Manning & Napier, Inc.
Q3 2016 Earnings Call Transcript

Published: 27 Oct 2016

[Operator:]

Good evening. My name is Melinda and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Manning & Napier Third Quarter 2016 Earnings Teleconference. Our hosts for today's call are Richard Yates, Chief Legal Officer; Chuck Stamey, Executive Vice President and Managing Direct of Sales; and Paul Battaglia, Vice President of Finance. Today's call is being recorded and will be available for replay beginning at 8 PM Eastern Tonight. The dial-in number is 404-537-3406 and then enter pin number 97654064. [Operator Instructions] It is now my pleasure to turn the floor over to Richard Yates.

[Richard Yates:]

Thank you, Melinda. Thanks everyone for joining us today to discuss Manning & Napier's third quarter 2016 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. With that allow me to introduce our Executive Vice President and Managing Director of Sales, Chuck Stamey. Chuck?

[Chuck Stamey:]

Thank you, Richard. Good evening and thank you for joining us. I will make some opening remarks before turning the call over to Paul Battaglia for a review of the financials. We’ll then open up the call to your questions. We are pleased that we’ve seen strong and broad improvement in the performance of our traditional and newer products year-to-date and for the one year period. Although we don't like to focus too much on short-term results, the favorable returns are encouraging our clients to stay the course. We believe the improved performance figures result from the changes we made last year to our research department which we discussed in previous calls. Those changes were designed to refocus our investment process, create high conviction portfolios, and stem outflows to help stabilize our AUM. As I mentioned, this is led to a turnaround in short-term performance which to us demonstrate that our research teams are better executing our investment process. Our expectation is that this will continue and the 3 to 5 year performance numbers will improve over time. At this time we're gaining traction with a handful of product that already has strong long-term track records. We believe these targeted products are well suited for the environment we find ourselves in today namely continued slow global economic growth. We continue to focus on actively servicing our clients, stabilizing relationships and promoting our solutions oriented services. Our distribution teams remain solid and we've not seen meaningful turnover among our sales channels year-to-date. Each year we look forward to hosting our client seminars which kicked off last month in various cities across the country and will continue into January. We've heard our client say they are encouraged by what they’ve seen from us recently namely nimble risk management that has contributed to outperformance during the year that has been tough for active managers in general. Now let's talk about 2016, 2017 sales priority. For the remainder of this year and throughout next year, we'll maintain our focus on our traditional core products but will also prioritize across all of our distribution channels some of our newer offerings where we have multiple research teams that continue to execute well on many fronts. For equities our disciplined value product has been a top quintile performer on a year-to-date, one year and three year basis. This product utilizes a factor-based strategy to invest in large-cap equities. Our global quality product has been a top quartile performer year-to-date and for the one, three and five year period. This product combines systematic analysis with bottom-up company specific research to identify proven businesses with attractive future prospects. Both of these products seek to provide stability and consistency over time even in uncertain market environments. We believe equity products such as these that focus on downside risk management will continue to be of interest across many of our distribution channels including institutional Taft-Hartley, regional sales and intermediary sales. In addition, our international series and real estate series are gaining traction within the intermediary sales channel. The international series has been a top decile performer year-to-date and for the one year period in a top quintile performer on a three and a 10-year basis. The real estate series has been a top quartile performer year-to-date and on a one, three and five year basis. We also see opportunities for the Rainier International Discovery product which invest in international, small-cap equity and is available as a separate account, collective or mutual fund. The International Discovery product has been a top decile performer over the past three years and has a five-star MorningStar rating. The international small-cap space is an attractive asset class for both institutional and retail investors. It's