Manning & Napier, Inc.
Q3 2018 Earnings Call Transcript

Published: 31 Oct 2018

[Operator:]

Good afternoon. My name is Brandon, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Manning & Napier Third Quarter 2018 Earnings Teleconference. Our hosts for today’s call are Nicole Kingsley Brunner, Chief Marketing Officer; Jeff Coons, Co-CEO and President; 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, Brandon, and thank you, everyone, for joining us today to discuss Manning & Napier’s Third 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 measures. Full GAAP reconciliations can be found in our earnings release and related SEC filings. With that, allow me to introduce our co-CEO and President Jeff Coons, Jeff?

[Jeff Coons:]

Thank you, Nicole. Good afternoon, and thank you for joining us. Looking back on the past quarter, we believe we’ve entered a higher risk regime for financial assets that will persist over the next 12 months. While we’re not calling for an imminent recession, the U.S. economy continues to show signs of progressing further into late cycle territory, and we will continue to follow our disciplines choosing to be selective in our investment decisions while avoiding overvalued areas of the market. Given our updated outlook, we’ve adjusted our positioning across many of our portfolios, and we believe that a neutral and underweight risk allocation is warranted in multi-asset class accounts. Within equities, we are favoring a bias to higher quality businesses and reasonably priced growth oriented companies. Considering where we are in the economic and market cycles, our investment disciplines have enabled us to deliver competitive returns across much of our product set. Notable items include, in our multi-asset class account, we gave back some of the outperformance we achieved in the first half of the year during the third quarter. However, our year-to-date 1 and 3-year performance still remains competitive to blended benchmarks and within our expectations considering our reduced equity allocations. Longer term performance in our equity series is trending higher as well. Regarding our specialty products, our disciplined value strategy again outperformed this large cap value benchmark ahead by over 200 basis points for the quarter. The disciplined value fund is in the top fifth percentile for its rolling 1, 3 and 5-year rankings versus peers and it recently crossed the $1 billion threshold for assets under management across all investment vehicles. Our high-yield bond series and newly renamed income series, formerly, the strategic income conservative series, each posted strong quarters and both are building compelling track records. Our high-yield bond fund was recently upgraded to 5 stars by Morningstar. Earlier this month, we held a high-yield webinar that saw a significant engagement from advisors and individual investors. As the interest rate environment continues to shift higher, we expect investors to turn to fixed income as an increasingly attractive alternative to equities. Further, as of the end of the third quarter, our Rainier International Discovery strategy outperformed its benchmarks by over 500 basis points year-to-date and is nearing $1 billion assets under management threshold. Our real estate series continues to stand out with strong 1, 3, and 5-year results as well. Lastly on performance, as we reflect on the 10-year anniversary of the global financial crisis, we are reminded of how risk management matters most when times are tough. Since the crisis, we have been in one of the longest bull markets in history, a period that has witnessed unabating passive inflows and the steady outperformance of growth stocks. All track records that are 10 years or less now exist entirely within this environment with markets having not experienced a significantly challenging period for over a decade. We feel that many of our traditional strategies have not had a recent opportunity to demonstrate the importance of the active risk management. Despite the performance challenges and continued outflows facing our traditional products, several of our specialty strategies are generating significant market interest and are contributing positive inflows to the firm. We are hopeful that several of our key distribution initiatives will increasingly gain traction in the coming years. As an example, we are seeing interest from platform providers in several of our products and are encouraged by the momentum we are building. In total, we have seen an improvement in net flows throughout 2018 and are encouraged by the early signs of stabilization. We continue to promote our custom solutions which we believe further enhance the value we deliver to clients. By incorporating a number of different proprietary and non-proprietary products from multiple research engines, we are able to provide a differentiated and complete investment solution to our clients. To-date, we have approximately $500 million of assets under management utilizing our custom solutions offering including both new business as well as enhancements made to existing relationships. This holistic approach extends into our advisory services as well including our family wealth management and endowments and foundations, and pension plans service offerings. We remain focused on building out an infrastructure that can support our unique sales structure as we seek to provide broad solutions for meeting our clients’ ever changing needs. An example of how our custom solution and consultative services have allowed us to expand and deepen relationships is a mid-sized healthcare pension plan utilizing multiple investment managers including Manning & Napier. The client was looking to have one consolidated approach with multiple strategies and exposures that actively adjust to changes in the market environment. This structure was intended to help the client more closely aligned their investment program with the liabilities of the plan, simplify their ongoing withdrawal process and consolidate reporting for the total plan. As a result of our offering, we earned the client’s trust to manage the entire $15 million portfolio with allocations across several proprietary and non-proprietary ETF-based investment strategies. Our digital marketing efforts are also gaining traction as clients and prospects alike engage with our thought leadership through web, email and more. Today, the average person spends 60 hours a week consuming digital content. Customers across all channels in the industry are changing their buying behaviors by first researching products and services digitally with 57% of the buying decision complete prior to engaging sales people. We continue to make progress on other initiatives focused on enhancing distribution. During the third quarter, we’ve released our semi-annual outlook, a forward-looking guide into how we are thinking about risks and opportunities in financial markets. We have also been developing our next issues of Prosper and Foundations magazines as we look to create engaging an educational content that deepens client relationships and attracts prospective clients. At the same time, we continue to foster client relationships through our traditional approaches including our annual client seminar series. Before turning the call over to Paul Battaglia, our Chief Financial Officer, I would like to provide an update on the progress we have made with our business review. Our third quarter results reflects some of the initiatives we identified on our last call, including completion of the early retirement offering and other workforce adjustments, along with progress on enhancing our informational technology infrastructure. Likewise, we have taken steps in the fourth quarter to retain our key contributors with long-term incentives in the form of both restricted stock units and deferred cash compensation invested in our mutual funds. We will continue to highlight to clients our ongoing efforts to ensure the stability of our investment teams and research processes. Nevertheless, we recognize that our shareholders are disappointed with our results in terms of flows and financial results over the past few years. Amid a difficult industry environment, unresolved questions regarding corporate governance have further challenged our business and been an impediment to our sales strategy. As we await a resolution on a permanent CEO search, our investors should know that everyone at the firm is working hard to help us emerge from one of the most difficult periods in our history and that we remain committed to adding shareholder value through improved cash flows, a strong balance sheet, and a deepened investment in the infrastructure of the firm. With that, I will turn the call over to Paul. Paul?

