1804 Embarcadero Road

Palo Alto, California 94303

(650) 565-4900

 

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

Jeffrey N. Maggioncalda

Chief Executive Officer

1804 Embarcadero Road

Palo Alto, California 94303

(650) 565-4900

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Approximate date of commencement of proposed sale to the public:   As soon as practicable after this Registration Statement becomes effective.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.   o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

 

 

TABLE OF CONTENTS

 

 

No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus.

 

You should rely only on the information contained in this prospectus and any free writing prospectus prepared by or on behalf of us. This prospectus is an offer to sell only the shares offered hereby but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

 

Through and including          , 2010 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscriptions.

 

The market data and certain other statistical information used throughout this prospectus are based on independent industry publications, governmental publications, reports by market research firms or other independent sources. Some data are also based on our good faith estimates. Although we believe these third-party sources are reliable, we have not independently verified the information attributed to these third-party sources and cannot guarantee its accuracy and completeness.

 

FINANCIAL ENGINES ^® , INVESTOR CENTRAL ^® , THE POWER TO SHAPE THE FUTURE ^® , FINANCIAL ENGINES INVESTMENT ADVISOR ^® , WE MAKE IT PERSONAL ^® , RETIREMENT HELP FOR LIFE ^® , the Financial Engines logo and a sun and cloud design mark are all trademarks or service marks owned by Financial Engines, Inc., registered in the United States and other countries. In addition, Financial Engines, Inc. owns the trademarks ADVICESERVER ^® and FORECASTER ^® , registered in Japan and FINENG ^® , registered in Tunisia. The mark ADVICE LIGHT is also a trademark owned by Financial Engines, Inc. All other trademarks, service marks and trade names appearing in this prospectus are the property of their respective owners.

 

PROSPECTUS SUMMARY

	•	Professional Management is a discretionary managed account service designed for plan participants who want affordable, personalized and professional portfolio management

		services, investment advice and retirement help from an independent investment advisor without the conflicts of interest that can arise when an advisor offers proprietary products. Our investment recommendations are limited to the investment alternatives available in a 401(k) plan as determined and approved by a plan fiduciary other than us, although we do take into account other identified holdings of the plan participant when offering investment advice. With the exception of employer stock, if any, included as an investment alternative, we do not provide advice on or manage single-company securities. We do not consult with, or make recommendations to, the plan sponsor regarding which investment alternatives to make available in a particular plan. In some cases, we provide this service by acting as a subadvisor to a plan provider acting as the investment manager to plan participants.

	•	Online Advice is a nondiscretionary Internet-based service that offers personalized advice to plan participants who wish to take a more active role in personally managing their retirement portfolios. In some cases, we provide this service by acting as a subadvisor to a plan provider acting as the investment advisor to plan participants.
	•	Retirement Evaluation is a retirement readiness assessment provided to plan participants upon plan rollout and generally annually thereafter, accompanied by a Professional Management enrollment form. Retirement Evaluations highlight specific risks in a plan participant’s retirement account and assess the likelihood of achieving the plan participant’s retirement income goals. The assessment also provides guidance on how to reduce these highlighted risks.

	•	First, we sign a contract that allows us to provide our Professional Management service to the plan sponsor’s employees;
	•	Second, we obtain plan and plan participant data, set up the plan on our systems and make our services available to all eligible plan participants upon completion of plan rollout;

	•	Third, we deliver Retirement Evaluations and enrollment materials to plan participants; and
	•	Fourth, for plan participants who elect to enroll in our Professional Management service, we allocate the plan participant’s 401(k) assets pursuant to the participant’s investment objectives and investment options available, at which time the participant’s 401(k) assets become AUM.

Assets Under Management		Total Members

	•	Our Optimization Engine allows us to make personalized investment recommendations, chosen from the investment options available within each plan, with consideration of the plan participant’s individual circumstances including investment horizon, existing investment allocations and characteristics of his or her 401(k) plan, as well as any anticipated benefits from other employer plans, such as cash balance or defined benefit plans. Our Optimization Engine also allows our advice to adjust for the risks and correlations of other financial assets and a participant’s risk tolerance. In addition, we provide personalized savings recommendations to help plan participants reach their retirement objectives;
	•	Our Simulation Engine allows us to model the risk and return characteristics of more than 30,000 securities, including the funds and employer stocks in the plans to which we provide services, taking into consideration factors such as asset class exposures, expenses, turnover, manager performance, active management risk, stock specific risk and the security’s tax-efficiency;
	•	Our Advice Engines’ ability to manage a plan participant’s employer stock holdings is an attractive feature to plan sponsors seeking to reduce the risk of fiduciary liability that can arise when employer stock is included in a 401(k) plan. The advice produced by our Advice Engines also generally reduces plan participants’ undiversified exposure to the equity risk that results from holding an overly-high concentration in employer stock; and
	•	Our Advice Engines are able to provide advice that takes into consideration after-tax returns by taking into account the specific tax characteristics of securities and the tax attributes of investor households.

THE OFFERING

 

Shares of common stock offered by Financial Engines		Shares
Shares of common stock offered by the selling stockholders		Shares
Total shares of common stock offered		Shares
Shares of common stock to be outstanding immediately after this offering		Shares
Option to purchase additional shares offered by Financial Engines		Shares
Option to purchase additional shares offered by the selling stockholders		Shares
Use of proceeds		We intend to use a portion of the net proceeds from this offering to prepay all of the then outstanding indebtedness under our term loan and the remainder for general corporate purposes, including working capital and capital expenditures. As of September 30, 2009, the amount outstanding under our term loan was $8.9 million. See “Use of Proceeds.”
Dividend Policy		We do not currently intend to declare dividends on shares of our common stock. See “Dividend Policy.”
Risk Factors		You should carefully read the “Risk Factors” section of this prospectus for a discussion of factors that you should consider carefully before deciding to invest in shares of our common stock.
Proposed Nasdaq Global Market symbol		“FNGN”

	•	10,560,935 shares of common stock issuable upon the exercise of options outstanding as of September 30, 2009, at a weighted average exercise price of $5.76 per share;
	•	108,290 shares of common stock issuable upon the exercise of a warrant outstanding as of September 30, 2009, at an exercise price of $9.23 per share; and
	•	2,000,000 shares of common stock reserved for future issuance under our 2009 Stock Incentive Plan following the date of this offering.

	•	the conversion of all of our outstanding shares of preferred stock into an aggregate of 22,349,972 shares of common stock effective upon the completion of this offering, assuming a one-to-one conversion ratio of our outstanding shares of preferred stock into common stock;
	•	our reincorporation from California into Delaware and the filing of our restated certificate of incorporation prior to the completion of this offering; and
	•	no exercise of the option to purchase additional shares granted to the underwriters.

														Nine Months Ended
		Year Ended December 31,												September 30,
		2006				2007				2008				2008				2009
														(Unaudited)
		(In thousands, except share and per share data)
Statements of Operations Data:
Total revenue		$	48,233			$	63,350			$	71,271			$	52,264			$	58,847
Cost of revenue			15,691				20,602				27,588				20,511				21,057
Gross profit			32,542				42,748				43,683				31,753				37,790
Total operating expense			41,096				44,247				46,722				32,962				35,540
Income (loss) from operations			(8,554	)			(1,499	)			(3,039	)			(1,209	)			2,250
Interest income (expense) and other, net			579				(274	)			(563	)			(323	)			(210	)
Income (loss) before income tax expense			(7,975	)			(1,773	)			(3,602	)			(1,532	)			2,040
Income tax expense			8				31				12				9				359
Net income (loss)			(7,983	)			(1,804	)			(3,614	)			(1,541	)			1,681
Less: Preferred stock dividend			930				—				2,362				—				—
Net income (loss) attributable to holders of common stock		$	(8,913	)		$	(1,804	)		$	(5,976	)		$	(1,541	)		$	1,681
Net income (loss) per share attributable to holders of common stock:
Basic		$	(1.00	)		$	(0.19	)		$	(0.61	)		$	(0.16	)		$	0.17
Diluted		$	(1.00	)		$	(0.19	)		$	(0.61	)		$	(0.16	)		$	0.05
Shares used to compute net income (loss) per share attributable to holders of common stock:
Basic			8,879				9,427				9,767				9,711				10,050
Diluted:			8,879				9,427				9,767				9,711				34,648
Pro forma net income (loss) per share (unaudited):
Basic										$	(0.19	)						$	0.05
Diluted										$	(0.19	)						$	0.05
Shares used to compute pro forma net income (loss) per share (unaudited):
Basic											32,117								32,400
Diluted											32,117								34,648

		As of September 30, 2009
										Pro Forma
		Actual				Pro Forma				as Adjusted
		(In thousands, unaudited)
Balance Sheet Data:
Cash and cash equivalents  (1)		$	15,798			$	15,798			$
Working capital			12,075				12,075
Total assets  (1)			50,514				50,514
Bank borrowings and note payable			8,889				8,889
Total liabilities			33,096				33,096
Total stockholders’ equity  (1)			17,418				17,418

 

														Nine Months Ended
		Year Ended December 31,												September 30,
		2006				2007				2008				2008				2009
						(In thousands, unaudited)
Other Financial Data:
Adjusted EBITDA  (2)		$	(855	)		$	8,333			$	8,409			$	4,595			$	11,427
Adjusted net income (loss)  (2)			(5,024	)			2,612				3,006				703				6,329

Notes to Summary Consolidated Financial Information and Other Data

 

(1)	The table above presents a summary of our balance sheet data as of September 30, 2009:

 

	•	on an actual basis;
	•	on a pro forma basis to give effect to the issuance of 22,349,972 shares of common stock issuable upon the conversion of all of our outstanding shares of preferred stock upon completion of this offering; and
	•	on a pro forma as adjusted basis to give effect to the sale of           shares of common stock in this offering at an assumed initial public offering price of $      per share, the mid-point of the price range set forth on the cover of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us and the repayment of $8.9 million of outstanding indebtedness.

