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EATON VANCE CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Item includes statements that are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, intentions or strategies regarding the future. All statements, other than statements of historical facts, included in this Form 10-Q regarding our financial position, business strategy and other plans and objectives for future operations are forward-looking statements. The terms "may," "will," "could," "anticipate," "plan," "continue," "project," "intend," "estimate," "believe," "expect" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such words. Although we believe that the assumptions and expectations reflected in such forward-looking statements are reasonable, we can give no assurance that they will prove to have been correct or that we will take any actions that may now be planned. Certain important factors that could cause actual results to differ materially from our expectations are disclosed in the "Risk Factors" section of this Form 10-Q and Item 1A in our latest Annual Report on Form 10-K. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by such factors. We do not assume any obligation to update any forward-looking statements. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The discussion and analysis below should be read in conjunction with the consolidated financial statements appearing elsewhere in this report. Management has presumed that the readers of this interim financial information have read or have access to Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in our Annual Report on Form 10-K for the year ended October 31, 2013. General Our principal business is managing investment funds and providing investment management and advisory services to high-net-worth individuals and institutions. Our core strategy is to develop and sustain management expertise across a range of investment disciplines and to offer leading investment products and services through multiple distribution channels. In executing this strategy, we have developed broadly diversified investment management capabilities and a powerful marketing, distribution and customer service organization. Although we manage and distribute a wide range of investment products and services, we operate in one business segment, namely as an investment adviser to funds and separate accounts. Through our subsidiaries Eaton Vance Management ("EVM") and Atlanta Capital Management, LLC ("Atlanta Capital") and other affiliates, we manage active equity, income and alternative strategies across a range of investment styles and asset classes, including U.S. and global equities, floating-rate bank loans, municipal bonds, global income, high-yield and investment grade bonds. Through our subsidiary Parametric Portfolio Associates LLC ("Parametric"), we manage a range of engineered alpha strategies, including systematic equity, systematic alternatives and managed options strategies, and provide portfolio implementation services, including tax-managed core and specialty index strategies, futures- and options-based portfolio overlay, and centralized portfolio management of multi-manager portfolios. We also oversee the management of investment funds sub-advised by third-party managers, including global, regional and sector equity, commodity and asset allocation strategies. Our breadth of investment management capabilities supports a wide range of products and services offered to fund shareholders, retail managed account investors, institutional investors and high-net-worth clients. Our equity strategies encompass a diversity of investment objectives, risk profiles, income levels and geographic representation. Our income investment strategies cover a broad duration and credit quality range and encompass both taxable and tax-free investments. We also offer a range of alternative investment strategies, including commodity- and currency-based investments and a spectrum of absolute return strategies. As of July 31, 2014, we had $288.2 billion in consolidated assets under management. 42 Our principal retail marketing strategy is to distribute funds and separately managed accounts through financial intermediaries in the advice channel. We have a broad reach in this marketplace, with distribution partners including national and regional broker-dealers, independent broker-dealers, independent financial advisory firms, banks and insurance companies. We support these distribution partners with a team of approximately 135 sales professionals covering U.S.and international markets. We also commit significant resources to serving institutional and high-net-worth clients who access investment management services on a direct basis. Through our wholly owned affiliates and consolidated subsidiaries we manage investments for a broad range of clients in the institutional and high-net-worth marketplace in the U.S. and internationally, including corporations, sovereign wealth funds, endowments, foundations, family offices and public and private employee retirement plans. Our revenue is derived primarily from investment advisory, administrative, distribution and service fees received from Eaton Vance funds and investment advisory fees received from separate accounts. Our fees are based primarily on the value of the investment portfolios we manage and fluctuate with changes in the total value and mix of assets under management. As a matter of course, investors in our sponsored open-end funds and separate accounts have the ability to redeem their investments at any time, without prior notice, and there are no material restrictions that would prevent them from doing so. Our major expenses are employee compensation, distribution-related expenses, facilities expense and information technology expense. Our discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to goodwill and intangible assets, income taxes, investments and stock-based compensation. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under current circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates. Business Developments Prevailing equity and income market conditions and investor sentiment affect the sales and redemptions of our investment products, managed asset levels, operating results and the recoverability of our investments. During the third quarter and first nine months of our fiscal year, the S&P 500 Index, a broad measure of U.S. equity market performance, had total returns of 3.0% and 11.6%, respectively. Over the same periods, the Barclays U.S. Aggregate Bond Index, a broad measure of U.S. bond market performance, had total returns of 0.9% and 2.7%, respectively. Our ending consolidated assets under management increased by $2.3 billion, or 1 percent, in the third quarter to $288.2 billion on July 31, 2014, reflecting market appreciation partially offset by net outflows. Net outflows for the third quarter were concentrated in floating-rate income, high yield and large-cap value equity mandates. Average consolidated assets under management increased from the prior quarter by 2 percent, or $4.9 billion, to $289.3 billion in the third quarter. The primary drivers of our overall and investment advisory effective fee rates are the mix of our assets by product structure, distribution channel and investment mandate, and the timing and amount of performance fees recognized. Shifts in managed assets among product structures, distribution channels and investment mandates with differing fee schedules can alter the total effective fee rate earned on our assets under management. Our overall average effective fee rate decreased to 51 basis points and 50 basis points in the third quarter and first nine months of fiscal 2014, respectively, from 53 basis points and 54 basis points in the third quarter and first nine months of fiscal 2013, respectively. Our average effective investment advisory and administrativefee rate 43 similarly decreased to 43 basis points in both the third quarter and first nine months of fiscal 2014, from 44 basis points and 46 basis points in the third quarter and first nine months of last year, respectively. Consolidated Assets under Management Consolidated assets under management of $288.2 billion on July 31, 2014 increased $19.4 billion, or 7 percent, from the $268.8 billion reported a year earlier. Consolidated assets under management on July 31, 2014 included $135.0 billion in long-term funds, $98.4 billion in institutional separate accounts, $20.9 billion in high-net-worth separate accounts, $33.8 billion in retail managed accounts and $0.2 billion in cash management fund assets. Long-term fund net outflows of $0.1 billion over the last twelve months reflect gross inflows of $37.8 billion offset by outflows of $37.9 billion. Institutional separate account net inflows were $1.0 billion and high-net-worth separate account net outflows were $1.0 billion over the past twelve months. Retail managed account inflows of $7.4 billion were offset by $7.4 billion of outflows over the past twelve months. Net market appreciation in managed assets increased assets under management by $19.6 billion over the last twelve months. We report managed assets and flow data by investment mandate. The "Alternative" category includes a range of absolute return strategies, as well as commodity- and currency-linked investments. The "Implementation Services" category includes Parametric's tax-managed core, centralized portfolio management and specialty index business lines, as well as their futures- and options-based overlay and exposure management services. Consolidated Assets under Management by Investment Mandate (1)(2) July 31, % (in millions) 2014 % of Total 