Manning & Napier, Inc.
Q2 2019 Earnings Call Transcript

Published: 31 Jul 2019

[Operator:]

Good evening. My name is Philip and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Second Quarter 2019 Earnings Conference Call. 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 be recorded and will be available for replay beginning at 8 p.m. Eastern Time tonight. The dial-in number is 404-537-3406 and enter pin number 1689814. At this time, all participants have been placed in a listen-only mode. And then floor will be open for your questions following the presentation [Operator Instructions].It is now my pleasure to turn the floor over to Ms. Nicole Kingsley Brunner.

[Nicole Kingsley Brunner:]

Thank you, Philip, and thank you, everyone for joining us today to discuss Manning & Napier's second 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 Chief Executive Officer, Mr. Marc Mayer. Marc?

[Marc Mayer:]

Thank you, Nicole. First, as always, we would like to begin with a review of how we performed for our clients.Beginning with our multi-asset class portfolio, we generated strong absolute results for clients during the quarter as well as for the first half of the year. Relative returns are generally in line with benchmarks with more aggressive multi-asset class mandates tending to outperform and more conservative mandates tending to underperform their benchmark.In general, our in-line relative performance reflects our risk management philosophy as we seek to participate in up market environments such as what we've seen thus far in 2019 while also remaining well positioned to provide a degree of downside protection should markets become more adverse.We are underweight equities relative to our neutral position in our multi-asset portfolios, a posture which served our clients very well during the sharp slowdown in the fourth quarter of 2018. However, our excellent security selection within equities allowed us to keep up in the strong equity markets of the first half of 2019.Turning next to our core fundamental U.S. and non-U.S. all equity portfolio, each performed well for the quarter building on strong first quarter performance. Year-to-date, our core U.S. equity composite is outperforming its benchmark by over 200 basis points and our core non-U.S. equity composite is outperforming its benchmark by over 400 basis points. We will provide more color on our core strategies later in the prepared remarks.Our disciplined value strategy had a challenging quarter underperforming its benchmark by a 192 basis points. Although, it has had a difficult first half of the year, the strategy maintains an excellent long-term track record. For instance, at MorningStar peer group, the disciplined value series ranks in the 9th and 11th percentile over the trailing three and five years, respectively.The real estate series posted another compelling quarter result and the strategy is off to a good start in 2019. The series is ahead of its benchmark by over 100 and 250 basis point for the quarter and year-to-date respectively and it ranks in the top third of its MorningStar peer group over the trailing three and five years.Our Rainier team has delivered excellent results thus far in 2019. The Rainier international discovery series outperformed its benchmark by 593 basis points in the second quarter alone and is now ahead of its benchmark by nearly 750 basis points year-to-date. These impressive results built on an already compelling long-term track record.Our fixed income team continues to deliver for clients in a difficult yield environment. We believe particularly in today's world that successful fixed income investing demands flexibility to adapt to changing market conditions and individual client needs. As an example, our unconstrained bond strategy has outperformed its benchmark over 1, 2, 3, and 5 years.In recent years, we have extended our multi-asset class expertise into our managed ETF portfolio solutions. In February, we further built out our managed ETF suite with our Fi360 managed ETF income offering, a strategy designed to boost the yield for income sensitive clients. Our income focused offering has seen interest and gaining traction as we market this strategy.Lastly, I'd like to take a moment to reflect on the performance of our key investment strategies over longer time horizons. It is well known that we went through some difficult performance periods during the middle of this decade. We are now approaching a time when those challenges quarters begin to roll