Manning & Napier, Inc.
Q1 2019 Earnings Call Transcript

Published: 1 May 2019

[Operator:]

Good evening. My name is April and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier First Quarter 2019 Earnings Teleconference. Our hosts for today's call are Nicole Kingsley Brunner, Chief Marketing Officer; Marc Mayer, Chief Executive Officer and Paul Battaglia, Chief Financial Officer. Today's call is being recorded and will be available for replay, beginning at 8

[Nicole Kingsley Brunner:]

Thank you, April and thank you, everyone for joining us today to discuss Manning & Napier's first quarter 2019 results. Before we begin, I would like to remind everyone that certain statements made during this call not based on historical facts, including any statements relating to financial guidance, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. Manning & Napier assumes no obligation or responsibility to update any forward-looking statements. During this call, some comments may include reference to non-GAAP financial measures. Full GAAP reconciliations can be found in our earnings release and related SEC filings. With that, allow me to introduce our Mr. Marc Mayer. Marc?

[Marc Mayer:]

Good afternoon and thank you, Nicole. I'd first like to begin with a review of how we performed for our clients. As you can see from Exhibit number 5 in the supplemental slides performance for the first quarter was competitive across our strategies as a strong rally and global financial markets boosted absolute returns across most asset classes. The strong market environment was in clear contrast with the sharp sell-off experienced at the end of last year. Our outperformance during the fourth quarter's market drawdown is reflective of our risk management focus, while our ability to leave little on the table during this year's buoyant market is a reflection of our flexible active approach to asset allocation driven by the bottoms up security selection. While two quarters is hardly long-term, we think our results in two very different environments are indicative of the benefits of our investment approach. Beginning first with our multi-asset class portfolios, our traditional risk based strategies generated robust absolute returns in the quarter. On a relative basis, while our more aggressive strategies outperformed or performed in line with their blended benchmarks, our neutral to more conservative strategies experience slight underperformance. Across our multi-asset class strategies, strong individual stock selection significantly aided relative returns and helped our portfolios perform competitively amid the rising market environment. Continuing along those lines, our US and international equity portfolios performed well in the quarter. The U.S. core equity series outperformed the S&P 500 by nearly 200 basis points. Our core non-US equity portfolio outperformed its benchmark by over 300 basis points in the quarter. We are optimistic that this strong quarter presages the restoration of the longer-term record of this flagship international strategy. The liner international small-cap portfolio outperformed its benchmark by 88 basis points in the quarter, helping it further build on an already compelling long-term track record. We look forward to continuing to promote the diversification benefits of the international small-cap asset class. Our disciplined value series, a US-based quantitative strategy generated strong absolute returns but trailed it's large cap value benchmark in the first quarter. The series maintains an excellent track record across nearly every rolling time period of its MorningStar peer ranking, the disciplined value series is in the fourth and second percentiles for its three and five year rankings respectively. One quarter of lagging relative performance does not change our view of the strategies compelling long-term attractiveness. Our research teams are focused on executing their time-tested investment processes. We believe the volatility spike experience late last year and the subsequent short rally this year call further attention to the unpredictability of today's investment environment. From considerable fear in December of 2018 to rising complacency now nearly four months later,, such patterns lead us to believe that a modest defensive tilt remains appropriate for client portfolios. Over the past six weeks, we have embarked on a strategic review of our business. The review first has involved listening, listening to our clients, our shareholders and our people. This process has reaffirmed that the fiduciary, client centric culture and disciplined research and investment processes at Manning & Napier remains strong. At our core, we are a wealth and investment manager that thrives on understanding our client's financial objectives and delivering holistic solutions to help them achieve their goals. A review has also confirmed that while our foundation remained strong, there's an opportunity for us to simplify and refocus our business. Through this process we will address the opportunities with a sense of urgency and purpose as we look to improve outcomes for clients, stabilize our financial model and position for future growth. I expect our strategic review will lead us to further build on our strengths. We will enhance our personalized solutions and services and refine our robust suite of superior investment management strategies. We will continue to improve our research processes, increase the effectiveness of our client relationship personnel and services and streamline an upgrade our IT and operations. We intend to modernize our technology platforms in order to improve the client and employee experience. We will focus on leveraging the external systems expertise developed by others rather than seeking to solve our technology and business process challenges solely with internally developed solutions. I am eager to address the challenge with the help of our new Chief Technology Officer, Chris Wiley as well as with others on the team. Manning & Napier have a long and distinguished tradition of wealth and investment management. Our goal has always been to deliver the necessary solutions that clients require with high touch client service. Financial markets have not stood still and the ongoing servicing demands of our client have evolved. We recognize these changes and are continuously working to enhance our client experience. As we move forward through the process, I look forward to sharing updates on our progress. We will remain true to who we are and focus on what we do best by building on our enduring and compelling strengths. We will continue to prioritize delivering best in class client solutions while simultaneously working to achieve a more sustainable financial model. With that, I'll turn the call over to Paul for an update on our financials.