the convergence of two market segments were active management has been able to add value non-U.S. equities and small-cap. Additionally we're leveraging the West Coast presence of the Rainier team to offer Manning products to their clients. We have seen positive initial sales closes across the two firms with Manning wraps selling Rainier products and vice versa. Our fixed income priorities include both unconstrained bond and high-yield bond product in the regional sales channel. The unconstrained bond product has been a top decile performer over the past 10 years and a top quartile performer over the past five years. The high-yield product has been a top quartile performer over the past one and three years. Given recent regulatory changes in money market reform, our national sales reps has seen an increased interest from municipalities, and higher education institutions as they look for ways to generate additional income. Earlier this year we launched our bank deposit investment account or BDIA program. These are customized, higher professional managed portfolios of fixed income securities that provide organizations the opportunity to earn more interest than they might currently be earning in the low yielding bank accounts. Finally in mid-September we announced the launch of our trusted IRA product. This is a product we established based on client request and that's something we expect to be a focus of our regional sales reps throughout 2017. Changing gears a bit, the Department of Labor's new fiduciary rules shares with Manning & Napier a goal of improving retirement security and preventing conflicts of interest. Manning & Napier supports are clear fiduciary standard and although we acknowledge that many of the regulations provisions create new and sometimes onerous requirements, we are committed to being in full compliance and helping our industry partners to comply with the regulatory framework. We are working closely with our broker-dealer platform advisor and other industry partners to facilitate industry-wide compliance and improve outcome for investors. We look forward to continuing to provide investors with innovative solution and to help protect and grow their wealth through changing market environments. In addition to our investment solutions, we will continue to provide our industry partners with thought leadership tools and resources that help demystify the regulation requirements, identify the best interest of plans, participants and investors, and help establish prudent processes for investment recommendations. We will be launching a campaign in the fourth quarter to address issues related to the new fiduciary rules. Given our long-standing commitment to act in a fiduciary capacity we expect few changes to our existing business practices although we are reviewing on mutual fund key structure to ensure competitiveness in the new fiduciary rule environment. We anticipate significant industry disruption and believe we're well-positioned to find opportunity amidst the disruption. As an experienced active manager with high active share, a time-tested repeatable investment process, and proven success managing risks in a wide variety of market cycles, we welcome a more robust and qualitative assessment of investment solutions. To that point, while we often do not comment on individual client details in these calls, we recently did establish a new business relationship but that was initiated due to these new pending regulations. Our new business partner needed a manager that could offer customized target date solutions to a wide demographic group. Our time-tested approach and the fact that we are independent asset manager with decades of asset allocation and risk management experience, made us a good fit for their needs. While we can't comment on specific asset levels, we expected to see these inflows over the next two to four quarters and this relationship is a good example of the opportunities these new regulations might well create. Interestingly, this relationship began as a result of our digital marketing strategy and the content we're really focused on fiduciary responsibility in age and risk-based fund offerings. This is just one example of our digital marketing strategy in action which includes driving prospects to our thought leadership content and resources via email, marketing and social postings. Year-to-date we've created 53 digital marketing campaigns and our goal with these campaigns is to identify new prospects and engage existing contacts with content in order to create new business opportunities. Beyond that, we have the ability to leverage these digital interactions into real sales opportunities. We believe a proactive digital strategy will be increasingly important as investors of all types change the way they gather information and make investment decisions. Thank you. I’ll now turn the call over to Paul Battaglia.

