Manning & Napier, Inc.
Q1 2013 Earnings Call Transcript

Published: 2 May 2013

[Operator:]

Good morning. My name is Latriscia and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Manning & Napier first quarter 2013 earnings teleconference. Our host for today are Patrick Cunningham, Chief Executive Officer; James Mikolaichik, Chief Financial Officer; and [Scott Williams], Internal Financial Reporting. Today's call is being recorded and will be available for replay beginning at 10 o'clock a.m. Eastern Standard Time. The dial-in number is 404-537-3406 and enter PIN number 36673575. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. (Operator Instructions). It is now my please to turn the floor over to Mr. [Scott Williams].

[Unidentified Company Participant:]

Thank you, Latriscia, and thank you, everyone, for joining us today to discuss Manning & Napier's first quarter 2013 results. Before we begin, I'd like to remind everyone that certain statements made during this call, which are not based on historical facts, including any statements related 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 Chief Executive Officer, Patrick Cunningham. Patrick?

[Patrick Cunningham:]

Good morning, everyone, and thank you for joining us. As usual, I'll make some opening remarks before turning the call over to Jim Mikolaichik, our CFO. Jim will then take you through the key financial highlights and when Jim's done, we'll then open the call up to Q&A. Let's start with the markets. S&P entered the quarter up over 10%, non-U.S. stocks were positive but up only 3% to 5% depending upon the benchmark, and bonds were slightly negative for the quarter. There were both encouraging and discouraging aspects of the markets movements. On the one hand, market volatility was low during the quarter, despite plenty of economic and political issues to content with. In addition, fund flows suggested more optimism for equity market investors with equity fund seeing greater flows than bond funds, and actively managed funds seeing greater flows in passive and EPS strategies. However, investors once again showed a preference for more defensive equity market sectors during the first quarter. While all sectors posted positive returns, consumer staples, healthcare and utilities saw the best returns. And finally, we continue to reach for dividend income in the phase of economic uncertainty. This bias towards defense equity market sectors has continued thus far in the second quarter as well. We continue to believe that there's a lot of money sitting on the sidelines in cash and bond funds, and the transition of that money into the equity markets will occur as investors realize the risks of these traditionally "safe investments." We have said for some time now that the greatest risks for long-term investors in the current environment is reinvestment rate risk, or accepting lower turns for safety. Another real risk to investors today is the high valuations for some areas of the bond markets and defensive equity market sectors. As investors realize these risks, we believe they will move out of bonds and cash and into the stock market in search of growth companies. Manning & Napier has been positioning our client portfolios in growth oriented investments for some time now. As a means of protecting against reinvestment rate risk, we believe that investing in companies that are in charge of their own destiny rather than those subject to economic cycles is a strategy for long-term outperformance and risk management for our clients. Despite the market's preference for these more defensive sectors, we delivered strong absolute and competitive relatively turns during the first quarter. Our World Opportunity Series and the return of 5.0% versus the All Country World Index ex U.S. of 3.2% and in line with the EP return of 5.2%. Our Equity Series earned a return of 11.7% versus 10.6% for the S&P 500 and our Pro-Blend Maximum Term Series which is the most aggressive of our lifestyle funds, earned a return of 9.2%. These short-term results reinforced our strong long-term results. In our World Opportunity Fund, we saw a 10-year annualized rate of return of 11.4% per year versus 9.7% for EP. For the Maximum Term Series, we saw a return of 9.6% per year over the last 10 years versus 8.5% for the S&P 500. And in our equity series, we saw a return of 9.9% per year for the last 10 years