2013 % of Total Change Equity(3) $ 96,054 33 % $ 90,774 34 % 6 % Fixed income(4) 44,287 16 % 45,821 17 % -3 % Floating-rate income 43,752 15 % 38,170 14 % 15 % Alternative 11,691 4 % 16,098 6 % -27 % Implementation services 92,223 32 % 77,673 29 % 19 % Cash management funds 187 0 % 219 0 % -15 % Total $ 288,194 100 % $ 268,755 100 % 7 % (1)Consolidated Eaton Vance Corp. See table on page 49 for managed assets and flows of 49 percent-owned Hexavest Inc. (2)Assets under management for which we estimate fair value using significant unobservable inputs are not material to the total value of the assets we manage. (3)Includes assets in balanced accounts holding income securities. (4)Includes assets in institutional cash management separate accounts. Equity and implementation services assets under management included $63.9 billion and $61.7 billion of assets managed for after-tax returns on July 31, 2014 and 2013, respectively. Fixed income assets included $26.2 billion and $26.7 billion of tax-exempt municipal bond assets on July 31, 2014 and 2013, respectively. Net outflows for long-term funds and separate accounts totaled $2.0 billion in the third quarter of fiscal 2014 compared to net inflows of $8.8 billion in the third quarter of fiscal 2013. Long-term funds net outflows were $1.6 billion in the third quarter of fiscal 2014, reflecting gross inflows of $8.6 billion and redemptions of $10.2 billion. Net flows into long-term funds totaled $3.7 billion in the third quarter of fiscal 2013, reflecting gross inflows of $11.6 billion and redemptions of $7.9 billion. 44 Separate account net outflows totaled $0.4 billion in the third quarter of fiscal 2014 compared to net inflows of $5.2 billion in the third quarter of fiscal 2013. The following tables summarize our consolidated assets under management and asset flows by investment mandate and investment vehicle for the three and nine months ended July 31, 2014 and 2013: 45 Consolidated Net Flows by Investment Mandate(1) Three Months Ended Nine Months Ended July 31, % July 31, % (in millions) 2014 2013 Change 2014 2013 Change Equity assets - beginning of period(2) $ 93,733 $ 89,534 5 % $ 93,585 $ 80,782 16 % Sales and other inflows 3,465 4,056 -15 % 10,920 13,823 -21 % Redemptions/outflows (4,129 ) (4,185 ) -1 % (14,766 ) (14,135 ) 4 % Net flows (664 ) (129 ) 415 % (3,846 ) (312 ) NM (3) Assets acquired(4) - - - - 1,572 NM Exchanges 468 46 917 % 1,000 162 517 % Market value change 2,517 1,323 90 % 5,315 8,570 -38 %Equity assets - end of period $ 96,054 $ 90,774 6 % $ 96,054 $ 90,774 6 % Fixed income assets - beginning of period(5) 43,917 49,949 -12 % 44,211 49,003 -10 % Sales and other inflows 3,344 2,065 62 % 8,420 8,732 -4 % Redemptions/outflows (3,299 ) (3,595 ) -8 % (9,336 ) (10,318 ) -10 % Net flows 45 (1,530 ) NM (916 ) (1,586 ) -42 % Assets acquired(4) - - - - 472 NM Exchanges 59 (277 ) NM 23 (358 ) NM Market value change 266 (2,321 ) NM 969 (1,710 ) NM Fixed income assets - end of period $ 44,287 $ 45,821 -3 % $ 44,287 $ 45,821 -3 % Floating-rate income assets - beginning of period 45,115 33,679 34 % 41,821 26,388 58 % Sales and other inflows 4,139 6,636 -38 % 13,094 15,987 -18 % Redemptions/outflows (5,491 ) (2,152 ) 155 % (11,037 ) (4,664 ) 137 % Net flows (1,352 ) 4,484 NM 2,057 11,323 -82 % Exchanges (62 ) 169 NM (57 ) 251 NMMarket value change 51 (162 ) NM (69 ) 208 NM Floating-rate income assets - end of period $ 43,752 $ 38,170 15 % $ 43,752 $ 38,170 15 % Alternative assets - beginning of period 12,112 16,022 -24 % 15,212 12,864 18 % Sales and other inflows 774 2,348 -67 % 2,630 6,925 -62 % Redemptions/outflows (1,208 ) (1,770 ) -32 % (6,164 ) (3,785 ) 63 % Net flows (434 ) 578 NM (3,534 ) 3,140 NM Assets acquired(4) - - - - 650 NM Exchanges (15 ) (22 ) -32 % (84 ) (138 ) -39 % Market value change 28 (480 ) NM 97 (418 ) NM Alternative assets - end of period $ 11,691 $ 16,098 -27 % $ 11,691 $ 16,098 -27 % Implementation services assets - beginning of period 90,815 70,966 28 % 85,637 30,302 183 % Sales and other inflows 14,429 12,933 12 % 43,399 26,663 63 % Redemptions/outflows (14,053 ) (7,504 ) 87 % (41,168 ) (18,396 ) 124 % Net flows 376 5,429 -93 % 2,231 8,267 -73 % Assets acquired(4) - - - - 32,064 NM Exchanges (456 ) - NM (913 ) (14 ) NM Market value change 1,488 1,278 16 % 5,268 7,054 -25 % Implementation services assets - end of period $ 92,223 $ 77,673 19 % $ 92,223 $ 77,673 19 % Total long-term fund and separate account assets - beginning of period 285,692 260,150 10 % 280,466 199,339 41 % Sales and other inflows 26,151 28,038 -7 % 78,463 72,130 9 % Redemptions/outflows (28,180 ) (19,206 ) 47 % (82,471 ) (51,298 ) 61 % Net flows (2,029 ) 8,832 NM (4,008 ) 20,832 NM Assets acquired(4) - - - - 34,758 NM Exchanges (6 ) (84 ) -93 % (31 ) (97 ) -68 % Market value change 4,350 (362 ) NM 11,580 13,704 -15 % Total long-term fund and separate account assets - end of period $ 288,007 $ 268,536 7 % $ 288,007 $ 268,536 7 % Cash management fund assets - end of period 187 219 -15 % 187 219 -15 % Total assets under management - end of period $ 288,194 $ 268,755 7 % $ 288,194 $ 268,755 7 % (1) Consolidated Eaton Vance Corp. See table on page 49 for managed assets and flows of 49 percent-owned Hexavest Inc. (2) Includes assets in balanced accounts holding income securities. (3) Not meaningful ("NM"). (4) Represents assets gained in the acquisition of The Clifton Group Investment Management Company on December 31, 2012. (5) Includes assets in institutional cash management separate accounts. 46 Consolidated Net Flows by Investment Vehicle(1) Three Months Ended Nine Months Ended July 31, % July 31, % (in millions) 2014 2013 Change 2014 2013 Change Long-term fund assets - beginning of period $ 134,942 $ 127,014 6 % $ 133,198 $ 113,249 18 % Sales and other inflows 8,634 11,597 -26 % 27,551 33,307 -17 % Redemptions/outflows (10,272 ) (7,932 ) 30 % (29,284 ) (21,316 ) 37 % Net flows (1,638 ) 3,665 NM (1,733 ) 11,991 NM Assets acquired(2) - - - - 638 NM Exchanges (6 ) (241 ) -98 % 41 (262 ) NM Market value change 1,671 (1,396 ) NM 3,463 3,426 1 % Long-term fund assets - end of period $ 134,969 $ 129,042 5 % $ 134,969 $ 129,042 5 % Institutional separate account assets - beginning of period(3) 96,564 84,724 14 % 95,724 43,338 121 % Sales and other inflows 14,717 13,480 9 % 42,620 28,366 50 % Redemptions/outflows (14,912 ) (8,901 ) 68 % (44,632 ) (21,792 ) 105 % Net flows (195 ) 4,579 NM (2,012 ) 6,574 NM Assets acquired(2) - - - - 34,120 NM Exchanges 377 152 148 % 280 157 78 % Market value change 1,647 18 NM 4,401 5,284 -17 % Institutional separate account assets - end of period $ 98,393 $ 89,473 10 % $ 98,393 $ 89,473 10 % High-net-worth separate account assets - beginning of period 20,968 18,027 16 % 19,699 15,036 31 % Sales and other inflows 794 1,055 -25 % 2,476 3,931 -37 % Redemptions/outflows (953 ) (614 ) 55 % (3,045 ) (2,385 ) 28 % Net flows (159 ) 441 NM (569 ) 1,546 NM Exchanges (433 ) (9 ) NM (30 ) (16 ) 88 % Market value change 475 612 -22 % 1,751 2,505 -30 % High-net-worth separateaccount assets - end of period $ 20,851 $ 19,071 9 % $ 20,851 $ 19,071 9 % Retail managed account assets - beginning of period 33,218 30,385 9 % 31,845 27,716 15 % Sales and other inflows 2,006 1,906 5 % 5,816 6,526 -11 % Redemptions/outflows (2,043 ) (1,759 ) 16 % (5,510 ) (5,805 ) -5 % Net flows (37 ) 147 NM 306 721 -58 % Exchanges 56 14 300 % (322 ) 24 NM Market value change 557 404 38 % 1,965 2,489 -21 % Retail managed account assets - end of period $ 33,794 $ 30,950 9 % $ 33,794 $ 30,950 9 % Total long-term fund and separate account assets - beginning of period 285,692 260,150 10 % 280,466 199,339 41 % Sales and other inflows 26,151 28,038 -7 % 78,463 72,130 9 % Redemptions/outflows (28,180 ) (19,206 ) 47 % (82,471 ) (51,298 ) 61 % Net flows (2,029 ) 8,832 NM (4,008 ) 20,832 NM Assets acquired(2) - - - - 34,758 NM Exchanges (6 ) (84 ) -93 % (31 ) (97 ) -68 % Market value change 4,350 (362 ) NM 11,580 13,704 -15 % Total long-term fund and separate account assets - end of period $ 288,007 $ 268,536 7 % $ 288,007 $ 268,536 7 % Cash management fund assets - end of period 187 219 -15 % 187 219 -15 % Total assets under management - end of period $ 288,194 $ 268,755 7 % $ 288,194 $ 268,755 7 % (1) Consolidated Eaton Vance Corp. See page 49 for managed assets and flows of 49 percent-owned Hexavest Inc. (2) Represents assets gained in the acquisition of The Clifton Group Investment Management Company on December 31, 2012. (3) Includes assets in institutional cash management separate accounts. 