basic (loss) /earnings per stapled security Diluted (loss) /earnings per security Consolidated 2007 $’000 2006 $’000 Note (2,165) 471 (1,694) 2,516 471 2,987 2,567 - 2,567 2,567 - 2,567 6 6 6 6 5.2 cents 8.5 cents (2.6 cents) 8.5 cents (3.0) cents 8.5 cents (3.0) cents 8.5 cents The Income Statement is to be read in conjunction with the accompanying notes to the Financial Statements. MAGELLAN FINANCIAL GROUP - INCOME STATEMENT 23 BALANCE SHEET AS AT 30 JUNE 2007 Assets Current assets Cash and cash equivalents Trade and other receivables Prepayments Financial assets Total current assets Non-current assets Property, plant and equipment Financial assets Loan to controlled entity Deferred tax assets Total non-current assets Total assets Liabilities Current liabilities Trade and other payables Tax liabilities Total current liabilities Non-current liabilities AASB132 Accounting Adjustment Total non-current assets Total liabilities Net assets 24 MAGELLAN FINANCIAL GROUP - BALANCE SHEET Consolidated Parent Note 2007 $’000 2006 $’000 2007 $’000 2006 $’000 8 9(a) 10 9(b) 5(d) 11 2(i) 74,408 1,982 64 405 1,638 203 22 22,349 67,515 413 5 - 1,569 226 9 - 76,859 24,212 67,933 1,804 408 24,772 - 2,594 - - - 10,852 32,772 27,293 - 776 1,150 1,422 - 776 27,774 11,628 35,344 28,069 104,633 35,840 103,277 29,873 5,151 - 5,151 30,033 30,033 108 675 783 - - 1,063 - 1,063 30,033 30,033 41 675 716 - - 35,184 783 31,096 716 69,449 35,057 72,181 29,157 Equity Issued securities AASB 132 Accounting Adjustment Contributed Equity Reserves Retained profit Total attributable to members of the Group Attributable to minority interests Total equity Note 2(i) 13 Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 2006 $’000 103,080 (34,715) 28,613 - 103,080 (34,715) 28,163 - 68,365 28,163 68,365 28,163 (1,203) 2,287 69,449 (374) 1,348 29,137 - 5,920 (1,203) 5,019 72,181 - (1,251) 2,245 29,157 - 69,449 35,057 72,181 29,157 The Balance Sheet is to be read in conjunction with the accompanying notes to the Financial Statements. MAGELLAN FINANCIAL GROUP - BALANCE SHEET 25 STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 2007 Attributable to Equity Holders of the Group Retained Profits/ (Accumulated Losses) Financial Assets Revaluation Reserve Contributed Equity Total Minority Interests Total Equity 30 June 2007 $’000 $’000 $’000 $’000 $’000 $’000 Equity as at beginning of year 28,163 1,348 (374) 29,137 5,920 35,057 Net gains realised on disposal of available for sale financial assets Net impact of disposal of controlling interest Revaluation of other financial assets Tax assets arising on revaluation of other financial assets Transaction costs associated with the issue of securities (note 13) Tax assets arising on transaction costs associated with the issue of securities (note 13) Total income and expenses for the year recognised directly in equity Net profit for the year Total (expense) / income for the year Issue of securities (note 13) ASB 132 Accounting Adjustment Dividends and distributions paid (note 7) Equity issued to minority interests Other Total transactions with equity holders in their capacity as equity owners Equity as at end of year - - - - (1,749) 525 (1,224) - (1,224) 76,141 (34,715) - - - - - - - - - - 2,516 2,516 - - (1,577) - - 41,426 68,365 (1,577) 2,287 374 374 (700) (326) - - (6,701) (6,701) (1,719) (1,719) 516 516 - - (1,749) 525 - - - - (1,719) 516 (1,749) 525 (829) (2,053) (7,401) (9,454) - 2,516 1,020 3,536 (829) 463 (6,381) (5,918) - - - - - - 76,141 (34,715) (1,577) - - 39,849 (1,203) 69,449 - - 76,141 (34,715) (471) (2,048) 911 21 461 - 911 21 40,310 69,449 The Statement of Changes in Equity is to be read in conjunction with the accompanying notes to the Financial Statements. 26 MAGELLAN FINANCIAL GROUP - STATEMENT OF CHANGES IN EQUITY Attributable to Equity Holders of the Group Retained Profits/ (Accumulated Losses) Financial Assets Revaluation Reserve Contributed Equity Total Minority Interests Total Equity 30 June 2006 $’000 $’000 $’000 $’000 $’000 $’000 Equity as at beginning of year 28,827 (1,219) Acquisition of a controlling interest Disposal of controlling interest Revaluation of other financial assets Tax assets arising on revaluation of other financial assets - - - - Tax assets arising on transaction costs associated with the issue of stapled securities 470 Other Total income and expenses for the year recognised directly in equity Net profit / (loss) for the year Total income / (expense) for the year Issue of securities Dividends and distributions paid Buy back of stapled securities Equity issued to minority interests Total transactions with equity holders in their capacity as equity owners Equity as at end of year 2 472 - 472 - - (1,136) - (1,136) 28,163 - - - 27,608 464 28,072 - - 4,943 (476) 4,943 (476) (534) (534) 700 166 160 160 - - 470 2 - - 9 160 470 11 (374) 98 - 2,567 5,176 371 5,274 2,196 (374) 2,665 4,805 7,470 - - - - - - - (1,136) - - - - - - (1,136) 651 651 (1,136) 651 (485) - - - - - - - 2,567 2,567 - - - - - 1,348 (374) 29,137 5,920 35,057 MAGELLAN FINANCIAL GROUP - STATEMENT OF CHANGES IN EQUITY 27 STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 2007 Attributable to Equity Holders of the Parent Contributed Equity Retained Profits / Accumulated Losses) Financial Assets Revaluation Reserve) 30 June 2007 $’000 $’000 $’000 Total Equity $’000 Equity as at beginning of year 28,163 2,245 (1,251) 29,157 Net gains realised on disposal of available for sale financial assets Revaluation of other financial assets Tax assets arising on revaluation of other financial assets Transaction costs associated with the issue of securities (note 13) Tax assets arising on transaction costs associated with the issue of securities (note 13) Total income and expenses for the year recognised directly in equity Net profit for the year Total (expense) / income for the year Issue of securities (refer note 13) AASB 132 Accounting Adjustment Dividens and distributions paid Total transactions with equity holders in their capacity as equity owners Equity as at end of year - - - (1,749) 525 (1,224) - (1,224) 76,141 (34,715) - 41,426 68,365 - - - - - - 4,351 4,351 - - (1,577) (1,577) 5,019 1,251 (1,719) 516 - - 48 - 48 - - - - (1,203) 1,251 (1,719) 516 (1,749) 525 (1,176) 4,351 3,175 76,141 (34,715) (1,577) 39,849 72,181 The Statement of Changes in Equity is to be read in conjunction with the accompanying notes to the Financial Statements. 28 MAGELLAN FINANCIAL GROUP - STATEMENT OF CHANGES IN EQUITY Attributable to Equity Holders of the Parent Contributed Equity Retained Profits / Accumulated Losses) Financial Assets Revaluation Reserve) 30 June 2006 $’000 $’000 $’000 Equity as at beginning of year 28,827 (1,219) Revaluation of other financial assets Tax assets arising on revaluation of other financial assets Tax assets arising on transaction costs associated with the issue of stapled securities Total income and expenses for the year recognised directly in equity Net profit for the year Total income / (expense) for the year Buyback of stapled securities Other Total transactions with equity holders in their capacity as equity owners Equity as at end of year - - 470 470 - 470 (1,136) 2 1,134 28,163 - - - - 3,465 3,465 - (1) (1) 2,245 - (1,787) 536 - (1,251) - (1,251) - - - (1,251) Total Equity $’000 27,608 (1,787) 536 470 (781) 3,465 2,684 (1,136) 1 (1,135) 29,157 The Statement of Changes in Equity is to be read in conjunction with the accompanying notes to the Financial Statements. MAGELLAN FINANCIAL GROUP - STATEMENT OF CHANGES IN EQUITY 29 STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 JUNE 2007 Consolidated Parent Note 2007 $’000 2006 $’000 1,686 1,460 - 25,232 (944) - - (675) (3,939) - 291 157 47,446 (72,696) 61 - - (1,200) 2007 $’000 120 1,303 - - - - (1,150) (675) (1,115) 2006 $’000 - 116 - 28,686 (42,384) - - - (829) 12 22,820 (25,941) (1,517) (14,411) 11,062 (26,732) 697 (6,424) (1,150) - - (719) (23,266) - - - - - - 6 - 6 29,140 (34,491) - - - - - - (5,351) - - - - - (13) 6 - (7) Cash flows from operating activities Receipt of fee income Interest received Dividends received Proceeds from sale of held-for-trading financial assets Purchases of held-for-trading financial assets Other income received Loan advanced to subsidiary Tax paid Administration and general expenses paid Net cash inflows / (outflows) from operating activities Cash flows from investing activities Proceeds from sale of financial assets Purchases of financial assets Net cash inflow on acquisition of controlled entity 14 Cash attributable to minority interests on disposal of controlled entity Loan repayment to related party Loans advanced Proceeds from repayment of loans advanced Purchase of plant and equipment Net cash (outflows) / inflows from investing activities 30 MAGELLAN FINANCIAL GROUP - STATEMENT OF CASH FLOWS Cash flows from financing activities Proceeds from issue of securities Payment of costs on issue of securities Repurchase of securities