Greenhill is a leading independent investment bank focused on providing financial advice related to significant mergers, acquisitions, restructurings, financings and capital raisings to corporations, partnerships, institutions and governments. We represent clients throughout the world and have offices in
the United States, United Kingdom, Germany, Canada, Japan, Australia, Swedenand Brazil. Our revenues are principally derived from advisory services on mergers and acquisitions (or M&A), financings and restructurings and are primarily driven by total deal volume and the size of individual transactions. Additionally, our private capital and real estate capital advisory group provides fund placement and other capital raising advisory services, where revenues are driven primarily by the amount of capital raised. Greenhill was established in 1996 by Robert F. Greenhill, the former President of Morgan Stanley and former Chairman and Chief Executive Officer of Smith Barney. Since our founding, Greenhill has grown steadily, recruiting a number of managing directors from major investment banks (as well as senior professionals from other institutions), with a range of geographic, industry and transaction specialties as well as different sets of corporate and other relationships. As part of this expansion, we opened a Londonoffice in 1998, opened a Frankfurtoffice in 2000 and began offering financial restructuring advice in 2001. On May 11, 2004, we converted from a limited liability company to a corporation, and completed an initial public offering of our common stock. We opened our second U.S. office in 2005, and we currently have five offices in the U.S. We opened a Canadian office in 2006. In 2008, we opened an office in Tokyo. Also in 2008, we entered the capital advisory business, which provides capital raising advice and related services to private equity and real estate funds and sponsors. In 2010, we acquired the Australian advisory firm, Caliburn, which has two Australian offices. In 2012, we opened our Stockholmoffice, and in October 2013, we opened an office in SÃo Paulo, Brazil. Over the past five years, we have recruited new managing directors and made internal promotions to managing director to increase our industry sector and geographic coverage. Since January 1, 2009, we have increased the number of client facing managing directors, mostly through outside hires, 1.5 times from 47 to 69 as of January 1, 2014. We have added managing directors with sector experience in Consumer Goods, Energy, Financial Services, Gaming and Hospitality, Healthcare, Industrials, Pharmaceuticals, and Telecommunications as well as a team of managing directors focused on real estate capital advisory. Additionally, over the past five years we have significantly increased our geographic reach by adding offices in the United States, Australia, Swedenand Brazil. Although we recruited fewer managing directors over the past three years as compared to the period from 2008 through 2010, we intend to continue our efforts to recruit new managing directors with industry sector experience both to expand globally the depth of our industry teams and to increase the sectors we cover. Furthermore, we intend to recruit new managing directors to increase our geographic reach. Prior to 2011, we also managed merchant banking funds and similar vehicles. We raised our first private equity fund in 2000, our first venture capital fund in 2006 and our first European merchant banking fund in 2007. We completed the initial public offering of our special purpose acquisition company, GHL Acquisition Corp., in 2008, and that entity merged with Iridium in 2009. Effective December 31, 2010, we exited the merchant banking business in order to focus entirely on our advisory business. Following our exit from the merchant banking business, we began the monetization of our investments in our previously sponsored merchant banking funds and Iridium. In 2011, we sold substantially all of our interests in GCP II and GSAVP for $49.4 million, which represented their total book value. In December 2012, the purchasers of GCP II exercised their put rights requiring us to repurchase substantially all of our original interests in two portfolio companies for $15.5 million. Also, in 2012, we sold our entire interest in GCP Europe for $27.2 million, which represented approximately 90% of its book value. In July 2013, we sold our entire investment in GCP III for $2.0 million, which represented the book value of our investment. At December 31, 2013, we held remaining investments in merchant banking funds with an estimated fair value of $11.7 million. In October 2011, we initiated a plan to sell our entire interest in Iridium systematically over a period of two or more years. As of December 31, 2013, we had sold all of our holdings in Iridium and realized aggregate proceeds of $70.5 millionsince we initiated the sale of our holdings in Iridium. The net proceeds from the sale of our investments in the merchant banking fund and Iridium realized over the past three years were in aggregate $133.6 million, and were principally used to repurchase our common stock and reduce the outstanding amount of our revolving loan facility. See "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". 26
Business Environment Economic and global financial market conditions can materially affect our financial performance. In addition, revenues and net income in any period may not be indicative of full-year results or the results of any other period and may vary significantly from year to year and quarter to quarter.
See "RiskFactors." Our advisory revenues were $287.0 millionin the year ended December 31, 2013compared to $291.5 millionin the year ended December 31, 2012, which represents a decrease of 2%. At the same time, worldwide completed M&A volume for 2013 decreased 1% from 2012 and the number of worldwide completed M&A transactions decreased by 10%, while worldwide announced M&A volume decreased 3% and the number of worldwide announced M&A transactions decreased 8% (1). While the general level of global transaction activity remained relatively weak in 2013, with a small further decline in completed transaction volume and a larger decline in the number of completed transactions, our business proved to be resilient, and our sources of revenue proved to be diverse, allowing us to again achieve all four of the primary objectives on which we have historically focused. Our market share increased again, as our advisory revenues for the year were down only 2%, while our large bank competitors experienced a greater aggregate decline of 7% in advisory revenues for the year. Since 2008, we have solidly outpaced that group, with our 32% cumulative advisory revenue increase over that period compared to a decline of 32% in aggregate large bank advisory revenues in the same period. And, in the past three of those years we accomplished that despite keeping our headcount flat. Our compensation ratio rose slightly this year, but was offset by a decline in our non-compensation costs, resulting in a repeat of last year's 25% pretax margin, which again was the best among our closest peers by a large margin. In 2013, our tax rate declined to the level it was prior to the financial crisis because we returned to generating more revenue from lower taxed foreign sources. Finally, we not only continued to maintain our strong dividend level but repurchased sufficient shares to bring our share count to a level slightly lower than a year ago, all while maintaining a balance sheet with no net debt. While we continue to expect M&A activity over time to rebound toward its historic levels, we continue to focus on building a truly global business. In that regard, our European revenues increased approximately 50% in 2013 as compared to 2012 despite market statistics showing a further decline in transaction activity in that region. We also had small gains in Canadian and Japanese client revenue. While Australian revenue declined, we were pleased to advise on several U.S. to Australiacross-border transactions in recent months, and we aim to build on that cross-border advisory capability. Although our Brazilian presence is in its very early days, we are already encouraged by the development of our team and the level of client assignments there. Further, while remaining solely focused on client advisory work, we continue to focus on increasing the breadth of our advisory activities. On the corporate advisory side, we continue to develop our advisory capabilities by industry sector, and believe we