versus 8.5% once again for the S&P 500. In addition, by the end of March, approximately 71% of our mutual fund assets were in funds rating either 4 or 5 stars by Morningstar. Flows for the first quarter of 2013 were generally flat and showed an improvement over last year. Specifically, we saw inflows of 2.73 billion and outflows of 2.75 billion. As we discussed at the end of last year, pervious negative flows were largely the result of our underperformance relative to benchmarks in 2011. We view 2013 as a year of transition as our improved investment turns begin to impact flows to our investment strategies. Let me share with you some additional points on first quarter flows. Our U.S. equity strategy has been the source of much of our past outflows given these relative results in 2011. This strategy experienced outflows once again in the first quarter but at a level that suggest such flows may have stabilized. We attribute this to our high level of communication and service with key relationships using this strategy. Our direct sales channels continue to improve new business flows across strategies as maintaining a very high client retention rate for our separate account clients. And overall, our lifecycle and non-U.S. equity strategies continue to show positive flows driven by both our direct and intermediary channels. History tells us that the further we move past our 2011 returns, the sooner we will see a return to positive flows. In the interim, we continue to focus on the three foundations of our business that have allowed us to grow for more than four decades. First, our strong team-based research engine that focuses on processes and strategies that can be repeated over time. Second, our solutions-oriented approach to prospecting and servicing which forces us to remain relevant in terms of our product offerings as market change. And third, a strong governance and operating structure that aligns the incentives of our employees with those of our clients and shareholders. This year, we will continue to ensure a deep and effective multichannel distribution structure. We have continued to recruit additional sales representatives in our direct channel and we plan to add three new territories within the next few weeks. To ensure a high level of service, we brought out two new service representatives this past January that will increase our overall communication efforts with clients, but also free up time for our more tenured sales representatives to do more prospecting. Our key accounts roles within our intermediary channel continue to expand the scope of our mutual fund offerings across various wirehouse and RAA platforms. Additionally, we continue to add our new fund offerings to existing selling agreements to drive new distribution. Our consultative approach within our intermediary channel, which is focused on helping retirement plan advisors provide holistic benefits consultation to their clients in the face of the conversions of health and wealth has been gaining traction. Our recent webinar on this topic was highlighted in publications such Plan Sponsor and Plan Advisor. As we discussed last quarter, we are also looking at ways to expand our global distribution including leveraging our current relationships in Europe and expanding into new markets. We have several alternative strategies in incubation and we are also actively reviewing potential acquisition targets that will help us get up and running in the alternative space real quickly. And lastly, I am pleased to say that we finalized our new long-term incentive plan for our employees. As you may know, sharing equity in the firm with key contributors to our growth and success has been a part of our history for many decades. Since we went public at the end of 2011, we have been working to develop a new plan that will allow us to continue offering equity to employees that make strong and lasting contributions to the firm. In mid April, we filed our new plan with the SEC and we will be finalizing our first round of equity brands to several members of management, key employees and Board members within the new few weeks. Equity participation in the firm has long been used as a means of attracting and retaining talented professionals, and I am very excited to continue this trend through the launch of our new plan. With that, let me pass it over to Jim for an update on our financials.