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease), on a pro forma as adjusted basis, each of cash and cash equivalents, total assets and total stockholders’ equity by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us and the repayment of $8.9 million of outstanding indebtedness.

 

(2)	“Adjusted EBITDA” represents net income (loss) before interest (income) expense, net, income tax expense, depreciation, withdrawn offering expense, amortization of internal use software, direct response advertising and deferred sales commissions and stock-based compensation.

 

“Adjusted Net Income (Loss)” represents net income (loss) before stock-based compensation expense and withdrawn offering expense.

 

Our management uses adjusted EBITDA and adjusted net income (loss):

 

	•	as measures of operating performance;

	•	for planning purposes, including the preparation of annual budgets;
	•	to allocate resources to enhance the financial performance of our business;
	•	to evaluate the effectiveness of our business strategies; and
	•	in communications with our board of directors concerning our financial performance.

	•	Adjusted EBITDA and adjusted net income (loss) do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;
	•	Adjusted EBITDA and adjusted net income (loss) do not reflect changes in, or cash requirements for, our working capital needs;
	•	Adjusted net income (loss) does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our debt;
	•	Adjusted EBITDA and adjusted net income (loss) do not reflect the non-cash component of employee compensation;
	•	Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements;
	•	Due to either net losses before income tax expenses or the use of federal and state net operating loss carryforwards in 2006, 2007 and 2008 and nine months ended September 30, 2008 and 2009, we had income tax payments of approximately $8,000, $31,000, $12,000,

		$9,000 and $359,000, respectively. Income tax payments will be higher if we generate net income before income tax expenses and our existing net operating loss carryforwards for federal and state income taxes of approximately $152 million and $77 million, respectively, as of September 30, 2009, have been fully utilized or expired; and

	•	Other companies in our industry may calculate adjusted EBITDA and adjusted net income (loss) differently than we do, limiting their usefulness as a comparative measure.

														Nine Months Ended
		Year Ended December 31,												September 30,
		2006				2007				2008				2008				2009
						(In thousands, unaudited)
Net income (loss)		$	(7,983	)		$	(1,804	)		$	(3,614	)		$	(1,541	)		$	1,681
Interest (income) expense, net			(579	)			352				563				323				506
Income tax expense			8				31				12				9				359
Depreciation			1,388				1,284				1,641				1,188				1,317
Withdrawn offering expense  (1)			—				—				3,031				—				—
Amortization of internal use software  (2)			2,488				3,020				2,196				1,634				2,053
Amortization of direct response advertising			—				—				—				—				10
Amortization of deferred sales commissions			864				1,034				991				738				853
Stock-based compensation expense  (3)			2,959				4,416				3,589				2,244				4,647
Adjusted EBITDA		$	(855	)		$	8,333			$	8,409			$	4,595			$	11,427

Note:	Adjustments to net loss represent after-tax adjustments at our historical effective tax rate ranging from 0-2%.

(1)	As of November 2008, we had incurred approximately $3.0 million of costs directly attributable to a planned initial public offering. These costs were being deferred until the completion of the offering. In the quarter ended December 31, 2008, these costs were charged to expense as a result of our decision in November 2008 to cease efforts to pursue an initial public offering because of the disruption in the equity capital markets and general adverse economic conditions present at that time.
(2)	Amortization of internal use software expense excluding stock-based compensation includes engineering costs associated with developing and enhancing our service offering including the website. Associated direct development costs are capitalized and amortized using the straight-line method over their estimated lives. Costs in this area include compensation and related expenses and fees for external consulting services.

(3)	Stock-based compensation expense is included in:

														Nine Months Ended
		Year Ended December 31,												September 30,
		2006				2007				2008				2008				2009
		(In thousands, unaudited)
Cost of revenue		$	358			$	648			$	817			$	501			$	818
Research and development			921				1,134				796				468				969
Sales and marketing			1,189				1,150				1,112				697				1,484
General and administrative			480				1,434				801				532				1,304
Amortization of internal use software			11				50				63				46				73
Total stock-based compensation expense		$	2,959			$	4,416			$	3,589			$	2,244			$	4,648

														Nine Months Ended
		Year Ended December 31,												September 30,
		2006				2007				2008				2008				2009
						(In thousands, unaudited)
Net income (loss)		$	(7,983	)		$	(1,804	)		$	(3,614	)		$	(1,541	)		$	1,681
Stock-based compensation expense			2,959				4,416				3,589				2,244				4,648
Withdrawn offering expense			—				—				3,031				—				—
Adjusted net income (loss)		$	(5,024	)		$	2,612			$	3,006			$	703			$	6,329

 

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below before making a decision to buy our common stock. The risks and uncertainties described below are not the only ones we face. If any of the following risks actually occurs, our business, financial condition, results of operations or growth prospects could be harmed. In that case, the trading price of our common stock could decline and you might lose all or part of your investment in our common stock. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also impair our business operations. You should also refer to the other information set forth in this prospectus, including our consolidated financial statements and the related notes.

 

Risks Related to Our Business

 

Our revenue and operating results can fluctuate from period to period, which could cause our share price to fluctuate.

 

Our revenue and operating results have fluctuated in the past and may fluctuate from period-to-period in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following factors, as well as other factors described elsewhere in this prospectus:

 

 

 

As a result of these and other factors, the results of any prior quarterly or annual periods should not be relied upon as indications of our future revenue or operating performance.

 

A substantial portion of our revenue is based on fees earned on the value of assets we manage. Our revenue and earnings could suffer if the financial markets experience a downturn or a slowdown in growth that reduces the value, or slows the growth, of our Assets Under Management.

 

We derive a significant and growing portion of our revenue from asset management fees based on the assets in the retirement accounts we manage, which we refer to as Assets Under Management, or AUM. We allocate these assets among the investments available to each particular plan participant. The investment alternatives for a particular plan are selected by the plan’s fiduciary, not by us, and may include retail mutual funds, institutional funds, exchange-traded funds, fixed-income investments and potentially higher volatility employer stock, if it is an investment alternative in a particular plan. In addition, our business is highly concentrated in the 401(k) plans of plan sponsors in the United States and the United States subsidiaries of international companies. The value of these investments can be affected by the performance of the financial markets globally, currency fluctuations, interest rate fluctuations and other factors. Currently, our fees are generally based on AUM on a day within the last 10 days of a quarter. As a result, a decline in the financial markets at the end of a quarter could have an adverse effect on our revenue, even if the financial markets had performed well earlier in the quarter. In addition, an economic downturn or slowdown in growth could cause plan participants or their employers to contribute less to their 401(k) plans and cause fewer eligible employees to participate in 401(k) plans, which could adversely affect the amount of AUM. If plan participants are not satisfied with the performance of their retirement portfolios due to a decline in the financial markets or otherwise, our cancellation rates could increase, which in turn would cause our AUM to decline. As of October 1, 2008, our voluntary cancellation rate over the preceding 12 months was 6.7% of our total number of members, and as of April 30, 2009, our voluntary cancellation rate had increased to 8.7% of our total number of members. As of September 30, 2009, our voluntary cancellation rate over the preceding 12 months was 7.5% of our total number of members. A voluntary cancellation occurs when a member proactively terminates their membership in our Professional Management service. This differs from a rollover or involuntary cancellation when a plan participant rolls out of their retirement plan and is no longer eligible for our Professional Management service. If any of these factors reduces the value of assets we have under management, the amount of fees we would earn for managing those assets would decline, which in turn would harm our revenue, operating results and financial condition. These percentages may not be indicative of future voluntary cancellation rates, which may increase.

 

Our revenue could be harmed if we experience unanticipated delays in rollouts of our services.

 

We generally do not earn platform fees from a plan sponsor until our services are available to plan participants and we do not earn fees for our Professional Management service until we begin to manage a participant’s account. If rollouts are delayed, our receipt of revenue would be delayed. This in turn would affect our operating results for a particular period.

Our revenue could suffer if we experience unanticipated variations in new enrollment campaigns or if we fail to enroll plan participants.

 

Unanticipated variations in the number, size or timing of new enrollment campaigns as well as ongoing annual campaigns at our existing plan sponsors could also affect our revenue for a particular period.

 

Our revenue could be harmed if we do not grow enrollment in our Professional Management service.

 

Our enrollment rate, and therefore our revenue, depend on plan participants signing up for or, in the case of a Passive Enrollment campaign, not declining, the Professional Management service. If we are unable to continue to grow our enrollment, our business may not grow as we anticipate. Increasing plan participant enrollment in our Professional Management service increases the AUM on which we earn fees. We may not be able to generate expected enrollment under a particular contract, which would negatively affect our revenue growth. For example, we have found that if plan sponsors do not use our standard enrollment campaign, enrollment rates tend to be lower. If fewer plan sponsors elect Passive Enrollment for their plan participants, which typically generates higher enrollment rates, our revenue may not grow at anticipated rates. Even when we have rolled out our Professional Management service at a particular plan sponsor, some plan participants may not be eligible for our services due to plan sponsor limitations on employees treated as insiders for purposes of securities laws or other characteristics of the plan participant. Certain securities within a plan participant’s account may be ineligible for management by us, such as employer stock subject to trading restrictions, and we do not manage or charge a fee for that portion of the account. Further, individual plan participants whose accounts we manage may choose at any time to stop having us manage those accounts. If large numbers of plan participants choose to stop using or are not able to continue using our Professional Management service, our revenue, operating results and financial condition would suffer. The voluntary cancellation rate by plan participants whose accounts we manage, measured as a percentage of AUM, was approximately 15% in 2008 and has averaged approximately 1% per month during our history and less than 1% per month during 2009. The overall average voluntary cancellation rate during the first year of membership in our Professional Management service is approximately 7.3% of such members. The overall average voluntary cancellation rate is approximately 5.9% of such members and approximately 3.4% of such members in the second and third year of service, respectively. These percentages may not be indicative of future voluntary cancellation rates, which may increase.