47 The following table summarizes our assets under management by investment affiliate as of July 31, 2014 and 2013: Consolidated Assets under Management by Investment Affiliate (1) July 31, % (in millions) 2014 2013 Change Eaton Vance Management (2) $ 143,337 $ 143,229 0 % Parametric 126,777 107,192 18 % Atlanta Capital 18,080 18,334 -1 % Total $ 288,194 $ 268,755 7 % (1) Consolidated Eaton Vance Corp. See page 49 for managed assets and flows of 49 percent-owned Hexavest Inc. (2) Includes managed assets of wholly owned subsidiaries Eaton Vance Investment Counsel and Fox Asset Management LLC, as well as certain Eaton Vance-sponsored funds and accounts managed by Hexavest and unaffiliated third-party advisors under Eaton Vance supervision. As of July 31, 2014, 49 percent-owned affiliate Hexavest Inc. ("Hexavest") managed $17.0 billion of client assets, an increase of 8 percent from the $15.7 billion of managed assets on July 31, 2013. Other than Eaton Vance-sponsored funds for which Hexavest is adviser or sub-adviser, the managed assets of Hexavest are not included in Eaton Vance consolidated totals. The following table summarizes assets under management and asset flow information for Hexavest for the three and nine months ended July 31, 2014 and 2013: 48 Hexavest Assets under Management and Net Flows Three Months Ended Nine Months Ended July 31, % July 31, % (in millions) 2014 2013 Change 2014 2013 Change Eaton Vance distributed: Eaton Vance sponsored funds - beginning of period(1) $ 221 $ 161 37 % $ 211 $ 37 470 % Sales and other inflows 6 19 -68 % 49 130 -62 % Redemptions/outflows (10 ) (6 ) 67 % (53 ) (12 ) 342 % Net flows (4 ) 13 NM (4 ) 118 NM Market value change 4 (1 ) NM 14 18 -22 % Eaton Vance sponsored funds - end of period $ 221 $ 173 28 % $ 221 $ 173 28 % Eaton Vance distributed separate accounts - beginning of period(2) 2,354 1,283 83 % 1,574 - NM Sales and other inflows 136 227 -40 % 519 1,378 -62 % Redemptions/outflows (122 ) (1 ) NM (201 ) (1 ) NM Net flows 14 226 -94 % 318 1,377 -77 % Exchanges - - - 389 - NM Market value change 29 6 383 % 116 138 -16 % Eaton Vance distributed separate accounts - end of period $ 2,397 $ 1,515 58 % $ 2,397 $ 1,515 58 % Total Eaton Vance distributed - beginning of period 2,575 1,444 78 % 1,785 37 NM Sales and other inflows 142 246 -42 % 568 1,508 -62 % Redemptions/outflows (132 ) (7 ) NM (254 ) (13 ) NM Net flows 10 239 -96 % 314 1,495 -79 % Exchanges - - - 389 - NM Market value change 33 5 560 % 130 156 -17 % Total Eaton Vance distributed - end of period $ 2,618 $ 1,688 55 % $ 2,618 $ 1,688 55 % Hexavest directly distributed - beginning of period(3) 14,477 13,831 5 % 15,136 12,073 25 % Sales and other inflows 597 785 -24 % 1,392 2,003 -31 % Redemptions/outflows (904 ) (530 ) 71 % (2,546 ) (1,363 ) 87 % Net flows (307 ) 255 NM (1,154 ) 640 NM Exchanges - - - (389 ) - NM Market value change 253 (40 ) NM 830 1,333 -38 % Hexavest directly distributed - end of period $ 14,423 $ 14,046 3 % $ 14,423 $ 14,046 3 % Total Hexavest assets - beginning of period 17,052 15,275 12 % 16,921 12,110 40 % Sales and other inflows 739 1,031 -28 % 1,960 3,511 -44 % Redemptions/outflows (1,036 ) (537 ) 93 % (2,800 ) (1,376 ) 103 % Net flows (297 ) 494 NM (840 ) 2,135 NM Market value change 286 (35 ) NM 960 1,489 -36 % Total Hexavest assets - end of period $ 17,041 $ 15,734 8 % $ 17,041 $ 15,734 8 % (1) Managed assets and flows of Eaton Vance-sponsored pooled investment vehicles for which Hexavest is adviser or sub-adviser. Eaton Vance receives management and/or distribution revenue on these assets, which are included in the Eaton Vance consolidated results. (2) Managed assets and flows of Eaton Vance-distributed separate accounts managed by Hexavest. Eaton Vance receives distribution revenue, but not investment advisory fees, on these assets, which are not included in the Eaton Vance consolidated results. (3) Managed assets and flows of pre-transaction Hexavest clients and post-transaction Hexavest clients in Canada. Eaton Vance receives no investment advisory or distribution revenue on these assets, which are not included in the Eaton Vance consolidated results. 49 Consolidated Ending Assets under Management by Asset Class(1) July 31, % of % of % (in millions) 2014 Total 2013 Total Change Open-end funds: Class A $ 28,644 10 % $ 29,628 11 % -3 % Class B 529 0 % 707 0 % -25 % Class C 9,567 3 % 9,839 4 % -3 % Class I 41,613 14 % 40,614 15 % 2 % Class N 1,904 1 % 2,076 1 % -8 % Class R 428 0 % 345 0 % 24 % Other 1,918 1 % 1,036 0 % 85 % Total open-end funds 84,603 29 % 84,245 31 % 0 % Private funds(2) 25,173 9 % 20,736 8 % 21 % Closed-end funds 25,380 9 % 24,280 9 % 5 % Total fund assets 135,156 47 % 129,261 48 % 5 %Institutional account assets(3) 98,393 34 % 89,473 33 % 10 % High-net-worth account assets 20,851 7 % 19,071 7 % 9 % Retail managed account assets 33,794 12 % 30,950 12 % 9 % Total separate account assets 153,038 53 % 139,494 52 % 10 % Total $ 288,194 100 % $ 268,755 100 % 7 % (1) Consolidated Eaton Vance Corp. See page 49 for directly managed assets and flows of 49 percent-owned Hexavest Inc. (2) Includes privately offered equity, fixed income and floating-rate bank loan funds and CLO entities. (3) Includes assets in institutional cash management separate accounts. Fund assets under management increased $1.8 billion, or 1 percent, from $133.4 billion on October 31, 2013, reflecting market price appreciation of $3.5 billion offset by net outflows of $1.7 billion. Separate account assets under management increased $5.8 billion, or 4 percent, from $147.3 billion on October 31, 2013, reflecting market appreciation of $8.1 billion offset by net outflows of $2.3 billion. Consolidated average assets under management presented in the following table represent a monthly average by asset class. This table is intended to provide information useful in the analysis of our asset-based revenue and distribution expenses. Separate account investment advisory fees are generally calculated as a percentage of either beginning, average or ending quarterly assets. Fund investment advisory, administrative, distribution and service fees, as well as certain expenses, are generally calculated as a percentage of average dailyassets. 50 Consolidated Average Assets under Management by Asset Class(1) Three Months Ended Nine Months Ended July 31, % July 31, % (in millions) 2014 2013 Change 2014 2013 Change Open-end funds: Class A $ 29,470 $ 29,760 -1 % $ 29,753 $ 29,511 1 % Class B 551 775 -29 % 595 857 -31 % Class C 9,650 9,935 -3 % 9,698 9,844 -1 % Class I 42,023 39,512 6 % 42,167 35,706 18 % Class N 1,951 1,982 -2 % 2,086 1,783 17 % Class R 424 336 26 % 403 321 26 % Other 1,955 981 99 % 1,728 806 114 % Total open-end funds 86,024 83,281 3 % 86,430 78,828 10 % Private funds(2) 24,230 20,321 19 % 23,008 19,361 19 % Closed-end funds 25,575 24,225 6 % 25,353 23,810 6 % Total fund assets 135,829 127,827 6 % 134,791 121,999 10 %Institutional account assets(3) 98,615 86,845 14 % 97,716 75,908 29 % High-net-worth account assets 21,029 18,497 14 % 20,354 17,063 19 % Retail managed account assets 33,845 30,548 11 % 33,106 29,333 13 % Total separate account assets 153,489 135,890 13 % 151,176 122,304 24 % Total $ 289,318 $ 263,717 10 % $ 285,967 $ 244,303 17 % (1) Assets under management attributable to acquisitions that closed during the relevant periods are included on a weighted average basis for the period from their respective closing dates. (2) Includes privately offered equity, fixed income and floating-rate bank loan funds and CLO entities. (3) Includes assets in institutional cash management separate accounts. Results of Operations In evaluating operating performance, we consider net income attributable to Eaton Vance Corp. shareholders and earnings per diluted share, which are calculated on a basis consistent with U.S. GAAP, as well as adjusted net income attributable to Eaton Vance Corp. shareholders and adjusted earnings per diluted share, both of which are internally derived non-U.S. GAAP performance measures. We define adjusted net income attributable to Eaton Vance Corp. shareholders and adjusted earnings per diluted share as net income attributable to Eaton Vance Corp. shareholders and earnings per diluted share, respectively, adjusted to exclude changes in the estimated redemption value of non-controlling interests redeemable at other than fair value ("non-controlling interest value adjustments"), closed-end fund structuring fees and other items management deems non-recurring (such as the impact of special dividends, costs associated with the extinguishment of debt and tax settlements) or non-operating in nature. Adjusted net income attributable to Eaton Vance Corp. shareholders and adjusted earnings per diluted share should not be construed to be a substitute for, or superior to, net income attributable to Eaton Vance Corp. shareholders and earnings per diluted share computed in accordance with U.S. GAAP. We provide disclosures of adjusted net income attributable to Eaton Vance Corp. shareholders and adjusted earnings per diluted share to reflect the fact that our management 51 and Board of Directors consider these adjusted numbers a measure of the Company's underlying operating performance. The following table provides a reconciliation of net income attributable to Eaton Vance Corp. shareholders and earnings per diluted share to adjusted net income attributable to Eaton Vance Corp. shareholders and adjusted earnings per diluted share, respectively, for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands, except per share data) 2014 2013 Change 2014 2013 Change Net income attributable to Eaton Vance Corp. shareholders $ 77,935 $ 23,203 236 % $ 224,194 $ 136,689 64 % Non-controlling interest value adjustments(1) (59 ) 405 NM 2,330 11,718 -80 % Closed-end fund structuring fees, net of tax(2) - 1,043 NM - 2,720 NM Loss on extinguishment of debt, net of tax(3) - 35,171 NM - 35,171 NM Settlement of state tax audit(4) - 6,691 NM - 6,691 NM Adjusted net income attributable to Eaton Vance Corp. shareholders $ 77,876 $ 66,513 17 % $ 226,524 $ 192,989 17 % Earnings per diluted share $ 0.63 $ 0.18 250 % $ 1.78 $ 1.07 66 % Non-controlling interest value adjustments - - - 0.02 0.09 -78 % Closed-end fund structuring fees, net of tax - 0.01 NM - 0.02 NM Loss on extinguishment of debt, net of tax - 0.28 NM - 0.28 NM Settlement of state tax audit - 0.05 NM - 0.05 NM Special dividend adjustment(5) - - - - 0.02 NM Adjusted earnings per diluted share $ 0.63 $ 0.52 21 % $ 1.80 $ 1.53 18 % (1) Please see page 61, "Net Income Attributable to Non-controlling and Other Beneficial Interests," for a further discussion of the non-controlling interest value adjustments referenced above. (2) Closed-end fund structuring fees, net of tax, associated with the initial public offering of Eaton Vance Municipal Income Term Trust and Eaton Vance