are still in the early stages of that process. In addition, we are pleased by our progress in the capital advisory (fund placement) business, which grew in 2013 and we believe has significant further potential still to be developed. Additionally, we continue to focus on managing our business in a disciplined manner. In the past few years we have entered new regions and upgraded our team while maintaining a flat headcount and flat non-compensation costs, resulting in repeatedly strong pre-tax profit margins. In 2013, we advised on transactions for the first time for such leading companies around the world as Actavis, Inc., Ameren Corporation, Danone SA, Dentsu Inc., Hitachi, Ltd., Japan Tobacco Inc. and SUPERVALU Inc. We also advised on new transactions in all major markets for clients for whom we had previous engagements such as AT&T Inc., Elders Limited, GlaxoSmithKline LLC, Inchcape plc, Inergy, L.P., Kinder Morgan Energy Partners, LINN Energy, LLC, Lion Pty Ltd., Meadwestvaco Corporation, Suncorp Group Limited and Tesco Plc. By geographic region in 2013, our advisory revenues were relatively well dispersed throughout our global locations. North America, and specifically our merger and acquisition activities in this region, where we generated in excess of 56% of our revenues, remained our largest contributor in 2013. Most of our other 2013 advisory revenues were generated in Europe, where we derived approximately 29% of our revenues and in Australia, where we derived approximately 12% of our revenues, which is a decline from strong prior years' levels but consistent with M&A market trends in that region. As compared to 2012, declines in North American and Australian revenues in 2013 were offset by an increase in European revenues, where we advised on a number of large transactions. (1) Source: Global M&A completed and announced transaction volume for the year ended December 31, 2013as compared to the year ended December 31, 2012. Source: Thompson Financial as of February 21, 2014. 27
By industry in 2013, improved performance in the consumer and retail, healthcare and financial services sectors generally offset a decline in activity in the technology, industrial and energy sectors. Further, we generated 11% of our advisory revenue from our capital advisory business, which primarily provides capital raising advice for private equity and real estate funds compared to 9% in 2012. After a significant increase in headcount from the time of our IPO through 2010, our headcount has remained relatively constant since then. During the past three years our compensation and benefits expense, which we measure as a percentage of revenues, have ranged from 53% to 55% of revenues. In 2013, our ratio of compensation and benefits expense to revenues was 54% and while significantly below our closest peers, it was still above our historic levels and policy goal of maintaining a ratio not to exceed 50%. Our non-compensation costs over the past three years have remained relatively consistent in absolute dollars consistent with our stable headcount and disciplined control over both fixed and variable costs. As a percentage of revenues, our non-compensation costs have ranged from 21% to 22% over the past three years, and were 21% in 2013. Our pre-tax margin over the past three years has ranged from 23% to 25%, and was 25% in 2013. Over the 10 year period since our IPO, our pre-tax margin ranged from 21% to 44% and as transaction activity rebounds, we will seek to return towards the higher end of our historic pre-tax margin range. Our historically strong profit margin and operating cash flow has allowed us to maintain an attractive dividend policy while also allowing us to repurchase a significant number of shares of our common stock. Our annual dividend payout has been
$1.80per common share since 2008. In 2013, we repurchased 853,870 shares of our common stock in open market repurchases and, in addition, repurchased from employees 226,505 restricted stock units at the time of vesting to settle tax liabilities. In aggregate in 2013, we repurchased 1,080,375 shares of our common stock and common stock equivalents at an average price of $51.28for a total purchase cost of $55.4 million. Our board has authorized up to $75 millionof additional share repurchases in 2014. We generally experience significant variations in revenues during each quarterly period. These variations can generally be attributed to the fact that our revenues are usually earned in large amounts throughout the year upon the successful completion of a transaction or restructuring or closing of a fund, the timing of which is uncertain and is not subject to our control. As a result, our quarterly results vary and our results in one period may not be indicative of our results in any future period. Results of Operations
The following tables set forth data relating to the Firm's sources of revenues:
Historical Revenues by Source For the Year Ended December 31, 2013 2012 2011 2010 2009 (in millions) Advisory revenues
$ 287.0 $ 291.5 $ 302.8 $ 252.2 $ 216.0Investment revenues 0.2 (6.4 ) (8.8 ) 26.1 82.6 Total revenues $ 287.2 $ 285.1 $ 294.0 $ 278.3 $ 298.6Advisory Revenues Historical Advisory Revenues by Client Location For the Year Ended December 31, 2013 2012 2011 2010 2009 North America 52 % 60 % 48 % 57 % 65 % Europe 33 % 22 % 22 % 20 % 34 % Australia 12 % 14 % 22 % 15 % - Asia, Latin America & Other 3 % 4 % 8 % 8 % 1 % 28
Historical Advisory Revenues by Industry For the Year Ended December 31, 2013 2012 2011 2010 2009 Communications & Media 9 % 7 % 7 % 7 % 1 % Consumer Goods & Retail 14 % 8 % 13 % 6 % 8 % Energy & Utilities 7 % 11 % 8 % 14 % 8 % Financial Services 13 % 7 % 22 % 17 % 19 % Healthcare 16 % 9 % 12 % 7 % 16 %
Real Estate, Lodging & Leisure 4 % 5 % 6 % 6 % 2 % Technology
6 % 13 % 2 % 4 % 10 %
We operate in a highly competitive environment where there are no long-term contracted sources of revenue. Each revenue-generating engagement is separately awarded and negotiated. Our list of clients with whom there is an active revenue-generating engagement changes continually. To develop new client relationships, and to develop new engagements from historic client relationships, we maintain an active business dialogue with a large number of clients and potential clients, as well as with their financial and legal advisors, on an ongoing basis. We have gained a significant number of new clients each year through our business development initiatives, through recruiting additional senior investment banking professionals who bring with them client relationships and through referrals from members of boards of directors, attorneys and other parties with whom we have relationships. At the same time, we lose clients each year as a result of the sale or merger of a client, a change in a client's senior management team, competition from other investment banks and other causes. A majority of our advisory revenue is contingent upon the closing of a merger, acquisition, financing, restructuring, fund or similar transaction. A transaction can fail to be completed for many reasons, including failure to agree upon final terms with the counterparty, failure to secure necessary board or shareholder approvals, failure to secure necessary financing, failure to achieve necessary regulatory approvals and adverse market conditions. While fees payable upon the successful conclusion of a transaction generally represent the largest portion of our advisory fees, we also earn on-going retainer and strategic advisory fees, and fees payable upon the commencement of an engagement or upon the achievement of certain milestones, such as the announcement of a transaction or the rendering of a fairness opinion and, in our capital advisory business, upon our client's acceptance of capital commitments, including before the final closing of the fund. We do not allocate our advisory revenue by type of advice rendered (M&A, financing advisory and restructuring, strategic advisory or other) because of the complexity of the assignments for which we earn revenue and because a single transaction can encompass multiple types of advice. For example, a restructuring assignment can involve, and in some cases end successfully in, a sale of all or part of the financially distressed client. Likewise, an acquisition assignment can relate to a financially distressed target involved in or considering a restructuring. Finally, an M&A assignment can develop from a relationship that we had on a prior restructuring assignment, and vice versa. We do, however, separately allocate capital advisory revenue. 2013 versus 2012. Advisory revenues were