[Paul Battaglia:]

Thanks Chuck, and thank you everyone for joining us today. I’ll provide an update on client flows and review the financials before opening the call up for your questions. I’ll start by addressing a few key metrics. We ended the quarter with assets under management or AUM of $34.8 billion. Net client outflows in the quarter were approximately $2.3 billion, revenue for the quarter was $63.3 million, a 2% decrease since last quarter and we reported third quarter economic net income per adjusted share of $0.16 slightly lower than the $0.17 per adjusted share in the second quarter and down from $0.21 per adjusted share in the third quarter of 2015. Turning to AUM and net client cash flows. AUM decreased by $900 million during the quarter, as net client outflows of $2.3 billion were partially offset by $1.4 million of market appreciation. When compared to September 30, 2015 AUM is decreased by $2.4 million or 6%. Our blended asset portfolios continue to be the most consistent generator of client inflows contributing approximately $743 million of our 1.1 billion of gross client inflows for the quarter. This includes approximately 515 million of gross inflows into our lifecycle and retirement target products that are prominent in the defined contribution space. By vehicle we had $750 million of gross inflows into mutual funds and collective trusts and $375 million into separate accounts. Gross client outflows were $3.4 billion for the quarter, an improvement from the $3.8 million we reported last quarter. Approximately $3.2 billion of the outflows were from our multi-asset class and equity portfolios with another 150 million in redemptions from our fixed-income products. By vehicle we had $2.2 billion of outflows from mutual funds and collective trusts and $1.2 billion of outflows from our separate accounts. Our rolling 12 months separate account retention rate stands at 84%. In recent quarters our outflows have been concentrated with our platform and institutional relationships, however this quarter we did see an increase in outflows from our direct defined contribution channel including a few larger plans that terminated during the quarter. As of September 30, our blended asset strategies made up 62% of our assets or $21.5 billion, our various equity strategies represented 34% of our total assets with the remaining 4% invested in our fixed-income products. Our mix of business this is generally unchanged from last quarter. Before getting into the details in the third quarter financials, I'd like to call your attention to a reclassification adjustment it is reflected in our third quarter results. We reclassified a portion of our distribution expenses associated with certain client relationships to properly classify these rebates as a reduction of revenue. Prior period results have been revised to reflect this presentation. This client rebate total approximately $8.9 million and $7.3 million for the nine months ended September 30, 2016 and 2015 respectively. There is no impact on current or previously reported operating income or earnings per share as a result of this reclassification. However, our revenue margins and distribution expenses in a percentage of revenue have changed as a result of this adjustment. Moving to the third quarter financials, we reported revenue of $63.3 million for the quarter down by 2% sequentially and by 16% compared to the third quarter of 2015. Overall revenue margins of 71 basis point in the quarter are down slightly from 72 basis point in the second quarter and down from 74 basis points reported this time last year with the decrease driven by changes in mutual fund and collective trust business mix. Operating expenses were $41.6 million in the quarter unchanged from last quarter and down $3.1 million or 7% from this time last year. Compensation related costs was $24.6 million for the quarter generally in line with both last quarter and the third quarter of last year. Our compensation ratio as a percentage of revenue was 39% in the quarter consistent with a 38% we reported in the second quarter and with what we discussed during the last call. We expect that the compensation ratio will remain in this range in the near-term. Distribution, servicing and custody expenses have decreased by approximately $200,000 sequentially and by $2.3 million compared to the third quarter of 2015. Distribution expenses for the quarter are approximately 24 basis points of fund and collective average assets after adjusting for the reclassification of client rebates. Other operating expenses of $8.2 million in the quarter were unchanged from last quarter and are down from $9.1 million reported this time last year. As a result, we reported pretax income for the quarter of $21.6 million, a 7% decrease since last quarter and a decrease of 13% from the third quarter of 2015. Economic net income for the quarter was $13.4 million or $0.16 per adjusted share. With that I'll summarize our year-to-date results through September 30. Revenues are $189.9 million down 23% from $248 million reported for the first nine months of last year. Year-to-date revenue margins of 71 basis points are down from 75 basis points last year. Operating expenses have decreased by $23.3 million to $122.4 million for the nine months ended September 30, 2016. Distribution, servicing and custody expenses have decreased by $12 million from last year while compensation related costs and other operating expenses have dropped by $8.7 million and $2.2 million respectively. The decreases are generally resulting from decreases in our overall AUM and the size of our work force. Non-operating income has improved by $1.2 million this year compared to loss of $6.8 million reported this time last year. As a result our year-to-date pretax income is $68.7 million with pretax margins of 36.2%. Economic net income per adjusted share is $0.52 for the nine months ended September 30, compared to $0.73 per share last year. With respect to the balance sheet, we continue to maintain a debt-free capital structure with a cash balance of $124 million and $80 million invested in new product concept as of September 30. Regarding equity ownership, we have approximately $81.1 million adjusted shares outstanding as of September 30. And finally we are happy to report that earlier today we announced the $0.16 per share dividend to our Class A shareholders. That concludes my formal remarks. I'll now turn the call back over to the operator and we look forward to your questions. Operator?

[Operator:]

[Operator Instructions] Our first question is coming from Robert Lee with KBW.