[Paul Battaglia:]

Thanks, Jeff, and thanks to everyone on the call for joining us today. I would like to begin by adding color to Jeff remarks and touching on some other notable items in the quarter before reviewing the financials. First, regarding our 2018 business plan review. As you will see from our earnings release, our employee count has decreased from 410 employees at June 30th to 377 as of September 30th. This reduction is largely attributable to the planned departures stemming from our early retirement offering and targeted workforce reductions that we introduced during our last call. We expect additional workforce reductions during the fourth quarter as our early retirees continue to transition their responsibilities. Our third quarter results include approximately $2.4 million in onetime severance costs related to workforce reductions. However, please keep in mind that based on the actions we’ve taken to-date, we’ve achieved approximately $6 million in fixed compensation savings on a run rate basis, compared to where we were prior to our business plan review. And we should see that impact begin to take effect in 2019. Another initiative that we reported on in recent calls has been the ongoing restructuring of our mutual fund complex with a goal to remain competitive with our peer group, retain existing clients and enhance distribution opportunities. During the third quarter specifically, we completed the merger of the World Opportunities Fund into the lower fee overseas series and our final stages of restructuring are planned for 2019. Finally, last Thursday, we announced a reduction in our quarterly dividend to Class A shareholders to $0.02 per share. Returning capital to investors in the form of dividends has been a priority throughout our history but it’s equally important to us that we earn the dividend and preserve the strength of our balance sheet. As a result, the Board of Directors reduced the dividend to a sustainable level, while we make the necessary investments in our business to achieve the priorities Jeff outlined earlier. The Board of Directors will continue to review the dividend in light of our overall business results in future quarters. Now, turning to the third quarter results and starting with assets under management. Assets increased from $22.8 billion as of June 30 to $23.1 billion on September 30th. The 1% increase was the result of market appreciation of approximately $480 million, partially offset by $245 million of net client outflows. When compared to September 30, 2017, AUM is decreased by $3.5 billion or 13%. Our separate account retention rate for the 12 months ended September 30th, improved to 85% compared to being in the 70% to 80% range for the last several quarters. Looking ahead, we expect that many of the AUM and client flow dynamics we’ve seen throughout 2018 will remain for the first part of 2019, especially in the current market environment. Namely, we expect the products like Disciplined Value, our managed ETF portfolios and International Discovery will continue to have the strongest sales pipelines and be a source of AUM growth. And while the 1 and 3-year track records for our core equity strategies have improved, headwinds persist on our blended portfolio strategies, including our target date funds. For many of our blended portfolio clients, our ability to add consultative services has helped to retain these relationships. Using these strategies to retain existing business and attract new clients will remain a priority in 2019. Moving to our third quarter financial results. We reported revenue of $40.5 million for the quarter, down 1% from revenue of $41.1 million reported last quarter with overall revenue margins of 70 basis points. Operating expenses were $36 million in the quarter, an increase of $1.2 million compared to the previous quarter. This increase is entirely attributable to the onetime cost stemming from the business review. Compensation as a percentage of revenue was 57% for the quarter but 51% when excluding the servants’ costs. Distribution, servicing and custody expenses, and other operating expenses were both in line with last quarter. Pretax earnings for the quarter were $5.3 million and economic net income was $3.7 million or $0.05 per adjusted share. With that I’ll summarize our results for the nine-months ended September 30th. We reported revenue of $123.9 million, down 21% from revenue of $156 million in 2017, and our overall revenue margins were 71 basis points for the year, in line with last year. Operating expenses were approximately $106 million, a decrease of $6.6 million or 6% from last year. Compensation and other operating expenses were in line compared to this time last year, while distribution expenses have decreased by $7.6 million, given mutual fund and collective trust asset reductions. As a result, our pretax income for the nine months ended September 30th was approximately $19.7 million and economic net income was $14 million or $0.18 per adjusted share. Turning to equity ownership, the adjusted share count remains at approximately 79 million adjusted shares outstanding as of September 30th. I’d like to conclude by mentioning that our third quarter P&L results are generally in line with what we expected when we made the commitment to pursue the initiatives we identified in our business plan review. We understood the short-term pressures on margin was likely, given the restructuring costs necessary to position us for future growth. The strength of our balance sheet with approximately $140 million in cash and other short-term investments, provides us with financial flexibility and resources necessary to execute on our strategy and position us for long-term success. Thank you for listening to the call and for your interest in Manning & Napier. And I’ll now turn the call back over to the operator. Brandon?