$287.0 millionfor the year ended December 31, 2013compared to $291.5 millionfor the year ended December 31, 2012, which represents a decrease of 2%. The slight decrease in our 2013 advisory revenues, as compared to 2012, resulted from a decrease in announcement and opinion fees and retainer fees, largely offset by an increase in fees from completed assignments, which were generally larger in scale than the prior year, and greater fund placement fees. Prominent advisory assignments completed in 2013 include:
• the acquisition by
• the sale of
• the acquisition by ASML Holding NV of
• the capital raising for
• the sale of
• the merger of
• the sale of GlaxoSmithKline's nutritional drinks brands Lucozade and Ribena to Suntory Beverage & Food Ltd.; • the sale by The Hartford Financial Services Group, Inc. of its Individual Life Insurance business to Prudential Financial, Inc.; • the acquisition by
Inergy LPfrom Crestwood Holdingsof Crestwood Holdings'general partner interest and incentive distribution right interest in Crestwood Midstream; and • the sale by SUPERVALU Inc. of its New Albertsons, Inc.subsidiary to an investor group led by Cerberus Capital Management L.P.During 2013, our capital advisory group served as global placement agent on behalf of private equity and real estate funds for seven final closings of the sale of limited partnership interests in such funds and two secondary market sales of limited partnership interests. Capital advisory fees for 2013 were $30.9 millioncompared to $25.8 millionfor 2012, reflecting an increase of $5.1 million, or 20%, primarily due to an increase in the scale of the fund closings. We earned advisory revenues from 143 different clients in 2013 and 160 clients in 2012. Of this group of clients, 35% were new to us in 2013 compared to 48% in 2012. We earned $1 millionor more from 58 clients in 2013, down 12% compared to 66 in 2012. The ten largest fee-paying clients contributed 43% and 36% to our total revenues in 2013 and 2012, respectively, and three of the top ten largest fee-paying clients in 2013 had in any prior year been among our ten largest fee-paying clients. In 2013, we earned approximately 10% of our total revenues from our single largest client engagement (advice to Coventry Health Care, Inc.in connection with its sale to Aetna). There were no clients in 2012 that accounted for 10% or more of our total revenues. 2012 versus 2011. Advisory revenues were $291.5 millionfor the year ended December 31, 2012compared to $302.8 millionfor the year ended December 31, 2011, which represents a decrease of 4%. The decrease in our 2012 advisory revenues, as compared to 2011, resulted from a slight change in the mix of our advisory assignments and resulting transactions, with fewer $1 millionor greater revenue clients nearly offset by having more $10 millionor greater revenue clients. Prominent advisory assignments completed in 2012 include: • the acquisition by Boyd Gaming Corporation of Peninsula Gaming, LLC; •the sale of Deltek, Inc.to Thoma Bravo, LLC; • the sale by The Hartford Financial Services Group, Inc. of its Retirement
•the representation of
Inergy, L.P.on the sale of its retail propane assets to Suburban Propane Partners, L.P.; •the sale of ISTA Pharmaceuticalsto Bausch & Lomb Inc.; •the representation of Lonmin plc on the refinancing of its balance sheet and associated rights offering; •the sale by Norwest Equity Partnersof its portfolio company, Becker Underwood, to BASF AG; •the acquisition by RedPrairie of JDA Software Group, Inc.; •the capital raise by Siris Capital Group, LLC; and •the acquisition by Superior Energy Services, Inc. of Complete Production Services, Inc.During 2012, our capital advisory group served as global placement agent on behalf of private equity and real estate funds for six final closings of the sale of limited partnership interests in such funds and two secondary market sales of limited partnership interests, achieving similar results to 2011. 30
We earned advisory revenues from 160 different clients in each of 2012 and 2011. Of this group of clients, 48% were new to us in 2012, compared to 36% in 2011. We earned
$1 millionor more from 66 clients in 2012, down 11% compared to 74 in 2011. The ten largest fee-paying clients contributed 36% and 35% to our total revenues in 2012 and 2011, respectively, and none of the top ten largest fee-paying clients in 2012 had in any prior year been among our ten largest fee-paying clients. We did not have any client in 2012 or 2011 that accounted for 10% or more of our total revenue. By geographic region in 2012, compared to 2011, a decline in both Australian revenues and revenues outside our primary markets was offset by an increase in North American revenues, driven by changes in general transaction activity in those markets. By industry sector, greater activity in the industrial, technology and energy sectors generally offset a sharp decline in activity in the financial services sector. Investment and Merchant Banking Revenues In December 2009, we sold our interest in the merchant banking business in order to focus entirely on our advisory business. Prior to that time, our merchant banking activities consisted primarily of management of and investment in Greenhill's merchant banking funds (GCP I, GCP II, GSAVP and GCP Europe). At the time of our exit, GCP Capital Partners Holdings LLC(or " GCP Capital"), an entity principally owned by former Greenhill employees and independent from us, took over the management of our merchant banking funds. Since our exit from the merchant banking business we have sought to realize value from our remaining principal investments, which principally consisted of investments in previously sponsored merchant banking funds and Iridium. In 2011, we sold substantially all of our interests in GCP II to certain unaffiliated third parties and certain principals of GCP Capitalfor an aggregate price of $44.8 million, which represented the book value of the assets sold. As part of that sale, the purchasers had put rights, substantially all of which were exercised and we acquired interests in two portfolio companies of GCP II for $15.5 millionin the fourth quarter of 2012. We also sold in 2011 our entire interest in GSAVP funds to certain unaffiliated third parties for $4.6 million, which also represented the book value of the assets sold. We did not recognize any gain or loss on the sales of our interest in GCP II or GSAVP because we sold our interests at book value. In 2012, we continued the liquidation of our previously sponsored merchant banking funds with the sale of our entire interest in GCP Europe for proceeds of $27.2 million, which represented approximately 90% of book value. We recognized a loss of $3.4 millionas result of this sale. This transaction was pursued in order to accelerate the liquidation of our investment portfolio and generate additional funds for share repurchases. In 2013, we sold our entire investment in GCP III for $2.0 million, which approximated the book value of the investment. At December 31, 2013, we had remaining investments in previously sponsored and other merchant banking funds of $11.7 million. See "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". In October 2011, we initiated a Rule 10b5-1 plan to sell our entire interest in Iridium over a period of two or more years. In December 2013, we completed the sale of our entire interest in Iridium. Over the sale period, we sold 9,804,016 shares of Iridium common stock for total proceeds of $70.5 million. The following table sets forth additional information relating to our investment and merchant banking revenues: For the Year Ended December 31, 2013 2012 2011 (In millions) Net realized and unrealized gain (loss) in Iridium $ 0.8 $ (5.0 ) $ (6.2 )Net realized and unrealized gains (losses) in investments in merchant banking funds (1.9 ) (3.4 ) (4.5 ) Sale of certain merchant banking assets 0.2 0.3 0.8 Interest income 1.1 1.7 1.1
Total investment and merchant banking revenues
Investment and merchant banking revenues accounted for 0% and negative 2% (an investment loss) of our revenues in 2013 and 2012, respectively. During the period 2011 through 2013, we generated investment revenues principally from gains (or losses) on the existing investments in the merchant banking funds and Iridium as these investments were liquidated. As a result of the sale of substantially all of our investments over the past three years, we do not expect to report significant investment revenues in future periods.
