Manning & Napier, Inc.
Q4 2017 Earnings Call Transcript

Published: 8 Feb 2018

[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 Fourth Quarter and Full Year 2017 Earnings Conference Call. Our host for today's call are Nicole Brunner, Director of Marketing Strategy; 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 p.m. Eastern Time tonight. The dial-in number is 404-537-3406 and enter pin number 4490479. [Operator Instructions]. It is now my pleasure to turn the floor over to Ms. Nicole Brunner.

[Nicole Brunner:]

Thank you, Philip, and thank you, everyone, for joining us today to discuss Manning & Napier's Fourth Quarter and Full Year 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 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 Executive Vice President and Managing Director of Sales, Chuck Stamey. Chuck?

[Charles Stamey:]

Thank you, Nicole. Welcome, and thank you all for joining us. I will start off with a review of our business in 2017 and a look at our priorities in 2018 before turning the call over to Paul for details on our flows and financials. 2017 was highlighted by record returns, both domestically and abroad, across several of the major indexes. Though economic growth stayed modest, investor expectations have remained high in what is already one of the longest bull markets on record. As a manager that's known for our risk management and downside protection capabilities, we are pleased that Manning & Napier was able to deliver competitive absolute and relative returns across much of our products set in this environment. A few highlights. Our Pro-Blend Maximum fund, the most aggressive of our Life Cycle funds, returned 24.2% in 2017 compared to 19.5% for the blended benchmark, and ranked third in its MorningStar category. Similarly, our Pro-Blend Extended Moderate and Conservative funds, all outperformed their blended benchmarks for the year. This performance is meaningful because these funds, along with their separate account counterparts, comprised the majority of our balanced firm's portfolio of assets, which makes up 62% of our firm-wide AUM as of December 31. Our Disciplined Value Fund, which was a distribution priority in 2017 due to its low-fee structure and quantitative approach, returned 23.1% for the year and outperformed the Russel 1000 benchmark by approximately 950 basis points. It also ranked third in its MorningStar category. The Rainier International Discovery Fund returned 42% for the year, outperforming its benchmark by over 1000 basis points. The fund is rated five stars by MorningStar and ranks in the top decile of its peer group for the trailing one and five year periods and since inception. The Real Estate Series gained 8.7% in 2017, 500 basis points better than it's U.S. REIT benchmark. The fund also carries a five-star rating from MorningStar, and ranked in the top quintile of its peer group for the trailing one, three and five year periods. Our Equity Series, which still faces longer-term performance challenges stemming from the 2014, 2015 results, rebounded strongly in 2017 with returns of 28.8%, beating the S&P 500 by 700 basis points. Other products that were key priorities for our distribution team, including high-yield bonds and our Strategic Income products, all delivered competitive returns in 2017 as well. We're pleased with our investment results for 2017 and the improvement had started to take place on many of our three-year track records that have been under pressure since 2015. Last year's performance, along with our client-service approach and value-added services, contributed to our ability to raise nearly $4 billion in gross client inflows during 2017. We are optimistic that our current pipeline and new distribution opportunities will drive client inflows going forward as the relative performance headwinds abate. Throughout 2017, we saw continued challenges that are broadly impacting our industry, including fee compression, passive investing trends, regulations like MiFID II and the increasing influence of intermediaries and consultants. In response to these challenges, we prioritized several initiatives that will help us remain close to our clients and attract new ones. First, we reduced fees on several products including fixed income and our Disciplined Value separate account strategies and on the Rainier International Discovery Fund. We restructured the fees on our Target Date mutual funds, including the creation of a zero revenue share class. In June, we launched 25 basis point, zero revenue share fee collective -- excuse me, collective trust version of our Disciplined Value product. We also expanded availability of our strategies to our adviser partners by offering several of our strategies in model form to third-party platforms. In addition, 2017 was notable for the traction we gained in our customized solutions. Our consultative advisory service that allows us to tailor an investment portfolio among proprietary and nonproprietary investments like ETFs to meet a client-specific investment objectives. In fact, our largest separate account close in 2017, $150 million mandate was won