[James Mikolaichik:]

Thank you, Patrick, and thank you everyone for joining us today. Hopefully, you had an opportunity to review our earnings results which were released yesterday after market close. As Patrick mentioned, I'll take you through the financial highlights before opening the call to Q&A. As we mentioned during our previous calls, my remarks will focus on certain non-GAAP financial measures primarily economic income, economic net income and adjusted earnings per share. We believe these measures are the best representation of our returns and cash flows and that they exclude certain non-cash accounting charges related to our initial public offering. However, our earnings release and related SEC filings do provide full GAAP reconciliations as well as additional detail related to our non-GAAP financial measures. With that, I'll turn to our net client cash flow and assets under management or AUM. We ended the first quarter with $48.1 billion in assets under management, an increase of 2.9 billion or 6% on a sequential basis and a 7% increase or $3.3 billion when compared to the first quarter last year. As of March 31, 2013, the composition of our client assets by investment vehicle was generally consistent with what we have reported previously, with 55% in separate accounts and 45% in mutual funds and collective investment trusts. By portfolio, 45% of our total client's assets were invested in blended asset portfolios or lifecycle products. With 52% invested in a variety of equity strategies and the remaining 3% in fixed income portfolios, which was also in line with prior periods. And as previously mentioned, the increase in our assets under management for the period was primarily attributable to strong investment performance. For the quarter, investment performance across all of our portfolios was 6.4%, including 7.1% returns in our equity portfolios. And gross client inflows through the quarter were 2.7 billion, or were offset by gross client outflows resulting in net client outflows of approximately $20 million. By investment vehicle, we experienced net inflows of 155 million into our mutual fund and collective trust products, offset by 175 million of net outflows from our separate accounts. Within our separate accounts, we had approximately $1 billion of gross client inflows offset by just under 1.2 billion of gross client outflows. And while we did experience client cash outflow for the quarter, the retention rate increased from 95% in 2012 to 97% year-to-date. Transitioning to our first quarter financial results, we reported revenue of 90.3 million for the quarter, an increase of 6% from 85 million reported in the first quarter of 2012 and an increase of 4% from revenue of 87.1 million reported in the fourth quarter of 2012. The changes in revenue were generally consistent with changes in average assets under management, which increased by 10% from the first quarter of 2012 and 6% since last quarter. Our revenue margins continue to remain strong with revenue as a percentage of average assets under management of 78 basis points through the first quarter, compared with 79 basis points this time last year and 78 basis points for the previous quarter. Before reviewing detailing operating expenses, I'd like to call attention to a reclassification. We reclassified 12b-1 expenses in sub-custody fees, distribution, servicing and custody expenses. The amounts for the prior-period results have been reclassified to conform to the current year presentation, and have no net impact on the previously reported or current results. Our operating expenses for the quarter were 50.4 million, which represented a $5.2 million increase compared to the first quarter of 2012 and an increase of 3.7 million compared to the previous quarter. The majority of the operating expense increase was due to compensation or related costs. The increase in compensation and related costs consisted of an increase in the analyst bonus, resulting from the strong absolute and relative investment returns during the quarter, as well as the investment in personnel related to our distribution expansion. Distribution, servicing and custody expense have increased in line with asset growth, but increased primarily due to sub-transfer agent and 12b-1 fee expenses. Other operating costs for the first quarter of 2013 were approximately 9% of revenue, down from 10% of revenue last quarter and up slightly from 80% of revenue this time last year. As a result, we reported economic income for the quarter of 40.1 million consistent with the first quarter of last year and generally in line with 40.5 million reported on a sequential basis. Our economic income margin year-to-date is 44.5% compared to 47.2% this time last year. Economic net income was 24.8 million or $0.28 per adjusted share which is in line with our results on a sequential basis and first quarter of 2012. Before closing I'll point out a few other items. First, our management team continues to own approximately 8% of our business and a large portion of that ownership is subject to vesting requirements through 2014. As a result, we are continuing to report non-cash compensation expenses, though expenses are variable in nature subject to the underlined investment criteria and the market value of our public stock. I would also remind everyone that the vesting is fully accounted for as part of our adjusted share count and do not have a dilutive impact to our shareholders. Second, during the first quarter, we completed our first annual exchange process as legacy shareholders exchanged approximately 500,000 Class A units of Manning & Napier group for approximately 7.4 million in cash. Subsequent to the exchange, the Class A units were retired and the exchange was accretive to our shareholders. We expect to have another legacy shareholder exchange during the first quarter of 2014 and we'll keep you informed of that as we move closer to the end of the year. Follow-up on Patrick's earlier comments, we recently completed the registration and implementation of our long-term incentive plan. Under the plan, we were granted approximately 480,000 units. The significant majority of which consists of restricted stock units with a three-year [clip] vesting. These unvested restricted stock units will not be entitled to dividend until the end of the vesting period, and the specific detail with a new plan were included in an 8-K filed yesterday after market close. The adjusted shares outstanding as of March 31, 2013 were 89,485,376 after the exchange and subsequent retirement of the approximately 500,000 units previously held by our legacy shareholders. This does not include the share issuance under our new plan and that will be accounted for on a going-forward basis. Our balance sheet remains healthy which continues to afford us the ability to invest in our business, while continuing to pay reasonable dividends to our owners. And to that end, we continue to have a debt-free capital structure. We maintained a cash balance of approximately 131 million as of March 31, 2013. As you're aware, Manning & Napier group distributed 31.3 million in cash to its members for the quarter, resulting in a quarterly dividend to $0.16 per share, which is consistent with the quarterly dividend that we have provided to shareholders in prior periods. That concludes the formal remarks. I'll now turn the call back over to the operator and we look forward to your questions. Operator?

[Operator:]

Thank you. The floor is now open for questions. (Operator Instructions). Our first question is coming from Chris Harris with Wells Fargo.