We recognized gains or losses from our investment in Iridium from marking to market our holdings at the end of each period to record unrealized gains or losses. To the extent we sold our holdings in Iridium for a price above or below our mark for the previously reported period, we recognized realized gains or losses on such sales during the period of sale. In 2013, we recognized a gain on our investment in Iridium of
$0.8 millionwhich compares to the recognition of a loss of $5.0 millionin 2012. We recognize revenue on investments in merchant banking funds based on our allocable share of realized and unrealized gains (or losses) reported by such funds on a quarterly basis. Investments held by merchant banking funds are recorded at estimated fair value. The value of merchant banking fund investments in privately held companies is determined by the general partner of the fund after giving consideration to the cost of the security, the pricing of other sales of securities by the portfolio company, the price of securities of other companies comparable to the portfolio company, purchase multiples paid in other comparable third-party transactions, the original purchase price multiple, market conditions, liquidity, operating results and other qualitative and quantitative factors. Discounts may be applied to the funds' privately held investments to reflect the lack of liquidity and other transfer restrictions. Investments in publicly traded securities are valued using quoted market prices discounted for any legal or contractual restrictions on sale. Because of the inherent uncertainty of valuations as well as the discounts applied, the estimated fair value of investments in privately held companies may differ significantly from the values that would have been used had a ready market for the securities existed. The values at which our investments are adjusted to estimated fair value at the end of each quarter and the volatility in general economic conditions, stock markets and commodity prices may result in significant changes in the estimated fair value of the investments from period to period, which may have a material effect, positive or negative, on our revenues and thus our results of operations. See "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates - Revenue Recognition - Investment Revenues". For our remaining investments in the merchant banking funds, the size and timing of changes in the fair value are tied to a number of different factors, including the performance of the particular portfolio companies, general economic conditions in the debt and equity markets and other factors which affect the industries in which the funds are invested. We will continue to record realized and unrealized changes in the fair value of our investments on a quarterly basis until such investments are fully liquidated. Adverse changes in general economic conditions, commodity prices, credit and public equity markets could negatively impact the amount of investment revenues we record in any period. 2013 versus 2012. For the year ended December 31, 2013, we recorded an investment gain of $0.2 millioncompared to an investment loss of $6.4 millionfor the year ended December 31, 2012. The net gain of $6.6 millionprincipally resulted from improved share price performance in the quoted value of Iridium during 2013 compared to 2012.
During 2013, we completed the sale of our investment in Iridium, selling 5,084,016 common shares at an average price of
For the year ended
The following table sets forth information relating to our operating expenses, which are reported net of reimbursements of certain expenses by our clients:
For the Year Ended December 31, 2013 2012 2011 (in millions, except employee data) Number of employees at year end 319 324 316 Employee compensation and benefits expense
$ 155.7 $ 151.8 $ 162.6% of revenues 54 % 53 % 55 % Non-compensation expenses 60.3 62.8 62.7 % of revenues 21 % 22 % 21 % Total operating expenses 215.9 214.6 225.3 % of revenues 75 % 75 % 77 % Total income before taxes 71.2 70.5 68.7 Pre-tax income margin 25 % 25 % 23 % Compensation and Benefits Expenses The principal component of our operating expenses is employee compensation and benefits expense. Since our IPO in 2004, we have sought to keep our total compensation and benefits expense to a ratio that does not exceed 50% of total revenues each year. While we achieved that objective during the period from our IPO through 2009, when our ratio of compensation to revenues was 46%, we have been affected over the past few years by the challenging transaction environment and our ratio of compensation to revenues has ranged between 53% and 55% since 2010. The ratio of compensation to revenues in 2013 was 54%. The actual compensation expense ratio is determined by management in consultation with the Compensation Committee and based on such factors as the relative level of revenues, anticipated compensation requirements to retain our employees, the cost to recruit and exit employees, and specifically managing directors, in any given period, the charge for amortization of restricted stock awards and related forfeitures and other relevant factors. Our compensation and benefits expenses principally consist of (i) base salary and benefits, (ii) annual incentive compensation payable as cash bonus awards and (iii) amortization of long-term incentive compensation awards of restricted stock units. Base salary and benefits are paid ratably throughout the year. Awards of restricted stock units are discretionary and are amortized into compensation expense (based upon the fair value of the award at the time of grant) during the service period over which the award vests, which is generally five years for the majority of the awards. As we expense these awards, the restricted stock units recognized are recorded within stockholders' equity. Cash bonuses, which are accrued each quarter, are discretionary and dependent upon a number of factors, including our financial performance, and are generally paid in February in respect of the preceding year. Our fixed compensation cost, which is the sum of base salaries and benefits and the amortization of previously issued restricted stock units, remained comparable year to year at approximately $131.0 millionand $130.0 millionfor 2013 and 2012, respectively. We expect that our fixed compensation cost for 2014 will be comparable to 2013 and 2012. Our estimate for fixed compensation costs for 2014 is based upon our headcount and salary levels as of January 1, 2014and decisions we make throughout the year relating to hiring, retaining and exiting employees may increase or decrease our full year fixed compensation cost. Our fixed compensation cost may vary from year to year based on such factors as headcount, changes in charges for the amortization of restricted stock units and other related matters. The aggregate amount of discretionary payments generally represents the excess amount of the total compensation amount over the amount of base salary and benefits and amortization of restricted stock awards. Cash payments of $25.0 million, $22.0 millionand $34.0 millionwere paid and/or accrued in 2013, 2012 and 2011, respectively. The majority of the payments in each of the last three years were made to professional employees who were not managing directors, consistent with our philosophy of providing our senior bankers a greater share of their compensation in the form of long term incentive compensation. While our ratio of compensation to revenues has exceeded 50% during the difficult M&A market that started in 2009, it continues to be our objective to reduce this ratio over time to a ratio not to exceed 50% when market activity and our revenue productivity improve. We will balance this policy goal with our objective of retaining our core personnel and compensating them competitively in order to maintain our strong franchise, and continuing to expand our industry expertise and geographic reach. 33
2013 versus 2012. For the year ended
December 31, 2013, our employee compensation and benefits expenses were $155.7 millioncompared to $151.8 millionfor 2012. Our 2013 compensation and benefits expenses increased $3.9 million, or 3%, from 2012. While total revenues remained relatively constant year to year, the increase in compensation expense in 2013 from the prior year resulted in a ratio of compensation expense to revenues in 2013 of 54% as compared to 53% in 2012. 