Manning & Napier, Inc.
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Good evening. My name is Jacob and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Second Quarter 2017 Earnings Teleconference. Our hosts for today’s call are Richard Yates, Chief Legal Officer; Chuck Stamey, Executive Vice President and Managing Director of Sales and Paul Battaglia, Vice President of Finance. Today’s call is being recorded and will be available for replay beginning at 8

[Richard Yates:]

Thank you, Jacob and thank you everyone for joining us today to discuss Manning & Napier’s second quarter 2017 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, maybe 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 statement. During this call, some comments may include references 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, Executive Vice President and Managing Director of Sales, Chuck Stamey. Chuck?

[Chuck Stamey:]

Thank you, Richard. Good afternoon and thank you all for joining us. For today's call, I'll provide a business update for the second quarter with a focus on our client service and distribution efforts; Paul Battaglia will follow me to provide details on our flows and financials after which we'll open up the call to your questions. The second quarter ended with a continuation of strong, relative and absolute performance across many of our legacy U.S. equity and multi-asset class portfolios, which is incrementally less than the client service burden across our distribution teams. Inflows to our traditional products continue to face headwinds from a challenged three and five-year performance periods as well as the continued trends towards passive investing by our larger institutional clients. We are however encouraged by the track records of the products that we have prioritized for distribution this year, which I'll detail shortly as well as with our advisory and other value-add services, which help deepen client relationships. The focus of our client service message had been on the proven benefits of active management across market cycles. I believe this message has resonated with clients and advisers many of whom remain skeptical of the ability of passive investing to achieve investment objectives in all environments and especially, late in an extended bull market in U.S. stocks. An example of our active management approach is we recently reduced overall equity exposure in our multi-asset class portfolios and trimmed some of our strongest performing technology stocks as their evaluations have become extended. These are the types of proactive risk management decisions our clients expect to see in their portfolios, especially in this later stage of the market cycle. I'll now highlight a number of our different product and service offerings where we are gaining traction. A sizable amount of our inflows this year have been outside of our traditional product set and have been lower fee in nature. We believe these opportunities have the potential to be good long-term relationships where we'll have the chance to provide solutions across multiple market cycles. While these opportunities are still not meaningful enough to offset the outflows, we've experienced in our legacy products, we're encouraged by the activity we've seen in the field. First is our custom portfolios, where we have the ability to manage allocation among our strategies to achieve different investment objectives. By way of example, we recently won a $150 million institutional mandate with the custom allocation between our multi-asset class and managed ETF strategies and we have additional prospect activity underway with similar opportunities. We're encouraged by the traction we're gaining with some of the key strategies that we've mentioned in previous calls, specifically we've seen over $350 million in inflows in strategies such as the real estate series, discipline value, our international series, global quality equity, strategic income, our ETF allocation strategies and fixed income products. Also during the second quarter, we announced the addition of our discipline value collective trust. This strategy is already available in separate account in mutual fund form and we've seen evidence in the field that the collective trust product present opportunities for us especially in the 401(k) marketplaces. Accordingly, we believe this 25-basis point, zero revenue share vehicle will allow us to be more competitive in that space. Additionally, we've seen increased institutional and consultant interest in the Rainier International Discovery fund, which continues to be rated four stars by MorningStar and through June 30, has outperformed its benchmark by 450 basis points in 2017 and by 360 and 500 basis points excuse me, 360 and 510 basis points for the three and five-year periods respectively on an annualized basis. Also, we are in the midst of an effort to restructure our fees across our mutual fund product set. This effort has three components/ First, we're introducing zero revenue share fee classes for all of our mutual funds to enhance distribution in the various segments of the defined contribution marketplace. Second, we're reducing fees on many of our offerings to further enhance our ability to compete and third, with respect to our target date products, we are equalizing our net fees across all share classes. We recognize that our overall revenue margins and the expense ratios for our fund offerings have generally been at the high end of their respective peer groups and given the overall pressure on fees that all active managers are facing, we believe that bringing our fund fees to a more competitive level will enhance our ability to gather assets in the future. I'll conclude my comments by reiterating our belief in the importance of continuing to invest in both our products and our people to achieve success for our clients and to that end, we've prioritized maintaining the resources allocated to our sales and research team and continuing to invest in support services for our clients. In addition to the focus on the lower fee products and the fund fee restructuring I just detailed, we continue to review pricing across our product set to ensure we're competitive, including our existing separate account relationships. We believe that these decisions will ultimately benefit our clients and shareholders alike. And with that, I'll turn the call over to Paul and we look forward to your questions, Paul?

