Manning & Napier, Inc.
Q2 2018 Earnings Call Transcript

Published: 1 Aug 2018

[Operator:]

Good evening. My name is Celecia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Second Quarter 2018 Earnings Conference Call. Our host for today's call are Nicole Kingsley Brunner, Chief Marketing Officer; Chuck Stamey, Co-CEO and Executive Vice President and Managing Director of Sales; and Paul Battaglia, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 8

[Nicole Brunner:]

Thank you, Celecia, and thank you, everyone, for joining us today to discuss Manning & Napier's Second Quarter 2018 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 measure. Full GAAP reconciliations can be found in our earnings release and related SEC filings. With that, allow me to introduce our co-CEO and Executive Vice President and Managing Director of Sales, Chuck Stamey. Chuck?

[Charles Stamey:]

Thank you, Nicole. Good afternoon, and thank you for joining us. The increase in market volatility that started during the first quarter continued during the second quarter, driven by rising trade tensions, geopolitical uncertainty and the impact of the strong U.S. dollar on emerging markets. This type of noisy market favors active management with increased volatility and stressed valuations, allowing active managers like Manning & Napier to take advantage and to provide strong risk-adjusted returns for our clients. Several of the products we've identified as key distribution priorities have taken advantage of this market and performed well. Most notably, our Disciplined Value strategy has outperformed its large-cap value benchmark by nearly 700 basis points for the 1-year period and by 360 basis points annualized for the past 3 years. Also, our Disciplined Value mutual fund was recently upgraded to 5 stars by MorningStar. The Disciplined Value strategy finished the second quarter with approximately $980 million in AUM across all vehicles. And we expect it to gain additional distribution momentum when it crosses the $1 billion threshold, as this is the minimum AUM level needed in many institutional searches. Our Rainier International Discovery Fund has outperformed by 500 basis points year-to-date through June 30, and by 1,100 basis points for the 1-year period and by over 300 basis points annualized for the 3-year period ending June 30. Also, our Pro-Blend and retirement target funds have had strong year-to-date results, outperforming their respective benchmarks and ranking favorably within their respective peer groups. As most of you know, our clients typically expect us to participate, but not lead, in the latter stages of a bull market, and to provide downside protection during sustained market losses. Despite the fact that we are in the 10th year of a bull market, we are pleased to have outperformed thus far in 2018, across much of our product set due to our stock selection strategies. This includes our multi-asset class accounts, the majority of our AUM, which have outperformed despite lower equity allocations than their respective indexes. Last quarter, we announced a new relationship with Fi360, and we are pleased to have seen some momentum with this relationship over the past quarter. Earlier this month, we hosted a joint webinar, which identified several hundred leads interested in our products. And as we head into the third quarter, we are preparing for our annual client seminars. As many of you have heard on previous calls, these seminars are a great opportunity for face-to-face engagement with our direct clients. These events also provide our clients with the opportunity to hear directly from our research team. Beyond the face-to-face events, we're offering a virtual event with a webinar so that our clients can access this information regardless of their physical location. The second quarter has also been noteworthy for the progress we've made on the business review that Jeff Coons, Richard Goldberg and I started after we were appointed to the office of CEO in March. As Jeff discussed on our last call, with the help of senior leaders throughout the firm, we kicked off this business review and identified several initiatives to strengthen our core business and improve profitability, keeping 4 main objectives in mind along the way. First, our aim has been to minimize any client disruption in order to protect existing relationships and the respective assets under management. Next, we identified products and services that represent the best opportunities for future AUM growth with a plan to feed these growth opportunities with the resources needed to succeed. Third, we continue to review our workforce and supporting resources, including our back office infrastructure and plan to make adjustments where feasible. And finally, we completed this review with the goal to position the business to be more agile in a changing business environment. I'd now like to provide a summary of the progress we've made to date. Our first steps have been concentrated on expense management. And to that end, during the second quarter, we rolled out an early retirement offering to employees that met specific age and service metrics. I want to be clear that employees from our sales and research teams were not eligible given our goal of minimizing client disruption. Employees that elected to participate in this program confirmed their elections during July, and we are working with each of them on their respective transition plans. Additionally, after reviewing current AUM, client accounts and revenue, we identified several other areas where workforce reductions were necessary and completed that process earlier this month. Turning to our initiatives for supporting AUM growth, we have started to implement changes to better leverage our most productive direct sales reps by taking a team-based service approach to certain client relationships. We believe this will increase our sales capacity and promote succession planning in our key markets. Further, we continue to direct more resources to enhancing our custom advisory service offering and broadening [adoption] revenue, we identified several other areas [and finally] we started implementing a plan to enhance our information technology infrastructure. While we expect this to be a multi-year project in total, we plan to leverage the strength of our balance sheet to invest in the resources we need to accelerate the time line where possible. We expect that our new structure will be more scalable and provide better support to our team and better service for our clients. Paul will discuss these initiatives in more detail shortly, and I'll be happy to address any further questions during Q&A. Before turning the call over to Paul though, I want to briefly reflect on our firm's vision, which is to help our clients meet their financial objectives through active investment management, innovative investment strategies and consultative solutions. We're able to help our clients achieve their goals through our people who help deliver our products and services to our clients. It has been an eventful year, and we remain dedicated to helping our clients achieve their goals. And for that, I want to thank our team for their continued commitment to servicing our clients and growing our business. By implementing these initiatives that I've just discussed, I am confident that we will be better positioned to serve our clients and to provide them with the investment products and services they will need to achieve their financial goals. We've been encouraged by the competitive relative returns that we've delivered across much of our product set during the first half of 2018. Sustained performance excellence will be a major factor in improving trends in the firm's AUM and margins. However, we also believe that the initiatives currently underway are equally important to helping us continue to provide best-in-class support for our clients now and in the future. And with that, I'll now turn the call over to our Chief Financial Officer, Paul Battaglia. Paul?