via Buy-Back scheme Repayment of loans Interest paid Dividends and distributions paid Net cash inflows / (outflows) from financing activities Net increase / (decrease) in cash and cash equivalents Effects of exchange rate movements Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year Note 13 13 Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 2006 $’000 77,051 (1,749) - (13) (22) (2,051) 648 - (991) - (588) - 76,140 (1,749) - - - (1,577) - - (991) - - - 73,216 (931) 72,814 (991) 72,770 (26,866) 65,946 (15,409) - (3) - - 1,638 74,408 28,507 1,638 1,569 67,515 16,978 1,569 The Statement of Cash Flows is to be read in conjunction with the accompanying notes to the Financial Statements. MAGELLAN FINANCIAL GROUP - STATEMENT OF CASH FLOWS 31 NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 30 JUNE 2007 These financial statements have been prepared under the historical cost convention, except for financial assets, which have been measured at fair value. Comparative information in respect of the previous period has been re-classified where this assists in the understanding of the current period’s financial report. (b) Compliance with IFRS The financial report complies with Australian Accounting Standards, which include Australian equivalents to International Financial Reporting Standards (AIFRS). The financial report also complies with International Financial Reporting Standards (IFRS). The preparation of the financial statements in conformity with AIFRS requires the use of certain critical accounting estimates and judgements, which are included below. (c) New Standards Not Yet Adopted Australian Accounting Standards and Interpretations that have recently been issued or amended but are not yet effective have not been adopted by the Group in the preparation of this financial report. The following standards, amendments to standards and interpretations have been identified as those which may impact the Group in the period of initial application.  AASB 7 Financial Instruments: Disclosures (August 2005) replaces the presentation requirements of financial instruments in AASB 132. AASB 7 is applicable for annual reporting periods beginning on or after 1 January 2007, and will require additional disclosures with respect to the Company’s financial instruments.  AASB 2005-10 Amendments to Australian Accounting Standards (September 2005) makes consequential amendments to AASB 132 Financial Instruments: Disclosure and Presentation, AASB 101 Presentation of Financial Statements, AASB 114 Segment Reporting, AASB 139 Financial Instruments: Recognition and Measurement and AASB 1 First-time Adoption of Australia Equivalents to International Financial Reporting Standards. AASB 2005- 10 is applicable for annual reporting periods beginning on or after 1 January 2007 and is expected to only impact disclosures contained within the consolidated financial report.  AASB 8 Operating Segments has been identified as those which may impact the Company in the period of initial application. They are available for early adoption at 30 June 2007, but have not been applied in preparing these financial statements. The impact of early adoption of this standard has been to remove disclosures previously presented under AASB 114 Segment Reporting. AASB 8 is effective for annual reporting periods beginning on or after 1 January 2009.  AASB 101 Presentation of Financial Statements (October 2006) has deleted the Australian specific Illustrative Financial Report Structure and reinstated the current IASB 1 guidance on Illustrative Financial Statement Structure. The revised AASB 101 is applicable for annual reporting periods beginning on or after 1 January 2007. 1. Corporate Information Magellan Financial Group Limited (the “Company”) is a company limited by shares and incorporated in Australia. The shares of the Company are publicly traded on the Australian Securities Exchange (ASX). Prior to 22 March 2007, the Company was party to an agreement to staple its shares to units in the Magellan Financial Group Trust (the “Trust”). The shares of the Company and the units of the Trust were jointly quoted on the ASX. The Constitutions of the Company and the Trust deemed that, as long as the two entities remained jointly quoted, the number of shares in the Company and the number of units in the Trust would be equal in number, and that the shareholders of the Company and the unitholders in the Trust would be identical. On 22 March 2007, shareholders of the Company and unitholders in the Trust voted to amend the Constitutions of the Company and the Trust respectively to terminate the stapling agreement. From 22 March 2007, shares in the Company remained listed on the ASX as individual securities and units in the Trust were de-listed. The Trust was subsequently wound up on 29 June 2007. The net assets of the Trust at the date of the de-stapling were nil. The Company was previously called Pengana Hedgefunds Ltd and the Trust was previously called Pengana Hedgefunds Trust. The names of the Company and the Trust were changed on 21 November 2006. The nature of the operations and the principal activities of the Company are described in the Directors’ Report. 2. Summary of Significant Accounting Policies The financial report is a general purpose financial report which has been prepared in accordance with Australian Accounting Standards (AASBs) adopted by the Australian Accounting Standards Board (AASB), and the Corporations Act 2001. (a) Basis of Preparation The principal accounting policies adopted in the preparation of the financial report are set out below. These policies have been consistently applied to all periods presented, unless otherwise stated. 32 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS (d) Basis of Consolidation The combined financial report of the Group comprises the consolidated financial reports of the Company and the Trust which were jointly quoted on the ASX until 22 March 2007 (refer note 1). The Company has applied AASB 127: Consolidated and Separate Financial Statements and AASB Interpretation 1002: Post-Date-of-Transition Stapling Arrangements in the preparation of this financial report. The parent company in this arrangement is the Company, which consolidates the Trust. The results of the Trust have been included up to the date of de-stapling. In accordance with AASB Interpretation 1002, the results of the Trust and the interests of unitholders in the net assets and equity of the consolidated group have been disclosed as a minority interest. In addition to the Trust, other controlled entities included within the consolidated financial report are: Ownership % Statement when the Company’s entitlement to it becomes certain, which will usually be at the end of the period to which the performance fee relates. Interest Income Interest income is recognised in the Income Statement as it accrues, using the effective interest rate method and if not received at balance date, is reflected in the Balance Sheet as a receivable. Dividend Income Dividend income is brought to account on the applicable ex- dividend date. (f) Expense Recognition Expenses are recognised in the Income Statement when a present obligation exists (legal or constructive) as a result of a past event that can be reliably measured. Expenses are recognised in the Income Statement if expenditure does not produce future economic benefits that qualify for recognition in the Balance Sheet. 30 June 2007 30 June 2006 (g) Employee Benefits Pengana Absolute Return Real Estate Fund Magellan Asset Management Ltd - 76.61 100 - The Company’s controlling interest in Pengana Absolute Return Real Estate Fund was disposed of on 3 October 2006. The controlling interest in Magellan Asset Management Limited (‘MAM”) was acquired on 21 November 2006. The results of these entities have been included from the date control was acquired and excluded from the date control ceased. All controlled entities have a 30 June financial year end. All inter-entity balances and transactions between entities in the consolidated group, including unrealised profits or losses, have been eliminated on consolidation. Accordingly policies of the subsidiaries have been changed where necessary to ensure consistency with those policies adopted by the parent entity. Acquisitions have been accounted for using the purchase method of accounting, which involves allocating the cost of the business combination to the fair value of assets acquired and the liabilities and contingent liabilities assumed at the date of acquisition. Minority equity interests in the equity and the results of the entities that are controlled are shown as a separate item in the consolidated financial report. (e) Revenue Recognition Management Fee Revenue Base management fee revenue is recognised in the Income Statement as it accrues based on the entitlements set out in Investment Management Agreements and other fund documentation. Performance fee revenue is