[Paul Battaglia:]

Thanks Marc. Good afternoon, everyone and thanks for joining us today. Looking at our results and starting with assets under management, AUM increased from $20.2 billion as of December 31 to $21.1 billion on March 31.. This 5% increase was the result of $1.8 billion in market appreciation, partially offset by approximately $850 million in net client outflows. When compared to March 31, 2018, AUM decreased by $2.3 billion or 10%. Marc discussed some of the performance highlights earlier, so I will address net outflows in the quarter, the majority of which came from our traditional strategies and were concentrated in our fund and collective trusts. We observed this trend in prior quarters with outflows that were largely from consultant intermediated business both Taft-Hartley and larger institutional clients. The annualized separate account retention rate for the quarter was 92% an increase from 86% in 2018. Our business has been built on the strength of the relationships we have with our clients and the value-added solutions we deliver. This is best illustrated in our direct channel which represent approximately $14 billion in total assets. More specifically about two thirds of the business is serviced by our regional sales force acting in an advisory focused capacity. We work closely with these clients to provide solutions that will help them achieve long-term financial objectives. In many cases this is accomplished through investment in our various blended asset strategies. In other cases, this is achieved through our various consultative services. While we provide these solutions for a variety of different client types, the common thread between all of our clients is that they value the holistic wealth management focused approach that we take to help them achieve their goals. We seek to build on that strength through both the continued emphasis of our advisory focused offerings as well as through the continued growth of strategies like disciplined value and international discovery, both remain a priority across our sales channels. Disciplined value has grown to approximately $1.5 billion in AUM and contributed net inflows of approximately $90 million for the quarter and despite underperformance last year, international discovery remains a distribution priority with approximately $800 million in AUM as of March 31. Turning our first quarter P&L, we reported revenue of $34.8 million for the quarter down 7% from revenue of $37.4 million reported last quarter with overall revenue margins of 68 basis points, down from the low 70 basis point range that we reported earlier in 2018 and in prior years. We've addressed this trend on prior calls noting that the decrease in average fees is resulting from the recently completed restructure of our mutual fund fees, a project that was completed over an 18 month period when increasing the competitiveness of our strategies and the continued changing of our business mix with lower fee strategies like disciplined value and fixed income now representing nearly 15% of our total AUM. Looking ahead, we expect that our average fees will settle in the 65 to 70 basis point range, now that the mutual fund fee restructure is fully implemented. However, any further changes in our business mix will also impact our fees going forward. Operating expenses were $33.5 million in the quarter an increase of $1.4 million compared to the previous quarter or $1.5 million decrease compared to the first quarter of 2018. The sequential increase is concentrated exclusively in compensation and related cost, which increased by 14% or $2.6 million in the quarter. The increase in the result of increases in our research bonus accruals based on performance through March 31 along with a full quarter of expense related to the awards granted in 2018 under our long-term incentive plan and other increases in stock-based compensation. Our compensation ratio for the quarter increased to 62%. By contrast, compared to the first quarter of last year, compensation is down by $2.3 million, which is largely the result of steps taken during last year's business review including nearly retirement offering during the third quarter of last year. As we've discussed on prior calls, our compensation and related cost as a percentage of revenue can be susceptible to swings on a quarterly basis due to the nature of our incentive compensation and overall business model. The first quarter ratio was a reflection of this and while we would expect it to normalize in future periods, compensation may change as the details of our strategic review come into focus in the next few months. We will provide updates during future quarters. Distribution, servicing and custody expenses represent approximately 24 basis points of average fund and collective trust assets and decreased by 14% during the quarter. The decrease is partially attributable to a 7% decrease in average fund and collective trust assets as well as from the elimination of certain distribution expenses as a result of the fund fee restructure I mentioned earlier. Other operating expenses were $8.3 million in the quarter, a decrease of approximately $630,000 from the fourth quarter. Pretax income for the quarter was $3.2 million and economic net income for the quarter was $2.2 million or $0.03 per adjusted share. Turning to equity ownership, the adjusted share count increased slightly from 79.7 million shares outstanding year-end to 80.4 million shares outstanding on March 31 with the increase attributable to new equity awards issued during the quarter. It should be noted that the adjusted shares included in our calculation of the non-GAAP financial measure, economic net income per adjusted share excludes unvested stock options awarded. For non-GAAP purposes, stock options will be included in our adjusted share count once vested. Additionally, later this week, we expect to complete the annual exchange processes, legacy shareholders will exchange approximately 1.3 million Class A units of Manning & Napier Group for approximately $3 million in cash. As in prior years, these units will then be retired and the exchange will be accretive to all remaining shareholders. With respect to the balance sheet, we continue to maintain a debt-free capital structure with cash and investments of $142 million which includes approximately $7 million invested in seeded products as of March 31 and during the quarter, we declared a $0.02 per share dividend to our Class A shareholders consistent with prior quarters. That concludes my formal remarks, I'll now turn the call back over to the operator and we look forward to your questions. April?