2012 versus 2011. For the year ended December 31, 2012, our employee compensation and benefits expenses were $151.8 millioncompared to $162.6 millionfor 2011. Our 2011 compensation and benefits expenses included a fourth quarter charge of $7.0 millionfor the accelerated vesting of restricted stock awards previously granted to employees who died in an airplane accident. Excluding that charge, our 2012 compensation and benefits expenses decreased $3.8 million, or 2%, from 2011. The ratio of compensation expense to revenues in 2012 was 53% as compared to 55% (53% excluding the accelerated charge for the vesting of restricted stock awards of two employees who died in an aircraft accident) in 2011. Our compensation expense is generally based upon revenues and can fluctuate materially in any particular year depending upon the changes in headcount, amount of revenues recognized, as well as other factors. Accordingly, the amount of compensation expense recognized in any particular year may not be indicative of compensation expense in future years. Non-Compensation Expenses Our non-compensation expenses include the costs for occupancy and equipment rental, communications, information services, professional fees, recruiting, travel and entertainment, insurance, depreciation and amortization, interest expense and other operating expenses. Reimbursed client expenses are netted against non-compensation expenses. Over the past three years, our non-compensation expenses have remained relatively constant in absolute dollars. Historically, our non-compensation costs, particularly occupancy and travel costs associated with business development, have increased as we have grown our business and made strategic investments. As we look forward to 2014, and assuming moderate headcount growth, we do not expect any material short term increases in our non-compensation expenses. Over the longer term, any increases in our non-compensation expenses will be dependent mostly on our geographic expansion to new locations, general inflation related increases in rent and other costs we incur and, to a much lesser extent, on an increase in headcount within our existing locations. 2013 versus 2012. For the year ended December 31, 2013, our non-compensation expenses were $60.3 millioncompared to $62.8 millionin 2012, representing a decrease of $2.5 million, or 4%. The decrease in non-compensation expenses principally resulted from the benefit of lower amortization of the Australian intangible assets, which were fully amortized in the first quarter of 2013, and lower other general operating costs offset by an increase in travel expenses associated with new business activities. Non-compensation expenses as a percentage of revenues for 2013 were 21% compared to 22% for 2012. The slight decrease in non-compensation expenses as a percentage of revenues resulted from the spreading of lower costs in 2013 over comparable revenues for 2013 as compared to 2012. 2012 versus 2011. For the year ended December 31, 2012, our non-compensation expenses were $62.8 million, compared to $62.7 millionfor the same period in 2011. In 2012, as compared to 2011, an increase in travel expenses and other operating costs were offset by lower amortization of the Australian intangible assets and a decrease in interest expense due to a reduction in average borrowings outstanding and a slight decrease in the average interest rate paid. Non-compensation expenses as a percentage of revenues for 2012 were 22% compared to 21% for 2011. The slight increase in non-compensation expenses as a percentage of revenues resulted from comparable costs for both years spread over slightly lower revenues in 2012 as compared to 2011. Our non-compensation expenses as a percentage of revenues can vary as a result of a variety of factors including fluctuation in annual revenue amounts, changes in headcount, the amount of recruiting and business development activity, the amount of office space expansion, the amount of reimbursement of engagement-related expenses by clients, the amount of our short term borrowings, interest rate and currency movements and other factors. Accordingly, the non-compensation expenses as a percentage of revenues in any particular year may not be indicative of the non-compensation expenses as a percentage of revenues in future years. 34
Provision for Income Taxes We are subject to federal, foreign and state and local corporate income taxes in
the United States. In addition, our non-U.S. subsidiaries are subject to income taxes in their local jurisdictions. 2013 versus 2012. For the year ended December 31, 2013, the provision for taxes was $24.5 million, which reflected an effective tax rate of 34%. This compared to a provision for taxes for the year ended December 31, 2012of $28.4 million, which reflected an effective tax rate of 40%. The decrease in the provision for income taxes and effective tax rate in the year ended December 31, 2013, as compared to 2012, resulted from a significant reduction in the effective tax rate in 2013 applied to slightly higher pre-tax income in 2013. The decrease in the effective tax rate of 6 percentage points principally resulted from an increase in non-U.S. earnings, which are taxed at substantially lower rates than U.S. earnings. In addition, in 2013 we benefited from a decrease in the amount of non-deductible capital losses related to our European investments, which had increased our annual effective tax rate in 2012. 2012 versus 2011. For the year ended December 31, 2012, the provision for taxes was $28.4 million, which reflected an effective tax rate of 40%. This compared to a provision for taxes for the year ended December 31, 2011of $24.1 million, which reflected an effective tax rate of 35%. The increase in the provision for income taxes and effective tax rate in the year ended December 31, 2012, as compared to 2011, resulted from both a greater proportion of our earnings being generated in the U.S. and the impact of capital losses not currently deductible related to the sale of our European investments. Since the U.S. imposes a higher federal and state tax rate than the other jurisdictions in which we operate, an increase in the portion of our pre-tax earnings allocated to the U.S. in 2012 as compared to 2011 increased our tax provision and effective tax rate in 2012. Further, as a result of the liquidation of our investment portfolio in Europeat a loss in 2012, we recorded capital losses not currently deductible, which also had the effect of increasing our tax provision and effective tax rate. The effective tax rate can fluctuate as a result of variations in the relative amounts of advisory and investment income earned and the tax rate imposed in the tax jurisdictions in which we operate and invest. Accordingly, the effective tax rate in any particular year may not be indicative of the effective tax rate in future years. Net Income and Earnings Per Share 2013 versus 2012. For the year ended December 31, 2013, net income allocated to common stockholders was $46.7 million, or $1.55per diluted share, as compared to net income allocated to common stockholders of $42.1 million, or $1.38per diluted share, in 2012. Although we realized slightly higher total revenues and income before tax in 2013 as compared to 2012, the increase in net income allocated to common stockholders of $4.6 millionprincipally resulted from a decrease in our effective tax rate from 40% in 2012 to 34% in 2013 as explained above. In addition, our increase in diluted earnings per share of $0.17in 2013 as compared to 2012 also benefited from a decrease in our diluted share count. During 2013, our fully diluted average shares outstanding decreased by 0.4 million to 30.2 million from 30.6 million in 2012. The decrease in our fully diluted average shares outstanding principally related to the weighted average impact of open market repurchases of 0.9 million shares partially offset by the recognition of 0.5 million restricted stock unit awards, net of shares deemed repurchased by us for the settlement of employee tax liabilities arising upon the vesting of the awards. The average shares outstanding at December 31, 2013do not include an additional 0.4 million contingent convertible preferred shares issued to the founding partners of Caliburn, which may be converted to an equal number of our common shares in the event that the second performance target related to the revenue target for the period April 1, 2013through March 31, 2015is achieved. If the revenue target for the second tranche is achieved, the shares will be deemed converted to common shares for EPS purposes at the time the performance target is met. If the revenue target for the second tranche is not achieved, the contingent convertible performance shares will be canceled. The contingent convertible performance shares related to the first performance target was met in 2012 and 0.7 million shares of common stock were included in our share count, effective December 2012, for EPS purposes. See "Note 9 - Equity" and "Note 10 - Earnings Per Share" of the Consolidated Financial Statements for a description of the convertible preferred shares. 2012 versus 2011. For the year ended December 31, 2012, net income allocated to common stockholders was $42.1 million, or $1.38per diluted share, as compared to net income allocated to common stockholders of $44.6 million, or $1.44per diluted share, in 2011. The decrease in net income allocated to common stockholders of $2.5 millionand earnings per share of $0.06resulted from an increase in our effective tax rate from 35% in 2011 to 40% in 2012 due to a greater proportion of our earnings being generated in the U.S. and the impact of capital losses related to our European investments, which are not currently deductible. Income before tax was $70.5 millionfor the year ended December 31, 2012as compared to $68.7 millionfor the year ended December 31, 2011. 35
During 2012, our fully diluted average shares outstanding decreased by 0.4 million to 30.6 million from 31.0 million in 2011. The decrease in our average shares outstanding principally related to the weighted average impact of open market repurchases of 1.7 million shares offset by the inclusion of 0.7 million shares of common stock for EPS purposes related to the successful achievement of the first performance target related to the Caliburn acquisition and the recognition of 0.5 million restricted stock unit awards, net of shares deemed repurchased by us for the settlement of employee tax liabilities arising upon the vesting of the awards.