Floating-Rate Income Plus Fund in fiscal 2013. (3) Reflects the loss on the Company's retirement of $250 million of its outstanding Senior Notes due in 2017. The loss on extinguishment of debt, net of tax, comprises the make-whole provision, acceleration of deferred financing costs and discounts tied to the original issuance, transaction costs associated with the tender offer, the loss recognized on a reverse treasury lock entered into in conjunction with the debt retirement and accelerated amortization of a treasury rate lock tied to the original debt. (4) Please see page 60 "Income Taxes" for further discussion of the tax settlement adjustment referenced above. (5) Reflects the impact of the special dividend paid in the first quarter of fiscal 2013 due to the disproportionate allocation of distributions in excess of earnings to common shareholders under the two-class method. We reported net income attributable to Eaton Vance Corp. shareholders of $77.9 million, or $0.63 per diluted share, in the third quarter of fiscal 2014 compared to net income attributable to Eaton Vance Corp. shareholders of $23.2 million, or $0.18 per diluted share, in the third quarter of fiscal 2013. We reported adjusted net income attributable to Eaton Vance Corp. shareholders of $77.9 million, or $0.63 per diluted share, in the third quarter of fiscal 2014 compared to adjusted net income attributable to Eaton Vance Corp. shareholders of $66.5 million, 52 or $0.52 per diluted share, in the third quarter of fiscal 2013. The change in net income attributable to Eaton Vance Corp. shareholders for the third quarter of fiscal 2014 compared to the third quarter of fiscal 2013 can be primarily attributed to the following: · An increase in revenue of $17.2 million, or 5 percent, primarily due to a 10 percent increase in average assets under management, offset by a decrease in our annualized effective fee rate to 51 basis points from 53 basis points due to a shift in asset mix. · An increase in expenses of $4.9 million, or 2 percent, reflecting increases in compensation, service fee expense, fund-related expenses and other operating expenses, offset by reduced amortization of deferred sales commissions. · A $10.9 million positive change in gains (losses) and other investment income, net, primarily due to an increase in other investment income and net investment gains recognized on our seed capital portfolio. · A decrease of $1.7 million in interest expense, reflecting the retirement of $250 million of our 2017 Senior Notesand the contemporaneous issuance of $325 million of 3.625 percent Senior Notes due 2023 ("2023 Senior Notes") in the third quarter of fiscal 2013. · The non-recurrence of a $52.9 million loss on extinguishment of debt related to the retirement of the 2017 Senior Notes referenced above. · A $0.9 million improvement in income (expense) of the Company's consolidated collateralized loan obligation ("CLO") entities, primarily reflecting a decrease in interest expense. · An increase in income taxes of $23.8 million, or 95 percent, reflecting an increase in the Company's income before taxes offset by a $6.7 million tax adjustment related to the settlement of a state tax audit during the third quarter of fiscal 2013. Consolidated CLO entity income that is allocated to other beneficial interest holders is not subject to tax in the Company's provision. · An increase in equity in net income of affiliates, net of tax, of $1.2 million, primarily reflecting an increase in the Company's proportionate net interest of sponsored funds accounted for under the equity method. · A $1.5 million increase in net income attributable to non-controlling and other beneficial interest holders, primarily reflecting an increase in net income attributable to non-controlling interest holders of the Company's CLO entities. Weighted average diluted shares outstanding decreased by 2.9 million shares, or 2 percent, from the third quarter of fiscal 2013. The change reflects the impact of share repurchases and a decrease in the dilutive effect of in-the-money options. We reported net income attributable to Eaton Vance Corp. shareholders of $224.2 million, or $1.78 per diluted share, in the first nine months of fiscal 2014 compared to net income attributable to Eaton Vance Corp. shareholders of $136.7 million, or $1.07 per diluted share, in the first nine months of fiscal 2013. We reported adjusted net income attributable to Eaton Vance Corp. shareholders of $226.5 million, or $1.80 adjusted earnings per diluted share, in the first nine months of fiscal 2014 compared to adjusted net income attributable to Eaton Vance Corp. shareholders of $193.0 million, or $1.53 adjusted earnings per diluted share, in the first nine months of fiscal 2013. The change in net income attributable to Eaton Vance Corp. shareholders for the first nine months of fiscal 2014 compared to the first nine months of fiscal 2013 can be primarily attributed to the following: · An increase in revenue of $81.3 million, or 8 percent, primarily due to a 17 percent increase in average assets under management, offset by a decrease in our annualized effective fee rate to 50 basis points from 54 basis points. The decrease in our effective fee rate reflects a change in asset mix, largely due to the Clifton acquisition in December 2012. · An increase in expenses of $28.3 million, or 4 percent, reflecting increases in compensation, distribution and service fee expenses, fund-related expenses and other operating expenses offset by reduced amortization of deferred sales commissions. 53 · A positive change of $0.4 million in gains (losses) and other investment income, net, primarily due to an increasein investment income recognized on our seed capital investments. · A $4.1 million decrease in interest expense, reflecting the retirement of $250 million of our 2017 Senior Notes and the contemporaneous issuance of $325 million of 3.625 percent 2023 Senior Notes in the third quarter of fiscal 2013. · The non-recurrence of a $52.9 million loss on extinguishment of debt related to the costs incurred upon retirement of the 2017 Senior Notes referenced above. · A $3.8 million improvement in income (expense) of the Company's consolidated CLO entities, which can be attributed to an increase in gains and other income, net, offset by an increase in interest and other expenses. · An increase in income taxes of $39.5 million, reflecting an increase in the Company's income before taxes offset by a $6.7 million tax adjustment related to the settlement of a state tax audit during the third quarter of fiscal 2013. · An increase in equity in net income of affiliates, net of tax, of $3.1 million, reflecting an increase in the Company's proportionate net interest in earnings of sponsored funds accounted for under the equity method. · A decrease in net income attributable to non-controlling and other beneficial interest holders of $9.8 million, primarily reflecting a decrease in the annual adjustment made to the estimated redemption value of non-controlling interests in the Company's majority-owned subsidiaries and a decrease in net income attributable to non-controlling interest holders in the Company's consolidated funds. Revenue Our overall average effective fee rate (total revenue, excluding other revenue, as a percentage of average assets under management) was 51 basis points and 50 basis points in the third quarter and first nine months of fiscal 2014, respectively, compared to 53 basis points and 54 basis points in the third quarter and first nine months of fiscal 2013, respectively. As noted above, the decrease in our overall average effective fee rate can be primarily attributed to the impact of lower fee implementation services mandates and the corresponding increase in implementation services assets as a result of the acquisition of Clifton. The following table shows our investment advisory and administrative fees, distribution and underwriter fees, service fees and other revenue for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 Change Investment advisory and administrative fees $ 311,756 $ 293,589 6 % $ 916,605 $ 833,791 10 % Distribution and underwriter fees 21,548 22,681 -5 % 64,381 67,597 -5 % Service fees 31,977 32,259 -1 % 95,097 94,521 1 % Other revenue 2,309 1,832 26 % 5,829 4,661 25 % Total revenue $ 367,590 $ 350,361 5 % $ 1,081,912 $ 1,000,570 8 % Investment advisory and administrative fees Investment advisory and administrative fees represented 85 percent of total revenue in the third quarter and first nine months of fiscal 2014, compared to 84 percent and 83 of total revenue in the third quarter and first nine months of fiscal 2013, respectively. 