recognised in the Income Wages and Salaries, Annual Leave and Sick Leave Liabilities for wages and salaries, including non-monetary benefits and annual leave expected to be settled within 12 months of the reporting date are recognised as a current liability in respect of employees’ services up to the reporting date and are measured at the amounts expected to be paid when the liabilities are settled. Liabilities for sick leave are recognised as an expense when the leave is taken and measured at the rates paid or payable. Bonus Plan Liabilities and expenses for bonuses are recognised where contractually obliged or where there is a past practice that has created a constructive obligation. Long Service Leave Liabilities for long service leave will be recognised when employees reach a qualifying period of continuous service. (h) Income Tax The income tax expense or benefit for the period is the tax payable or receivable on the current period taxable income or loss based on the current income tax rate adjusted by changes in deferred tax assets and liabilities attributable to temporary differences between the tax bases of assets and liabilities and their carrying amounts in the financial statements, and to unused tax losses. Under AASB 112: Income Taxes, deferred tax balances are determined using the Balance Sheet method which calculates temporary differences based on the carrying amounts of an entity’s assets and liabilities in the Balance Sheet and their associated tax bases. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 33 (i) Financial Instruments The Company has issued options (ASX code: MFGOA) (Initial Options) which when exercised entitle the option holder to be issued with one new ordinary share in the Company (ASX code: MFG) and one additional option (Secondary Option) (refer note 13). The Initial Options are regarded by AASB 132 Financial Instruments: Presentation as compound financial instruments which comprise: (i) an option on a share; and (ii) an option on an option. The Standard regards the option on an option as a derivative contract for the future delivery of the Company’s own shares and hence as a financial liability which is required to be measured at fair value. The financial liability is valued as at the dates the Initial Options were issued and this value is recognised on the Balance Sheet. At each subsequent reporting date, gains or losses arising from changes in fair value are recognised in the Income Statement. The financial liability components of the initial options have been measured at their theoretical fair values determined using a Black–Scholes option pricing framework as at the relevant Initial Option issue dates. Theoretical values have been used to determine the fair values at the relevant Initial Option issue dates as there was no market in the Initial Options until they were listed on ASX on 17 May 2007. At balance date, the financial liability components were measured at their market fair value using the observed market value for the Initial Options less a Black-Scholes option pricing framework value for the option on a share component of the Initial Options ((i) above). The following primary assumptions have been adopted in determining the fair value of financial liability components of the Initial Options in the current financial year: 21 November 2006 First Issue date (1) 16 May 2007 Second Issue date 29 June 2007 Initial Options Strike price Maturity date Interest Rate (semi-annual) Dividend yield Expected volatility Secondary Options Strike price Maturity date Interest Rate (semi-annual) Dividend yield Expected volatility No of Initial Options on issue (millions) Cumulative Initial Options on issue (millions) Closing market price for Shares (MFG) (1) Closing market price for Initial Options (MFGOA) Theoretical value of option on a share component of MFGOA Fair value of each Secondary Option $1.20 $1.20 $1.20 30 June 2009 30 June 2009 30 June 2009 6.36% 0.00% 30% 6.59% 0.00% 30% 6.83% 0.00% 30% $1.30 $1.30 $1.30 30 June 2011 30 June 2011 30 June 2011 6.27% 0.00% 30% 19.2 19.2 $2.30 - - $1.33 6.59% 0.00% 30% 9.1 28.3 $2.00 - - $1.01 6.94% 0.00% 30% n/a 28.3 $2.20 $2.22 $1.16 $1.06 (1) The market price of the Company’s securities rose materially over the period from the announcement of the recapitalisation on 7 September 2006 (closing market price of $1.00) to 21 November 2006, being the First Issue Date. 34 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS (j) Earnings Per Share Basic and diluted earnings per share are determined by dividing the operating profit after income tax by the weighted number of ordinary shares outstanding during the financial year. (k) Cash and Cash Equivalents Cash comprises current deposits with banks. Cash equivalents are short-term highly liquid investments that are readily convertible to known amounts of cash, are subject to an insignificant risk of changes in value, and are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. Cash at the end of the period, as shown in the Cash Flow Statement, is reconciled to the related item in the Balance Sheet. (l) Financial Assets Fixed Term Deposits Fixed term cash deposits (maturity less than 1 year from balance date) are classified as current financial assets and are designated as assets held to maturity. Held-for-Trading Financial Assets Short-term trading securities are classified as held-for- trading financial assets and are carried at fair value. Gains or losses arising from changes in fair value are recognised in the Income Statement. All held-for-trading assets that were held by the Group are short-term investments held by Pengana Absolute Return Real Estate Fund, a controlled entity up until 3 October 2006. Available-for-Sale Financial Assets Long term investments are classified as available-for-sale financial assets and are carried at fair value. Unrealised changes in fair value are taken directly to an asset revaluation reserve within equity until the asset is sold, at which time the cumulative change in fair value previously reported in equity is recognised in the Income Statement. Investments in operating subsidiaries are also classified as available-for-sale financial assets and are carried at cost in accordance with AASB 127: Consolidated and Separate Financial Statements. From time to time, the Company may hold controlling interests in unlisted unit trusts which classify their long-term investments as ‘at fair value through profit and loss’. On consolidation of these trusts into the results of the Group, these long-term investments are designated are available- for-sale financial assets to achieve consistency with long- term investments held directly by the Company. They are carried at fair value. Unrealised changes in fair value are taken directly to an asset revaluation reserve within equity until the asset is sold, at which time the cumulative change in fair value previously reported in equity is recognised in the Income Statement. (m) Trade and Other Receivables Receivables are recognised as and when they are due. They are initially recognised at fair value and are subsequently measured at amortised cost using the effective interest method, less any allowance for uncollectible amounts. Debts which are known to be uncollectible are written off. A provision for doubtful debts is raised when there is evidence the amount will not be collected. (n) Property, Plant and Equipment Property, plant and equipment are stated at historical cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful life of the assets as follows: Furniture, fittings and leasehold improvements* - over five to ten years Computer equipment - over two to three years * where remaining lease term is less than five years, leasehold improvements are depreciated over the lease term. If the estimated recoverable amount of an asset is greater than its carrying amount, the carrying amount will be written down to the estimated recoverable amount. (o) Trade and Other Payables Trade and other payables are carried at amortised cost. They represent liabilities for good and services received by the Company prior to the end of the financial period that remain unpaid at balance sheet date. They are recognised at the point where the Company becomes obliged to make future payments in respect of the purchase of these goods and services. (p) Directors’ Entitlements Liabilities for Directors’ entitlements to fees are accrued at nominal amounts calculated on the basis of current fee rates. Contributions to Directors’ superannuation plans are charged as an expense as the contributions are paid or become payable. (q) Contributed Equity Ordinary shares issued by the Company and units issued by the Trust are classified as equity. Units issued by the Trust are separately identified as relating to minority interests in the Statement of Changes in Equity. Transaction costs that arise on the issue of shares are shown in equity as a deduction, net of tax, from