Geographic Data For a summary of the total revenues, income before taxes and total assets by geographic region, see "Note 16 - Business Information" to the Consolidated Financial Statements.
Liquidity and Capital Resources Our liquidity position is monitored by our Management Committee, which generally meets monthly. The Management Committee monitors cash, other significant working capital assets and liabilities, debt and other matters relating to liquidity requirements. We evaluate our liquid cash operating position on a regular basis in light of current market conditions. At
December 31, 2013, we had cash and cash equivalents on hand of $42.7 million, of which $25.2 millionwas held outside the U.S. We retain our cash in financial institutions with high credit ratings and/or invest in short-term investments which are expected to provide liquidity. We generate cash from our operating activities principally in the form of advisory fees. Historically, we also generated cash from our investment activities in the form of proceeds from the sales and distributions of our investments. We use our cash primarily for recurring operating expenses and the payment of dividends and non-recurring disbursements such as the repurchase of shares of our common stock and the funding of leasehold improvements for the build out of office space. Our recurring monthly operating disbursements principally consist of base compensation expense, occupancy, travel and entertainment, and other operating expenses. Our recurring quarterly and annual disbursements consist of cash bonus payments, tax payments, dividend payments, and repurchases of our common stock from our employees in conjunction with the payment of tax liabilities incurred on vesting of restricted stock units. These amounts vary depending upon our profitability and other factors. Because a portion of the compensation we pay to our employees is distributed in annual bonus awards (usually in February of each year), our net cash balance is typically at its lowest level during the first quarter of each year and generally accumulates from our operating activities throughout the remainder of the year. In general, we collect our accounts receivable within 60 days, except for fees generated through our private equity and real estate capital advisory services, which are generally paid in installments over a period of three years, and certain restructuring transactions, where collections may take longer due to court-ordered holdbacks. At December 31, 2013, we had long-term receivables related to private equity and real estate capital advisory engagements of $34.0 million. Our current liabilities typically consist of accounts payable, which are generally paid monthly, accrued compensation, which includes accrued cash bonuses that are generally paid in the first quarter of the following year to the large majority of our employees, and current taxes payable. In February 2014, we paid cash bonuses and accrued benefits of approximately $8.2 millionrelating to 2013 compensation to our employees. In addition, we expect to pay approximately $15.3 millionin 2014 principally related to income taxes owed in the United Statesand the United Kingdomfor the year ended December 31, 2013. At December 31, 2013, accounts payable and accrued expenses and advisory fee receivables included value added taxes of $4.8 million, which related to year-end transaction activity. To provide for working capital needs and other general corporate purposes in the United States, we have a $45.0 millionrevolving bank loan facility which matures on April 30, 2014. Historically, we have been able to extend the maturity date of the revolving loan facility for a one year period shortly before maturity, and we expect to renew the revolving loan facility this year although our ability to do so this year and in the future is not certain. Borrowings under the facility are secured by any cash distributed in respect of our investment in the U.S. based merchant banking funds and cash distributions from Greenhill & Co., LLC. At December 31, 2013, we had $30.8 millionoutstanding under the revolving bank loan facility. The revolving loan facility has a prohibition on the incurrence of additional indebtedness without the prior approval of the lenders and requires that we comply with certain financial and liquidity covenants on a quarterly basis. At December 31, 2013, we were compliant with all loan covenants and we expect to continue to be compliant with all loan covenants in future periods. 36
Historically, we have generated significant earnings outside the U.S. In 2011, we reviewed our reinvestment needs in our foreign locations and determined that based on our business model, which is now focused entirely on our advisory business, it is unlikely that we will have future needs that require us to permanently reinvest our foreign earnings in the local jurisdictions. Accordingly, to support our corporate cash needs in the U.S. we may repatriate foreign earnings in excess of our local working capital requirements and other forecasted local needs. To the extent we repatriate foreign earnings from jurisdictions with a lower tax rate than the U.S. we may be subject to an incremental amount of U.S. tax on such earnings. However, we currently have excess foreign tax credits, and may generate additional foreign tax credits, which may be available to offset any incremental U.S. tax amount. As a result, we would expect to incur a minimal amount, if any, of incremental U.S. tax from any such repatriation in the near future. Since our exit from the merchant banking business in 2010, we have sought to realize value from our remaining principal investments, which principally consisted of investments in previously sponsored merchant banking funds and Iridium. During 2011, we sold substantially all of our interests in GCP II and all of our interests in GSAVP to unaffiliated third parties and received proceeds of
$49.4 million, of which $15.5 millionwas repaid in December 2012upon exercise by the purchasers of a put option. In 2012, we continued the liquidation of our previously sponsored merchant banking funds with the sale of our entire interest in GCP Europe for proceeds of $27.2 million. In July 2013, we sold our entire investment in GCP III for proceeds of $2.0 million. As part of that sale, the buyers assumed our remaining commitment to GCP III and eliminated our last remaining commitment to investments in merchant banking funds. Also in July 2013, we sold one of the remaining capital interests in GCP II for a nominal amount to realize tax benefits.