[Robert Lee:]

Thanks. Good afternoon. I just had a couple of questions. I guess the first one is related to the dividend, I mean understanding your cash generations probably a little bit above your earnings but certainly given this quarter - just earning your dividend at this point, so now maturing for error. So how are you thinking about the sustaining the current payout or going forward or is it, use some of the cash in the balance sheet for a while I mean if earnings don't rebound in the near term what's your thoughts on that?

[Paul Battaglia:]

Hi, Rob this is Paul Battaglia. The dividend policy is a topic that is on the agenda for the Board Directors meeting every quarter and it was part of the discussion this quarter as well. And the Board, I think tries to balance, they understand the importance of the dividend to our shareholders with trying to have cash available to support new initiatives. Now the good news is that we have $125 million of cash on the balance sheet, we’ve got flexibility with the credit facility. We are looking to see flows and prove is the result of the performance, the short term performance rebound and hoping to see our results sort of support the dividend going forward. But it is something that is quarterly decision by the Board and they look at both short term and near term - short term and long term impacts and try to balance everything.

[Robert Lee:]

Okay. And then I'm just - I was just wondering may be kind of an update I mean, one, two years ago when you guys went first went public one of the distribution strategies was building out more regional offices, doing hiring for that and quite frankly really haven't heard too much about it in the last couple of years and certainly as you struggle with performance and flows, but could may be update us on kind of where that initiative kind of stands, is that actually kind of pulls back in or is that actually place where you think there is potential to kind of - in a leverage some of this better performance and growth.

[Chuck Stamey:]

Hi, Chuck Stamey here, happy to take that question. You're right, we did talk about expanding our direct sales presence post IPO which we did primarily focused in the Texas area Southeast and some areas in the Midwest and that continues to track which you’re right on the money. The short term performance challenges have slowed the development in those territories that continues to track and we continue to expect to see continued growth in those markets and that’s another reason why the Rainier acquisition also made sense to us. It give us a West Coast presents to build from, they have a good strong direct sales capability that lines up well with our approach to sales and so we believe that will be kind of a anchor of a West Coast direct sales presence for Manning offering not just Rainier products but our entire products that going forward. So, in short term I would say it might have slowed a bit due to the performance challenges but we do expect to see continued direct sales rep expansion going forward.

[Robert Lee:]

Okay. And then, to one more questions, kind of curious, you called out as an example some recent success I guess winning that target date mandate, I think was target date mandate, can you may be size that for us, is that something that's going to noticeably impact flows, in a - or is that really kind of small but illustration some of the successes that you've been having.

[Chuck Stamey:]

Yes, I can't share a lot of detail with you on the size, the good news is for us I think, you will see its impact likely over the next two to four quarters. I think it’s a little bit of both, it's a target take win but also I think an example of what we've - you turn the term around and like many people have a solution sale meaning it wasn't just the best performing product set but it was a combination of active asset allocation and active approach to the portfolio kind of additional non-performance services that we could offer the client that made us their best, their best fit. Details to come and hopefully the flows will show up over the next two to four quarters but that’s really about as far as I can go today on that topic.

[Robert Lee:]

Okay. Thanks for taking my questions.

[Operator:]

Your next question is coming from the line of Chris Harris with Wells Fargo.

[Chris Harris:]

Thanks. I believe you guys mentioned few larger 401(k) plans terminated relationship this quarter, so wonder if you can talk a little bit about that, what was the behind the decision around that's and how many assets do you have remaining in 401(k) plans?

[Paul Battaglia:]

Yes, this is Paul. I think we are still in the $8 billion to $9 billion range in terms of DC assets. I don’t have the exact number in front of me at this time but I think we’re still in that neighborhood. I think what we started to see is themes that we’ve talked about on recent calls, these have mainly been accounts that had been with us three or five years on average, so there is unique circumstances with everyone but I think that these were clients that will come with us during sort of the - that had a rough ride performance wise, that have been with us through the 2014 time period when we had the most volatility and I think rebound - the recent rebound wasn't enough to sort of over take that.

[Chuck Stamey:]

Chuck Stamey here, I’ll build on Paul's answer. All of that is 100% on the money, I also would acknowledge that we're 8 years into a ball market recovery and there is continued focus on less active approaches and that's been an element of some of the decisions that we’ve seen recently as well.