[Nathan Burk:]

Nathan Burk filling for Chris. My question is on the SMA business. Obviously, it looks like the gross sales here have been okay, but it's the reduction piece that has really kind of picked up. And so I'm wondering if there is maybe one or two things that you can point to in your discussions with clients that might be driving these redemptions? And then, specifically, are you seeing any meaningful competition from the alternatives?

[Patrick Cunningham:]

Chris – no, we didn't catch your name actually. I think it was…

[Nathan Burk:]

Nathan Burk.

[Patrick Cunningham:]

Hi, Nathan. Good morning.

[Nathan Burk:]

Hi. Good morning.

[Patrick Cunningham:]

Your question – there were several questions woven into that, so let me try to pick it apart. From a redemption standpoint, the largest – the area that's been – had the most significant impact on the net outflows has been the U.S. equity portfolios. And once again, what we have done is first of all, the recent performance has improved, they've improved I would say significantly. We have obviously done a tremendous amount of work in terms of servicing our clients and letting them know why we're positioned they way we are, why we think this is the right positioning given the current market risks in the current market environment and assuring them that we're staying consistent and true to a process and discipline of investing that has produced competitive returns over market cycles for now more than four decades. So I think you can say – you get to the part where they see what you're doing and you're doing what you say you're doing. And as long as you continue to do that and things improve, we believe that that will ultimately have a positive impact on the flows.

[Nathan Burk:]

Yeah, okay. And then, are you hearing anything from clients with regard to going into alternatives from the institutional investors?

[Patrick Cunningham:]

I think there's a – we're not hearing a lot about it obviously from our clients directly, because our clients are dealing primarily with their core holdings. But certainly if you look at the marketplace, the concerns that people have with bonds right now particularly government bonds and sort of the safer bond – part of the bond market, there's some significant concerns. And obviously you look at the flows into the alternative space, obviously it's telling you that – I think it's more out of the fixed income area than it is out of the equities but it's clearly a trend that we believe is going to continue. And as you know, we've already incubated our own alternative products which – and a part of what Jim and the M&A team are doing is looking at alternative managers as potential acquisitions as well. So we understand that space is going to have a place for the foreseeable future and we intend over time to be participants.

[Nathan Burk:]

Okay, great. And then my final question here is on margin. So it looks like there was some pressure here quarter-over-quarter and then obviously due to compensation from good performance. And so I'm wondering, if flows don't really pick up here but performance is still good, is there potential for further compression here or maybe how should we think about the margin going forward? Thanks.

[Patrick Cunningham:]

Jim, do you want to address that please.

[James Mikolaichik:]

Our margins I think we've said and held along have historically remained in the mid 40s range. And when performance dips and where performance is often big where we have distribution, net client cash flows in our momentum which is what we – or flat, we tend to have compensation costs come down because we have a highly variable portion of our compensation in those two areas. That's why you've seen it north of 45% in a 47% which I quoted earlier to almost I think just over 50% within the last year and a half. But typically what we generally see is we're in the mid 40s to low 40s when things are going really well and we're in a great group process. So, that's generally where they move around and generally where we think it's a comfortable place for us to operate and we watch the rest of our investing around that to make sure that we're tempering it with the growth that we experience, but we think we're in a comfortable spot at the moment.

[Operator:]

Our next question is coming from the line of Michael Kim with Sandler O'Neill.

[Michael Kim:]

Hi, guys. Good morning. Just a couple of questions here. First, from a distribution standpoint, are you starting to see maybe some early results as your wholesalers have transitioned from being more focused on maybe stemming withdrawals as opposed to more of a focus on generating new sales, just given the rebound in performance across the platform. And then I know you touched on this earlier, but more broadly how are you thinking about incremental headcount needs from a distribution perspective as you look out through this year?