the proceeds from issue of shares. (r) Dividends Provision is made for the amount of any dividend declared, determined or publicly recommended by the Directors on or before the end of the financial year but not paid at balance date. (s) Goods and Services Tax (GST) Revenue, expenses and assets recognised net of the amount of any GST except when GST incurred on a purchase of goods and services is not recoverable from the taxation authority, in which case the GST is recognised as part of the cost of the acquisition of the asset. MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 35  3. Management Fee Revenue MAM is appointed to act as Investment Manager for the Flagship Fund Limited (Flagship Fund). Base Fee A quarterly fee calculated at 0.3125% (excluding GST) of the market value of all assets less total indebtedness of Flagship Fund. Performance Fee An annual fee calculated as 10% (excluding GST) of the absolute dollar value of the investment performance (after deducting the base fee), if the total annual return in the relevant annual period:  Exceeds the percentage change in the Australian Dollar MSCI for the relevant annual period and  Exceeds the Australian Government 10-year bond rate on the first day of each quarter occurring within the relevant annual period. No performance fee was earned for the year. Management Fee Revenue Base fee Consolidated 2007 $’000 2,568 2,568 2006 $’000 - - 4. Changes in the Fair Value of Financial Assets The changes in fair value of financial assets recognised in the Income Statement comprise: a) Revaluation of financial assets - held for trading b) Net gain on sale of financial assets - held for trading - available for sale Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 - 1,928 2,493 - 2,493 - 1,686 1,686 - - (59) (59) 2006 $’000 - - 4,913 4,913 36 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 5. Income Tax a) Income tax attributable to the financial year differs from the prima facie amount payable on operating (losses) / profit. The difference is reconciled as follows: Consolidated Parent Note 2007 $’000 2006 $’000 2007 $’000 2006 $’000 Operating (loss) / profit before income tax expense (2,082) 2,725 (471) 4,370 Prima facie income tax credit / (expense) on operating loss at 30% 625 (817) 141 (1,311) Net profits / (losses) of Magellan Financial Group Trust Other non-assessable income and non- deductible expenses Minority interests share profit of other controlled trust – not subject to tax i) ii) Deferred income tax relating to issue transaction costs Adjustments to prior period tax expense Other 141 - 171 - - - (494) 44 376 (259) 517 104 - - - - - - - 44 - (259) 517 104 937 (529) 141 (905) i) The Magellan Financial Group Trust distributed all its income ($471,000) for the period ended 29 June 2007 and is not liable to pay tax. The reconciling item reflects the nominal tax effect of these earnings, computed at 30%. ii) This is the nominal tax effect of the minority share ($569,000) of a controlled trust that is not normally subject to tax, calculated at 30%. Current income tax Deferred income tax c) Income tax benefit / (charge) directly to equity comprises: Current income tax Deferred income tax arising from:- - Revaluation of financial assets available-for-sale - Costs associated with the issue of securities (refer note 13) - 937 937 - 356 525 881 (675) 146 (529) - 160 470 630 - 141 141 - (20) 525 505 (675) (230) (905) - 536 470 1,006 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 37 d) Deferred tax as at 30 June relates to the following: Tax losses carried forward Costs associated with the issue of securities deductible in future years Revaluation of financial assets available-for-sale Other temporary differences Deferred tax asset 6. Earning Per Stapled Security Consolidated Parent 2007 $’000 1,223 527 516 328 2,594 2006 $’000 - 211 536 29 776 2007 $’000 451 527 516 (72) 1,422 2006 $’000 - 211 536 29 776 The following reflects the earnings and weighted average stapled security data used in calculation of basic and diluted earnings per stapled security. a) Earnings per security after AASB 132 adjustment Basic earnings per security Net profit attributable to stapled security holders – basic Weighted average number of securities for basic earnings per security (‘000) Basic earnings per stapled security Diluted earnings per security Consolidated 2007 $’000 2,516 57,233 2006 $’000 2,567 30,152 5.2 cents 8.5 cents Net (loss) / profit attributable to stapled security holders – diluted (1,694) 2,567 Weighted average number of securities for diluted earnings per security (‘000) Diluted (loss) / earnings per stapled security 65,555 30,152 (2.6 cents) 8.5 cents The net (loss) / profit attributable to stapled security holders on a fully diluted basis can be reconciled to the basic net profit as follows: Net profit attributable to stapled security holders – basic Deduct AASB 132 accounting adjustment Net (loss) / profit attributable to stapled security holders – diluted 2,987 (4,681) 2,567 - 1,694 2,567 38 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS  Consolidated 2007 $’000 2006 $’000 The weighted average number of securities on a fully diluted basis can be reconciled to the weighted average number of securities used to calculate basic earnings per security as follows: Weighted average number of securities already issued (‘000) Weighted average number of securities on assumed exercise of Initial Options (‘000) Weighted average number of securities on assumed exercise of Secondary Options (‘000) 57,302 30,152 4,780 3,383 - - Weighted average number of securities for diluted earnings per security (‘000) 65,555 30,152 b) Earnings per security before AASB 132 adjustment Net (loss) / profit attributable to stapled security holders Weighted average number of securities for basic earnings per security (‘000) Diluted (loss) / earnings per stapled security c) Further information (1,694) 2,567 57,302 30,152 (3.0 cents) 8.5 cents The Company has on issue 28.3m options (2006: nil) that represent potential ordinary shares. Details of the terms of these options are included in note 13. The AASB 132 Accounting Adjustment arises from the classification of the option embedded in the Initial Options as a financial liability and the requirement to recognise changes in net market value of this liability in the Income Statement. This adjustment is no longer applicable once the Initial Options have been exercised and has been reversed in the determination of the earnings on a fully diluted basis. For the calculation of the earnings per security before the AASB 132 Accounting Adjsutment, the effect of these options in the calculation of earnings per share for the current reporting period is anti-dilutive. The fully diluted earnings per security is therefore the same as the basic earnings per security. However, these options have the potential to dilute basic earnings per security before AASB 132 Accounting Adjustment in the future. There are no other potential ordinary shares on issue (2006: nil). The net profit attributable to stapled security holders includes the net profit of the Trust up to and including 22 March 2007 when the units of the Trust were de-stapled from the shares of the Company (refer note 1). The earnings of the Trust post de- stapling were nil and the Trust was wound up on 29 June 2007. 7. Dividends and Distributions Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 2006 $’000 a) Dividends and distributions declared and paid during the year Dividends on ordinary shares (5.39c per share) Trust distribution (1.61c per unit) Total per stapled security / share (7c per stapled security) 1,577 471 2,048 - - - 1,577 - 1,577 - - - No final dividend has been declared. MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 39 b) Franking credit balance Balance at 1 July 2006 Franking credits arising from tax paid in year Franking credits on dividends paid in year Franking account balance at 30 June 2007 Dividends paid during the year were franked at 30% (2006: nil). 