because of this service. And we've also enhanced our relationships with several other clients by providing this solution as well. Another example of how we're modernizing our distribution strategy is through digital marketing. Simply put, the way we're connecting with our clients and prospects is changing. We have a dedicated effort in place to create engaging content that positions us as a thought leader. This content strategy focuses on educating investors rather than simply pushing products, and mirrors the consultative nature of our firm. Our digital strategy focuses on disseminating content in various ways, including through our website and social media. We are able to connect to new prospects and stay close to existing clients through targeted content, including promoting product services and covering topics that are most relevant to them. A recent example of this in action is our newly launched financial planning magazine, Prosper, targeted at high-net-worth individuals. This resource was created and promoted in both print and digital mediums and has been valuable in servicing and uncovering new assets with existing clients as well as attracting new prospects. Our commitment to these initiatives, combined with client outflows that have generally resulted from prior year performance challenges, have reduced our operating margins in recent periods. We will continue to operate our business prudently and responsibly, which includes both rationalizing current products and services along with maintaining the resources necessary to support our existing clients and invest for the future through these new initiatives. Looking ahead to 2018, we remain focused on the priorities we've been working on to both drive new business and keep us close to our existing clients. First and most importantly, our investment team is focused on the execution of our strategies and disciplines. Continued strong performance, combined with putting historical period of underperformance further behind us, will be a critical component of our improved client flows in the future. Second, we will remain focused on increasing our distribution efforts and growing our sales pipeline. Our distribution teams are maintaining good-meeting activity on a variety of strategies with strong short-term as well as improving long-term performance track records. The direct regional sales team, which sells to mid-market institutions, endowments, foundations, not-for-profits and high-net-worth individuals, has been the most prominent contributor to cash flows recently, and we expect meaningful contributions from them in 2018. While we did see outflows from defined contributions in 2017, we are committed to this market. We have had success engaging with D.C. clients through our participative education services and digital content, and believe there is an opportunity for us to regain traction with competitively priced mutual funds and our collectives, including the Disciplined Value CIT. Additionally, we're actively building on the success experience with our digital marketing strategy in 2017 as a way to complement our traditional distribution strategies. In fact, we've been actively communicating the impacts of the recently enacted tax reforms to our clients through online content, which has facilitated financial planning conversations and uncovered additional assets. The products with the most competitive track records, including International Discovery, Disciplined Value and high-yield bond, are areas of focus of our distribution teams in 2018. We also expect to see interest in our actively managed, ETF-based strategies continue to increase. Having said that, we believe in our core balance strategies as solid investment solutions for our clients in this environment, and these strategies continue to represent the majority of our AUM and client inflows. We expect that our consultative services, including our customized solutions, will be a major point of emphasis for us both as a new business driver and as a means of retaining and enhancing existing client relationships. Along these lines, we are evaluating new ideas to dedicate seed capital too, both in terms of new products and enhanced service capabilities, and expect to make further investments in 2018. We have a strong tradition of innovation that we look to build on through development of products and services that can help our clients achieve their financial goals and be a source of future revenue growth. In closing, the foundation of our business is a strong relationships we have with our clients, which we are able to achieve through our talented team of professionals and by understanding their investment needs. While the markets have been on an unprecedented run, our clients also look to us to provide risk management and downside protective -- protection through our active approach. We remain focused on ensuring that our products, our services and our people are well-positioned to support our clients in both the current environment and over the long term. And with that, I'll now turn the call over to Paul Battaglia for a review of the financials. Paul?