off key longer-term time period.For example, our multi-asset class and core all equity portfolios will be rolling off some challenging performance of the next couple of quarters. Rolling off these underperformance periods should meaningfully improve our three-year relative results against both benchmarks and peers. Our five year relative results will take a bit longer to be effective.You know those times mid decades were difficult for our clients and consequently, we took actions to our investment processes. We believe we are seeing the benefits of those changes. I'd like to now speak about our organizational evolution and provide an update on our strategic review.As we evaluate our business strength, we acknowledge that although we are a relatively small asset manager, we are in fact one of the largest independent RIAs, that's registered investment advisors with almost half of our AUM managed for wealth management clients. While we have been historically viewed solely and I will pause it somewhat incorrectly as an investment manager, the realities of our roots are always been in wealth management.This stays fast to the founding of the firm almost 50 years ago to focus on advising and directly serving high net worth families, small and mid-sized businesses, endowments and foundations. Today, our wealth management teams are regionally focused throughout upstate New York, Ohio, Western Pennsylvania and Western Florida. Each of our advisors has assets under management that averaged nearly $1 billion, a scale that ranks among some of the most productive advisor teams in the industry in terms of AUM.Going forward, we view the wealth management business directly advising and serving high net-worth families, smaller and mid-sized businesses and endowments and foundations as our most significant growth opportunity, and we intend to build on our strengths by increasing our investment in this space. We believe that our shape regional focus in less wealth served and less competitive geographies is strength and we will continue that focus.Our increased wealth management focus is designed to continue to work seamlessly alongside our existing asset management businesses. Our own investment strategies will remain at the heart of our wealth management offering. We have a proud history of delivering multi-asset class solutions to our clients. We are highly distinctive and having a successful multi-asset class investment discipline employing dynamic allocation track records dating back to 1973.Our flagship long-term growth strategy which at almost $6 billion represents over one quarter of our assets as compounded at 9.43% since inception on January 1, 1973. A $100,000 invested in long-term growth at that time would be worth $6.5 million. That is the type of skill and experience around which we can surely build.Our investment approach will remain fully integrated and align with our long standing research principles. At the same time as we refocus our wealth management efforts, we will continue to promote our investment capabilities through intermediaries and institutional investors.Regarding our asset management business, we recently promoted Aaron McGreevy to lead our intermediary and institutional distribution efforts, including our Taft-Hartley clients. The promotion reaffirms our commitment to institutional clients and financial intermediaries particular to our Taft-Hartley partners with whom Aaron has maintained long-standing relationships.Additionally, our new Chief Technology Officer, Chris Briley, is continuing to evaluate our Information Technology needs. This addition is focused on improving efficiencies, managing expenses, and modernizing our client experience. To be a larger and even more successful wealth manager will require a substantial evolution of our technology platform.To facilitate this effort, we have engaged in leading technology consultants, to conduct a digital assessment of our IT processes and capabilities as well as our related business processes. This will have a one-time impact on our expenses during the second half of the year when realized efficiencies to be expected down the road.We are also conducting an accelerated evaluation of our subscale projects, products and services. While we do not have a significant amount of detail, we can provide at this time an examination of our cost structure remains ongoing as we seek to further rationalize and reduce our expenses.With that, I'll turn the call over to Paul for more detail on our financials.