8. Trade and Other Receivables Parent 2007 $’000 2006 $’000 - 675 (673) 2 - - - - Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 2006 $’000 Trade receivables Accrued interest Loan to Carpe Diem Capital Pty Limited Other Related party receivables - Controlled entity - Other related parties 9. Other Financial Assets a) Current Held for trading - Unlisted unit trusts Held to maturity - Cash term deposits b) Non-current - Listed shares - Unlisted shares – controlled entity - Unlisted shares – other - Unlisted unit trusts – controlled entity - Unlisted unit trusts – other i) ii) iii) iv) v) i) i) 321 423 - 28 772 - 1,210 1,982 - 405 405 24,772 - - - - 24,772 40 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS - - 137 66 203 - - - 409 - 4 413 - - 203 413 22,349 - 22,349 - - 700 - 10,152 10,852 - - - 24,772 8,000 - - - - - 137 76 213 13 - 226 - - - - - - 17,141 10,152 32,772 27,293 c) Valuation Methodologies and Material Investments i) The fair values of unlisted unit trusts are deemed to be the redemption unit prices at balance sheet date reported by the manager of those trusts. Details of unlisted unit trusts that were controlled entities of the Company during the year are disclosed in note 2(d). The holding in other unlisted trusts at 30 June 2006 of $10.2m was wholly comprised of an investment in Wallace Australia Opportunities Fund. These units were redeemed on 30 September 2006 for consideration of $10.2m. ii) The fair value of cash term deposits is determined on an amortised cost basis using the effective interest rate method. iii) The fair value of listed shares are determined to be the closing bid price of shares on the last business day preceding the balance sheet date. The holding in listed shares at 30 June 2007 comprises wholly of shares in the Flagship Fund, an ASX listed investment company of which MAM is the investment manager (refer note 2(d)) iv) The carrying value of shares in unlisted companies that are operating subsidiaries of the Company represent the cost of the investment in those subsidiaries, in accordance with AASB 127 : Consolidated and Separate Financial Statements. Details of controlled entities during the year are disclosed in note 2d. v) Where there is no active market for shares in an entity, the directors select a valuation technique that, in their opinion, best estimates the fair value of the asset. Possible valuation techniques include using recent arms length market transactions, where available, referring to the fair value of another instrument that is substantially the same, discounted cash flow analysis or an option pricing model. The investment of $0.7m in an unlisted entity at 30 June 2006 comprised a 20% holding in PAR Management Pty Ltd by the Trust. Fair value was determined with reference to an offer that had been received and accepted. The asset was sold for $0.7m on 14 November 2006. 10. Property, Plant and Equipment Consolidated 2007 2006 Leasehold Improvements $’000 Office Equipment, Fixtures and Fittings $’000 Leasehold Improvements $’000 Total $’000 Office Equipment, Fixtures and Fittings $’000 Total $’000 Cost at 1 July 2006 Additions Aquisitions of controlled entity Cost at 30 June 2007 Accumulated depreciation and impairment losses at 1 July 2006 Depreciation charge for the year Accumulated depreciation and impairment losses at 30 June 2007 - 249 12 261 - 18 18 - 150 33 183 - 18 18 - 399 45 444 - 36 36 Net carrying amount at 30 June 2007 243 165 408 - - - - - - - - - - - - - - - - - - - - - - - - All property, plant and equipment is held by a controlled entity of the parent company. The net carrying value of property, plant and equipment of the parent company at 30 June 2007 is $nil (2006:$nil). MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 41 11. Trade and Other Payables Consolidated Parent 2006 $’000 2007 $’000 2006 $’000 Trade payables Accrued interest Other payables Related party receivables - Controlled entity - Other related parties 2007 $’000 173 3,609 559 4,341 - 810 6 69 33 108 - - 33 142 65 240 13 810 5,151 108 1,063 12. Cash Flow Statement Reconciliation a) Reconciliation of net profit after tax to net cash flows from operations: Net (loss) / profit after tax before AASB 132 Accounting Adjustment (1,145) 2,196 (330) 3,465 Adjusted for: (Gains) on sale of available-for-sale financial assets (269) - (59) Unrealised (gains) on financial assets held for trading Depreciation Profit on share buy-back Loss on impairment of loan Other non-cash items Changes in assets and liabilities (Increase) / decrease in trade debtors and other receivables (Increase) / decrease in prepayments (Increase) in deferred tax assets arising from operational cash flows Decrease in financial assets held for trading Decrease in other assets (Increase) in loan receivable Increase / (decrease) in trade creditors and other payables (Decrease) /increase in current tax liabilities Increase / (decrease) in deferred tax assets recognised Net cash movement on acquisition and disposal of controlled entities - 37 - - - (954) (15) (937) 21,944 - - 4,834 (675) - - (25,215) - (145) 64 127 572 18 (776) - 114 - (9,144) 675 630 - - - - - 4 (188) - - - (1,150) 1,022 (675) (141) 4,943 - - 1 40 - 41 - - 41 - (19,205) - (145) 64 - 583 25 (776) - - - (102) 675 1,005 22,820 (25,941) (1,517) (14,411) 42 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 13. Contributed Equity Contributed equity Stapled securities - fully paid Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 2006 $’000 68,365 - 68,365 - - 28,163 - 28,163 68,365 28,163 68,365 28,163 On 22 March 2007 shares in the Company were de-stapled from units in the Trust (refer note 1). All securities on issue by the Group as at 30 June 2007 were ordinary shares in the Company. The Company has issued options (Initial Options) to subscribe in shares of the Company. The total number of Initial Options on issue at 30 June 2007 was 28,334,066 (2006: nil). The key terms and rights attaching to the Initial Options are as follows: - Initial Options can be exercised during any two month period following the announcement of the Company’s full year or half year results in each year prior to the expiry date. - Upon exercise of an Initial Option, the option holder will be issued with one new ordinary share in the Company and one additional option (Secondary Option). - The exercise price of the Initial Options is $1.20. - The Initial Options expire on 30 June 2009. The key terms of the Secondary Options are as follows: - Secondary Options can be exercised during any two month period following the announcement of the Company’s full year or half year results in each year prior to the expiry date. - Upon exercise of a Secondary Option, the option holder will be issued with one new ordinary share in the Company. - The exercise price of the Secondary Options is $1.30. - The Secondary Options expire on 30 June 2011. The movement during the year of Group securities on issue were as follows: Number Value Stapled Securities Shares Options Total AASB 132 Adjustment After AASB 132 Adjustment $’000 $’000 $’000 $’000 $’000 $’000 Balance at 1 July 2006 Placement – 24 November 2006 Issue costs (net of tax) 29,259 38,400 - - - - De-stapling – 22 March 2007 (67,659) 67,659 Entitlements and Priority Offers – 16 May 2007 Issue costs (net of tax) Balance at 30 June 2007 - - - 39,696 - - 19,200 - - 9,134 - 28,163 37,440 (1,033) - 38,701 (191) - (25,459) - - (9,256) - 107,355 28,334 103,080 (34,715) 28,163 11,981 (1,033) - 29,445 (191) 68,365 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 43 14. Acquisition and Disposal of Controlled Entities a) Acquisition of MAM On 21 November 2006, the Company acquired 100% of the share capitalof MAM from NPH Funds, a related party of the Company. Consideration paid was $10 which represented the fair value of the net assets of MAM at the date of acquisition. The fair values of the identifiable assets and liabilities of MAM at the date of acquisition were as follows Cash and cash equivalents Trade and other receivables Prepayments Financial assets Property, plant and equipment Trade and other payables Accurued expenses Sub-ordinated loan from NPH Funds Net assets The net cash flow on acquisition was as follows: Consideration paid Net cash at aquisition date Cash and cash equivalents $ 697,017 426,342 27,151 165,000 44,240 (188,868) (20,872) (1,150,000) 10 - (10) 697,017 697,007 Since the date of acquisition, the Company has subscribed for an additional $8,000,000 of shares in MAM, bringing its total cost of investment to $8,000,010. b) Disposal of Controlling Interest in Pengana Absolute Return Real Estate Fund On 3 October 2006, the Company disposed of its controlling interest in the Pengana Absolute Return Real Estate Fund for $18.8m. The net assets of the fund at the date of disposal comprised financial assets held for trading. The net cash inflow to the group arising from this disposal was $18.8m. 44 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 15. Financial Risk Management Objectives and Policies The Group’s principal financial instruments comprise listed shares in the Flagship Fund, and cash accounts. On 3 July 2007, the Company provided $15m and $5m of seed capital to the Magellan Global Fund and the Magellan Infrastructure Fund respectively, two unlisted unit trusts of which MAM is the Responsible Entity and Investment Manager. The Company continues to hold these investments. Market and Foreign Currency Risk The Group has direct exposure to market risk and foreign currency risk via its investment in the Flagship Fund, which is traded on the ASX, and its investments in the Magellan Global Fund and Magellan Infrastructure Fund (Unlisted Funds). The market price of the Flagship Fund shares is influenced by the fair value of the underlying investment assets it holds and by its exposure to foreign currency fluctuations. The