[Operator:]

[Operator Instructions] And your first question comes from Ken Worthington from JP Morgan.

[Ken Worthington:]

Hi. Good afternoon. I guess maybe start with expenses, on compensation. So, as we think about 2019 and beyond, is the best way to think about it in terms of you just taking $6 million out of, I think you said the 2017 run-rate? So first, maybe, correct me if I’m wrong there. And then, can we think about it really managing -- are you managing the compensation to a ratio? You mentioned 51%. Is that something that you think you can hold on to, based on your outlook for the business, over the next one to two years?

[Paul Battaglia:]

Hi, Ken. This is Paul. And let me start by I think addressing the first part of your question. The $6 million run rate is savings that we achieved compared to where we were prior to starting the plan. So, I think if you look at the Q2 number, which was for the period ended June 30th, prior to these adjustments, and you made the adjustment your model from that, that’s a place to start. As you know, there are still variable components to our compensation in the form of sales commissions and the research bonus. And those will play out depending on how sales and performance looks as we head into 2019. So, there’s not a specific metric that we are managing towards at this point. I think, the rate that we have right now in that 50% range and hopefully the low 50% range is probably a reasonable place to think about as we head into 2019. But, a lot of it will depend on obviously what happens with revenue and what happens with AUM and sales, and then that impact on variable expenses as well.

[Ken Worthington:]

Okay. And then, you mentioned the retention packet, my interpretation, retention package for your key people. Is that included in your $6 million number or is that addictive and is it even relevant? I don’t how bigger or not big it might be.

[Paul Battaglia:]

Right, yes. So, let me try to size it for you. And we’re still rolling it out. The awards won’t be officially granted until later on in November. But basically, based on today’s stock price, we’re talking about a $5 million pool approximately that we’ll vest over three years. So, you will spread that out starting in the fourth quarter, it’s not part of the $6 million number that I quoted. And so, that will offset that to a certain extent, starting in the fourth quarter of 2018.

[Ken Worthington:]

And then, on operating costs. You mentioned that the cost of the review is in there. How much is that? And I assume that that drops out in 1Q ‘19 or by 1Q ‘19.

[Paul Battaglia:]

Well, yes. So, I mean, I think in terms of what we know right now, the third quarter included $2.4 million of severance costs as well as some spending on the IT side, some of which is running through the P&L and the other operating expenses, and the rest of which is on the balance sheet. And it will remain on the balance sheet until those systems get put in the place, which could be later on next year or even the first part of 2020. So, I think that is really what’s going through there right now. What was the second part of your question?

[Ken Worthington:]

I guess I’m trying to get at is, you had $8.4 million of other operating costs, there were some extra costs in there. What are the other -- you mentioned 2.4 but a bunch of that is comp…

[Paul Battaglia:]

Sorry. In terms of what’s in other operating expenses, I’d say there’s probably about $900,000 that’s running through there in the third quarter that is specific to some of the consulting services and some of the depreciable costs related to the IT restructure that we’ve been able to recognize this quarter. There is a larger spending on IT that is still yet to take place. And how that will -- how a lot of that will look is it will first reside on the balance sheet as it increase in software -- primarily software. And then as those services and those softwares get put into -- become implemented into our system, we’ll begin to take depreciation on those over the life of those systems but those won’t take effect until later on in 2019 or early 2020.

[Ken Worthington:]

Okay. And then last one. On the specialty products, you mentioned generating positive sales. So, I think you mentioned it a couple of times. I don’t think you actually referred to the any specialty products. Can you give us some examples of them?

[Jeff Coons:]

Yes. So, this is Jeff. I can. The two products that are a focus for us, Disciplined Value, and that’s grown pretty well across the various SMA and fund formed over $1 billion. Rainier international small cap is another that we’ve seen good inflows. Those are probably the two strongest. Although some of the other specialties we’re seeing positive flows as well.

[Paul Battaglia:]

The managed ETF portfolios is one that we’ve talked about on the other calls. And I think last time we talked about a relationship with Fi360 we established. And we’re still early days on that. But that’s another one that is differentiated compared to our traditional products. So, an active management spend to it, but something that we think can play well in the market as a complement to some of the other things we already have.

[Ken Worthington:]

Okay, great. Thank you very much.

[Operator:]

And there are no more questions in queue.

[Paul Battaglia:]

Thank you.

[Jeff Coons:]

Thank you again for your time.

[Operator:]

This does conclude today’s conference call. You may now disconnect.