[Patrick Cunningham:]

Good morning, Michael. Regarding distribution, this is an area where we continue to – I would say we're in a constant mode of looking for ways to improve, enhance and grow our distribution capabilities. So, as I mentioned in the formal remarks, we have – I'll address the productivity of the more recent items, but we have three new territories, three new individuals that we expect to be on board very shortly. So we are continuing to grow our direct channel. The hires that we made last which somewhere in the early mid part of the year, somewhere a little bit later part of the year, they are starting to become productive. I can't give you specific numbers obviously but we see activity level improving as they understand how we do things and are able to communicate that to their contacts and their centers of influence. So, I'm encouraged about the quality of the new hires and I obviously believe that they're going to have a positive impact on distribution going forward.

[James Mikolaichik:]

Michael, with respect to the flows in general, specifically with the wholesalers that you mentioned, we did have one rebalance which I think some of you guys reported on that that happened over the January-February period which is a large cash flow that had not as much to do with Manning as it had to do with the platform. So, on the whole, for the quarter, the flows into the mutual fund and the collective space and the activity I think as encouraging. And moving towards what we're seeing on the whole of the industry. So, I think that's been good news for most folks in our space.

[Patrick Cunningham:]

I'll add one last thing. The messaging that we're doing with our – the retirement plan advisors have and continue to grow to be the intermediary to the 401(k) market, particularly in the 50 million and under space. The investment consultants are on the very large plan via independent, but the RPAs who typically work with wirehouses or RAA organizations that are in the intermediary to the 401(k) plan. And the messaging that we are giving them now which is they should be aware of the conversions of health and wealth because there are going to benefit dollars that are going to be either allocated to the health plan or to the retirement plan and it's not as subtle as it used to be and we're – the retirement plan advisors, they get called on by hundreds and hundreds of wholesalers. If you have something meaningful, something that is impactful on their practice management, we are seeing initial very encouraging results about the recent activity of that message.

[Michael Kim:]

Okay, that's helpful. And then, maybe just a follow-up on the M&A front, it does sound like maybe you're getting a bit more active particularly as it relates to alternatives. So, can you just talk a little bit about what you're seeing in terms of opportunities and pricing trends and competition?

[Patrick Cunningham:]

One was the M&A activity and then the pricing trends and competition, do you want to do the M&A, Jim, talk a little bit about that.

[James Mikolaichik:]

Pricing trends and competition, were you speaking about M&A specifically or just in general?

[Michael Kim:]

In terms of M&A opportunities.

[James Mikolaichik:]

It appears at the smaller end, so firms in a couple 100 million alternative shops that are just up and running to 2 billion, 3 billion to 5 billion to 10 billion, it appears there's a lot more activity and a lot more opportunities that have come into the market during the first quarter. And I think as a result of – probably Artisan going public in a reasonable fashion and the ORIX deal with Robeco looking like that, that may get through. M&A seems to be in a place where people are now with the markets going the way they're going and equities moving and inflation now seeming to cause people to fear rising rates, there appears to be a willingness on the buy side and a willingness on the sell side to start to think about doing deals again. I think it's too early to tell what the pricing will absolutely be on these, but obviously the prices of (inaudible) have moved up in total. So people watch that and use it as comparables. But a lot of flow in activity of smaller firms that are looking to find good homes, I think has been positive and we certainly have been working hard to see if we can participate in that. But as always, the fit and the cultural aspect very vital and important to a firm like us. So, we're taking our time and making sure we find the right place of things.

[Michael Kim:]

Okay, that's helpful. Thanks for taking my questions.

[Patrick Cunningham:]

Thanks, Mike.

[Operator:]

Our next question is from Adam Beatty with Bank of America Merrill Lynch.

[Adam Beatty:]

Thank you and good morning. First, just a question on some of the territorial expansion, you mentioned three new territories. Does that imply like three new local reps in addition to the two new service reps?

[Patrick Cunningham:]

Correct.

[Adam Beatty:]

Okay. And is there a way to sort of break out – in the increase in compensation, how much of that is sort of toward investment professionals for the performance versus some of the new hires that you've had or maybe the timing in the quarter of those hires?

[James Mikolaichik:]

Those are things that we – Adam, good morning by the way. Those are things that we obviously track but we don't report those and disclose them publicly. We talked about analyst compensation as one of the factors that increased due to the good performance. So once again, there's a relative but clearly an absolute component to our analyst comp plan. And when you have returns that are double digits on an absolute basis, that does have an impact on our analyst comp. But it's also true that for our sales people, they have a higher comp on the first year than they do on the service debt of the first year. So, it's both that will impact the margins when we are – when things are going well for the firm. But we do continue to add people and they don't – they are productive right out of the gate typically speaking. It takes anywhere from six to 18 months for them to get productive. So that will have an impact.