fair value of the interests held in the Flagship Fund and the Unlisted Funds is directly related to the fair value of the underlying investments and foreign currency exposure of those funds. The investments in the Flagship Fund and the Unlisted Funds (collectively the “Funds”) will be held as long term investments. Changes in the fair value of these securities are taken to the asset revaluation reserve and thus do not affect the reported profit of the Group. The Group also has indirect exposure to the market and foreign currency risks of the Funds via its entitlements to receive investment management fees and performance fees. Investment management fees are based on the asset values of the funds and performance fees are subject to performance hurdles being met and when earned are based on the performance of the Funds. The policies adopted by the Flagship Fund to manage its market, foreign currency and other financial risks are disclosed in its 30 June 2007 Annual Report and the policies adopted by the Unlisted Funds to manage these risks are disclosed in their Product Disclosure Statements dated 23 July 2007. Credit Risk The Group’s only significant credit risk is in relation to management and any performance fees receivable from the Funds. Investment management fees from the Flagship Fund are payable quarterly and are due within two weeks of the end of each quarter. Management fees from the Unlisted Funds will be payable monthly and due within two weeks of the end of each month. Any performance fees are receivable within two weeks of year end for the Flagship Fund and within two weeks of each half year end for the Unlisted Funds. The ongoing ability of Funds to pay management fees to the Group is influenced by the market and foreign currency risks described above. The Group’s cash balances and financial assets are held with Westpac Banking Corporation Limited and National Australia Bank Limited in operating bank accounts, at call bank accounts and term deposits maturing in less than 12 months. The counterparty risk presented by these major banks is considered to be low. Interest Rate Risk The Group is exposed to interest rate risk via its cash balances, which have arisen from the capital restructure undertaken by the Group over the past year (see note 13). It is the Group’s intended to maintain cash balances in short term, floating interest accounts so that the Group is able to take advantage of suitable opportunities to develop the business as they arise. The Group’s exposure to interest rate risk and the effective weighted average interest rate for classes of financial assets and financial liabilities is set out below: Liquidity Risk The Group’s investments in the Funds are intended as long term strategic investments and there is no intention to sell any their shares or redeem any of their units in the foreseeable future. The Group has sufficient cash reserves to finance business operations and new business opportunities in the short to medium term. MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 45 Consolidated 30 June 2007 Financial assets Current Cash and cash equivalents Trade and other receivables Prepayments Other financial assets (i) Non-current Other financial assets Financial liabilities Current Trade and other payables Non-current AASB 132 Accounting provision Weighted average interest rate % Floating interest rate $’000 Non- interest bearing $’000 Total carrying amount $’000 6.2 - - 6.4 - - - 74,408 - - 405 - 1,982 64 - 74,408 1,982 64 405 74,813 2,046 76,859 - - - 24,772 24,772 5,151 5,151 30,033 30,033 (i) Other current financial assets comprise fixed term deposits provided as security for lease guarantees provided by the Group’s bank in respect of its premises leases. These deposits mature within one year of balance sheet date. The Group is currently committed to providing security in this form but intends to renegotiate these arrangements with its bank and/or lessors. Parent 30 June 2007 Financial assets Current Cash and cash equivalents Trade and other receivables Prepayments Non-current Other financial assets Loan to controlled entity Financial liabilities Current Trade and other payables Non-current AASB 132 Accounting provision 46 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 6.2 67,515 - - - - - - - - 67,515 - - - - - - 413 5 418 67,515 413 5 67,933 32,772 32,772 1,150 1,150 33,922 33,922 1,063 1,063 30,033 30,033 Consolidated 30 June 2006 Financial assets Current Cash and cash equivalents Trade and other receivables Prepayments Other financial assets Non-current Other financial assets Financial liabilities Current Trade and other payables Parent 30 June 2006 Financial assets Current Cash and cash equivalents Trade and other receivables Prepayments Non-current Trade and other receivables Financial liabilities Trade and other payables Weighted average interest rate % Floating interest rate $’000 Non- interest bearing $’000 Total carrying amount $’000 4.5 6.7 - - - - 4.5 6.7 - - 1,638 137 - - - 66 22 1,638 203 22 22,349 22,349 1,775 22,437 24,212 - - 1,569 137 - 1,706 - - 10,852 10,852 108 108 - 89 9 98 1,569 226 9 1,804 27,293 27,293 41 41 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 47 16. Key Management Personnel Key management personnel include persons and corporate entities having authority and responsibility for planning, directing and controlling activities of the Group. Details of Key Management Personnel Directors Name Directorship Appointed Resigned Hamish Douglass Chairman and Executive Director Chris Mackay Deputy Chairman and Executive Director Naomi Milgrom Non-executive Director Paul Lewis Brett Cairns Roger Davis Non-executive Director Non-executive Director Non-executive Director & Chairman Mark Beames Non-executive Director Dean Smorgon Non-executive Director Russel Pillemer Executive Director Damien Hatfield Executive Director 21 November 2006 21 November 2006 20 December 2006 20 December 2006 22 January 2007 - - - - - - - - - - 20 December 2006 21 November 2006 21 November 2006 21 November 2006 21 November 2006 In addition to the Executive Directors, the Key Management Personnel are shown below: Executives Name Directorship Nerida Campbell Chief Financial Officer and Chief Operating Officer David Simpson General Counsel and Company Secretary Darren Barkas Group Financial Controller Appointed 6 July 2007 10 November 2007 23 April 2007 Resigned - - - There were no changes of Key Management Personnel after balance date and before the date that the financial report was authorised for issue. Compensation of Key Management Personnel The Executive Directors have not been remunerated by the Group in relation to acting as Directors of the Group or, in the case of Mr Douglass, as a member of the Audit and Risk Committee. Only the Non-executive Directors of the Company were remunerated by the Company and received the following amounts during the year: Naomi Milgrom Paul Lewis Brett Cairns Roger Davis Mark Beames Dean Smorgon Short term Benefits Primary Salary $ Post-employment Benefits Superannuation $ 10,477 10,000 8,333 51,253 1,274 40,973 927 - - 2,064 37,750 1,377 Total $ 11,404 10,000 8,333 53,317 39,024 42,350 48 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS In addition to the Executive Directors, the remuneration of the Key Management Personnel is shown below: Short Term Benefits Salary $ Cash Bonus $ 200,314 133,517 31,103 200,000 110,000 20,000 Post Employment Superannuation $ 12,686 8,458 2,424 Total $ 413,000 251,975 53,527 Nerida Campbell David Simpson Darren Barkas Service Agreements Remuneration and other terms of employment for the Non-executive Directors are formalised in service agreements. The Non- executive Directors’ service agreements have no fixed term of agreement unless the Director is not re-elected by the Shareholders of the Company. The Executive Directors (Mr Mackay and Mr Douglass) do not have service agreements. All other employees have service agreements. Messrs Douglass and Mackay have a financial interest in NPH Funds which has entered into a Management Services Agreement with the Company (details on the fees payable under the Management Services Agreement are set out in note 17). There are no fixed term agreements between the Group and its employees. Employment may be terminated with three months notice by either the Group or its employees. There are no provisions for any termination payments other than for unpaid remuneration and accrued annual leave. Equity Instrument Disclosure Relating to Key Management Personnel and Related Parties Share Holdings The number of ordinary shares held in the Company at balance date are: Name Naomi Milgrom Paul Lewis Brett Cairns Hamish Douglass (i) Chris Mackay (i) (ii) Balance at 1 July 2006 Acquisitions Disposals - - - - - 6,018,000 30,000 18,661 12,645,337 20,728,698 - - - - - Balance at 30 June 2007 6,018,000 30,000 18,661 12,645,337 20,728,698 (i) Mr Douglass and Mr Mackay are directors of