 

We plan to extend and expand our services and may not accurately estimate the impact of developing and introducing these services on our business.

 

We plan to extend our services into new areas, including helping investors turn their retirement assets into retirement income. For example, we intend to work within the existing 401(k) plans we service to help our Professional Management members manage their defined contribution assets and maintain their retirement goals while directing payouts from their retirement accounts. We also recently introduced the Financial Engines Retirement Evaluation, a personalized retirement assessment designed to let plan participants know how close they are to reaching their retirement income goals based on their current savings and investments. We intend to invest significant resources to the research, development, sales and marketing of these new services. We have limited experience in these areas, including the determination of income payments from defined contribution accounts. If our assessments or forecasts with respect to the expected duration and sufficiency of assets to support retirement income payments to participants are inaccurate, or if we fail to ensure that payouts are made at the times expected, our business and reputation could suffer. We may not be able to anticipate or manage new risks and obligations or legal, compliance or other requirements that may arise if we offer investment management or retirement income payout services for accounts other than 401(k) accounts. We may not be able to accurately estimate the impact of these future

services on our business or how the benefits of these services will be perceived by our clients. In addition, the anticipated benefits of these services on our business may not outweigh the resources and costs associated with their development. If we do not realize the anticipated benefits of these services, our business would suffer.

 

Our revenue is highly dependent upon a small number of plan providers with whom we have relationships, and the renegotiation or termination of our relationship with any of these plan providers could significantly impact our business.

 

Our relationships and data connections with plan providers allow us to effectively manage plan participant accounts and integrate our services into plan providers’ current service platforms. These relationships also provide us with an advantage in trying to sign potential plan sponsors. If a plan provider were to terminate our contract, reduce its volume of business or substantially renegotiate the terms of its contract with us, our revenue could be reduced.

 

Of our eight primary retirement plan provider relationships, three are subadvisory relationships. The fees we earn through our subadvisory relationships are based on services to more than 650 plan sponsors as of September 30, 2009; however, we do not have a direct relationship with those plan sponsors and therefore may be less able to influence decisions by those plan sponsors to use or continue to use our services. We have historically earned, and expect to continue to earn on a combined basis, a significant portion of our revenue through these three retirement plan providers. The renegotiation or termination of our relationship with any of these plan providers could significantly impact our business. In 2008, 18%, 17% and 11% of our total revenue was attributable to JPMorgan, ING and Vanguard, respectively, the three retirement plan providers with whom we have subadvisory relationships. Revenue attributable to these three plan providers includes subadvisory fees they pay to us directly, as well as revenue from certain plan sponsors that work with these plan providers but pay us directly. JPMorgan, Vanguard and ING directly accounted for approximately 17%, 11% and 10%, respectively, of our total revenue in 2008.

 

Our contracts with plan providers generally have terms ranging from three to five years, and have successive automatic renewal terms of one year unless terminated in accordance with prior notice requirements. Certain of the plan provider agreements are in or will soon be in renewal periods. For example, our contracts with Fidelity and Vanguard will enter renewal periods on April 1, 2010 and December 31, 2010, respectively, unless a notice of termination is received by February 1, 2010 with respect to Fidelity or by June 30, 2010 with respect to Vanguard. A plan provider may also terminate its contract with us at any time for specified breaches. In addition, there are unpredictable factors, other than our performance, that could cause the loss of a plan provider. If we lose one of our plan providers with whom we have a relationship or if one of those plan providers significantly reduces its volume of business with us or renegotiates the economic terms of its contract with us, our revenue, operating results and financial condition could be harmed.

 

Some plan providers with whom we have relationships also provide or may provide competing services.

 

Some plan providers with whom we have relationships, such as Fidelity, offer or may offer directly competing investment guidance, advice and portfolio management services to plan participants. We also face indirect competition from products that could potentially substitute for our portfolio management, investment advisory and retirement planning services, most notably target-date retirement funds, which are offered by a number of plan providers with whom we have relationships, including J.P. Morgan, Fidelity and Vanguard.

Our revenue is highly dependent upon the plan sponsors with whom we have relationships, and the renegotiation or termination of our relationship with any of these plan sponsors could significantly impact our business.

 

A substantial portion of our revenue is generated as a result of contracts with plan sponsors. Under these contracts, we earn annual platform fees that are paid by the plan sponsor, plan provider or the retirement plan itself as well as fees based on AUM that are generally paid by plan participants. In 2008, revenue from contracts in place on December 31, 2007 accounted for approximately 99% of our total revenue. Our contracts with plan sponsors typically have initial terms of three years and evergreen clauses that extend the initial term until terminated by either party after a specified notice period. At any time during the initial term or thereafter, a plan sponsor can cancel a contract for fiduciary reasons or breach of contract. A plan sponsor can generally terminate a contract after the initial term upon 90 days notice. As of September 30, 2009, the cancellation rate for plan sponsors that offered our Professional Management service over the past 12 months was approximately 1% of our plan sponsors. If a plan sponsor cancels or does not renew a contract, we would no longer earn platform fees under that contract. In addition, we would no longer manage any assets in that plan, and consequently would no longer earn fees based on AUM in that plan. If a significant number of plan sponsors were to cancel their contracts with us or fail to renew those contracts, our revenue, operating results and financial condition would be adversely affected.

 

Our Professional Management service makes up a significant and growing part of our revenue base. Our business could suffer if fees we can charge for these services decline.

 

We earn fees for our Professional Management service based on the value of assets in the accounts we manage. In 2008, asset management fees from our Professional Management service accounted for approximately 55% of our total revenue. We believe that these services will continue to make up a substantial and growing portion of our revenue for the foreseeable future. There are many investment advisory and management services and other financial products available in the market place, which could result in downward pressure on fees for our Professional Management service. Government regulation, such as legislative constraints on fees, could also limit the fees we can charge for our Professional Management service. Performance incentives in contract terms may reduce the fees we charge for Professional Management service and may also reduce our gross margin. If we are forced to lower the fees we charge for our Professional Management service, it could harm our revenue, operating results and financial condition.

 

Our failure to increase the number of plan sponsors with whom we have relationships could harm our business.

 

Our future success depends on increasing the number of plan sponsors with whom we have relationships. If the market for our services declines or develops more slowly than we expect, or the number of plan sponsors that choose to provide our services to their plan participants declines or fails to increase as we expect, our revenue, operating results or financial condition could suffer.

 

We rely on plan providers and plan sponsors to provide us with accurate and timely plan and plan participant data in order for us to provide our portfolio management services, investment advice and retirement help, and we rely on plan providers to execute transactions in the accounts we manage.

 

Our ability to provide high-quality portfolio management services, investment advice and retirement help depends on plan sponsors and plan providers supplying us with accurate and timely data. Errors or delays in the data we receive from plan providers or plan sponsors, or missing data, could lead us to make advisory or transaction errors that could harm our reputation or lead to financial liability, or may prevent us from providing our services to, or earning revenue from, otherwise eligible plan participants. In addition, when we make changes in an account we manage, we instruct the plan

provider to execute the transactions. If a plan provider fails to execute transactions in an accurate and timely manner, it could harm our reputation or lead to financial liability.

 

We may be liable to our plan sponsors, plan participants or plan providers for damages caused by system failures, errors or unsatisfactory performance of services.

 

If we fail to prevent, detect or resolve errors in our services, our business and reputation could suffer. Errors in inputs or processing, such as plan set-ups, transaction instructions or plan participant data, could be magnified across many accounts. Concentrated positions held by many plan participants, particularly in employer stock, could result in a large liability if a systematic input or processing error was to cause us to make errors in transactions relating to those positions. We may not be able to identify or resolve these errors in a timely manner. Since inception of the Professional Management service in 2004, we have made payments to plan participants in an aggregate amount of approximately $360,000 due to system errors and other incidents. In addition, failure to perform our services for Professional Management members on a timely basis could result in liability. We may also have liability to the plan provider where we have a subadvisory relationship with the plan provider. After an error is identified, resolving the error and implementing remedial measures would likely divert the attention and resources of our management and key technical personnel from other business concerns. Any errors in the performance of services for a plan sponsor or plan provider, or poor execution of these services, could result in a plan sponsor or plan provider terminating its agreement. Although we attempt to limit our contractual liability for consequential damages in rendering our services, these limitations on liability may be unenforceable in some cases, or may be insufficient to protect us from liability for damages. ERISA and other applicable laws require that we meet a fiduciary obligation to plan participants. We maintain general liability insurance coverage, including coverage for errors or omissions; however, this coverage may not continue to be available on reasonable terms or may be unavailable in sufficient amounts to cover one or more large claims. An insurer might disclaim coverage as to any future claim. A successful assertion of one or more large claims against us that exceeds our available insurance coverage or changes in our insurance policies, including premium increases or the imposition of a large deductible or co-insurance requirement, could harm our operating results and financial condition.

 

If our reputation is harmed, we could suffer losses in our business and revenue.