[Adam Beatty:]

Okay, that's helpful. And sort of to follow-on to that and bear with me if it's a little hazy, but just in terms of what you would say right now is the AUM capacity of the personnel that you have? In other words, if everyone in all the regions were at a mature level of productivity, how much additional capacity do you feel that you have?

[James Mikolaichik:]

Obviously, that's something that we look at carefully. And we believe that we have a tremendous amount of – bear in mind, we have 85 people who are involved in our research area. We have 40 bottom up analysts, we have I believe a very robust research engine that could handle, I would say doubling the capacity at least that we have now. So we're not up against a near-term capacity issue that we're concerned about right now.

[Patrick Cunningham:]

(Inaudible) the sales and servicing side, that's why we have continued to add over the past couple of years to make sure that we get the right servicing environment or on our sales people too, a lot of them to be efficient and leverageable. The wholesaling area and the platforms in the institutional space is certainly leverageable because of the size of the accounts but also on the (inaudible) side and our regional direct reps. We continue to make sure that we have the right types of resources and teams around them to be able to handle the growth that we hope comes in the near future.

[Adam Beatty:]

At least you've tried to align product capacity with distribution capacity basically?

[Patrick Cunningham:]

We're always looking at both and we have to look at the infrastructure to make sure that everything can support from operation to the investment engine to the selling capability and the servicing. We want to make sure that our clients get the same experience as they witnessed when we acquire an account to the type of experience if that experience carries through the likes of the account with us.

[Adam Beatty:]

Okay, great. Thanks for taking my questions. I'll get back in the queue.

[Patrick Cunningham:]

Thank you.

[Operator:]

(Operator Instructions). Our next question is coming from the line of Ken Worthington with JP Morgan.

[Unidentified Analyst:]

Hi. This is Rahul filling in for Ken this morning. A couple of questions. One, with healthcare getting more complex, what has been the impact on your relationship with your clients when proving advice on benefits in general? And how are you translating this into new business on the investment side?

[Patrick Cunningham:]

Good question. We have been – for some time, we have recognized that there was convergence of health and wealth and that it would be a significant problem facing our clients, so our midmarket clients in particular. So, we have put together a variety of solutions in that space. Our belief is that the single biggest way to keep healthcare cost under control is to foster consumerism. That healthcare reform is sort of – is fostering consumers almost immediately. It accelerated the process that we saw was developing over time. So when you do consumerism in healthcare, how do you – first of all, how do you design the plan? Well, we have experts on start who helped clients design the plan and can get paid various ways for that consulting advice either through brokerage commission or through consulting fees. We have technology that enables the participants, the employees to understand. If you think it's difficult selecting between 10 options out of a 401(k) plan, imagine the difficulty of not only selecting a health plan but also managing that, particularly if it's a high deductable plan. So we have technology solutions as well. So when we solve clients problems, they appreciate that and they pay us either through having us manage more of their assets or through other direct revenue sources.

[Unidentified Analyst:]

Got it. Another question on performance. The ones you performed was good, you attributed that in your release to be migration to growth-oriented investing. Can you [flush] that out a little further and give us some additional thoughts on your thought process and the end result from that?

[Patrick Cunningham:]

Sure. Just for the record, we tend to be early in transitioning our portfolios. I'll give you an example. In 1999 and for a couple of years beforehand, we had less than – in 1990, less than 5% in technology. The S&P had over 30% and NASDAQ had over 70%. We felt strongly that valuations were way out of whack and that there was high risk in that sector. If you look at 1999, you'd have to say based upon that positioning that we were relatively on the position, but you can never time these things and we never pretend that we could be timers. We're a bottom up shop and we look at companies that have good growth prospects that are trading in reasonable undervalued prices. When we looked at this environment and we looked at the kind of yields that we were getting on fixed income instruments, we looked at the valuations in the defensive sectors such as utilities, we've looked at the types of returns and growth you could get out of those sectors. We concluded and it was a bottom up process that populated the portfolio, but it was consistent with our top down view that this would not meet the return expectations of clients on a going-forward basis. 2% is not enough. So, positioning the portfolios with companies that have growth that is above the growth of the economy, meaning they have some tailwind at their back that will help drive growth, gain market share. We believe that that is where the money will go eventually. Now, I will tell you in the first quarter that didn't happen. There was still a defensive – and even into the second quarter, we're starting to see while they're moving equities, they're still moving into some of these defensive areas which we think over time people will see that that is risky and they will move into the more oriented companies. And so we obviously believe that that's the right positioning and we're sticking to our [knitting].