Under the terms of our stock equity plan we generally repurchase from our employees that portion of restricted stock unit awards used to fund income tax withholding due at the time the restricted stock unit awards vest. Based upon the number of restricted stock unit grants outstanding at
Since 2004, we have paid quarterly dividends to our shareholders and dividend equivalent payments to our employees, who hold restricted stock units. Our quarterly dividend has been
$0.45per share since 2007. For the year ended December 31, 2013, we made dividend distributions of $56.2 million, or $1.80per common share and outstanding restricted stock unit. We intend to continue to pay quarterly dividends subject to capital availability and periodic determinations that cash dividends are in the best interest of our stockholders. Future declaration and payment of dividends on our common stock is at the discretion of our Board of Directors and depends upon, among other things, our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors as the Board of Directors may deem relevant. Our acquisition of Caliburn in 2010 was funded with the issuance of 1,099,874 shares of our common stock and 1,099,877 contingent convertible preferred shares. The contingent convertible preferred shares do not pay dividends and were issued in tranches of 659,926 shares and 439,951 shares, which convert to common shares promptly following the third and fifth anniversary of the closing of the acquisition, respectively, if certain revenue targets are achieved. The performance target for the first tranche was met prior to the third anniversary and 659,926 contingent convertible preferred shares were converted to common shares in April 2013. The second tranche of contingent convertible preferred shares is subject to a measurement period of revenues from April 1, 2013to March 31, 2015. If the revenue target for the second tranche is achieved, the contingent convertible preferred shares will be converted to common shares on April 1, 2015. If the revenue target for the second tranche is not achieved, the remaining contingent convertible preferred shares will be canceled. While we believe that the cash generated from operations and funds available from the revolving bank loan facility will be sufficient to meet our expected operating needs, tax obligations, common dividends payments, share repurchases and build-out costs of new office space, we may adjust our variable expenses and other disbursements, if necessary, to meet our liquidity needs. There is no assurance that our current lender will continue to renew our revolving loan facility annually on comparable terms, and if it is not renewed that we would be able to obtain a new credit facility from a different lender. In that case, we could be required to promptly secure alternative forms of financing, issue additional securities, reduce operating costs or take a combination of these actions, in each case on terms which may not be favorable to us. In the event that we are not able to meet our liquidity needs, we may consider a range of financing alternatives to meet any such needs. Cash Flows 2013. Cash and cash equivalents decreased by $7.6 millionfrom December 31, 2012, including a decrease of $1.0 millionresulting from the effect of the translation of foreign currency amounts into U.S. dollars at the year-end foreign currency conversion rates. We generated $67.8 millionfrom operating activities, which consisted of $100.8 millionfrom net income after giving effect to the non-cash items and a net increase in working capital of $33.0 million(primarily due to an increase in advisory fees receivable due to a number of large transaction closings shortly prior to December 31, 2013). We generated $35.8 millionfrom investing activities, which consisted of proceeds from the sale of Iridium of $34.2 million, distributions from merchant banking fund investments of $1.3 million, partially offset by $0.6 millionused to fund capital calls for our merchant banking fund investments and $1.2 millionfor the build out of office space and other capital needs. We used $110.2 millionin financing activities, including $56.2 millionfor the payment of dividends, $42.5 millionfor open market repurchases of our common stock and $12.9 millionfor the repurchase of our common stock from employees in conjunction with the payment of tax liabilities in settlement of restricted stock units and $0.3 millionfor distributions to non-controlling interests, partially offset by net borrowings on our revolving loan facility of $1.7 million. 38
2012. Cash and cash equivalents decreased by
Contractual Obligations The following table sets forth information relating to our contractual obligations as of
Payment Due by Period Less than More than
Contractual Obligations Total 1 year Years 2-3 Years 4-5 5 years
(in millions) Operating lease obligations
$ 82.9 $ 15.4 $ 27.5 $ 23.2 $ 16.8Revolving loan facility 30.8 30.8 - - - Total $ 113.7 $ 46.2 $ 27.5 $ 23.2 $ 16.8
Off-Balance Sheet Arrangements We do not invest in any off-balance sheet vehicles that provide financing, liquidity, market risk or credit risk support, or engage in any leasing or hedging activities that expose us to any liability that is not reflected in our consolidated financial statements.
Market Risk Our investments are limited to (1) short-term cash investments, which we believe do not face any material interest rate risk, equity price risk or other market risk and (2) principal investments made in merchant banking funds. We maintain our cash and cash equivalents with financial institutions with high credit ratings. Although these deposits are generally not insured, management believes that we are not exposed to significant credit risk due to the financial position of the depository institutions in which those deposits are held. We monitor the quality of our investments on a regular basis and may choose to diversify such investments to mitigate perceived market risk. Our cash and cash equivalents are denominated in U.S. dollars, Australian dollars, Canadian dollars, pound sterling, euros, yen, Swedish krona, and Brazilian real and we face foreign currency risk in our cash balances held in accounts outside
With regard to our investments in merchant banking funds, we face exposure to changes in the fair value of the companies in which we have directly or indirectly invested, which historically has been volatile. We manage the risks associated with the merchant banking portfolio by assessing information provided by the funds. In addition, the reported amounts of our advisory revenues may be affected by movements in the rate of exchange between the Australian dollar, Canadian dollar, pound sterling, euro, and yen (in which collectively 45% of our revenues for the year ended
Critical Accounting Policies and Estimates We believe that the following discussion addresses Greenhill's most critical accounting policies, which are those that are most important to the presentation of our financial condition and results of operations and require management's most difficult, subjective and complex judgments. Basis of Financial Information Our consolidated financial statements are prepared in conformity with GAAP in
the United States, which require management to make estimates and assumptions regarding future events that affect the amounts reported in our financial statements and footnotes, including investment valuations, compensation accruals and other matters. Management believes that the estimates used in preparing its consolidated financial statements are reasonable and prudent. Actual results could differ materially from those estimates. Certain reclassifications have been made to prior year information to conform to current year presentation. The consolidated financial statements include all consolidated accounts of Greenhill & Co., Inc.and all other entities in which we have a controlling interest after eliminations of all significant inter-company accounts and transactions. In accordance with the accounting pronouncements on the consolidation of variable interest entities, we consolidate the general partners of the merchant banking funds in which it has a majority of the economic interest. The general partners account for their investments in the merchant banking funds under the equity method of accounting. As such, the general partners record their proportionate shares of income (loss) from the underlying merchant banking funds. As the merchant banking funds follow investment company accounting, and generally record all their assets and liabilities at fair value, the general partners' investment in merchant banking funds represents an estimation of fair value. We do not consolidate the merchant banking funds since we, through our general partner and limited partner interests, do not have a majority of the economic interest in such funds and the limited partners have certain rights to remove the general partner by a simple majority vote of unaffiliated third-party investors. Revenue Recognition Advisory Revenues
It is our policy to recognize revenue when (i) there is persuasive evidence of an arrangement with a client, (ii) the agreed-upon services have been completed and delivered to the client or the transaction or events noted in the engagement letter are determined to be substantially complete, (iii) fees are fixed and determinable, and (iv) collection is reasonably assured.