 

Our reputation, which depends on earning and maintaining the trust and confidence of plan providers, plan sponsors and plan participants that are current and potential customers, is critical to our business. Our reputation is vulnerable to many threats that can be difficult or impossible to control, and costly or impossible to remediate. Regulatory inquiries or investigations, lawsuits initiated by other plan fiduciaries or plan participants, employee misconduct, perceptions of conflicts of interest and rumors, among other developments, could substantially damage our reputation, even if they are baseless or satisfactorily addressed. In addition, any perception that the quality of our investment advice may not be the same or better than that of other providers can also damage our reputation. Any damage to our reputation could harm our ability to attract and retain plan providers, plan sponsor customers and key personnel. This damage could also cause plan participants to stop using or enrolling in our Professional Management service, which would adversely affect the amount of AUM on which we earn fees.

 

Any failure to ensure and protect the confidentiality of plan provider, plan sponsor or plan participant data could lead to legal liability, adversely affect our reputation and have a material adverse effect on our business, financial condition or results of operations.

 

Our services involve the exchange of information, including detailed information regarding plan participants provided by plan providers and plan sponsors, through a variety of electronic and non-electronic means. In addition, plan participants routinely input personal investment and financial information, including portfolio holdings and, in some instances, credit card data, into our systems. We

rely on a complex network of process and software controls to protect the confidentiality of data provided to us or stored on our systems. If we do not maintain adequate internal controls or fail to implement new or improved controls, this data could be misappropriated or confidentiality could otherwise be breached. We could be subject to liability if we inappropriately disclose any plan participant’s personal information, or if third parties are able to penetrate our network security or otherwise gain access to any plan participant’s name, address, portfolio holdings, credit card number or other personal information. Any such event could subject us to claims for unauthorized credit card purchases, identity theft or other similar fraud claims or claims for other misuses of personal information, such as unauthorized marketing or unauthorized access to personal information.

 

Many of our agreements with plan sponsors and plan providers do not limit our potential liability for breaches of confidentiality and consequential damages. If any person, including any of our employees, penetrates our network security, misappropriates or mishandles sensitive data, inadvertently or otherwise, we could be subject to significant liability from our plan sponsors and plan providers for breaching contractual confidentiality provisions or privacy laws. In addition, our agreements with plan sponsors and plan providers require us to meet specified minimum system security and privacy standards. Given the growing concern over privacy and identity theft, we have been and expect to continue to be subject to increased scrutiny by both plan providers and plan sponsors, which have increased the frequency and thoroughness of their audits. If we fail to meet these standards, our plan sponsors and plan providers may seek to terminate their agreements with us. Unauthorized disclosure of sensitive or confidential data, whether through breach of our computer systems, systems failure or otherwise, could damage our reputation, expose us to litigation, cause us to lose business, harm our revenue, operating results or financial condition and subject us to regulatory action, which could include sanctions and fines.

 

Privacy concerns could require us to modify our operations.

 

As part of our business, we use plan participants’ personal data. For privacy or security reasons, privacy groups, governmental agencies and individuals may seek to restrict or prevent our use of this data. We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols imposed by law, regulation, industry standards or contractual obligations. Increased domestic or international regulation of data utilization and distribution practices, including self-regulation, could require us to modify our operations and incur significant additional expense, which could have an adverse effect on our business, financial condition and results of operations.

 

Acquisition activity involving plan providers or plan sponsors could adversely affect our business.

 

Acquisitions or similar transactions involving our plan providers or plan sponsors could negatively affect our business in a number of ways. After such a transaction, the plan provider or plan sponsor might terminate, not renew or seek to renegotiate the economic terms of their contracts with us. Companies involved in these transactions may experience integration difficulties that could increase the risk of providing us inaccurate or untimely data or delay rollout of our services. Any of our existing plan sponsors may be acquired by an organization or a plan sponsor with no relationship with us, effectively terminating our relationship, or be acquired by a plan sponsor with an online services-only relationship rather than a Professional Management relationship which might cause us to lose business and harm our revenue, operating results or financial condition. Plan providers could be acquired by a company offering competing services to ours, which could increase the risk that they terminate their relationship with us, or be acquired by an organization with no relationship with us which might cause us to lose that plan provider, have to renegotiate the economic terms of their contract with us and harm our revenue, operating results or financial condition. For example, ING Groep N.V. recently announced a restructuring of its business to reduce debt, including the potential sale of certain divisions. ING Investment Advisors, L.L.C., an indirect subsidiary of ING Groep N.V.,

accounted for 10% of our total revenue in 2008. We cannot predict the impact, if any, that these corporate actions may have on our revenue, operating results or financial condition.

 

Our ability to compete, succeed and generate profits depends, in part, on our ability to obtain accurate and timely data from third-party vendors on commercially reasonable terms.

 

We currently obtain market and other financial data we use to generate our investment advice from a number of third-party vendors. Termination of one or more of our agreements or exclusion from, or restricted use of a data provider’s information could decrease the information available for us to use and offer our clients and may have a material adverse effect on our business, financial condition or results of operations. For example, we obtain mutual fund data from Lipper, corporate action data from Interactive Data, stock data from MSCI Inc.’s Barra unit and stock price data from FTID. We do not currently have secondary sources or other suppliers for some of these data items. If these data feed agreements were terminated, backup services would take time to set up and our business and results of operations would be harmed. We rely on these data suppliers to provide timely and accurate information and their failure to do so could harm our business.

 

In addition, some data suppliers may seek to increase licensing fees for providing content to us. If we are unable to renegotiate acceptable licensing arrangements with these data suppliers or find alternative sources of equivalent content, we may experience a reduction in our profit margins or market share.

 

Our portfolio management and investment advisory operations may subject us to liability for losses that result from a breach of our fiduciary duties.

 

Our portfolio management and investment advisory operations involve fiduciary obligations that require us to act in the best interests of the plan participants to whom we provide advice or for whom we manage accounts. We may face liabilities for actual or claimed breaches of our fiduciary duties. We may not be able to prevent plan participants, plan sponsors or the plan providers to or through whom we provide investment advisory services from taking legal action against us for an actual or claimed breach of a fiduciary duty. Because we currently provide investment advisory services on substantial assets, we could face substantial liability to plan participants or plan sponsors if we breach our fiduciary duties. In addition, we may face liabilities for actual or claimed deficiencies in the quality or outcome of our investment advisory recommendations, investment management and other services, even in the absence of an actual or claimed breach of fiduciary duty. While we believe that we would have substantial and meritorious defenses against such a claim, we cannot predict the outcome or consequences of any such potential litigation.

 

Competition could reduce our share of the portfolio management, investment advisory and retirement planning market and hurt our financial performance.

 

We operate in a highly competitive industry, with many investment advice providers competing for business from individual investors, financial advisors and institutional customers. Direct competitors that offer independent portfolio management and investment advisory services to plan participants in the workplace include Morningstar, Inc., GuidedChoice and ProManage LLC. Plan providers that offer directly competing portfolio management and investment advisory services to investors in the workplace include Fidelity and Merrill Lynch. We currently have a relationship with Fidelity that allows us to provide our services to plan sponsors for whom Fidelity is the plan provider who elect to hire us. We also face indirect competition from products that could potentially substitute for our portfolio management services, investment advice and retirement help, most notably target-date retirement funds. Target-date funds are offered by multiple financial institutions, including BlackRock (formerly Barclays Global Investors), T. Rowe Price, Fidelity and The Vanguard Group, Inc. These funds provide generic asset allocation based on the investment horizon of the investor. Target-date funds, managed accounts and balanced funds have been granted Qualified Default Investment Alternative, or QDIA, status by the Department of Labor. Plan providers offer or may choose to offer directly and indirectly

competitive products in the future. The plan providers with whom we do not have contractually exclusive relationships may enter into similar relationships with our competitors. This in turn may harm our business.

 

Many of our competitors have larger customer bases and significantly greater resources than we do. This may allow our competitors to respond more quickly to new technologies and changes in demand for services, to devote greater resources developing and promoting their services and to make more attractive offers to potential plan providers, plan sponsors and plan participants. Industry consolidation may also lead to more intense competition. Increased competition could result in price reductions, reduced gross margins or loss of market share, any of which could hurt our business.

 

Our future success depends on our ability to recruit and retain qualified employees, including our executive officers.

 

Our ability to provide portfolio management services, investment advice and retirement help and maintain and develop relationships with plan participants, plan providers and plan sponsors depends largely on our ability to attract, train, motivate and retain highly skilled professionals, particularly professionals with backgrounds in sales, technology and financial and investment services. We believe that success in our business will continue to be based upon the strength of our intellectual capital. For example, due to the complexity of our services and the intellectual capital invested in our investment methodology and technology, the loss of personnel integral to our investment research, product development and engineering efforts would harm our ability to maintain and grow our business. Consequently, we must hire and retain employees with the technical expertise and industry knowledge necessary to continue to develop our services and effectively manage our growing sales and marketing organization to ensure the growth of our operations. We believe there is significant competition for professionals with the skills necessary to perform the services we offer. We experience competition for analysts and other employees from financial institutions and financial services organizations such as hedge funds and investment management companies that generally have greater resources than we do and therefore may be able to offer higher compensation packages. Competition for these employees is intense, and we may not be able to retain our existing employees or be able to recruit and retain other highly qualified personnel in the future. If we cannot hire and retain qualified personnel, our ability to continue to expand our business would be impaired and our revenue could decline.

 

If our intellectual property and technology are not adequately protected to prevent use or appropriation by our competitors, our business and competitive position would suffer.