54 The increase in investment advisory and administrative fees in the third quarter and first nine months of fiscal 2014 from the same periods a year earlier reflects a 10 percent and 17 percent increase in average assets under management, respectively, offset by a decline in our effective fee rates. The decline in our effective investment advisory and administrative fee rate to 43 basis points in the third quarter and first nine months of fiscal 2014 from 44 basis points and 46 basis points in the third quarter and first nine months of fiscal 2013, respectively, can be primarily attributed to the impact of a shift in product mix from higher fee to lower fee mandates. Performance fees totaled $0.9 million in both the third quarter of fiscal 2014 and 2013. Performance fees totaled $2.0 million and $1.0 million in the first nine months of fiscal 2014 and fiscal 2013, respectively. Distribution and underwriter fees The following table shows the total distribution payments with respect to our Class A, Class B, Class C, Class N, Class R and private equity funds for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 Change Class A $ 343 $ 308 11 % $ 995 $ 778 28 % Class B 869 1,256 -31 % 2,797 4,210 -34 % Class C 17,113 17,633 -3 % 50,831 51,890 -2 % Class N 71 50 42 % 212 71 199 % Class R 269 213 26 % 754 599 26 % Private funds 954 890 7 % 2,898 2,720 7 %Total distribution plan payments $ 19,619 $ 20,350 -4 % $ 58,487 $ 60,268 -3 % The decrease in distribution plan payments in the third quarter and first nine months of fiscal 2014 from the same periods a year earlier reflects decreases in average Class B and Class C distribution fees, offset by increases in average Class A, Class N, Class R and private fund distribution fees. Underwriter fees and other distribution income were $1.9 million in the third quarter of fiscal 2014, a decrease of 17 percent, or $0.4 million, from the third quarter of fiscal 2013, primarily reflecting a decrease of $0.2 million in underwriter fees received on sales of Class A shares and a decrease of $0.2 million in contingent deferred sales charges received on certain Class A share redemptions. Underwriter fees and other distribution income were $5.9 million in the first nine months of fiscal 2014, a decrease of 20 percent, or $1.4 million, from the same period a year earlier, primarily reflecting a decrease of $1.2 million in underwriter fees received on sales of Class A shares and a decrease of $0.3 million in contingent deferred sales charges received on certain Class A share redemptions. Service fees Service fee revenue decreased 1 percent, or $0.3 million, to $32.0 million in the third quarter of fiscal 2014 from the same period a year earlier, primarily reflecting a decrease in average assets under management in funds and classes of funds subject to service fees. Service fee revenue increased 1 percent, or $0.6 million, to $95.1 million in the first nine months of fiscal 2014 from the same period a year earlier, primarily reflecting an increase in average assets under management in funds and classes of funds subject to service fees. 55 Other revenue Other revenue, which consists primarily of sub-transfer agent fees, miscellaneous dealer income, custody fees, Hexavest-related distribution and service revenue, and sublease income, increased by $0.5 million and $1.2 million in the third quarter and first nine months of fiscal 2014, respectively, from the same periods a year earlier, primarily reflecting an increase in Hexavest-related revenue. Expenses Operating expenses increased by 2 percent, or $4.9 million, in the third quarter of fiscal 2014 from the same period a year earlier and by 4 percent, or $28.3 million, in the first nine months of fiscal 2014 from the same period a year earlier, reflecting increases in compensation, distribution and service fee expenses and fund-related expenses and other operating expenses, offset by reduced amortization of deferred sales commissions as more fully described below. The following table shows our operating expenses for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 Change Compensation and related costs: Cash compensation $ 100,567 $ 101,708 -1 % $ 304,442 $ 293,392 4 % Stock-based compensation 17,065 13,671 25 % 46,668 40,828 14 % Total compensation and related costs 117,632 115,379 2 % 351,110 334,220 5 % Distribution expense 35,591 35,452 0 % 105,924 104,645 1 % Service fee expense 29,780 29,013 3 % 87,266 86,488 1 % Amortization of deferred sales commissions 4,084 4,983 -18 % 13,408 14,518 -8 % Fund-related expenses 9,380 8,230 14 % 26,288 23,728 11 % Other expenses 39,945 38,454 4 % 117,235 109,371 7 % Total expenses $ 236,412 $ 231,511 2 % $ 701,231 $ 672,970 4 % Compensation and related costs The following table shows our compensation and related costs for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 ChangeBase salaries and employee benefits $ 51,877 $ 47,730 9 % $ 153,442 $ 140,227 9 % Stock-based compensation 17,065 13,671 25 % 46,668 40,828 14 % Operating income-based incentives 34,062 36,022 -5 % 107,413 99,167 8 % Sales incentives 13,824 17,080 -19 % 40,878 50,529 -19 % Other compensation expense 804 876 -8 % 2,709 3,469 -22 % Total $ 117,632 $ 115,379 2 % $ 351,110 $ 334,220 5 % 56 The increase in base salaries and employee benefits in the third quarter and first nine months of fiscal 2014 reflects an increase in base compensation associated with higher headcount, annual merit increases, and an increase in employee benefits. The increase in stock-based compensation reflects increases in headcount, expenses associated with subsidiary long-term equity plans and retirements in the third quarter of fiscal 2014. The increase in operating-income based incentives year-over-year reflects the increase in pre-bonus adjusted operating income. Sales incentives decreased primarily due to lower compensation-eligible sales. Other compensation expense decreased dueto lower sign-on bonuses. Distribution expense The following table shows our distribution expense for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 ChangeClass A share commissions $ 997 $ 1,240 -20 % $ 3,240 $ 5,453 -41 % Class C share distribution fees 13,923 13,836 1 % 40,535 41,201 -2 % Closed-end fund structuring fees - 1,688 NM - 4,401 NM Closed-end fund dealer compensation payments 4,811 4,515 7 % 14,078 13,173 7 % Intermediary marketing support payments 11,781 10,327 14 % 35,408 29,458 20 % Discretionary marketing expenses 4,079 3,846 6 % 12,663 10,959 16 % Total $ 35,591 $ 35,452 0 % $ 105,924 $ 104,645 1 % The decrease in Class A share commissions in the third quarter and first nine months of fiscal 2014 reflects a decrease in Class A fund sales on which we pay a commission. Class C share distribution fees decreased in the first nine months of fiscal 2014 due to lower Class C share assets held more than one year on which these fees are based. The decrease in closed-end fund structuring fees reflects the non-recurrence of closed-end structuring fees paid in the third quarter and first nine months of fiscal 2013. The increase in closed-end fund dealer compensation payments reflects an increase in average assets under management subject to those arrangements. The increase in marketing expenses associated with intermediary marketing support payments to our distribution partners reflects increases in average assets subject to those arrangements. The increase in discretionary marketing expenses primarily reflects an increase in the use of outside agencies. Service fee expense Service fee expense increased by 3 percent, or $0.8 million, in the third quarter of fiscal 2014 from the same quarter a year earlier, reflecting an increase in average fund assets retained more than one year in funds and share classes that are subject to service fee payments. Service fee expense increased 1 percent, or $0.8 million, in the first nine months of fiscal 2014 versus the same period a year earlier for the same reason. Amortization of deferred sales commissions Amortization expense decreased 18 percent, or $0.9 million, in the third quarter of fiscal 2014 from the same period a year earlier, reflecting decreases in Class B share and Class C share amortization expense. In the third quarter of fiscal 2014, 81 percent of total amortization related to Class C shares, 9 percent to Class B shares and 10 percent to private funds. In the third quarter of fiscal 2013, 79 percent of total amortization related to Class C shares, 16 percent to Class B shares and 5 percent to private funds. 57 Amortization expense decreased 8 percent, or $1.1 million, in the first nine months of fiscal 2014 compared to the same period a year earlier, reflecting a decrease in average Class B share and private fund amortization expense offset by an increase in Class C share amortization expense. Fund-related expenses Fund-related expenses increased 14 percent, or $1.2 million, in the third quarter of fiscal 2014 from the same period a year earlier and 11 percent, or $2.6 million, in the first nine months of fiscal 2014 over the same period a year earlier. The increase in both compared periods primarily reflects an increase in sub-advisory expenses resulting from growth in Company-sponsored funds managed by unaffiliated sub-advisers. Other expenses The following table shows our other expense for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 Change Travel $ 4,083 $ 3,871 5 % $ 12,004 $ 10,701 12 % Communications 1,315 1,420 -7 % 3,928 4,031 -3 % Information technology 17,282 14,774 17 % 47,209 40,909 15 % Professional services 2,437 3,096 -21 % 9,240 8,738 6 % Facilities-related 9,566 10,106 -5 % 28,924 29,744 -3 % Other corporate expense 5,262 5,187 1 % 15,930 15,248 4 % Total $ 39,945 $ 38,454 4 % $ 117,235 $ 109,371 7 % The increase in travel expense in the third quarter of fiscal 2014 from the third quarter of fiscal 2013 relates to an overall increase in travel. The increase in information technology expense can be attributed to increases in project-related consulting, software licensing and maintenance fees, and market data costs. The decrease in professional services expense can be attributed to decreases in external legal costs and general recruiting costs. The decrease in facilities-related expenses can be primarily attributed to a decrease in depreciation expense. The increase in other corporate expenses reflects an increase in other corporate taxes. The higher travel expense in the first nine months of fiscal 2014 from the first nine months of fiscal 2013 can be attributed to an increase in travel. The increase in information technology expense can be attributed to increases in project-related consulting, software licensing and maintenance fees, and market data costs. The