[Chris Harris:]

Got it, helpful. And then just my follow up question regarding sort of outlook for the industry and how you guys are thinking about things. I appreciate you guys just close the Rainier transaction but you would think that there would be some incentives for some smaller managers to perhaps consolidate. Wondering if you guys are seeing opportunities like that, if you’re in the market at all or do you feel, given what you got going on with Rainier year, out of the market for the time being.

[Chuck Stamey:]

Yes, I think we’ll continue to work with our Board on opportunities that make sense to us. I think as you heard last call with [indiscernible] the internal focus on research here is execution of our existing strategies, if it were product outside of that, that made sense I think the Board and senior management would take a look but I think at this point executing our current plan is a first and foremost on managements mind currently.

[Chris Harris:]

Okay. Thank you.

[Operator:]

Your next question is coming from the line of Ken Worthington with JPMorgan.

[Will Cuddy:]

Hi, this is Will Cuddy filling in for Ken. So Chuck you had mentioned some of the cross-selling in prepared remarks for Rainier and the West Coast distribution opportunity. How is that integration going in general and how these changes take time, when could we expect to see flow impact from the cross-selling with Rainier?

[Chuck Stamey:]

So, it's going quite well. Culturally it was a very good fit. One commonality that both firms had was a presence in the Taft-Hartley a union segment of the market which made for a lot of common acquaintances within the consulting space which frankly has been real plus. It’s been a real plus for the Rainier reps now having a broader set of products to offer to their clients, where we seen them effectively sell a product that is basically an active asset allocation product, it utilizes ETFs as the underlying vehicle, so kind of a non-proprietary asset allocation vehicle that Rainier reps had sold Manning products into their clients and we've also seen Manning reps selling Rainier products. The integration is going quite well. The teams are working very closely together while we are keeping, I think effectively ring fenced research departments to be very separate, the sales teams are together. The Rainier sales reps are on weekly and by weekly calls with the Manning reps and are working in a very coordinated fashion. So, I would expect to see their impact in 2017. As to size, I really can’t comment on that but I would be very surprise if we’re not seeing continued sales across both channels in 2017.

[Will Cuddy:]

Okay. Thank you. Other questions are asked and answered. Thank you for taking our questions.

[Operator:]

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

[Ari Ghosh:]

Hi, good afternoon guys. So just want to touch on the lifecycle funds real quick, looks like some of the growth in flows in those funds have been slowing the shift, so just wondering if you could flush that out a little bit. And then also what you’re seeing in terms of fee pressure. I think around 20%, 25% of AUM might be in the mutual fund rep, so, like you are seeing fee pressure there and do you see any hiccups in the future related to this.

[Chuck Stamey:]

Right, it’s Chuck Stamey here, I’ll start to response. Looking at flows in that space I think we’ve got some long term trend and some short term trends that are kind of in conflict with each other. The short term positives are we have improving performance, we got a good long term track record but in a short term we have seen - in the intermediate term we have seen some pressure due to performance in the 2014, 2015 area and I think that has affected overall flows in that space. Longer term trend to your point as we’re also seeing more people looking at passive strategy and I think that’s a longer term trend that until we see more market volatility all active managers are likely going to have to live with. Coincidently this is a third longest ball market in history so not exactly an environment where I'd expect active managers to be leading the parade and we’re certainly seeing that hold true. I do think to your problem on fees, I think anybody who is in the DC space especially in the QDIA kind of the target date, target risk area is going to be looking at ongoing fee pressure. As part of the new regs, fee awareness is going to be part of our mindset. We’re looking at mutual fund and collective pricing to make sure we’re in the right place and I will say by the way we are, we had a robust mutual fund share across products that we think is well structured. We also have a very competitive and flexible collective investment trust which allows us to price our products competitively now. But I think like all DCIO mangers will continue to look at what is the most effective pricing for all of our target date and risk based offerings going forward and I think it's fair to say those fees are likely to going to stay under pressure.