 

Our future success and competitive position depend in part on our ability to protect our proprietary technology and intellectual property. We rely and expect to continue to rely on a combination of trademark, copyright, patent and trade secret protection laws to protect our proprietary technology and intellectual property. We also require our employees, consultants, vendors, plan sponsors and plan providers to enter into confidentiality agreements with us. We have nine issued U.S. patents, three of which have been issued on our user interface, four of which relate to outcomes-based investing, including our financial advisory system, our pricing module and load-aware optimization, and two of which have been issued on advice palatability. We also have seven pending U.S. patent applications. In addition, we have issued patents and pending applications in foreign jurisdictions. One or more of our issued patents or pending patent applications may be deemed to be directed to methods of doing or conducting business, and may therefore be categorized as so-called “business method” patents. The general validity of software patents and “business method” patents has been challenged in a number of jurisdictions, including the United States. The United States Supreme Court is currently considering a case that may impact the scope of patent eligible subject matter. Our patents may become less valuable if software or business methods are found to be a non-patentable subject matter or if additional requirements are imposed that our patents do not meet.

The steps we have taken may be inadequate to prevent the misappropriation of our proprietary technology. Our patent and trademark applications may not lead to issued patents and registered trademarks. There can be no assurance that others will not develop or patent similar or superior technologies, products or services, or that our patents, trademarks and other intellectual property will not be challenged, invalidated or circumvented by others. The legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and still evolving. Unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for doing so, which could harm our business. Policing unauthorized use of proprietary technology is difficult and expensive and our monitoring and policing activities may not be sufficient to identify any misappropriation and protect our proprietary technology. In addition, third parties may knowingly or unknowingly infringe our patents, trademarks and other intellectual property rights, and litigation may be necessary to protect and enforce our intellectual property rights. If litigation is necessary to protect and enforce our intellectual property rights, any such litigation could be very costly and could divert management attention and resources.

 

We also expect that the more successful we are, the more likely it becomes that competitors will try to develop products that are similar to ours, which may infringe on our proprietary rights. If we are unable to protect our proprietary rights or if third parties independently develop or gain access to our or similar technologies, our business, revenue, reputation and competitive position could be harmed.

 

Third parties may assert intellectual property infringement claims against us, or our services may infringe the intellectual property rights of third parties, which may subject us to legal liability and harm our reputation.

 

Assertion of intellectual property infringement claims against us, plan providers or plan sponsors could result in litigation. We might not prevail in any such litigation or be able to obtain a license for the use of any infringed intellectual property from a third party on commercially reasonable terms, or at all. Even if obtained, we may be unable to protect such licenses from infringement or misuse, or prevent infringement claims against us in connection with our licensing efforts. We expect that the risk of infringement claims against us will increase if more of our competitors are able to obtain patents for software products and business processes, and if we hire employees who possess third party proprietary information. Any such claims, regardless of their merit or ultimate outcome, could result in substantial cost to us, divert management’s attention and our resources away from our operations and otherwise harm our reputation. Our process for controlling employees’ use of third party proprietary information may not be sufficient to prevent assertions of intellectual property infringement claims against us.

 

Any inability to manage our growth could disrupt our business and harm our operating results.

 

We expect our growth to place significant demands on our management and other resources. Our success will depend in part upon the ability of our senior management to manage growth effectively. Expansion creates new and increased management and training responsibilities for our employees. In addition, continued growth increases the challenges involved in:

 

 

 

Our ability to raise capital in the future may be limited and our failure to raise capital when needed could prevent us from executing our growth strategy.

 

In the absence of this offering, we believe that our existing cash and cash equivalents will be sufficient to fund our planned capital expenditures and other anticipated cash needs for at least the next 12 months. If our capital resources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or obtain debt financing. We have not made arrangements to obtain additional financing and there is no assurance that financing, if required, will be available in amounts or on terms acceptable to us, if at all.

 

We will be subject to additional regulatory compliance requirements, including section 404 of the Sarbanes-Oxley Act of 2002, as a result of becoming a public company and our management has limited experience managing a public company.

 

We have never operated as a public company and will incur significant legal, accounting and other expenses that we did not incur as a private company. The individuals who constitute our management team have limited experience managing a publicly traded company, and limited experience complying with the increasingly complex and changing laws pertaining to public companies. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives and we may not successfully or efficiently manage our transition into a public company. We expect rules and regulations such as the Sarbanes-Oxley Act of 2002 to increase our legal and finance compliance costs and to make some activities more time-consuming and costly. We will need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company. For example, Section 404 of the Sarbanes-Oxley Act of 2002 requires that our management report on, and our independent auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting in our annual report on Form 10-K for the fiscal year ending December 31, 2011. Section 404 compliance may divert internal resources and will take a significant amount of time and effort to complete. We may not be able to successfully complete the procedures and certification and attestation requirements of Section 404 by the time we will be required to do so. If we fail to do so, or if in the future our chief executive officer, chief financial officer or independent registered public accounting firm determines that our internal controls over financial reporting are not effective as defined under Section 404, we could be subject to sanctions or investigations by The NASDAQ Stock Market, the Securities and Exchange Commission, or the SEC, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our stock. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent auditors.

 

Our insiders who are significant stockholders may control the election of our board and may have interests that conflict with those of other stockholders.

 

Our directors and executive officers, together with members of their immediate families, beneficially owned, in the aggregate, approximately 47% of our outstanding capital stock as of September 30, 2009. As a result, acting together, this group has the ability to exercise significant control over most matters requiring our stockholders’ approval, including the election and removal of directors and significant corporate transactions.

We have an accumulated deficit and have incurred net losses in the past. We may incur net losses in the future.

 

As of September 30, 2009, we had an accumulated deficit of approximately $161.4 million. We have incurred net losses in each year through 2008. We may incur net losses in the future.

 

We could face liability for certain information we disclose, including information based on data we obtain from other parties.

 

We may be subject to claims for securities law violations, negligence, or other claims relating to the information we disclose, such as the mutual fund assessments we call “scorecards.” Individuals who use our services may take legal action against us if they rely on information that contains an error, or a company may claim that we have made a defamatory statement about it or its employees. We could also be subject to claims based upon the content that is accessible from our website through links to other websites. We rely on a variety of outside parties as the original sources for the information we use in our published data. These sources include securities exchanges, fund companies and transfer agents. Accordingly, in addition to possible exposure for publishing incorrect information that results directly from our own errors, we could face liability based on inaccurate data provided to us by others. Defending claims based on the information we publish could be expensive and time-consuming, and could adversely impact our business, operating results and financial condition.

 

If our operations are interrupted as a result of service downtime or interruptions, our business and reputation could suffer.

 

The success of our business depends upon our ability to obtain and deliver time-sensitive, up-to-date data and information. Our operations and those of our plan providers and plan sponsors are vulnerable to interruption by technical breakdowns, computer hardware and software malfunctions, software viruses, infrastructure failures, fire, earthquake, power loss, telecommunications failure, terrorist attacks, wars, Internet failures and other events beyond our control. Any disruption in our services or operations could harm our ability to perform our services effectively which in turn could result in a reduction in revenue or a claim for substantial damages against us, regardless of whether we are responsible for that failure. We rely on our computer equipment, database storage facilities and other office equipment, which are located primarily in the seismically active San Francisco Bay Area. We maintain off-site back-up facilities in Phoenix, Arizona for our database and network equipment, but these facilities could be subject to the same interruptions that may affect our headquarters. If we suffer a significant database or network facility outage, our business could experience disruption until we fully implement our back-up systems. We also depend on certain significant vendors for facility storage and related maintenance of our main technology equipment and data at these locations. Any failure by these vendors to perform those services, any temporary or permanent loss of our equipment or systems or any disruptions to basic infrastructure like power and telecommunications could impede our ability to provide services to our plan participants, harm our reputation, cause plan participants to stop using our investment advisory or Professional Management services, reduce our revenue and harm our business. Our agreements with our plan providers or plan sponsors also require us to meet specified minimum system security and privacy standards. If we fail to meet these standards, our plan sponsors and plan providers may seek to terminate their agreements with us. This in turn could damage our reputation and harm our market position and business.

Risks Related to Our Industry

 

Changes in laws applicable to our portfolio management, investment advisory and retirement planning services may adversely affect our business.

 

We may be adversely affected as a result of new or revised legislation or regulations imposed by the SEC, Department of Labor or other U.S. regulatory authorities or self-regulatory organizations that supervise the financial markets and retirement industry. In addition, we may be adversely affected by changes in the interpretation of existing laws and rules by these governmental authorities and self-regulatory organizations. It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law. It is difficult to predict the future impact of the broad and expanding legislative and regulatory requirements affecting our business. For example, legislation or regulation regarding fees may affect our business. Future legislation or regulation could change or eliminate certain existing restrictions relating to conflicts of interest, which might lower the relative value of our independence. Changes to laws or regulations could increase our potential liability for offering portfolio management services, investment advice and retirement help, affect our ability to offer our Passive Enrollment option or invalidate pre-dispute arbitration clauses in our agreements, leading to increased costs to litigate any claims against us. Changes to laws or regulations could also increase our legal compliance costs, divert internal resources and make some activities more time-consuming and costly. The laws, rules and regulations applicable to our business may change in the future and we may not be able to comply with any such changes. If we fail to comply with any applicable law, rule or regulation, we could be fined, sanctioned or barred from providing investment advisory services in the future, which could materially harm our business and reputation.

 

We are subject to complex regulation and any compliance failures or regulatory action could adversely affect our business.