[Unidentified Analyst:]

Thank you. That's all I had.

[Operator:]

Your last question is a follow-up question from the line of Adam Beatty with Bank of America Merrill Lynch.

[Adam Beatty:]

Thanks again for taking all my questions. Just a question – I know you've had a lot on flows, on the seasonality of flows. As I look at your disclosure, it seems as though Q1 was very similar to Q4 just in terms of kind of gross versus net and I think of your firm as focused on retirement, a pioneer in balance of retirement oriented products. And we've seen – even with firms that don't have that focus kind of a retirement pop in gross and net sales in the first quarter. And don't get me wrong, stability is a good thing but just how do you view that and how come the flows wind up so stable?

[James Mikolaichik:]

Well, I think the answer is that there's positive cash flow into 401(k) plan throughout the year. The thing that would make a pop would be, either a pop in the good way or bad way would be people typically make their changes to their menu on fiscal year basis. They'll look at the end of a fiscal year and say okay, I want to change out these lifecycle funds or these other lifecycle funds or I want to add options that I don't currently have. So I think the seasonality has to do with the fiscal year and it has to do with major changes in menu as opposed to simple quarter-by-quarter cash flow for 401(k) plan.

[Adam Beatty:]

Okay, thanks. I appreciate that. And then a question on sort of product development, specifically maybe focused on alternatives. You have a, as you say a bottom up investment process. To the extent that you didn't do M&A and buy something in, do you feel as though there are any adjustments or separate processes that you would need to develop an alternative capability?

[Patrick Cunningham:]

The alternative strategy is that we are developing, really are leveraging the work of our primary engine, okay? I'm happy to talk to you about this in more detail offline, Adam, but these are strategies that are long, short strategies, puts and calls, but they are using as the bases for the underlying holdings of the research done by our current large research department.

[Adam Beatty:]

Okay. That's actually very helpful. I appreciate that. That's all I had today. Thanks a lot.

[Patrick Cunningham:]

Thanks, Adam.

[Operator:]

Okay. And we do have another question, which makes this our last question from John Dunn with Sidoti & Company.

[John Dunn:]

Good morning. I just have a follow-up on the healthcare consulting side. Do you have any sense of what the level of profitability that generates might be?

[Patrick Cunningham:]

That whole endeavor is one that I would characterize as still in its relatively early phases and it has no meaningful impact in terms of the revenue side. We're trying different configurations of products in different channels to see what we believe is the right packaging. So it doesn't have a meaningful impact at this point.

[James Mikolaichik:]

Yes, John, we don't break out our research and development in any specific manner at this point. But it's something we always believed deeply and making sure that we're staying current with what our clients issues and problems will be in the future so that we can interact with them. And while there's so much uncertainty around the healthcare space and how the actual process will rollout as people try to engage with the changes from the government, we know that we're going to need to be able to speak to people and help them with it in one way shape or form. So we think it's an important part of our spending and we know that if you help people in the long run, there will be business results that follow as we get into the [thick] of it.

[John Dunn:]

Makes sense. And then just lastly, are you seeing any geographic diversions in SMA flows?

[James Mikolaichik:]

No, nothing noticeable. Honestly, the flows have been generally pretty consistent from an SMA standpoint where we had the more difficult time last year was as Patrick said earlier was the U.S. equity performance which has rebounded pretty well and it came mostly in platform business not really as much in our direct rep business. So no, there's not really a geographic – any geographic thing that we've seen.

[John Dunn:]

Got you. Thank you very much.

[Patrick Cunningham:]

Thank you.

[Operator:]

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