[Paul Battaglia:]

Thanks Chuck. Good afternoon and thank you for joining us. I'll provide an update on our second quarter results before opening the call up to your question. Starting with assets under management and net client cash flows, AUM decreased from $31.6 billion as of March 31, to $27.1 billion at the end of the second quarter. This 14% decrease was the result of $5.6 billion in net client outflows being partially offset by $1.1 million of market appreciation. When compared to June 30, 2016, AUM decreased by $8.6 billion or 24%. As of June 30, our blended asset strategies made up 61% of our assets or $16.6 billion, our various U.S. non-U.S. equity strategies represent 34% of our total assets and the remaining 5% were invested in our fixed income products. On our last call, we discussed that we had been provided notice of approximately $4 billion to $4.5 billion of institutional outflows that we expected the transition away during the second and third quarters of 2017. We can now update this estimate to be approximately $4.3 billion of institutional redemption of which $3.6 billion were completed during the second quarter and another $700 million are expected during the third quarter. Our trailing 12-month separate account retention rate currently stands at 81%, though that rate may decrease in conjunction with the upcoming outflows. Additionally, during the third quarter, we expect to complete the pending sale of the U.S. -- of the Rainier U.S. product set to Hennessy Advisors Rainier US products currently represent approximately $500 million of AUM that will transition away as part of the transaction. This portion of the business is not material to our overall P&L and there are no notable one-time cost associated with the transaction. Moving to our second quarter financial results, we reported revenue of $51.5 million for the quarter down 7% from revenue of $55.5 million reported last quarter. Our overall revenue margins were 72 basis points in the quarter in line with 71 basis points in Q1 while on revenue I'll take a brief moment to touch on our expectations regarding the fund theory structure Chuck mentioned earlier. The project to restructure our fund fees is underway now; however, a majority of the revenue impact will not be felt until the first half of 2018. The impact on our overall revenue margins will vary depending on the business mix at the time of the fee change. However, we are targeting fee reductions of up to 17 basis points for some of the funds in our complex with the most aggressive reductions coming in the retirement target fund and collectives. These reductions will be partially offset by reductions in distribution and servicing expenses. We'll provide updates on the anticipated economic impact of these changes as we get closer to implementation. Turning to expenses, operating expenses were $36.6 million in the quarter, a decrease of $2.2 million sequentially and a $5 million decrease compared to the second quarter of 2016. More than half of the sequential decrease and 43% of the decrease from this time last year is the result of decreases in compensation and related costs. Compensation and related cost represent 43% of revenue and looking ahead we expect that our compensation ratio will remain in the 40% range given the expected pressure on AUM and revenue. Our overall headcount as of June 30 is 444 employees, a decrease of just over 5% since the beginning of the year. Distribution, servicing and custody expenses decreased by $300,000 during the quarter, but now represent 28 basis points of fund and collective average assets compared to 23 basis points we reported in previous quarters. The increase in the average fee is resulting from the fact that we did not pay distribution expenses on many of the institutional relationships that transitioned out during the second quarter. Other operating expenses were $7.2 million in the quarter, down from $8 million last quarter and $8.2 million this time last year. As a result, we reported pretax income for the quarter of $15.8 million an 11% decrease since last quarter. Economic net income for the quarter was $9.7 million or $0.12 per adjusted share. With that, I'll summarize our year-to-date results. We reported revenue of $107 million through June 30 down 15% from revenue of $126.5 million reported this time last year and our overall revenue margins of 71 basis points are in line with last year. Our pretax income year-to-date was $33.7 million and economic net income was $20.6 million or $0.26 per adjusted share. Turning to equity ownership, the adjusted share count as of June 30, was 79.1 million adjusted shares, generally unchanged from last quarter and the management team including Bill Manning currently owns approximately 80% of the company. With respect to the balance sheet, we continue to maintain a debt-free capital structure with cash and cash equivalents of $93 million and investments of $5 million including $17.3 million invested in seeded products as of June 30. And finally, as you're aware, during the quarter we declared an $0.08 per share dividend to our Class A shareholders consistent with the previous quarter. That concludes my formal remarks. I'll now turn the call back over to the operator and we look forward to your question. Operator?

[Operator:]

[Operator instructions] Your first question comes from the line of Ari Ghosh with Credit Suisse.