 

The financial services industry is subject to extensive regulation at the federal and state levels. It is very difficult to predict the future impact of the legislative and regulatory requirements affecting our business. The securities laws and other laws that govern our activities as a registered investment advisor are complex and subject to rapid change. The activities of our investment advisory and management operations are primarily subject to provisions of the Investment Advisers Act of 1940, referred to as the Investment Advisers Act, and the Employee Retirement Income Security Act of 1974, as amended, referred to as ERISA, as well as certain state laws. We are a fiduciary under ERISA. Our investment advisory services are also subject to state laws including anti-fraud laws and regulations. The Investment Advisers Act addresses, among other things, fiduciary duties, recordkeeping and reporting requirements, disclosure requirements and also includes general anti-fraud prohibitions. If we fail to comply with any applicable law, rule or regulation, we could be fined, sanctioned or barred from providing investment advisory services in the future, which could materially harm our business and reputation. Any claim of noncompliance, regardless of merit or ultimate outcome, could subject us to investigation by the SEC or other regulatory authorities. This in turn could result in substantial cost to us and divert management’s attention and other resources away from our operations. Furthermore, investor perceptions of us may suffer and this could cause a decline in the market price of our common stock. Our compliance processes may not be sufficient to prevent assertions that we failed to comply with any applicable law, rule or regulation.

 

We face additional scrutiny when we act as subadvisor and any failure to comply with regulations or meet expectations could harm our business.

 

Some of the plan providers to whom we are subadvisors are broker-dealers registered under the Securities Exchange Act of 1934, referred to as the Exchange Act, and are subject to the rules of the Financial Industry Regulatory Authority, or FINRA. When we act as a subadvisor, we may be subject to the oversight by regulators of another advisor. We may be affected by any regulatory examination of that plan provider.

In addition, our subadvisory arrangements are structured to follow Advisory Opinion 2001-09A, a Department of Labor opinion provided to SunAmerica Retirement Markets. Although an advisory opinion provides guidance about the Department of Labor’s interpretation of ERISA, it is directly applicable only to the entity to whom it is issued. SunAmerica Retirement Markets is an entity unrelated to us or the plan providers to whom we act as subadvisor. We could be adversely affected if the Department of Labor increases examination of these subadvisory arrangements or changes the interpretive positions described in the Advisory Opinion. We could be adversely affected if ERISA is amended in a way that overturns or materially changes the Department of Labor’s position in Advisory Opinion 2001-09A, such as the imposition of additional requirements relating to conflicts of interest on the plan providers to whom we act as a subadvisor. Future legislation or regulation could impose additional requirements relating to conflicts of interest on some of the plan providers to whom we act as a subadvisor. These plan providers may not be able to comply with these requirements, and we may therefore not be able to continue to provide our services on a subadvised basis. In such event, we could incur additional costs to transition our services for affected plan providers and their plan sponsors to another structure. Legislation has been introduced in Congress and there have been several Congressional hearings addressing these issues, although final versions of these bills have not been adopted and signed into law, and the final scope and wording of the legislation, or the implementing rules and regulations, are not yet known.

 

If government regulation of the Internet or other areas of our business changes or if consumer attitudes toward use of the Internet change, we may need to change the manner in which we conduct our business or incur greater operating expenses.

 

The adoption, modification or interpretation of laws or regulations relating to the Internet or other areas of our business could adversely affect the manner in which we conduct our business or the overall popularity or growth in use of the Internet. Such laws and regulations may cover sales and other procedures, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts, consumer protection, broadband residential Internet access and the characteristics and quality of services. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses, make it more difficult to renew subscriptions automatically, make it more difficult to attract new subscribers or otherwise alter our business model. Any of these outcomes could have a material adverse effect on our business, financial condition or results of operations.

 

Our business will suffer if we do not keep up with rapid technological change, evolving industry standards or changing requirements of plan sponsors and plan participants.

 

We expect technological developments to continue at a rapid pace in our industry. Our success will depend, in part, on our ability to:

 

 

In addition, we must continue to meet changing plan provider and plan sponsor expectations and requirements, including addressing plan complexities and meeting plan provider and plan sponsor demands for specific features and delivery dates. We must accomplish all of these tasks in a timely

and cost-effective manner and our failure to do so could harm our business, including materially reducing our revenue and operating results. Further, a key aspect of our growth strategy is to expand our investment research capabilities and introduce new services. In both the year ended December 31, 2008 and the nine months ended September 30, 2009, our research and development expense represented 19% of our total revenue. We expect that our research and development expense will continue to represent a meaningful percentage of our revenue in the future. A viable market for our new service offerings may not exist or develop, and our offerings may not be well received by potential plan sponsor customers or individual plan participants or investors.

 

Risks Related to this Offering and our Common Stock

 

Our share price may be volatile and you may be unable to sell your shares at or above the offering price.

 

Prior to this offering, there has not been a public market for our common stock. We cannot predict the extent to which a trading market will develop or how liquid that market might become. The initial public offering price for our shares will be determined by negotiations between us and representatives of the underwriters and may not be indicative of prices that will prevail in the trading market. The market price of shares of our common stock could be subject to wide fluctuations in response to many risk factors listed in this section and others beyond our control, including:

 

 

Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, interest rate changes or international currency fluctuations, may cause the market price of shares of our common stock to decline. If the market price of shares of our common stock after this offering does not exceed the initial public offering price, you may not

realize any return on your investment in us and may lose some or all of your investment. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

 

If securities or industry analysts do not publish research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline.

 

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

Substantial future sales of our common stock in the public market could cause our stock price to fall.

 

Additional sales of our common stock in the public market after this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline. Upon completion of this offering, we will have           shares of common stock outstanding. All shares sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933. The remaining 32,784,581 shares of common stock outstanding after this offering will be available for sale as follows:

 

 

Our directors, executive officers and substantially all of our stockholders have agreed, with limited exceptions, that they will not sell any shares of common stock owned by them without the prior written consent of Goldman, Sachs & Co., on behalf of the underwriters, for a period of 163 days from the date of this prospectus; provided, however, that if (1) during the last 17 days of the initial lock-up period, we release earnings results or announce material news or a material event or (2) prior to the expiration of the initial lock-up period, we announce that we will release earnings results during the 15-day period following the last day of the initial lock-up period, then in each case the lock-up period will be automatically extended until the expiration of the 17-day period beginning on the date of release of the earnings results or the announcement of the material news or material event, as applicable, unless Goldman, Sachs & Co. waives, in writing, such extension. As a result, the maximum possible lock-up period is 180 days beginning on the date of this prospectus. At any time and without public notice, Goldman, Sachs & Co. may in its sole discretion release some or all of the securities from these lock-up agreements. As resale restrictions end, the market price of our common stock could decline if the holders of those shares sell them or are perceived by the market as intending to sell them. In addition, after this offering, the holders of approximately 23,596,952 shares of common stock will be entitled to rights to cause us to register the sale of those shares under the Securities Act. All of these shares are subject to the 163-day lock-up. Registration of these shares

under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration.

 

We intend to file a registration statement under the Securities Act covering           shares of common stock reserved for issuance under our stock plans. This registration statement is expected to be filed soon after the date of this prospectus and will automatically become effective upon filing. Accordingly, shares registered under this registration statement will be available for sale in the open market unless those shares are subject to vesting restrictions with us or the contractual restrictions described above.

 

As a new investor, you will experience immediate and substantial dilution.

 

Purchasers in this offering will immediately experience substantial dilution in net tangible book value. Because our common stock has been sold in the past at prices substantially lower than the initial public offering price that you will pay, you will suffer immediate dilution of $      per share in net tangible book value, based on an assumed initial offering price of $      per share of common stock. The exercise of outstanding options, may result in further dilution. In addition, we may raise additional capital through public or private equity or debt offerings, subject to market conditions. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance could result in further dilution to our stockholders.

 

Management may apply our net proceeds from this offering to uses that do not increase our market value or improve our operating results.

 

We intend to use our net proceeds from this offering for general corporate purposes, including as yet undetermined amounts related to working capital and capital expenditures, as well as to repay our term loan. Our management will have considerable discretion in applying our net proceeds and you will not have the opportunity, as part of your investment decision, to assess whether we are using our net proceeds appropriately. Until the net proceeds we receive are used, they may be placed in investments that do not produce income or that lose value. We may use our net proceeds for purposes that do not result in any increase in our results of operations, which could cause the price of our common stock to decline.

 

Delaware law and our corporate charter and bylaws will contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.

 

Provisions in our certificate of incorporation and bylaws, that we intend to adopt before the completion of this offering, may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

 

 

In addition, because we will be incorporated in Delaware before the completion of this offering, we will be governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit or restrict large stockholders, in particular, those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our certificate of incorporation and bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future and result in our market price being lower than it would without these provisions.

 

We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

 

We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. In addition, the provisions of our term loan prohibit us from paying cash dividends. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future and the success of an investment in shares of our common stock will depend upon any future appreciation in their value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

 

This prospectus contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” In some cases, you can identify forward-looking statements by terms such as “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “design,” “estimate,” “predict,” “potential,” “plan,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements include, but are not limited to, statements about:

 

 

These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements.

 

We discuss many of these risks in this prospectus in greater detail under the heading “Risk Factors.” Also, these forward-looking statements represent our estimates and assumptions only as of the date of this prospectus. Unless required by U.S. federal securities laws, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made.

 

You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

USE OF PROCEEDS

 

We estimate that we will receive net proceeds from this offering of approximately $      million, based on an assumed initial public offering price of $      per share, the mid-point of the range set forth on the cover of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) the net proceeds to us from this offering by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

The principal purposes for this offering are to increase our working capital, create a public market for our common stock, facilitate our access to the public capital markets and increase our visibility in our markets.

 

We currently intend to use our proceeds from this offering to prepay the outstanding indebtedness under our term loan. As of September 30, 2009, the outstanding balance under this term loan was $8.9 million. The interest rate currently applicable to this term loan is equal to 1.50% above prime rate, with a minimum prime rate of 4.00% per annum, resulting in a minimum interest rate of 5.50% per annum. The indebtedness outstanding under this term loan is scheduled to mature on May 1, 2012.

 

We expect to use the remainder of our proceeds from this offering for general corporate purposes, including working capital and capital expenditures.