[Paul Battaglia:]

Thanks, Marc. Good afternoon everyone and thanks for joining us today. Looking at our financial results and starting with assets under management, we finished the second quarter with AUM $21.3 billion, a slight increase from $21.1 billion on March 31. The increase was the results of $685 million in market appreciation partially offset by approximately $575 million of net client outflows.When compared to June 30 of last year, AUM is decreased by $1.6 billion or 7%. We've seen a decrease in the overall rate of outflows, gross outflows of approximately $2.7 billion or 31% improvement from this time last year, and growth outflows for the quarter drops to $1.1 billion. The second quarter turnover rate was 21% annualized and is 27% when annualized for six months into June 30. These outflow rates are more in line with the low to mid 20% range that we experienced prior to the difficult performance periods in 2014 and 2016.By contrast, starting in 2015, as performance headwinds increased, turnover rates had increased to the high 30% or low 40% range. The improvement in our turnover rate is further support that our overall servicing efforts, importantly including our value added advisory services are effective in supporting long-term relationships.This improvement directly correlates to the increase in share of our overall business that utilizes our wealth management services. Our annualized separate account retention rate provides further evidence of this, as the rates for the second quarter improved to 94% and stands at 93% for the six month end of June 30.While we are pleased by the improvement in the rate of outflows, we must acknowledge that the rate of gross client inflows has flowed considerably. Difficult long-term performance track records and some of our key strategy coupled with the changes in our organization and macro trend toward passive investing have all played a role in this trend.As Mark discussed earlier, evolving our distribution strategy including both our wealth management team as well as through intermediary and institutional channels is among our top priorities right now. We believe that by demonstrating stability and client AUM and in our organization along with improving long-term track record and modernizing our platform will provide a foundation from which we can grow.Turning to the second quarter P&L we reported revenue of $34.3 million for the quarter, down 1% from revenue of $34.8 million last quarter, with overall revenue margin at 65 basis points. The sequential decrease in revenue in top line margin is attributable to the second quarter being the first full quarter of result following the completion of our fund fee restructure in March.Though the 65 basis point revenue margin is down from 68 basis points reported last quarter it is in line with expectations which we communicated on prior calls. It is our expectation that fees will remain in the mid 60 basis point range, though where we fall in that range will largely be dependent on the overall AUM mix going forward.Operating expenses were $31.8 million in the quarter a decrease of 1.7 million compared to the previous quarter and a $3 million decrease compared to the second quarter of 2018. Compensation related costs for the quarter dropped by $1.3 million or 6% sequentially, primarily due to decreases in headcount and share-based compensation; however, our compensation related costs as a percentage of revenue remain elevated at approximately 60%.In our press release, we made note of strategic actions taken during the quarter included the anticipated sale of prospective partners as well as the continued reduction in the size of our workforce. While there are not significant non-recurring compensation costs in the second quarter results compared to prior period, we have achieved future run rate savings that will begin to be realized during the second half of 2019 as a result of the actions taken to-date and the overall workforce attrition.However, near-term savings resulting from these changes are likely to be offset by nonrecurring costs that we will incur as part of the future actions stemming from our strategic review. We'll provide more color on those actions as they take shape in future quarters. Distribution, servicing and custody expenses decreased by 20% during the quarter, however, average mutual fund and collective trust assets increased by 1%.As mentioned previously, the variance in the rate of change is largely attributable to the mutual funds fee restructure. Distribution, servicing and custody expenses represent approximately 19 basis points of average funding collective trust assets and that's what we expect to see in future quarters.Other operating expenses were $8.6 million in the quarter, an increase of approximately $300,000 from the first quarter. Pretax income for the quarter was $3.6 million and economic net income for the quarter was 2.5 million or $0.03 per adjusted share.With that, I'll summarize our year-to-date results through June 30th. We've reported revenue of $69.1 million down 17% from $83.3 million last year with overall revenue margins of 67 basis points. Operating expenses were $65.3 million, a decrease of 4.4 million or 6% from last year as decreases in distribution expenses in compensation were offset by increases in other operating costs.They were elevated as a percentage of revenue, compensation and related costs in June 30th at $41.6 million dollars are down by 3.9 million or 8% when compared to last year. A majority of the decreased is due to the decrease in the overall size of the workforce down from four times at this time last year to 336 as of June 30.As discussed earlier, we have seen decreases in distribution service and custody expenses following the completion of our mutual fund fee structure in March. And we've seen a 13% increase in other operating costs since last year's largely resulting from our technology enhancement initiative with over $1 million of incremental expense during the year, resulting from this initiative.Additionally, other operating costs in 2018 benefited from the 2.1 million gain related to the sale of the U.S. mutual fund -- Rainier U.S. mutual fund last year. As a result, our pretax income for June 30 was $6.7 million with a net income from a $4.8 million or $0.06 per adjusted share.Turning to equity ownership. The adjusted share count stands -- decreased slightly from 80.4 million shares our standing as of March 31st to 79.1 million shares on June 30th with the change resulting from the completion of the annual exchange process during the quarter. As part of that process, legacy shareholders exchange approximately 1.3 million Class A units of f Manning & Napier Group for $3.1 million in cash. Subsequent to the exchange, these units were retired.With respect to balance sheet, we continue to maintain a debt free capital structure with cash, cash equivalents and short-term investment for approximately $147 million as of June 30th. And during the quarter, we declared a $0.02 per share dividend tour class A shareholders consistent with previous quarters.That concludes my formal remarks. And I will turn the call back over to the operator and we look forward to your questions. Operator?

[Operator:]

The floor is now open for questions. [Operator instructions] Our first question is from the line of Ken Worthington from JP Morgan.

[Will Cuddy:]

This is Will Cuddy filling in for Ken. So in the release, you mentioned you're selling prospective partners. The press release had mentioned expenses. How much revenue was the business generating? And are there other opportunities like this to sell non-core businesses?

[Paul Battaglia:]

Hi Will, thanks for the question. We haven't disclosed the revenue previously was not a meaningful portion of the business. In terms of other opportunities like it, I don’t see there is anything that in the near-term we'd expect you to see nothing that we want to report right now. I think this was kind of unique part of the business that was up strategic significant under prior leadership.And as Mark mentioned in his comments, the strategy of involving our distribution to largely a wealth management focus made this something that we thought we could do without and so, we saw an opportunity to reduce some expense and moving in other direct, and that’s trend we're operating under right now.