[Ari Ghosh:]

Great, that’s helpful. And then just a quick follow up on DOL rule. You mentioned in the past that you know you feel pretty comfortable with the rule. I was just wondering if they were any surprises or incremental cost that may be want - you didn’t anticipate initially, just to get compliant for the rule and if that's fully baked in or if there is anything incremental that we can think about moving forward.

[Chuck Stamey:]

Right, I think given that work we're not in a commission or transactional kind of revenue model. I don't think there is much to feel for us in terms of incremental costs. We're more focused on providing guidance and support for our distribution partner, so our advisor partners and platform partners. And we have invested to give them thought leadership and our thinking in one on one meetings with advisors, topical content at conferences to help them identify best practices. So, I’m not sure there is much that you’re not aware of in terms of our adherence and meeting with those regulations and I'll - to further Richard Yates, our council for additional comments here.

[Richard Yates:]

Yes, sure Ari, Richard here. On the tactical side we're not seeing anything, it's a fair bit of work, but we’re not to complied which – we're full on board but we’re not seeing unanticipated expenses or the like to be heading. I think the longer term question will be which Chuck was alluding to earlier in terms of where does the marketplace come in terms of fees for the active management and so we're reviewing that but in terms of actual incremental spend to comply we don’t see anything unanticipated at this point.

[Ari Ghosh:]

Okay, great guys. Thank you. And then if I can just squeeze one final one in, just on the M&A front you touched on that earlier, I was just wondering what your thoughts were on maybe being part of a larger asset manager or a distribution platform, just in light of the environment that we are in regulatory pressures, active to passive, do you think that your current situation right now would that be helped if you or may be a large distribution platform or if you lifted some kind of the JV of that major.

[Chuck Stamey:]

Right, so Chuck Stamey here, I'll weigh on that. I think unlike a lot of smaller asset managers, we have a pretty robust distribution capability. In fact one of the reasons why Rainier made sense to us was because we had the ability to kind of scale their products, pretty quickly using our team. Second I think we’re truly inactive, active manager. I think the people who are really in trouble right now are the ones who are kind of in the middle meeting their kind of traditional style box or asset class type managers where, they’re being swapped out for an ETF on a regular basis. For better adverse we’re an active share manager. So while I think our Board and Management will continue to look at all options, again I think we’ve got plenty of opportunity to execute our plans currently to number one stabilize our current relationships, client assets and get back in a growth track given the current track records we have and the improving track record in our legacy products as well.

[Ari Ghosh:]

Great, thank you very much. Thanks for taking my questions.

[Operator:]

Your last question comes as a follow up from the line of Robert Lee with KBW.

[Robert Lee:]

Thanks and thank you for taking my follow up. I guess the DOL related question, one of things that we hear about was the attending changes coming up, is that a lot of distribution platforms or shrinking their list of specific strategy that they look at demanders that they deal with because they have to - as you suggested have to be tighter on their due diligence process and try to - and big un-wheel the list. So as distributors kind of narrow their platforms, I mean do you at all feel, whether it’s because of some of the trailing performance or some products somehow disadvantage and maintaining shelf space or getting new shelf space going forward and or maybe as a second part of that, your distribution is in retail channels outside of your direct distribution was that less of an issue.

[Richard Yates:]

Yes, Richard here. Jumping on that, we're not seeing that, what we are seeing in the space is a fair bit of disruption and compression and the universes on a commission based platforms which is never been our primary channels. So, we don't view it as that - we don’t view that disruption as being a negative act for us, it's more of a potential opportunity given our products and our current fee structures particularly across the institutional shares either on the fund or they are collected for us. So we’re not seeing pain in that at this point. And I'll Chuck…

[Chuck Stamey:]

Right, thanks Richard. Yes, I think that's accurate and you just to reaffirm I think, the places where we’re seeing the most consolidation or likely we’ll see the most consolidation are in the traditional large cap value, large cap gross basis, and being more of a unconstrained active manger we're seeing less of that. And I think you also made a good point with us many of our assets through our direct reps, I think we’re less reliant on those types of keyhole gate makers than some other firms might be so, while we're certainly aware of that and watching that, it hasn’t been a major issue for us to-date.

[Robert Lee:]

Great. Thanks for taking my follow up.

[Operator:]

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