We recognize advisory fee revenues for mergers and acquisitions or financing advisory and restructuring engagements when the services related to the underlying transactions are completed in accordance with the terms of the engagement letter and all other requirements for revenue recognition are satisfied.
We recognize private equity and real estate capital advisory fees at the time of the client's acceptance of capital or capital commitments to a fund in accordance with the terms of the engagement letter. Generally, fee revenue is determined based upon a fixed percentage of capital committed to the fund. For multiple closings, revenue is recognized at each interim closing based on the amount of capital committed at each closing at the fixed fee percentage. At the final closing, revenue is recognized at the fixed percentage for the amount of capital committed since the last interim closing.
While the majority of our fee revenue is earned at the conclusion of a transaction or closing of a fund, on-going retainer fees, substantially all of which relate to non-success based strategic advisory and financing advisory and restructuring assignments, are also earned and recognized as advisory fee revenue over the period in which the related service is rendered.
Our clients reimburse certain expenses incurred by us in the conduct of advisory engagements. Expenses are reported net of such client reimbursements. Investment Revenues
Investment revenues consist of (i) gains (or losses) on our investments in certain merchant banking funds, Iridium and other investments, and (ii) interest income. We recognize revenue on our investments in merchant banking funds based on our allocable share of realized and unrealized gains (or losses) reported by such funds. We recognize revenue on our other investments, including Iridium, which considers our influence or control of the investee, based on gains and losses on investment positions held, which arise from sales or changes in the fair value of investments. The amount of gains or losses are not predictable and can cause periodic fluctuations in net income and therefore subject us to market and credit risk. Cash and Cash Equivalents We consider all highly liquid investments with a maturity date of three months or less, when purchased, to be cash equivalents. Cash equivalents primarily consist of money market funds and overnight deposits. Advisory Fees Receivables Receivables are stated net of an allowance for doubtful accounts. The estimate for the allowance for doubtful accounts is derived by utilizing past client transaction history and an assessment of the client's creditworthiness. Included in the advisory fees receivable balance are long term receivables related to private equity and real estate capital advisory engagements, which are generally paid in installments over a period of three years. Included as a component of investment revenues on the consolidated statements of income is interest income related to capital advisory engagements. Credit risk related to advisory fees receivable is disbursed across a large number of clients located in various geographic areas. We control credit risk through credit approvals and monitoring procedures but do not require collateral to support accounts receivable. Investments Our investments in merchant banking funds are recorded under the equity method of accounting based upon our proportionate share of the estimated fair value of the underlying merchant banking fund's net assets. The value of merchant banking fund investments in privately held companies is determined by management of the fund after giving consideration to the cost of the security, the pricing of other sales of securities by the portfolio company, the price of securities of other companies comparable to the portfolio company, purchase multiples paid in other comparable third-party transactions, the original purchase price multiple, market conditions, liquidity, operating results and other qualitative and quantitative factors. Discounts may be applied to the funds' privately held investments to reflect the lack of liquidity and other transfer restrictions. Investments in publicly traded securities are valued using quoted market prices discounted for any legal or contractual restrictions on sale. Because of the inherent uncertainty of valuations as well as the discounts applied, the estimated fair values of investments in privately held companies may differ significantly from the values that would have been used had a ready market for the securities existed. The values at which our investments are carried on its consolidated statements of financial condition are adjusted to estimated fair value at the end of each quarter and the volatility in general economic conditions, stock markets and commodity prices may result in significant changes in the estimated fair value of the investments from period to period. Goodwill Goodwill is the cost in excess of the fair value of identifiable net assets at acquisition date. We test goodwill for impairment at least annually. An impairment loss is triggered if the estimated fair value of an operating unit is less than estimated net book value. Such loss is calculated as the difference between the estimated fair value of goodwill and its carrying value. Goodwill is translated at the rate of exchange prevailing at the end of the periods presented in accordance with the accounting guidance for foreign currency translation. Any translation gain or loss is included in the foreign currency translation adjustment included as a component of other comprehensive income in the consolidated statements of changes in equity. 41
Restricted Stock Units We account for its share-based compensation payments under which the fair value of restricted stock units granted to employees with future service requirements is recorded as compensation expense and generally amortized over a five-year service period following the date of grant. Compensation expense is determined based upon the fair market value of our common stock at the date of grant. As we expense the awards, the restricted stock units recognized are recorded within equity. The restricted stock units are reclassed into common stock and additional paid-in capital upon vesting. We record dividend equivalent payments, net of estimated forfeitures, on outstanding restricted stock units as a dividend payment and a charge to equity.
Earnings per Share We calculate basic earnings per share ("EPS") by dividing net income allocated to common stockholders by the sum of (i) the weighted average number of shares outstanding for the period and (ii) the weighted average number of shares deemed issuable due to the vesting of restricted stock units for accounting purposes. In addition, the contingent convertible preferred shares will also be included in the weighted average number of shares to the extent they are deemed to have met the performance targets. We calculate diluted EPS by dividing net income allocated to common stockholders by the sum of (i) basic shares per above and (ii) the dilutive effect of the common stock deliverable pursuant to restricted stock units for which future service is required. Under the treasury method, the number of shares issuable upon the vesting of restricted stock units included in the calculation of diluted EPS is the excess, if any, of the number of shares expected to be issued, less the number of shares that could be purchased by us with the proceeds to be received upon settlement at the average market closing price during the reporting period. Provision for Taxes We account for taxes in accordance with the guidance for income taxes which requires the recognition of tax benefits or expenses on the temporary differences between the financial reporting and tax bases of its assets and liabilities. We follow the guidance for income taxes in recognizing, measuring, presenting and disclosing in its financial statements uncertain tax positions taken or expected to be taken on its income tax returns. Income tax expense is based on pre-tax accounting income, including adjustments made for the recognition or derecognition related to uncertain tax positions. The recognition or derecognition of income tax expense related to uncertain tax positions is determined under the guidance. Deferred tax assets and liabilities are recognized for the future tax attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period of change. Management applies the "more-likely-than-not criteria" when determining tax benefits. Financial Instruments and Fair Value We account for financial instruments measured at fair value in accordance with accounting guidance for fair value measurements and disclosures which establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under the pronouncement are described below: Basis of Fair Value Measurement Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities; Level 2 - Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and Level 3 - Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. A financial instrument's level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. In determining the appropriate levels, we perform a detailed analysis of the assets and liabilities that are subject to these disclosures. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs or instruments which trade infrequently and therefore have little or no price transparency are classified as Level 3. Transfers between levels are recognized as of the end of the period in which they occur.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk Quantitative and qualitative disclosures about market risk are set forth above in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operation - Market Risk".