[Paul Battaglia:]

Thanks, Chuck. Good afternoon, and thank you for joining us today. Before we get into our second quarter and year-to-date results, I want to provide some additional context on the adjustments stemming from our business plan review that Chuck mentioned, one should expect to see in the coming quarters. First and perhaps most importantly, I want to reiterate that none of the early retirements or early adjustments we have made to date have impacted our sales or investment teams. Those teams remain focused on growth opportunities and continued strong performance. With regard to the early retirement offering, just under 20 employees of the firm elected to participate. Those employees will depart on a staggered schedule to maintain business continuity, with the majority of them transitioning out over the remainder of the year. Further, we have identified approximately 20 additional positions for elimination. Some of the changes were completed in July, with the remainder occurring over the next few months. In total, the competition benefits associated with the eliminated positions represents approximately $6 million annually. We expect these savings to be realized gradually over the next several quarters based on the staggered departure dates for the eliminated positions. However, we are also estimating approximately $3 million in onetime severance charges related to these changes that will be recorded over the remainder of 2018. Looking ahead, the next phase of our plan is continued focus on our growth initiatives and enhancing our IT infrastructure. We expect that this will include investment in new systems and outsourced solutions that will be more scalable than our existing proprietary systems. Updating our performance reporting system is a top priority under our plan, and a good example of where an outsourced industry standard solution will be a better alternative for reporting performance to our clients and other distribution partners in our current systems. We are planning a ramp-up spending on these initiatives starting in the second half of 2018 and into 2019. But the P&L impact will likely lag from that timing as many of these costs will be capitalized and depreciated over the next several years. Additionally, we will continue to monitor key metrics in our business and be ready to take additional contingent steps to maintain margins if outflows persist or other changes takes place. Now turning to assets under management and net client cash flows. AUM decreased from $23.4 billion as of March 31, to $22.8 billion on June 30. This 3% decrease was the result of approximately $875 million of net client outflows, offset by approximately $280 million of market appreciation during the quarter. When compared to June 30, 2017, AUM has decreased by $4.2 billion or 16%. Our separate account retention rate for the 12 months ended June 30, 2018, was 84%. Net client outflows slowed in the second quarter as a result of our continuing servicing efforts, our value-added consultative offerings and strong short-term absolute and relative returns. While we have not yet turned the corner to positive net client flows, we are encouraged by our pipeline and optimistic that we will see continued stabilization of AUM as we demonstrate our ability to add value for clients through our stock selection strategies, our risk management approach and consultative services. Moving to our second quarter financial results. We reported revenue of $41.1 million for the quarter, down 3% sequentially with overall revenue margin of 71 basis points. Operating expenses were $34.8 million in the quarter, a decrease of approximately $200,000 compared to the previous quarter, and a $1.8 million decrease compared to the second quarter of 2017. Compensation-related costs decreased by $2.1 million when compared to the previous quarter, and by approximately $550,000 compared to this time last year. Compensation as a percent of revenue was approximately 53% for the quarter. Distribution, servicing and custody expenses decreased by 6% during the quarter, in line with changes in assets and revenues, and represent approximately 24 basis points of average mutual fund and collective trust assets. Other operating expenses were $8.6 million in the quarter, a $2.1 million increase over the previous quarter, with the increase being the result of the $2.1 million expense reduction resulting from sales proceeds recognized in the first quarter. Pretax income for the quarter was $6.7 million and economic net income for the quarter was $4.6 million or $0.06 per adjusted share. With that, I'll summarize our mid-year results. We reported revenue of $83.3 million, down 22% from revenue of $107 million in 2017, and our overall revenue margins were 71 basis points for the year, in line with prior year-to-date. Operating expenses were $69.8 million, a decrease of $5.5 million or 7% from last year. Compensation and other operating expenses have decreased modestly since last year, while distribution expenses have decreased by $5.2 million, in line with the decrease in mutual fund assets. Compensation-related costs of $45.5 million year-to-date represent 55% of revenue. As a result, for 2018 year-to-date, our pretax income was $14.4 million and economic net income was $10.2 million or $0.13 per adjusted share. Before closing, I will address a few other metrics. We reported approximately $78.8 million adjusted shares outstanding as of June 30, which was unchanged for the quarter. And with respect to the balance sheet, we continue to maintain a debt-free capital structure with cash and cash equivalents of approximately $77 million and another $69 million in short-term investments, which includes $5 million invested in seeded products as of June 30. And during the quarter, we declared an $0.08 per share dividend to our Class A shareholders consistent with the prior quarter. That concludes my formal remarks. I will now turn the call back over to the operator. And Chuck and I will be happy to address any questions. Operator?