increase in professional services expense can be attributed to increases in general recruiting costs offset by decreases in external legal costs. The decrease in facilities-related expenses can be primarily attributed to a decrease in depreciation expense. The increase in other corporate expenses reflects an increase in other corporate taxes and the amortization of intangible assets related to the Clifton acquisition. Non-operating Income (Expense) The main categories of non-operating income (expense) for the three and nine months ended July 31, 2014 and 2013 are as follows: 58 Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 Change Gains (losses) and other investment income, net $ 2,917 $ (8,027 ) NM $ 2,592 $ 2,223 17 % Interest expense (7,443 ) (9,167 ) -19 % (22,247 ) (26,309 ) -15 %Loss on extinguishment of debt - (52,886 ) NM - (52,886 ) NM Other income (expense) of consolidated CLO entities: Gains and other investment income, net 1,434 1,704 -16 % 15,247 7,881 93 % Interest and other expense (1,758 ) (2,939 ) -40 % (13,781 ) (10,211 ) 35 % Total non-operating expense $ (4,850 ) $ (71,315 ) -93 % $ (18,189 ) $ (79,302 ) -77 % Gains (losses) and other investment income, net, had positive change of $10.9 million in the third quarter of fiscal 2014 compared to the same period a year earlier, primarily reflecting an increase of $1.9 million in interest earned and a $9.0 million positive change in net investment gains (losses). In the third quarter of fiscal 2014, we recognized $0.1 million of gains related to our seed capital investments and associated hedges, compared to a net loss of $5.8 million in the third quarter of fiscal 2013. In the third quarter of fiscal 2013, we recognized a loss of $3.1 million on a reverse treasury lock entered into in conjunction with the retirement of the 2017 Senior Notes. Gains (losses) and other investment income, net, increased $0.4 million in the first nine months of fiscal 2014 compared to the same period a year earlier, primarily reflecting an increase of $1.4 million in interest income earned, offset by an increase of $0.9 million in foreign currency losses. In the first nine months of fiscal 2014 we recognized $2.8 million of losses related to our seed capital investments and associated hedges, compared to net gains of $0.4 million in the first nine months of fiscal 2013. In the first nine months of fiscal 2013, we recognized a loss of $3.1 million on a reverse treasury lock entered into in conjunction with the retirement of the 2017 Senior Notes. Interest expense decreased $1.7 million and $4.1 million in the third quarter and first nine months of fiscal 2014, respectively, reflecting the retirement of $250 million of our 6.5 percent Senior Notes due 2017 and the contemporaneous issuance of $325 million of 3.625 percent Senior Notes due 2023 in the third quarter of fiscal 2013. Loss on extinguishment of debt of $52.9 million in the three and nine months ended July 31, 2013 consisted of the tender premium associated with the retirement of $250 million of 2017 Senior Notes, acceleration of certain deferred financing costs and discounts tied to the retired portion of the 2017 Senior Notes, and transaction costs associated with the debt retirement. Net income (loss) of the consolidated CLO entities was -$0.3 million in the three months ended July 31, 2014 and $1.2 million for the nine months ended July 31, 2014. Approximately -$0.9 million and -$2.0 million of consolidated CLO entities' net income/(losses) was included in net income attributable to non-controlling and other beneficial interests for the three and nine months ended July 31, 2014, respectively, which reflects the third-party note holders' proportionate interests in the net income (loss) of the consolidated CLO entities for the respective periods. Net income attributable to Eaton Vance shareholders included $0.6 million and $3.2 million associated with the consolidated CLO entities for the three and nine months ended July 31, 2014, respectively, which represents management fees earned by the Company offset by the Company's proportionate interest in the net income (loss) of the consolidated CLO entities for the respective periods. 59 Income Taxes Our effective tax rate, calculated as income taxes as a percentage of income before income taxes and equity in net income of affiliates, was 38.7 percent and 38.3 percent in the third quarter and first nine months of fiscal 2014, respectively, compared to 52.9 percent and 40.0 percent in the third quarter and first nine months of fiscal 2013, respectively. Excluding the effect of the consolidated CLO entities' net income (losses) allocated to other beneficial interest holders, our effective tax rate would have been 38.5 percent and 38.1 percent in the third quarter and first nine months of fiscal 2014, respectively. During the third quarter of fiscal 2013, we received a settlement offer from one state to resolve all matters relating to the tax authority's audit of our fiscal years 2004 to 2009 for a lump sum payment of $19.6 million. We accepted the offer and made payment on July 31, 2013. The $19.6 million payment resulted in a net increase to income tax expense of $6.7 million, equal to the amount of payment less previously recorded reserves of $9.3 million and a federal benefit on the increased tax benefit of $3.6 million. Excluding the effect of the consolidated CLO entities' net income (loss) allocated to other beneficial interest holders and the impact of the one-time tax settlement, our effective tax rate would have been 37.7 percent and 36.5 percent in the third quarter and first nine months of fiscal 2013. Our policy for accounting for income taxes includes monitoring our business activities and tax policies for compliance with federal, state and foreign tax laws. In the ordinary course of business, various taxing authorities may not agree with certain tax positions we have taken, or applicable law may not be clear. We periodically review these tax positions and provide for and adjust as necessary estimated liabilities relating to such positions as part of our overall tax provision. Equity in Net Income of Affiliates, Net of Tax Equity in net income of affiliates, net of tax, for the third quarter of fiscal 2014 primarily reflects our 49 percent equity interest in Hexavest, our seven percent minority equity interest in a private equity partnership managed by a third party and equity interests in certain funds we sponsor or manage. Equity in net income of affiliates, net of tax, increased to $3.8 million and $12.3 million in the third quarter and first nine months of fiscal 2014 from $2.7 million and $9.3 million in the same periods a year earlier. The following table summarizes the components of equity in net income of affiliates, net of tax, for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 Change Investments in sponsored funds, net of tax $ 922 $ (33 ) NM $ 3,712 $ 2,215 68 % Investment in private equity partnership, net of tax 3 138 -98 % 326 357 -9 % Investment in Hexavest, net of tax and amortization 2,915 2,547 14 % 8,306 6,697 24 % Total $ 3,840 $ 2,652 45 % $ 12,344 $ 9,269 33 % 60 Net Income Attributable to Non-controlling and Other Beneficial Interests The following table summarizes the components of net income attributable to non-controlling and other beneficial interests for the three and nine months ended July 31, 2014 and 2013: Three Months Ended Nine Months Ended July 31, % July 31, % (in thousands) 2014 2013 Change 2014 2013 Change Consolidated sponsored funds $ 42 $ (206 ) NM $ 259 $ 3,886 -93 % Majority-owned subsidiaries 4,261 4,007 6 % 11,268 11,596 -3 % Non-controlling interest value adjustments(1) (59 ) 405 NM 2,330 11,718 -80 % Consolidated CLO entities (910 ) (2,359 ) -61 % (2,005 ) (5,592 ) -64 % Net income attributable to non-controlling and other beneficial interests $ 3,334 $ 1,847 81 % $ 11,852 $ 21,608 -45 % (1) Relates to non-controlling interests redeemable at other than fair value. Net income attributable to non-controlling and other beneficial interests is not adjusted for taxes due to the underlying tax status of our consolidated subsidiaries, which are treated as partnerships or other pass-through entities for tax purposes. Changes in Financial Condition, Liquidity and Capital Resources The assets and liabilities of our consolidated CLO entities do not affect our liquidity or capital resources. The collateral assets of our consolidated CLO entities are held solely to satisfy the obligations of the entities and we have no right to these assets beyond our direct investment in, and management fees generated from, the entities. The note holders of the entities have no recourse to the general credit of the Company. As a result, the assets and liabilities of our consolidated CLO entities are excluded from the discussion of liquidityand capital resources below. The following table summarizes certain key financial data relating to our liquidity and capital resources on July 31, 2014 and October 31, 2013 and uses of cash for the nine months ended July 31, 2014 and 2013: 61 Balance Sheet and Cash Flow Data July 31, October 31, (in thousands) 2014 2013 Balance sheet data: Assets: Cash and cash equivalents $ 362,017 $ 461,906 Investment advisory fees and other receivables 171,403 170,220 Total liquid assets $ 533,420 $ 632,126 Investments $ 642,475 $ 536,323 Liabilities: Debt $ 573,616 $ 573,499 Nine Months Ended July 31, (in thousands) 2014 2013 Cash flow data: Operating cash flows $ (3,971 ) $ (229 ) Investing cash flows 158,473 165,207 Financing cash flows (253,845 ) (246,879 ) Liquidity and Capital Resources Liquid assets consist of cash and cash equivalents and investment advisory