 

As of the date of this prospectus, however, we have not determined all of the anticipated uses for the proceeds of this offering or the amounts that we will actually spend on the uses set forth above. The amount and timing of actual expenditures may vary significantly depending upon a number of factors, including the amount of cash generated from our operations, competitive and technological developments and the rate of growth, if any, of our business. Accordingly, our management will have significant flexibility in applying the net proceeds of this offering. Pending use of the net proceeds as described above, we intend to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities.

 

We will not receive any proceeds from the sale of shares of common stock by the selling stockholders.

DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our capital stock. We expect to retain all of our earnings to finance the expansion and development of our business and we do not currently intend to pay any cash dividends on our capital stock in the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Our board of directors will determine future dividends, if any. Our term loan currently prohibits us from paying dividends. See the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

The following table describes our capitalization as of September 30, 2009:

 

 

You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 

 

The actual, pro forma and pro forma as adjusted information set forth in the table above:

 

 

 

As of September 30, 2009, 1,167,331 shares remained available for future issuance under our 1998 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1998 Stock Plan. Shares originally reserved for issuance under our 1998 Stock Plan, but which are not subject to outstanding options on the effective date of our 2009 Stock Incentive Plan, and shares subject to outstanding options under our 1998 Stock Plan on the effective date of our 2009 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, up to a number of additional shares not to exceed 2,000,000, will become available for awards under our 2009 Stock Incentive Plan.

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) the net proceeds to us from this offering by approximately $      million, or approximately $      million if the underwriters exercise their option to purchase additional shares of common stock in full, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

Our pro forma net tangible book value as of September 30, 2009 was $5.5 million, or $0.17 per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the pro forma number of shares of common stock outstanding, assuming the issuance of 22,349,972 shares of common stock upon the conversion of all of our outstanding shares of series A preferred stock, series B preferred stock, series C preferred stock, series D preferred stock, series E preferred stock and series F preferred stock. Net tangible book value dilution per share represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after completion of this offering on a pro forma as adjusted basis. After giving effect to the sale of the           shares of common stock by us at an assumed initial public offering price of $      per share, which is the mid-point of the price range set forth on the cover of this prospectus, and the application of our estimated net proceeds from the offering, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our net tangible book value as of September 30, 2009 would have been $     , or $      per share of common stock. This represents an immediate increase in net tangible book value of $      per share of common stock to existing common stockholders and an immediate dilution in net tangible book value of $      per share to new investors purchasing shares of common stock in this offering. The following table illustrates this per share dilution:

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) the net proceeds to us from this offering by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

The following table summarizes as of September 30, 2009, on the pro forma basis described above, the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing and new investors purchasing shares of common stock in this offering, before deducting the estimated underwriting discounts and commissions and estimated offering expenses.

 

 

The table above:

 

 

 

To the extent that any outstanding options are exercised, there will be further dilution to new investors. The warrant outstanding as of September 30, 2009 expired in October 2009.

 

As of September 30, 2009, 1,167,331 shares remained available for future issuance under our 1998 Stock Plan. Upon the completion of this offering, no shares of our common stock will remain available for future issuance under our 1998 Stock Plan. Shares originally reserved for issuance under our 1998 Stock Plan, but which are not subject to outstanding options on the effective date of our 2009 Stock Incentive Plan, and shares subject to outstanding options under our 1998 Stock Plan on the effective date of our 2009 Stock Incentive Plan that are subsequently forfeited or terminated for any reason before being exercised, up to a number of additional shares not to exceed 2,000,000, will again become available for awards under our 2009 Stock Incentive Plan.

 

Sales by selling stockholders in this offering will reduce the number of shares of common stock held by existing stockholders to           or approximately     % of the total number of shares of common stock outstanding after this offering and will increase the number of shares of common stock held by new investors by           to approximately     % of the total number of shares of common stock outstanding after this offering.

 

The following selected consolidated financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2007 and 2008, and the selected consolidated statements of operations data for each of the years ended December 31, 2006, 2007 and 2008, have been derived from our audited consolidated financial statements which are included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2005 and 2006 and the selected consolidated statements of operations data for the year ended December 31, 2005 have been derived from our audited consolidated financial statements not included in this prospectus. The selected consolidated balance sheet data as of December 31, 2004 and the selected consolidated statements of operations data for the year ended December 31, 2004 have been derived from our unaudited consolidated financial statements not included in this prospectus. The selected consolidated balance sheet data as of September 30, 2009 and the selected statements of operations data for the nine months ended September 30, 2008 and 2009 have been derived from our unaudited condensed consolidated financial statements which are included elsewhere in this prospectus. Historical results are not necessarily indicative of the results to be expected in the future, and results of interim periods are not necessarily indicative of results for the entire year.

 

 

The following discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including but not limited to, those set forth under “Risk Factors” and elsewhere in this prospectus.

 

Overview

 

We are a leading provider of independent, technology-enabled portfolio management, investment advice and retirement help to participants in employer-sponsored defined contribution retirement plans, such as 401(k) plans. We use our proprietary advice technology platform to provide our services to millions of retirement plan participants on a cost-efficient basis. Our business model is based on workplace delivery of our services. We target three key constituencies in the retirement plan market: plan participants, plan sponsors and plan providers.

 

We deliver our services to plan sponsors and plan participants primarily through existing connections with eight retirement plan providers. We target large plan sponsors across a wide range of industries, and, as of September 30, 2009, had signed contracts to make our services available through 107 Fortune 500 companies and seven Fortune 20 companies. As of September 30, 2009, we were under contract to provide either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only, through more than 765 plan sponsors with approximately 7.6 million plan participants whose retirement savings represented more than $500 billion in assets. Within this group, we provide our full suite of services to 341 plan sponsors representing approximately 3.7 million participants and approximately $242 billion in Assets Under Contract, or AUC. As of September 30, 2009, we had approximately $23.5 billion in Assets Under Management, or AUM, and managed the accounts of approximately 383,000 members who have delegated investment decision-making authority to us.

 

Financial Engines was co-founded in 1996 by Professor William F. Sharpe, a recipient of the 1990 Nobel Prize in Economic Sciences for his pioneering work on the theory of financial economics, including how prices of financial assets are determined and the link between risk and return, Professor Joseph A. Grundfest, a former SEC commissioner and a professor of law at Stanford Law School, and the late Craig Johnson, then Chairman of the Venture Law Group. The company was founded to address the need for independent investment advice. Traditionally, high quality, personalized investment advice had been available only to large institutions and the affluent. Professor Sharpe’s vision was to leverage technology to make high quality independent advice available to millions regardless of their wealth or investment expertise.

 

A pioneer in our market, we introduced our Online Advice service in 1998. Following the introduction of Online Advice, we focused on expanding our service offerings to provide investors with advice on multiple tax-deferred accounts and taxable investments. Over the next five years, we made significant investments in technology and usability of our platform that allowed us to expand and enhance our service offerings, including our Retirement Evaluation, a personalized printed retirement assessment. In 2004, we launched our Professional Management service to provide personalized and professional portfolio management to retirement plan participants.

 

As part of our growth strategy, we plan to:

 

 

 

We benefit from a number of attributes of our business model, such as:

 

 

In evaluating our results, we focus on several key operating and financial data including AUC, enrollment rate, AUM, GAAP net income, adjusted EBITDA and adjusted net income. Given our business model, we believe AUC and enrollment rate are indicators of our growth potential.

 

Revenue

 

We generate revenue primarily from management fees on AUM as well as from platform fees by providing portfolio management services, investment advice and retirement help to plan participants of employer-sponsored retirement plans.

 

Professional Management.   We derive Professional Management revenue from management fees paid by plan participants for our Professional Management service. Our Professional Management service is a discretionary investment management service, which includes a Retirement Plan analyzing investments, contribution rate and projected retirement income, and a Retirement Checkup designed to help plan participants to develop a strategy for closing the gap, if any, between the participant’s retirement goal and current retirement income forecast. The services are generally made available to plan participants in a 401(k) plan by written agreements between Financial Engines and the plan provider, plan sponsor and the plan participant. The arrangement generally provides for management fees based on the value of assets we manage for plan participants, and is generally payable quarterly in arrears. Our Professional Management revenue is generally the product of managed accounts fee rates and the value of AUM at the end of each quarter. Our AUM increases or decreases based on asset enrollment rates, inflows or outflows of funds into accounts we manage pursuant to our Professional Management service and market fluctuations. Inflows or outflows are based on contributions, rollovers and withdrawals by our members.

Platform.   We derive our platform revenue from recurring, annual subscription-based platform fees for access to either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only. Platform fees are paid by the plan sponsor, plan provider or the retirement plan itself, depending on the plan structure, and vary depending on the type of service provided. Our Online Advice service is a nondiscretionary Internet-based investment advisory service, which includes features such as recommendations among the investment alternatives available in the employer sponsored retirement plan, a summary of the current value of the plan account, a forecast of how much the plan account investments might be worth at retirement, whether a change is recommended to the contribution rate, risk and diversification and/or unrestricted employer stock holdings and a projection of how much the participant may be able to spend at retirement. Plan participants may use the service as frequently as they choose to monitor progress toward their financial goals, receive forecasts and investment recommendations and access educational content at our website.

 

Other Revenue.   Other revenue includes reimbursement for marketing and member materials from certain subadvisory relationships, reimbursement for providing personal statements to participants from a limited number of plan sponsors and plan implementation fees. A small portion of other revenue is derived from a defined benefit consulting business.

 

Costs and Expenses

 

Employee compensation and related expenses represent our largest expense. We allocate compensation and other related expenses, including stock-based compensation, to our cost of revenue, research and development, sales and marketing, general and administrative as well as amortization of internal use software expense categories. While we expect our headcount to increase over time, we believe that the economies of scale in our business model will allow us to grow our compensation and related expenses at a lower rate than revenue.