[Paul Battaglia:]

Thanks, Chuck. Good evening and thank you for joining us today. I'll provide an update on our fourth quarter results before opening the call up to your questions. Earlier today, we reported pretax earnings of $21.6 million for the fourth quarter or $0.04 per adjusted share. I'd like to point out a few notable items in the quarter before we run through the financials. First, our operating results include the impacts from the sale of two of the three Rainier U.S. fund to Hennessy Advisors. In the fourth quarter, we recognized $1 million in proceeds from the sale of the large- and mid-cap fund that closed in December, which we've included as a reduction of other operating expenses. We will recognize additional proceeds related to the sale of the SMID-cap fund in the first quarter of 2018. The fourth quarter also includes onetime compensation charges of approximately $800,000 related to restructure in Rainier team. Additionally, the enactment of the Tax Cuts and Jobs Act into law in December impacted both our pretax income and our income tax expense during the quarter. The reduction in the federal tax rate led to a $16.5 million income tax charge in the quarter due to the decrease of our net deferred tax assets as of December 31. This onetime noncash charge resulted in an increase to our effective tax rate used to calculate economic net income, which came in at 85% for the quarter and 54% for the year ended December 31. This change to our deferred tax assets caused the corresponding decrease in the expected future payments due under the terms of our tax receivable agreement. As a result, we recognized $12.9 million of nonoperating income in the quarter, which again is a noncash and nonrecurring item in our reporting. To summarize, the new tax rule has resulted in a onetime increase in our tax provision, it was almost entirely offset by an increase in nonoperating income. On a go-forward basis, we are currently estimating a reduction in the effective tax rate used to determine economic net income to approximately 27%, and we'll provide updates in future quarters. Now turning to assets under management and net client cash flows. AUM decreased from $26.5 billion as of September 30 to $25.1 billion as of December 31. This 5% decrease was the result of $2 billion in net client outflows and $122 million of mutual fund asset disposed to be a transaction during the quarter. Market appreciation during the quarter was approximately $700 million. When compared to December 31, 2016, AUM has decreased by $6.6 billion or 21%. Our separate account retention rate in 2017 was 80%. Looking ahead, as I mentioned earlier, during January, we completed the sales of the Rainier's SMID-cap fund, which represented $250 million of our AUM on December 31. Additionally, we expect that the client flow trends we have seen in recent quarters will continue in the near term, with outflows from our traditional products set, especially AUM distributed through third-party intermediaries, to be partially offset by sales and strategies with the most appealing track records and continued traction of our custom offerings. Moving to our fourth quarter financial results. We reported revenue of $45.7 million for the quarter, down 6% from revenue of $48.8 million reported last quarter. And our overall revenue margins were 70 basis points, generally in line with last quarter. Operating expenses were $37.3 million in the quarter, an increase of $250,000 sequentially and consistent with the fourth quarter of 2016. The sequential increase is concentrated exclusively in compensation and related costs, which increased by 7% or $1.5 million in the quarter. The increase includes both the onetime restructuring cost, I mentioned previously, along with incentive compensation for the investment team, a strong absolute and relative performance and the roll-off of negative performance from both the one and three-year performance numbers led to the increase. Compensation and related costs, as a percentage of revenue, increased to 52% for the quarter. Distribution, servicing and custody expenses decreased by 8% during the quarter, in line with changes in assets and revenues, and represent approximately 29 basis points of average mutual fund and collective trust assets. Other operating expenses were $7.2 million in the quarter, a $700,000 reduction from the third quarter, with the reduction resulting from the recognition of the Rainier sales proceeds. On an ongoing basis, when excluding the sales proceeds, other operating expenses of approximately $7.5 million would be in line with prior periods. And if you're accounting for the tax-related charges, I mentioned earlier, we finished the quarter with pretax income of $21.6 million and economic net income of $0.04 per adjusted share. With that, I'll summarize our full year results. We finished the year with revenue of $202 million, down 19% from 2016. And our overall revenue margins were 71 basis points for the year, generally in line with last year. Operating expenses were $150 million, a decrease of $10 million or 6% from 2016, as decreases of 19% and 17% in distribution expenses in other operating costs were offset by a 4% increase in compensation. Compensation-related costs of $92 million for the year represented approximately 46% of revenue. As a result, our 2017 pretax income was $67.9 million or a 25% decrease from 2016, and economic net income was $31.4 million or $0.40 per adjusted share. Turning to equity ownership. The adjusted share count decreased from 81 million shares outstanding at the end of 2016 to 79 million shares outstanding as of December 31. As a reminder, the Class B common stock held by Bill Manning expired in November. This was not a dilutive event to shareholders as the shares represented voting rights only and did not have any economic rights. The management team, including Bill Manning, continues to own approximately 80% of the company. With respect to the balance sheet. We continue to maintain a debt-free capital structure with $78 million of cash and another $70 million of investments, including nearly $7 million invested in seeded products as of December 31. And during the quarter, we declared an $0.08 per share dividend to our Class A shareholders, consistent with the previous quarter. Before concluding my formal remarks, I will address the few items to consider for 2018. First, we will be adopting the new revenue recognition standard, ASC 606, on a prospective basis effective January 1. At this time, we do not anticipate the adoption of the standard will have a material impact on our earnings, but the impacts on our revenue margin -- it will impact our revenue margin and other revenue base ratios, given the anticipated changes to both revenue and distribution expenses. Second, also with respect to revenue, though our revenue margins have remained generally unchanged throughout 2017, we expect the future revenue margins may decrease modesty both as a result of changes in business mix and fee restructuring completed during 2017 across our mutual fund and collective trust products set. Third, we expect to continue to manage our business prudently in light of our operating margin trends, including closely monitoring our controllable expenses. To date, our efforts on this front are best evidenced by a comparison to peak levels in 2014. Operating expenses have decreased by 12% annually and 33% in total, and employee headcount has decreased by 18% over the same time. While we expect these efforts will carry into 2018, we remain committed to retaining the people and resources that are required to serve our existing clients and prospects and to prioritizing the new initiatives that will be source to the future growth. And finally, as I mentioned earlier, we expect that our effective tax rate used to calculate economic net income will decrease to approximately 27% as a result of the recent tax changes. However, we do not expect that our day-to-day operations will be materially impacted, as only a fraction of our company is currently subject to C Corp taxation. With the new rules in place, we are evaluating our structure and capital policy, and we'll provide updates as to any future changes as they become available. That concludes my formal remarks. I'll now turn the call back over to the operator, and we will take any questions. Operator?