fees and other receivables. Cash and cash equivalents consist of cash and short-term, highly liquid investments that are readily convertible to cash. Investment advisory fees and other receivables primarily represent receivables due from sponsored funds and separately managed accounts for investment advisory and distribution services provided. Liquid assets represented 32 percent and 38 percent of total assets on July 31, 2014 and October 31, 2013, respectively, excluding those assets identified as assets of the consolidated CLO entities. Not included in the liquid asset amounts are $186.8 million and $20.1 million of highly liquid short-term debt securities with remaining maturities between three and 12 months held as of July 31, 2014 and October 31, 2013, respectively, which are included within Investments on our Consolidated Balance Sheets. Our seed investments in consolidated funds and separate accounts are not treated as liquid assets because they may be longer term in nature. The $98.7 million decrease in liquid assets in the first nine months of fiscal 2014 primarily reflects net cash used for operating activities of $4.0 million, the payment of $79.9 million of dividends to shareholders, the repurchase of $227.9 million of Non-Voting Common Stock and the payment of $26.9 million to acquire additional interests in Atlanta Capital, offset by net proceeds from sales and purchases of available-for-sale securities of $56.0 million, proceeds from the issuance of Non-Voting Common Stock of $44.0 million and $132.2 million impact of the consolidated CLO entities' investing and financing activities. On July 31, 2014, our debt consisted of $250.0 million aggregate principal amount of 2017 Senior Notes and $325.0 million aggregate principal amount of 2023 Senior Notes. We also maintain a $300.0 million unsecured revolving credit facility with several banks that expires on June 4, 2015. The facility provides that we may borrow at LIBOR-based rates of interest that vary depending on the level of usage of the facility and our credit ratings. The agreement contains financial covenants with respect to leverage and interest coverage and requires 62 us to pay an annual commitment fee on any unused portion. We had no borrowings under our revolving credit facility at July 31, 2014 or at any point during the first nine months of fiscal 2014. We were in compliance with all debt covenants as of July 31, 2014. We continue to monitor our liquidity daily. We remain committed to growing our business and expect that our main uses of cash will be paying dividends, acquiring shares of our Non-Voting Common Stock, making seed investments in new products and strategic acquisitions, enhancing our technology infrastructure and paying the operating expenses of our business, which are largely variable in nature and fluctuate with revenue and assets under management. We believe that our existing liquid assets, cash flows from operations and borrowing capacity under our existing credit facility are sufficient to meet our current and forecasted operating cash needs for the next twelve months. The risk exists, however, that if we need to raise additional capital or refinance existing debt in the future, resources may not be available to us in sufficient amounts or on acceptable terms. Our ability to enter the capital markets in a timely manner depends on a number of factors, including the state of global credit and equity markets, interest rates, credit spreads and our credit ratings. If we are unable to access capital markets to issue new debt, refinance existing debt or sell shares of our Non-Voting Common Stock as needed, or if we are unable to obtain such financing on acceptable terms, our business could be adversely affected. Recoverability of our Investments Our $642.5 million of investments as of July 31, 2014 consisted of our 49 percent equity interest in Hexavest, positions in Company-sponsored funds and separate accounts entered into for investment and business development purposes, and certain other investments held directly by the Company. Investments in Company-sponsored funds and separate accounts and direct investments by the Company are generally in liquid debt or equity securities and are carried at fair market value. We test our investments, other than equity method investments, for impairment on a quarterly basis. We evaluate our investments in non-consolidated CLO entities and investments classified as available-for-sale for impairment using quantitative factors, including how long the investment has been in a net unrealized loss position, and qualitative factors, including the credit quality of the underlying issuer and our ability and intent to continue holding the investment. If markets deteriorate in the quarters ahead, our assessment of impairment on a quantitative basis may lead us to impair investments in future quarters that were in an unrealized loss position atJuly 31, 2014. We test our investments in equity method investees, goodwill and indefinite-lived intangible assets in the fourth quarter of each fiscal year and as facts and circumstances indicate that additional analysis is warranted. There have been no significant changes in financial condition in the first nine months of fiscal 2014 that would indicate that an impairment loss exists at July 31, 2014. We periodically review our deferred sales commissions and identifiable intangible assets for impairment as events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. There have been no significant changes in financial condition in the first nine months of fiscal 2014 that would indicate that an impairment loss exists at July 31, 2014. Operating Cash Flows Cash used for operating activities totaled $4.0 million in the first nine months of fiscal 2014, an increase of $3.8 million from $0.2 million in the first nine months of fiscal 2013. The increase in net cash used for operating activities year-over-year primarily reflects an increase in net cash used in the operating activities of our consolidated CLO entities, partially offset by an increase in deferred taxes, a decrease in the timing differences in the cash settlements of our other assets and liabilities, and a decrease in the net purchase of trading securities. Cash used for operating activities in the nine months ended July 31, 2013 reflects the lump sum payment of $19.6 million to resolve matters relating to a state tax audit. 63 Investing Cash Flows Cash provided by investing activities totaled $158.5 million in the first nine months of fiscal 2014 compared to $165.2 million in the first nine months of fiscal 2013. The decrease in cash provided by investing activities year-over-year can be primarily attributed to a decrease of $14.7 million in the net proceeds from sales and purchases of available-for-sale securities and a decrease of $77.3 million in the net proceeds from the sale and maturities of consolidated CLO entity investments, offset by a decrease in cash utilized for acquisitions in the first nine months of fiscal 2014. Payments to the sellers of Clifton and TABS totaled $67.2 million and $14.1 million, respectively, in the first nine months of fiscal 2013. Financing Cash Flows Cash used for financing activities totaled $253.8 million in the first nine months of fiscal 2014 compared to $246.9 million in the first nine months of fiscal 2013. In the first nine months of fiscal 2014 we paid $26.9 million to acquire additional interests Atlanta Capital, repurchased and retired a total of 6.0 million shares of our Non-Voting Common Stock for $227.9 million, and issued 3.1 million shares of our Non-Voting Common Stock in connection with the grant of restricted share awards, the exercise of stock options and other employee stock purchases for total proceeds of $44.0 million. As of July 31, 2014, we have authorization to purchase an additional 7.2 million shares under our current share repurchase authorization and anticipate that future repurchases will continue to be an ongoing use of cash. Our dividends per share were $0.66 in the first nine months of fiscal 2014, compared to $1.60 per share in the first nine months of fiscal 2013. Dividends declared per share in the first nine months of fiscal 2013 include a one-time special dividend of $1.00 per share declared and paid in December 2012. We currently expect to declare and pay comparable regular dividends on our Voting and Non-Voting Common Stock on a quarterly basis. In the first nine months of fiscal 2014, cash used for financing activities also included $405.6 million in principal payments made on senior notes, lines of credit and redeemable preferred shares of consolidated CLO entities, as well as $429.6 million related to the issuance of new senior notes and redeemable preferred shares of those entities. Contractual Obligations We have future obligations under various contracts relating to debt, interest payments and operating leases. During the nine months ended July 31, 2014, there were no material changes to our contractual obligations as previously reported in our Annual Report on Form 10-K for the year ended October 31, 2013. During the third quarter of fiscal 2014, we deconsolidated one of our CLO entities, which resulted in a reduction of $314.7 million in the contractual obligations of the Company's consolidated CLO entities. Interests held by non-controlling interest holders of Atlanta Capital and Parametric are not subject to mandatory redemption. The purchase of non-controlling interests is predicated on the exercise of a series of puts held by non-controlling interest holders and calls held by us. The puts provide the non-controlling interest holders the right to require us to purchase these retained interests at specific intervals over time, while the calls provide us with the right to require the non-controlling interest holders to sell their retained equity interests to us at specified intervals over time, as well as upon the occurrence of certain events such as death or permanent disability. As a result, there is significant uncertainty as to the timing of any non-controlling interest purchase in the future. Non-controlling interests are redeemable at fair value or based on a multiple of earnings before interest and taxes of the subsidiary, which is a measure that is intended to represent fair value. As a result, there is significant uncertainty as to the amount of any non-controlling interest purchase in the future. Although the timing and amounts of these purchases cannot be predicted with certainty, we anticipate that the purchase of non-controlling interests in our consolidated subsidiaries may be a significant use of cash in future years. 