 

Other costs and expenses include the costs of marketing materials and postage, fees paid to plan providers for facilitating the exchange of plan and plan participant data as well as implementing our transaction instructions for member account and amortization and depreciation for hardware and software purchases.

 

The following summarizes our cost of revenue and certain significant operating expenses:

 

Cost of Revenue.   Cost of revenue includes expenses from portfolio management, operations, advisor call center operations, technical operations, including information technology, customer support, installation and set-up costs, data connectivity fees and printed materials costs for certain subadvisory relationships for which we are reimbursed. These expenses are shared across the different revenue categories and we are not able to meaningfully allocate such costs between separate categories of revenue. Consequently, all costs and expenses applicable to our revenue are included in the category cost of revenue in our statements of operations. Costs in this area are primarily related to employee compensation and related expenses, payments to third parties and purchased materials.

 

Research and Development.   Research and development expense includes costs associated with defining and specifying new features and ongoing enhancement to our Advice Engines and other aspects of our service offerings, financial research, quality assurance, related administration and other costs that do not qualify for capitalization. Costs in this area are primarily related to employee compensation for our investment research, product development and engineering personnel and related expenses and, to a lesser extent, related external consulting expenses.

 

Sales and Marketing.   Sales and marketing expense includes costs associated with plan provider and plan sponsor relationship management, marketing our services, plan provider and plan sponsor marketing, direct sales, printing of, and postage for marketing materials for, direct advisory relationships and amortization of direct response advertising. Costs in this area are primarily related

to employee compensation for sales and marketing personnel and related expenses, which include commissions, printed materials and general marketing programs.

 

General and Administrative.   General and administrative expense includes costs for finance, legal, compliance and administration. Costs in this area include employee compensation and related expenses and fees for consulting and professional services. Following this offering, we expect that we will incur additional expenses as a result of becoming a public company for, among other things, SEC reporting and compliance, including compliance with the Sarbanes-Oxley Act of 2002, director fees, insurance, transfer agent fees and other similar expenses. General and administrative expenses are expected to continue to increase due to incremental headcount increases, the general growth of our business and the costs associated with being a public company.

 

Amortization of Internal Use Software.   Amortization expense includes engineering costs associated with developing and enhancing our service offering, including the website. Associated direct development costs are capitalized and amortized using the straight-line method over the estimated lives of the underlying technology. Costs in this area include employee compensation and related expenses and fees for external consulting services.

 

Critical Accounting Policies and Significant Management Estimates

 

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

 

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that there are several accounting policies that are critical to understanding our business and prospects for future performance, as these policies affect the reported amounts of revenue and other significant areas that involve management’s judgment and estimates.

 

These significant policies are:

 

 

These policies and our procedures related to these policies are described in detail below. In addition, please refer to the notes to consolidated financial statements for further discussion of our accounting policies.

Revenue Recognition.   We recognize revenue when all four of the following revenue recognition criteria have been met:

 

 

Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires the company to make judgments and estimates. Specifically, arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting, including whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting. Other significant judgments include determining whether we are acting as the principal in a transaction and whether separate contracts are considered part of one arrangement.

 

Revenue recognition is also impacted by our judgment used in determining allowances for uncollectible receivables. We consider various factors, including a review of specific transactions, the credit-worthiness of the customers, historical experience and market and economic conditions when calculating these provisions and allowances. Estimates are evaluated each quarter to assess the adequacy of the amounts recorded.

 

We generate revenue through three primary sources: Professional Management revenue, platform revenue and other revenue.

 

We generate Professional Management revenue on the value of assets we manage for plan participants, which fees are generally payable quarterly in arrears. Revenue derived from management fees for our Professional Management service is recognized as the services are performed. In certain instances, fees payable by members are deferred for a specified period, and are waived if the member cancels within the specified period. Effective January 1, 2009, we commenced recognizing revenue during certain of these fee deferral periods based on our estimate of the expected retention and cancellation rates determined by historical experience of similar arrangements. We currently only recognize revenue for fee deferral periods of approximately three months or less and where the member has actively enrolled in our Professional Management service. If we use different assumptions for expected retention and cancellation rates, or if actual retention and cancellation rates differ materially from our estimates, future revenue recognized may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and earnings (loss) per share. As a result of recognizing revenue during the fee deferral periods, our revenue during the nine months ended September 30, 2009 was higher by approximately $0.5 million compared to the nine months ended September 30, 2008.

 

Platform revenue includes annual subscription-based platform fees for access to either our full suite of services, including Professional Management, Online Advice and Retirement Evaluation, or our Online Advice service only. Platform fees are paid by the plan sponsor, plan provider or the retirement plan itself, depending on the plan structure, and vary depending on the type of service provided. Subscription fees for our Online Advice service are generally paid annually in advance and recognized ratably over the term of the subscription period, which is typically three to five years in length, beginning after the completion of customer setup and data connectivity. Other revenue is recognized as the related services are performed, in accordance with the specific terms of the contract with the customers.

 

Deferred revenue primarily consists of billings or payments received in advance of revenue recognition generated by subscription fees for our Online Advice service and implementation service revenue described above. For these services, we generally invoice our customers in annual or quarterly installments payable in advance. Accordingly, the deferred revenue balance does not

represent the total contract value of annual or multi-year, noncancelable subscription contracts. Implementation service revenue is recognized ratably over the estimated customer life, which is usually three to five years.

 

Deferred Sales Commissions.   We defer certain commission payments to our sales force. Deferred sales commissions consist of incremental costs paid to our direct sales force associated with the execution of noncancelable customer contracts. The deferred sales commission amounts are recoverable through future revenue streams under the noncancelable customer contracts. We believe this is the preferable method of accounting as the commission charges are so closely related to the revenue from the noncancelable customer contracts that they should be recorded as an asset and charged to expense over the life of the related noncancelable customer contracts, which is typically three years. Amortization of deferred sales commissions is included in sales and marketing expense in the accompanying consolidated statements of operations.

 

Direct Response Advertising.   Our advertising costs consist primarily of print materials associated with new customer solicitations. We account for our advertising costs in accordance with Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or Codification or ASC, 340-20, Capitalized Advertising Costs (previously American Institute of Certified Public Accountants Statement of Position (SOP) 93-7, Reporting on Advertising Costs ). Advertising costs that do not qualify as direct response advertising are expensed to sales and marketing at the first time the advertisement takes place. Effective July 1, 2009, we commenced capitalization of advertising costs associated with Active Enrollment campaigns on a prospective basis as it was then determined that we had sufficient and verifiable historical patterns over a reasonable period to demonstrate probable future benefits of such campaigns.

 

ASC 340-20 requires the capitalization of direct response advertising only if the primary purpose of the advertising is to elicit sales to customers who could be shown to have responded specifically to the advertising and the direct-response advertising results in probable future benefits. The capitalized costs are amortized over the period over which the future benefits are expected to be received. Because of how we earn revenue from our Professional Management service, demonstrating that the direct-response advertising related to our direct advisory active choice campaigns results in probable future benefits requires us to make several assumptions about the gross revenues we will earn and costs we will incur as a result of each campaign.

 

We have developed forecasting methodologies that have a degree of reliability sufficient to reasonably estimate the future gross revenue stream associated with a given campaign. The significant estimates and judgments we use in our forecasting methodologies include average period of probable future benefits, market movement, AUM cancellation rates and net contribution rates. AUM cancellation rate is defined as the rate at which assets will cancel out of Professional Management program due to voluntary member terminations. A voluntary member termination is when a member contacts Financial Engines and terminates their membership in the Professional Management service. Involuntary cancellations (such as employee terminations, layoffs, etc.) are captured in the net contribution rate. Net contribution rate is defined as the net amount assets will increase as a result of new contributions in to the 401(k) plan less the amount assets will decrease as a result of disbursements from the 401(k) plan. We have estimated the average period of probable future benefits to be three years by analyzing our historical member retention rates and have estimated AUM cancellation rates by analyzing our historical AUM cancellation rates. In light of recent stock market volatility, we currently have assumed no market movement and a zero net contribution rate.

 

At September 30, 2009, $1.2 million of advertising costs associated with Active Enrollment campaigns were reported as assets. Advertising expense was $1.2 million, $1.8 million and $2.6 million for the years ended December 31, 2006, 2007 and 2008, respectively, of which direct advised Active Enrollment campaign expense was $1.2 million, $1.6 million and $2.5 million, respectively. Advertising expense was $2.3 million and $2.0 million for the nine months ended

September 30, 2008 and 2009, respectively, of which direct advised Active Enrollment campaign expense was $2.2 million and $1.8 million, respectively.

 

The table below evaluates the sensitivity of two of our most significant estimates, namely average period of probable future benefits and assumed market movement, on the realizability of net capitalized direct response advertising costs as of September 30, 2009. This sensitivity analysis considered all campaigns that were eligible for capitalization under our current assumptions of a three-year average period of probable future benefits and 0% market movement per year.

 

 

 

The sensitivity table above indicates that we would have recorded an impairment charge as of September 30, 2009 if (a) the market was projected to decrease by 40% per year over the estimated period of probable benefits or (b) the estimated period of probable benefits was to decrease from three years to one year.

 

Valuation of Long-Lived Assets.   Long-lived assets, such as property, equipment and capitalized website development costs subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset group exceeds the fair value of the asset group.

 

Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to long-lived assets during the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009.

 

Income Taxes.   We are subject to income taxes in the U.S. Significant judgments are required in determining the consolidated provision for income taxes.

 

We use the asset and liability method to account for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance to reduce deferred tax assets to an amount whose realization is more likely than not.