NPH Funds Pty Ltd (NPH Funds). NPH Funds is 40% owned by a company controlled by Hamish Douglass and 60% owned by New Privateer Holdings Limited (NPH) a company of which Chris Mackay is a director and has a 36% shareholding (approximately 55% on a fully diluted basis). NPH Funds acquired during the year and owned at 30 June 2007 12,606,006 shares in the Company. (ii) NPH acquired during the year and owned at 30 June 2007 6,696,651 shares in the Company. MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 49 Option Holdings The number of Initial Options expiring 30 June 2009 held at balance date are: Name Naomi Milgrom Paul Lewis Brett Cairns Hamish Douglass (i) Chris Mackay (i) (ii) Balance at 1 July 2006 Acquisitions Disposals - - - - - 3,001,801 3,000 1,867 6,304,535 9,992,874 - - - - - Balance at 30 June 2007 3,001,801 3,000 1,867 6,304,535 9,992,874 (i) Mr Douglass and Mr Mackay are directors of NPH Funds Pty Ltd (NPH Funds). NPH Funds is 40% owned by a company controlled by Hamish Douglass and 60% owned by New Privateer Holdings Limited (NPH) a company of which Chris Mackay is a director and has a 36% shareholding (approximately 55% on a fully diluted basis). NPH Funds acquired during the year and owned at 30 June 2007 6,300,601 Initial Options in the Company (ii) NPH acquired during the year and owned at 30 June 2007 3,069,666 Initial Options in the Company The key terms and rights attaching to the Initial Options are disclosed in note 13. 17. Transactions with Related Parties a) NPH Funds Pty Limited i) Services Fee The Company is party to a Management Services Agreement with NPH Funds under which it engages NPH Funds to provide strategic and management services. The directors of NPH Funds, Chris Mackay and Hamish Douglass, are also directors of the Company and of its controlled entity, MAM. Under the terms of this agreement, the Company pays NPH Funds a quarterly Services Fee, calculated at the rate of 0.3125% per quarter of the market capitalisation of the Company at the end of the quarter. The market capitalisation is calculated with reference to the average daily volume weighted price for the last 10 days of that quarter. The Management Services Agreement commenced on 21 November 2006 and the Company has recognised an expense of $1,412,955 in relation to the Service fee for the year ended 30 June 2007 (2006: nil). The balance owing from the Company to NPH Funds at balance sheet date in respect of this fee was $810,100. ii) Performance Fee Under the terms of the Management Services Agreement, an annual performance is payable to NPH Funds if the total return to shareholders of the Company from dividends received and share market price movements exceeds certain minimum hurdles. The initial performance fee is payable as at 30 June 2008 if the total return to Company shareholders exceeds 10% for the period from 21 November 2006 until 30 June 2008. Subsequent performance fees are receivable on an annual basis thereafter, subject to the total return to shareholders for each year ending on 30 June of that year exceeding 10%. For any period for which a performance fee is receivable, the amount of that fee will be: - 10% of the dollar value of the total return to shareholders if that total return is greater than 10% but less than 20%. -15% of the dollar value of the total return to shareholders if that total return is greater than 20%. If the average of the total return to shareholders over three consecutive periods for the purposes of calculating performance fees is less than 10%, no performance fee is receivable in respect of the third period even if the total return to shareholders for that period individually is in excess of 10%. Similarly, no performance fee is receivable for the year ended 30 June 2009 if the average total return to shareholders of that period and the initial period is less than 10%, even if the return for the year ending 30 June 2009 is greater than 10%. No performance fee has crystallised during the year ended 30 June 2007 and no expense has been recognised in the Income Statement for the year ended 30 June 2007. A contingent liability exists in respect of the performance fee that may be payable as at 30 June 2008 in respect of the performance of the Company for the period to 30 June 2007. It is not possible to reliably estimate the fee that may be payable at that date. 50 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS iii) Issue of Share Capital On 20 November 2006, the Company issued 10.5m shares and 5.25m options to NPH Funds under the recapitalisation programme. On 16 May 2007, the Company issued a further 2.1m shares and 1.0m options to NPH Funds. The shares were offered on an arms length basis on the same terms and conditions as those available to all other eligible investors. iv) Acquisition of MAM On 21 November 2006, the Company acquired 100% of the share capital of MAM from NPH Funds. Consideration paid was $10 which represented the fair value of the net assets of MAM at the date of acquisition. Details of the assets acquired are shown in note 14a. v) Repayment of Sub-ordinated Loan At the time of acquisition of MAM by the Company, MAM had a sub-ordinated loan from NPH Funds of $1,150,000. On 29 November 2006, the Company provided a new sub-ordinated loan facility to MAM and MAM repaid its loan from NPH Funds in full. Total interest of $18,958 (2006: $nil) was paid by MAM to NPH Funds in respect of the loan. Interest on the sub-ordinated loan was charged at a commercial rate. vi) Administration Services Provided to NPH Funds NPH Funds has engaged MAM to provide administration, secretarial and accounting services. During the year ended 30 June 2007, administration fee revenue of $50,000 has been earned (2006: nil). The balance owing from NPH Funds at 30 June 2007 in respect of these services was $50,000 (2006: nil). b) The Flagship Fund MAM is appointed as the investment manager of the Flagship Fund. Under the Investment Management Agreement, MAM is entitled to the following fees: i) Base Fee A quarterly fee is payable, calculated as 0.3125% of the market value of all assets held by the Flagship Fund less total debt. The total base fees earned by MAM from the Flagship Fund for the period from 12 December 2006 (date of appointment as investment manager) to 30 June 2007 were $2,567,900 (2006: $nil). The amount owing from the Flagship Fund to MAM at balance sheet date was $1,151,935 (2006: $nil). ii) Performance Fee MAM is entitled to an annual performance fee calculated as 10% of the absolute dollar value of the investment performance of the Flagship Fund (after deducting the base fee) provided that: - the total annual return in that period exceeds the return of the A$ MSCI for the same period; and - the total annual return in that period exceeds the Australian Government 10-year bond rate (measured as an average of the 10-year bond rate published in the Australian Financial Review, or similar publication, on the first day of each quarter occurring within the relevant annual period; and - the portfolio value less borrowings on the last day of the relevant annual period is more than that on the last day of the last period for a which a performance fee was paid to the Company within the last three years. No performance fee was receivable from the Flagship Fund for the initial period from 12 December 2006 to 30 June 2007 (2006: nil). c) Magellan Asset Management Limited (MAM) The Company has provided an interest-free sub-ordinated loan facility to its wholly owned subsidiary MAM. Under the terms of MAM’s Australian Financial Services Licence, the loan cannot be repaid without the prior consent of the Australian Securities and Investments Commission. The current loan agreement commenced on 29 November 2006, following the acquisition of MAM by the Company. The amount drawn down on the facility at 30 June 2007 was $1,150,000 (2006: nil). At balance date, there was also a balance of $13,473 payable to MAM in respect of expenses paid by MAM on behalf of the Company. Prior to its acquisition by the Company, MAM incurred $355,943 of expenses on behalf of the Company. These were recharged at cost to the Company. d) Magellan Financial Group Trust (the Trust) MAM paid expenses of $48,640 on behalf of the Trust during the year ended 30 June 2007 in its capacity as Investment Manager of the Trust. MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 51 As part of the winding up of the Trust the Investment Manager acquired for cash the residual receivables and liabilities of the Trust. These comprised: Insurance premiums refundable Other receivables Expenses incurred, not yet invoiced $ 6,160 1,065 (2,387) 4,838 Costs anticipated to arise in respect to completing the winding up of the Trust will be borne by MAM. e) Pengana Capital Limited Prior to 21 November 2006, Pengana Capital Limited was the appointed Investment Manager of the Trust. Pengana received management fees of $108,982 from the Company (2006: $297,901) in respect of the provision of these services. During the year, entities associated with Pengana Capital Limited acquired certain assets of the Trust. All transactions between the Trust and entities associated with the former Investment Manager were at arm’s length, and at market value on normal commercial terms and conditions. f) Aurora Funds Management Limited Aurora Funds Management Limited (Aurora) was the appointed Responsible Entity of the Trust until 29 June 2007, the date on which the Trust was wound up. In accordance with the Trust Constitution, Aurora was entitled to receive fees for the provision of services to the Trust and to be reimbursed for certain expenditure incurred in the administration of the Trust. Total fees paid to Aurora during the period ended 29 June 2007 were $57,291 (2006: $41,391). During the year ended 30 June 2007 Aurora incurred certain expenses on behalf of the Trust of $56,572 (2006: nil). These costs were reimbursed by the Trust. Disclosures relating to key management personnel are set out in note 16. 