[Will Cuddy:]

Okay. Trying another way, was it cash flow positive and if you're able, Paul, to answer that?

[Paul Battaglia:]

No, I think it was a net loss position and we think of it as, it was primarily a technology R&D kind of part of the firm, largely compensation and other operating centers in terms of where the expenses resides on the P&L. And so, we think of it as being accretive to the P&L upon completion of the transaction as a result of the expense savings that we'll achieve.

[Will Cuddy:]

Okay. Thanks Paul. So turning to wealth management, so can you elaborate a little bit more on this? So just the RIA business corresponds to your direct segment? And are these RIAs open architecture? Can I, I guess they're working with high net-worth client, they're may be offering your products that are also potentially third-party products as well?

[Marc Mayer:]

Well, it's Marc. This is what we've historically called our direct segment, direct in that, we have an unmediated relationship with the clients who are, as I indicated, not just individuals and families, also small businesses, endowments and foundations. We are not really an open architecture organization. And when I say really, the, I mentioned in my remarks, managed ETF portfolios for example.So, we're not manufacturing the underlying ETFs, we're buying those on the market. But we are not offering a supermarket of investment options from other firms. It is as we evolve our wealth management offering, it is our intention to wear appropriately and very carefully and judiciously, consider deploying outside managed strategies, particularly in alternative areas.

[Will Cuddy:]

Okay. If I was to separate this business from the other portions of your business, can you give us an idea of what the growth rate would be? And how that industry, the contracts for other parts of, this was a non-RIA wealth management side?

[Paul Battaglia:]

Will, this is Paul. I mean, I think, I don't know but I have the exact answer to your question in front of me in terms of the growth rate. But I mean, I would say in terms of if you want to think of it, in terms of the turnover rate, I'd say this has been sort of the -- in many ways, this is the legacy core business on which, we've grown from the beginning, right?A lot of it is in our multi-asset class portfolios. And I know that there's a page in our supplemental that has AUM buy portfolio and that multi-asset class has been the steadiest of the three, right, where we've had multiple, we believe, we've been able to use both active management and active asset allocation to be able to help clients meet objectives.And in many cases, there are other services, advisory or wealth management type services that we bring to the relationship that helps make these types of relationships stickier than say, a larger institution or intermediate relationship where we are just providing a single asset class solution.So, I think that's probably in terms of the experience over the last few years where we've had, where we've been in more of a, an outflow position than a growth position. I'd say this is a business that has been the strongest in terms of having the least amount of outflows relative to the institutional or the other segments of our distribution.

[Will Cuddy:]

Okay.

[Marc Mayer:]

And if I could just add, I think the observation that, it is the most persistent and stable business. I think even though it has not been growing in net new business terms over the last few years. It also hasn't been shrinking at any particularly alarming rate, and that forms the basis for reinvigorating and reinvesting in this business because I believe and we believe that it is very fruitful area for growth.

[Will Cuddy:]

I just want to make sure I'm going to understand this correctly, and these relationships that your high net worth are they essentially bankers acting as fiduciaries and how they place these clients in a particular product offering offered by Manning this year?

[Marc Mayer:]

Well, we are registered investment advisors, so we are acting as a fiduciary. We're not operating and we're registered as a broker dealer, but we're not operating as brokers in that. You know, these are discretionary mandates, many as Paul said multi-asset class mandates where we have large portions, in some cases the entirety of clients assets invested across the capital markets at our discretion.

[Will Cuddy:]

I know I've been asking a lot here, but just one more. When you think about turning on the growth, can you outline like a high level like how you think about like, accelerating growth within the RIAs and direct channel?

[Marc Mayer:]

So, I'd say a simple answer is increased sales capacity. So, we -- I indicated that our existing advisors have very substantial books of business, large numbers of relationships with very substantial assets, around a $1 billion in some cases a little more, in some cases a little less, but that's a large financial advisor, that's a large ROI.What we want to understand is through deployment of better technology, better organizational structure, management discipline, will we create incremental sales capacity with our existing teams. I think the answer is to an extent, but then the opportunities for growth will also depend on adding additional advisors.And so, we have not been adding to our sales footprint through our advisor footprint for quite a while and the anticipation is that that will change as all the other elements of the strategy begin to come together.

[Operator:]

And there are no further questions at this time.

[Marc Mayer:]

Thank you.

[Paul Battaglia:]

Thank you everyone.

[Operator:]

Thank you. This does conclude today's conference call. Please disconnect your lines at this time and have a wonderful day.