[Operator:]

[Operator Instructions] Thank you. Our first question is coming from the line of Kenneth Worthington with JPMorgan.

[Kenneth Worthington:]

Hi, good afternoon. Thanks for taking my question. May be first, the greater investment, enhanced IT, you did say that you're going to capitalize most of it so there would be a delay. Help us kind of figure out what's the magnitude of the cost that is likely to flow through the P&L if the investing goes according to plan?

[Paul Battaglia:]

Ken, this is Paul. I don't know that I have a number to give you just yet. I think that -- we're still in the stage of vendor selection, system selection. The reality is that, that will determine a lot of accounting for it. The way that I expected it to work will be, the depreciation won't actually begin in most cases until the system is actually put into service. So projects that we start this year may take anywhere from 12 to 18 months to implement. And when they are implemented, is when the depreciation kicks in. So I don't think you'll see a big impact in the immediate term. So we'll be able to provide you updates in future quarters. I think it's probably later in 2019 that you start to see some of it roll through that other operating expense line in the form of depreciation.

[Kenneth Worthington:]

Okay. And then on the -- of expenses, and I apologize if I missed this, other operating expenses seems elevated this quarter. What drove that?

[Paul Battaglia:]

Yes, no. This is Paul, again. I think that they were depressed last quarter. Last quarter we had a onetime expense reduction related to the sale. The proceeds from the sale of the U.S. funds on the Rainier side, that was about $2.1 million. So if you take that out quarter-over-quarter, they were about flat.

[Kenneth Worthington:]

Got it. Got it. Okay. And then how are you thinking about the balance sheet really with regard -- I guess, with dividend. You guys reduced the dividend payment more than a year ago. The GAAP earnings, the adjusted earnings are coming under, and obviously, you pay on cash not on earnings. But do you feel kind of comfortable with this payout going forward? Or is it something that needs to be revisited at some point?

[Paul Battaglia:]

Yes, this is Paul, again. I mean, I think the reality is that we revisited and considered it against all the strategic initiatives on a quarterly basis, with the senior management team and the Board of Directors, and that will continue to be the case. So we have always historically prioritized distribution of earnings back to shareholders throughout our history, both prior to our IPO and as a public company. But having said that, we've identified some initiatives that we do expect to leverage the balance sheet to be able to complete. And so that will be part of the consideration in future quarters.

[Kenneth Worthington:]

Okay. And then maybe lastly, in the past, you've kind of helped us with a pipeline of outflows or maybe sales. Any color that you can give us on the pipeline here? Thanks.