18. Contingent Liabilities and Commitments for Expenditure Capital Commitments The directors are not aware of any capital commitments as at the date of this report. Lease Commitments MAM has entered into non-cancellable operating leases for its office premises at Levels 1 and 7 at 1 Castlereagh Street Sydney and for office equipment. Commitments for minimum lease payments in relation to non-cancellable operating leases are payable as follows: Within one year Later than one year but not later than five years 2007 $’000 513 2,002 2,515 Contingent Liabilities The Company has a contingent liability in respect of a performance fee that may be payable at as 30 June 2008. Details are provided in note 17(a) (ii). The performance fee that would be payable as at 30 June 2008, in the event that if the Company’s 10 day average share price for the trading period immediately prior to 30 June 2008 was $1.55 (the 10 day average share price for 23 August 2007), is $8.9 million. 19. Segment Information The Company operates solely from Australia. It operates in one sector, being the provision of investment management services. 52 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 20. Events Subsequent to Reporting Date Seeding of Magellan Global Fund and Magellan Infrastructure Fund On 3 July 2007, the Company subscribed for $15m and $5m respectively of units in the Magellan Global Fund and Magellan Infrastructure Fund, two new unlisted investment trusts of which MAM is appointed as Responsible Entity and Investment Manager. Management Services Agreement with NPH Funds Pty Ltd There is a Management Services Agreement (MSA) between the Company and NPH Funds, details of which are set out in note 17 a). NPH Funds is 40% owned by a company controlled by Hamish Douglass, the Chairman of Magellan, and 60% owned by New Privateer Holdings Limited (NPH) an ASX listed company in which Chris Mackay, the Deputy Chairman of Magellan, has a 36% shareholding (approximately 55% on a fully diluted basis). Since the end of the financial year, Hamish Douglass and Chris Mackay have advised the Boards of the Company and NPH that they do not wish to participate in any possible performance fees that may arise under the management services agreement between the Company and NPH Funds. Messrs Douglass and Mackay will examine whether, if they do not participate in any possible performance fees that may become payable, the arrangements, between the Company, NPH Funds, NPH and themselves can be restructured to achieve an outcome that benefits the Company’s future development. 21.Auditor’s Remuneration Amounts received or due and receivable by Ernst & Young Australia for: - an audit of the financial report for the entity and any other entity in the consolidated group - non audit services in relation to the entity and any other entity in the consolidated group Consolidated Parent 2007 $’000 2006 $’000 2007 $’000 2006 $’000 112 9 121 72 - 72 77 - 77 45 - 45 MAGELLAN FINANCIAL GROUP - NOTES TO THE FINANCIAL STATEMENTS 53 DIRECTORS’ DECLARATION FOR THE YEAR ENDED 30 JUNE 2007 In accordance with a resolution of the Directors of Magellan Financial Group Limited, I state that: In the opinion of the Directors: (a) the financial statements, notes and the additional disclosures included in the Directors Report designated as audited, of the company and of the consolidated entity are in with the Corporations Act 2001, including: (i) giving a true and fair view of the financial position of the company and the consolidated entity as at 30 June 2007 and of their performance for the year ended on that date; and (ii) complying with Australian Accounting Standards and Corporations Regulations 2001; and (b) there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable. This declaration has been made after receiving the declarations required to be made to the directors in accordance with section 295A of the Corporations Act 2001 for the financial year ending 30 June 2007. On behalf of the Board Hamish Douglass Chairman Sydney 30 August 2007 54 MAGELLAN FINANCIAL GROUP - DIRECTORS’ DECLARATION MAGELLAN FINANCIAL GROUP - INDEPENDENT AUDIT REPORT 55 56 MAGELLAN FINANCIAL GROUP - INDEPENDENT AUDIT REPORT SHAREHOLDER INFORMATION AS AT 23 AUGUST 2007 Distribution of Shareholders The distribution of shareholders of the Comapny as at 23 August 2007 is presented below: Distribution Schedule of Holdings Number of Holders Number of Ordinary Shares Percentage of Shares in Issue 1-1,000 1,001-5,000 5,001-10,000 10,001-100,000 100,001 and over Total Number of holders with less than a marketable parcel Twenty Largest Shareholders 1,187 1,603 615 615 61 4,081 84 792,130 4,085,668 4,436,259 15,711,147 82,329,766 107,354,970 12,201 0.74 3.81 4.13 14.64 76.68 100.00 0.01 The distribution of shareholders of the Comapny as at 23 August 2007 is presented below: Holder Name Cavalane Holdings Pty Ltd NPH Funds Pty Ltd New Privateer Holdings Limited UBS Wealth Management Australia Nominees Pty Ltd Nota Bene Investments Pty Ltd Cogent Nominees Pty Ltd HSBC Custody Nominees (Australia) Limited Doulev Pty Ltd Pakham Investments Pty Ltd Mr David Doyle Innisfallen Investments Pty Ltd Forbar Custodians Limited Christopher John Mackay DBR Corporation Pty Ltd Merrill Lynch (Australia) Nominees Pty Ltd Perpetual Trustees Consolidated Limited Darian Investments Pty Limited Cairnton Holdings Limited Reidco Pty Ltd Emmanuel Capital Pty Ltd Total shares held by the twently largest shareholders Total shares in issue Number of Ordinary Shares Percentage of Shares in Issue 18,006,006 12,606,006 6,696,651 6,530,497 6,006,006 5,799,317 2,964,413 2,286,006 2,196,513 1,500,000 1,356,662 1,344,465 1,206,026 1,032,673 956,650 798,795 724,006 666,667 607,966 550,000 78,835,325 107,354,970 16.77 11.74 6.24 6.08 5.59 5.40 2.76 2.13 2.05 1.40 1.26 1.25 1.12 0.96 0.89 0.74 0.67 0.62 0.57 0.51 68.78 100.00 MAGELLAN FINANCIAL GROUP - SHAREHOLDER INFORMATION 57 Substantial Shareholders The names of the substantial shareholders of the Company and their holdings as at 23 August 2007 are listed below: Shareholder Chris Mackay, Hamish Douglass and Associates * Cavalane Holdings Pty Ltd (an entity controlled by Consolidated Press Holdings Ltd) Number of Ordinary Shares Percentage of Shares in Issue 20,741,363 18,006,006 19.32 16.77 * Mr Douglass and Mr Mackay are directors of NPH Funds Pty Ltd (NPH Funds). NPH Funds is 40% owned by a company controlled by Hamish Douglass and 60% owned by New Privateer Holdings Limited (NPH) a company of which Chris Mackay is a director and has a 36% shareholding (approximately 55% on a fully diluted basis). NPH Funds holds 12,606,006 shares and NPH holds 6,696,651 shares in the Company. Voting Rights Subject to the Company Constitution: a) at meetings of shareholders, each shareholder is entitled to vote in person, by proxy, by attorney or by representative; b) on a show of hands, each shareholder present in person, by proxy, by attorney or by representative is entitled to one vote; and c) on a poll, each shareholder present in person, by proxy, by attorney or by representative is entitled to one vote for every share held by the shareholder. In the case of joint holdings, only one joint holder may vote. Stock Exchange Listing The Company’s ASX code is “MFG” for its shares and “MFGOA” for its listed options. 58 MAGELLAN FINANCIAL GROUP - SHAREHOLDER INFORMATION CORPORATE DIRECTORY Directors Naomi Milgrom Paul Lewis Brett Cairns Hamish Douglass Chris Mackay Company Secretary David Simpson Auditors Ernst & Young 680 George Street Sydney NSW 2000 Registered Office Magellan Financial Group Limited ABN 59 108 437 592 Level 1, 1 Castlereagh Street Sydney NSW 2000 Telephone: +61 2 8114 1888 Email: info@magellangroup.com.au Fax: +61 2 8114 1800 MAGELLAN FINANCIAL GROUP - CORPORATE DIRECTORY 59 Design by Coredesign. 

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