[Ari Ghosh:]

Hey, good evening, guys. So quick question over here. So, I am just looking at the overall credit for the last few years, AUM is down around 35%, outflows continue at a pretty elevated level and I understand that you're going to take a while for good performance to kind of filter into long-term performance numbers, but I am just curious in the meantime what are some of the strategic options that you're considering or strategic pivots to preserve the earnings power over here?

[Chuck Stamey:]

Right, thank you for the question. This is Chuck Stamey. I'll take a shot at that. I think you're right. We have seen a reasonable decline, a significant decline in AUM primarily focused in some of the asset class products that were particularly popular, non-US equity in particular, our U.S. core equity as well. Our approach is to broaden the offerings and focus more of the marketing and new business efforts on some of the products that are actually more competitive and have some of the trends or some of the elements that we think are important in the marketplace such as lower fees, for example discipline value, global quality are equity strategies that we think are well positioned for the current marketplace. So that's the focus. The challenge has been frankly the inflows that we've seen in those products have not been large enough to offset the outflows in those -- the challenged products that I mentioned. So, in short, we're attempting to diversify our distribution strategies to help lessen the net impact of the outflows.

[Paul Battaglia:]

And this is Paul, Ari. I would add to that from an expense management perspective, I think you can see in some of the numbers, we're trying to manage the business prudently. The other operating expenses are down on a run rate basis and also the comp ratio is up. We've seen a decrease in headcount mainly through attrition and in some of the dollars related to compensation have gone down. But as Chuck mentioned earlier we think we've got a good team in place. We've really wanted to protect the research team and the sales team. The decrease in headcount is outside of those areas and we want to keep the team intact with the idea that the team is going to help support the growth that you're wanting to see when performance turns around and we can get selling again.

[Ari Ghosh:]

Appreciate the color there, thanks guys. And then just really quick on the target date fee reductions, are these cuts only on the mutual fund assets or will it impact pretty much the entire $20 billion excluding the CIT the SMA assets. And then if I am just looking at the new expense bands, it still sort of look in line with the peer median. So how are you considering and thinking about the cups that you made versus your current performance versus what the peer groups looks like from a fee and performance standpoint?

[Chuck Stamey:]

Right, so Chuck Stamey again. I'll take a shot at some of these questions. So, this reflects the mutual funds, not the separate accounts and there's some additional supplemental material that I think you're referencing here. When we're looking at the peer groups, we're looking to see really where are the competitive active managers within the space. We think these reductions get us where we need to be because that being said, there is an overall trend towards lower fee I think in the ninth year of a bull market, we know directly fees are modestly coming down across the industry. We think this will put us in a competitive place and frankly as we look at short-term performance in our funds, we're seeing strong results there. So, we think this puts us in the right spot, but like any prudent business we will continue to monitor that and trends within the industry going forward.

[Paul Battaglia:]

And Ari, just to clarify, there are some reduction in the collective as well. It's not exclusive to 40X funds. So, I think we reported 9.4 of total funding collective assets. As I said, there's a range of reductions does not uniform across the complex, but that's the number that the reduced revenue rate will be based off of.

[Ari Ghosh:]

Got it. Appreciate the color.

[Operator:]

[Operator instructions] And your last question comes the line of Ken Worthington with JPMorgan.

[Will Cuddy:]

Good evening. This is Will Cuddy filling for Ken. Phil on Rainier, you had mentioned that investment of a couple of equity funds. Can you talk about -- more about your thinking there and can you also talk about other opportunities for similar approaches to other parts of your business?

[Chuck Stamey:]

Right, Chuck here. So, as you know, the primary focus for us now is the distribution of the international small-cap product, which is being ported over to the Manning & Napier fund complex. We're excited about the institutional acceptance that that transition is getting and we're pleased with the number of RFPs and due diligence discussions underway there. So, we're excited about that. We will continue to explore other strategic opportunities like that going forward as they make sense for us to evaluate. Did that answer your question?

[Will Cuddy:]

Yeah it does. Thank you. And I may have missed this, but on the run rate for other operating expenses, what should we look for, for that and how much more flexibility do you have there?

[Paul Battaglia:]

Yeah this is Paul. I think where you've seen us for the last several quarters has been moving from the $8 million $8.5 million dollar range down to the year I think $7 million to $8 million range. I would say that's where we feel comfortable operating right now. We still want to make investments in the business and we still need to support the existing AUM and account set. So, I think that's a reasonable run rate for us to -- for you to benchmark from this point forward.

[Will Cuddy:]

Okay. Thank you. That's helpful.

[Operator:]

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