[Charles Stamey:]

Yes. This is Chuck Stamey here, Ken. We don't comment specifically on pipeline metrics on these calls. That being said, we have seen strong performance across our core products set and our newer products. That resulted in overall higher prospecting activity, which we would hope would flow through with increased AUM and revenues. The timing on that, as you know, is very difficult to predict. But we are encouraged by the trends that we're seeing.

[Paul Battaglia:]

And I would just add to that, I think, as Chuck alluded to in his prepared remarks, that $1 billion threshold for Disciplined Value is a nice milestone that we'll be happy to have. Rainier International's small-cap is heading that direction. We talked about Fi360, and that being kind of in the early stages. So there are some encouraging signs and things that haven't been present on prior calls when you've asked that question. So timing and continued strong performance, I think, are always the 2 wildcards there. But I think, those are the things that we're looking at as we project out into the future.

[Kenneth Worthington:]

Okay, great. Thank you very much.

[Operator:]

[Operator Instructions] And at this time, I'm showing -- we do have a question from John Bank from [SOWP].

[Unidentified Analyst:]

Hello, can you hear me? Hi, thank you. SOW Partners. Just a clarification on the comment on the workforce and the workforce reductions. You said you -- just to clarify, you said you identified sort of 20 positions and an additional 20 more. The $6 million annual savings, does that cover the 20 you identified or the entire 40?

[Paul Battaglia:]

That's right across the 40 individuals, both the early retirements and then the other adjustments.

[Unidentified Analyst:]

Yes. And I understand that the workforce positions were a result of some strategic thinking. But is -- I'm curious as to whether that portion of the thinking is sort of over. Because it sounds to me, especially with the IT rollout, maybe that sort of retrenchment sort of idea is no longer, and that's more sort of a -- you're trying to grow the AUM side, rather than reduce the workforce side. Would that be an accurate assessment?

[Charles Stamey:]

So -- Chuck Stamey here. I'd say we've taken steps that we think are prudent, given our business realities today. As conditions change in the future, we would likely continue to be thoughtful about what we think is the appropriate path. That could be a combination of both expense management, but also spending to increase new sources of revenue and assets. So I think it would be a combination. Does that make sense?

[Unidentified Analyst:]

Yes, no, of course. It does make sense. Let me just pick up in there for 1 second, and just got a detailed question on the -- this IT plan with the vendors and all that. What type of sort of a -- what's the headline number for that final investment decisions, sort of a term sheet. What are we talking about, is it like a $50 million, sort of a system that you're putting in? Or like, what are we talking about in terms of scale?

[Paul Battaglia:]

See, I mean, we're not ready to put a number on it just yet. I think there -- the performance reporting system that we had mentioned during the call is, I think, sort of the headline item for us right now. And we're still working through vendor selection, system selection, working with consultant to help us on the implementation side. So I think the -- as I alluded to earlier in my response to Ken, I think, the takeaway right now is that I don't think you should expect any big P&L activity as a result of those infrastructure spending items during the second half of 2018. It won't roll through the P&L until it's putting this into service, which we think will be a little bit further down the road. So we will be able to, I think, put a better range of outcomes on that in future quarters, and we'll provide updates as we have them.

[Unidentified Analyst:]

I think the nature of the question wasn't exactly what runs through the P&L, but what's the asset? What assets are you putting on your books. But aside from that, the -- back to the workforce thing. The reason I ask is, which way you're leaning, and it sounds like you're leaning for sort of these growth initiatives. And I understand the pipeline that's coming up. But if you sort of go through the employees handling [indiscernible] that graph is sort of going down to the right. So what are we -- in terms of initiatives, it sounds as if you're betting on the same thing. And the workforce reductions are sort of put on the back burner?

[Charles Stamey:]

So I might have a different interpretation of our plan. I think we've got a number of product offerings that are distinct from our legacy core offerings. Additional value-added services, which differentiate those offerings and also get us into some new larger institutional markets. So I would not necessarily say, we're trying to repeat from the same playbook. We are certainly building on our strengths, but also extending into new markets and looking for new opportunities as well. Doing that, but while being mindful of managing expenses in a prudent way.

[Unidentified Analyst:]

Great. Thank you so much. Thank you.

[Operator:]

[Operator Instructions] I'm showing there are no further questions. This does conclude today's conference call. Please disconnect your lines at this time, and have a wonderful day.