64 We have presented all redeemable non-controlling interests at redemption value on our Consolidated Balance Sheets as of July 31, 2014. We have recorded the current quarter change in the estimated redemption value of non-controlling interests redeemable at fair value as a component of additional paid-in capital and have recorded the current quarter change in the estimated redemption value of non-controlling interests redeemable at other than fair value (non-controlling interests redeemable based on a multiple of earnings before interest and taxes of the subsidiary) as a component of net income attributable to non-controlling and other beneficial interests. Based on our calculations, the estimated redemption value of our non-controlling interests, redeemable at either fair value or other than fair value, totaled $99.9 million on July 31, 2014 compared to $74.9 million on October 31, 2013. Redeemable non-controlling interests as of July 31, 2014 consist of third-party investors' ownership in consolidated investment funds of $10.2 million, non-controlling interests in Atlanta Capital redeemable at other than fair value of $13.6 million, non-controlling interests in Parametric issued in conjunction with the Clifton acquisition and redeemable at fair value of $22.8 million, non-controlling interests in Parametric issued in conjunction with the Parametric Risk Advisors final put redeemable at fair value of $9.9 million, and profit interests granted under the long-term incentive plans of Parametric and Atlanta Capital redeemable at fair value of $29.3 million and $14.1 million, respectively. Redeemable non-controlling interests as of October 31, 2013 consist of third-party investors' ownership in consolidated investment funds of $4.0 million, non-controlling interests in Parametric Risk Advisors and Atlanta Capital redeemable at other than fair value of $6.1 million and $13.6 million, respectively, non-controlling interests in Parametric issued in conjunction with the Clifton acquisition and redeemable at fair value of $13.9 million, and redeemable profit interests granted under the long-term incentive plans of Parametric and Atlanta Capital of $24.9 million and $12.3 million, respectively. On November 1, 2013, the non-controlling interest holders of Parametric Risk Advisors entered into a Unit Acquisition Agreement with Parametric to exchange their remaining ownership interests in Parametric Risk Advisors, including the 10 percent interest subject to the fiscal 2013 call, for indirect ownership interests in Parametric. The indirect ownership interests issued in this exchange contain put and call features that are exercisable over a four-year period beginning in 2018. Indirect capital and profit interests in Parametric issued in connection with the transaction totaled 0.8 percent on July 31, 2014. As a result of this exchange, Parametric became the sole owner of Parametric Risk Advisors effective November 1, 2013. Indirect profit interests granted to Parametric's employees under a long-term equity incentive plan of that entity increased to 5.1 percent at July 31, 2014, reflecting a 0.4 percent profit interest granted on November 1, 2013 under the plan. Indirect capital and profit interests in Parametric held by the principals of Clifton totaled 1.9 percent on July 31, 2014, reflecting indirect interests issued in conjunction with the Clifton acquisition on December 31, 2012. The indirect ownership interests issued in this exchange contain put and call features that are exercisable over a four-year period beginning in 2014. Capital and profit interests in Parametric held by us decreased to 97.3 percent and 92.2 percent, respectively, on July 31, 2014, reflecting the transactions described above. In fiscal 2013, we exercised a call option requiring the non-controlling interest holders of Atlanta Capital to sell a 3.4 percent profit interest and a 0.2 percent capital interest in Atlanta Capital to us for $12.8 million. In addition, the non-controlling interest holders of Atlanta Capital exercised a put option requiring us to purchase an additional 3.8 percent profit interest and a 0.3 percent capital interest in Atlanta Capital for $14.1 million. The purchase price of the call and put options was based on a multiple of earnings before taxes based on the financial results of Atlanta Capital for the fiscal year ended October 31, 2013. Upon the execution of the call and put options, we reduced redeemable non-controlling interests and recorded a liability within other liabilities on our Consolidated Balance Sheets. The transactions settled in December 2013. 65 Non-controlling interest holders of Atlanta Capital have the right to sell a 3.1 percent profit interest and their remaining 0.1 percent capital interest in Atlanta Capital to us at a multiple of earnings before taxes based on the financial results of Atlanta Capital for the fiscal year ended October 31, 2014 and each year thereafter subject to certain restrictions. We have the right to purchase the remaining non-controlling interest at a multiple of earnings before taxes based on Atlanta Capital's financial results for the fiscal year ending October 31, 2015 and each year thereafter through October 31, 2017. Neither the exercise of the puts nor the exercise of the calls is contingent upon the non-controlling interest holders of Atlanta Capital remaining employees. Indirect profit interests in Atlanta Capital held by its employees, including profit interests granted under a long-term equity incentive plan, were 13.8 percent, reflecting the transactions above and a 1.2 percent profit interest granted on November 1, 2013. Capital interests in Atlanta Capital held by us increased to 99.9 percent and profit interests increased to 86.2 percent, respectively, after reflecting the transactions described above. Foreign Subsidiaries We consider the undistributed earnings of our Canadian and Australian subsidiaries as of July 31, 2014 to be indefinitely re-invested in foreign operations. Accordingly, no U.S. income taxes have been provided thereon. As of July 31, 2014, we had approximately $17.8 million of undistributed earnings in these subsidiaries that is not available to fund domestic operations or to distribute to shareholders unless repatriated. Repatriation would require us to accrue and pay U.S. corporate income taxes. We do not have a current plan to repatriate these funds. Off-Balance Sheet Arrangements We do not invest in any off-balance sheet vehicles that provide financing, liquidity, market or credit risk support or engage in any leasing activities that expose us to any liability that is not reflected in our Consolidated Financial Statements. Critical Accounting Policies There have been no updates to our critical accounting policies from those disclosed in Management's Discussion and Analysis of Financial Condition in our Form 10-K for the fiscal year ended October 31, 2013. Accounting Developments Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2014-13, Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity, which provides a measurement alternative for an entity that consolidates collateralized financing entities ("CFE"). If elected, the alternative method results in the reporting entity measuring both the financial assets and financial liabilities of the CFE using the more observable of the two fair value measurements, which effectively removes measurement differences between the financial assets and financial liabilities of the CFE previously recorded as net income (loss) attributable to non-controlling and other beneficial interests and as an adjustment to appropriated retained earnings. The reporting entity continues to measure its own beneficial interests in the CFE (other than those that represent compensation for services) at fair value. The new guidance is effective for the Company's fiscal year that begins on November 1, 2016 and requires either a retrospective or modified retrospective approach to adoption, with early adoption permitted. The Company is currently evaluating the potential impact on its Consolidated Financial Statements and related disclosures. 66 Revenue from Contracts with Customers In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes existing accounting standards for revenue recognition and creates a single framework. The new guidance is effective for the Company's fiscal year that begins on November 1, 2017 and interim periods within that fiscal year and requires either a retrospective or a modified retrospective approach to adoption. The Company is currently evaluating the potential impact on its Consolidated Financial Statements and related disclosures, as well as the available transition methods. Early adoption is prohibited. |