[Operator:]

[Operator Instructions] Your first question is coming from the line of Ken Worthington from JPMorgan.

[Will Cuddy:]

It's Will Cuddy filling in for Ken. So first on compensation, could you potentially break out some of the pieces that increased quarter on quarter like seasonality like payroll taxes, severance and research bonus and you did mention potential normalization of the compensation ratio. What would be a normal range?

[Paul Battaglia:]

This is Paul. In terms of the breakdown for the quarter, the main seasonality or the one-time items in the quarter are really directed or really related to awards paid to our Board of Directors, stock awards as well as the award that we addressed earlier with the disclosure of the Marc Mayer's compensation plan when he joined the firm back in February. The other normal item I would say is last quarter we talked about the long-term incentive plan that was - the awards that were issued in December of 2018, so you have a full quarter of expense related to those as opposed to just one month of expense in the fourth quarter. So equal [ph] the last several quarters up until now, I think we've been operating in the low to mid-50% range I think and that is we've had some noise around severance charges in prior quarters especially in the third quarter of 2018. On a normalized basis I think that's a realistic expectation right now. I think as we have - as Marc mentioned during his remarks and as I touched on as well, a review of the business is ongoing and if there are additional restructuring costs that end up coming to light as we go through that plan, that would change that ratio, but for the time being, when I think of normalized, at least for the rest of 2018, I am thinking back into that, that mid-50% range barring anything unusual.

[Will Cuddy:]

Great. Thanks Paul. And then also on the non-comp expenses, so there is a couple of initiatives and investments occurring. How should we be thinking about growth of that line item as you would invest back into the business for some of these initiatives?

[Paul Battaglia:]

I think we are obviously being very mindful of the P&L right now given the revenue trends that we've seen recently. I think that we have been operating with that line in the 20% to 24% range when you think of it as a percentage of revenue. For the time being I think that is where we think we will remain for the next few quarters. As we think about some of the initiatives, not all of those will hit the P&L right away, for example investments in technology will be amortized over a longer useful life. So I don't think that there's any one time shocks that we would tell you that build in right now. I think trying to pin it to that percentage of revenue in that low 20% range is probably the best that I would tell you to do right now.

[Will Cuddy:]

Great. Thanks Paul. And then last modeling question, so thanks for the walk forward on the share count near term, could you maybe expand that through the course of the year as we think about the share count growth over the rest of the year that would be helpful as well?

[Paul Battaglia:]

Yeah, so I think like we said, we do expect a modest reduction in the share count later on this year later on in the second quarter as a result of the exchange. The adjusted share count that we provide is already fully diluted in terms of the restricted stock awards. So future vesting of prior awards won't necessarily change that share count because they're already included in the adjusted share count. So where you may have changes would be any unanticipated departures from the firm where awards are forfeited on if any of the option, the performance options related to Marc's awards vest later on in the year in which case we would - we would trigger including those into the adjusted share count. So absent those, I don't anticipate any material changes that would have included in the model right now.

[Will Cuddy:]

Okay. Thank you for taking my questions.

[Operator:]

And that concludes our questions for today. Thank you. This does conclude today's conference call. Please disconnect your lines at this time and have a wonderful day.