Manning & Napier, Inc.
Q2 2015 Earnings Call Transcript

Published: 30 Jul 2015

[Operator:]

Good morning. My name is Maria, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Manning & Napier Second Quarter 2015 Teleconference. Our hosts for today’s call are Patrick Cunningham, Chief Executive Officer; James Mikolaichik, Chief Financial Officer; and Scott Williams, Director of Financial Reporting. Today’s call is being recorded and will be available for replay beginning at 10 a.m. Eastern. The dial-in number is [phone] and enter PIN number 80425728. At this time all participants have been placed in a listen-only-mode and the floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. Scott Williams.

[Scott Williams:]

Thank you, Maria. And thank you everyone for joining us today to discuss Manning & Napier’s second quarter 2015 results. Before we begin, I would like to remind everyone that certain statements made during this call, which are 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, let me introduce our Chief Executive Officer, Patrick Cunningham. Patrick?

[Patrick Cunningham:]

Thank you, Scott, and good morning, everyone and thank you for joining us. I've structured my comments for this morning specifically around providing an update on the reorganization that took place within our research department towards the end of the first quarter. As you know, we had a primary goal with the changes we made to our research team and that was to improve our focus. With that in mind, let me provide you with an update on the department and our various portfolios. Ebrahim Busheri has fully embraced his new role as Director of Investments. His first order of business was to review every holding in our core portfolios and under his leadership the new core teams performed these reviews. I've said in on many of these meetings and I can tell you first hand that I've seen the improvements resulting from these smaller teams. When looking at our core portfolios, you will see progress towards our goal of greater focus. For example, cash positions in our equity strategies have been reduced. Another result of this process has been a reduction in the number of holdings for our core U.S. and non-U.S. equity strategies. Individuals that were elevated to new positions are also settling into their roles. Our fixed income team is now under the management of Marc Bushallow and our Capital Goods Group is now managed by Michael [Canola] [ph], both 10-year veterans of the firm. These management transitions have gone smoothly, which I believe is a testament to the depth of our team and our ongoing succession planning. While it’s likely too early to fully attribute any investment returns to these steps we closed out the quarter with good relative returns in our non-U.S. equity strategy and many of our life cycle strategies. However, the structural changes we made to the Research Department and the changes that will continue to occur in our portfolio as a result will become evident over time not over any given month or quarter. The key takeaway is that we're making the changes necessary to continue providing competitive investment strategies for our clients. I regularly receive direct feedback from clients and business partners that they're supportive of the changes we made to the research team. Turning to distribution and our service strategy, we continue to prioritize our service efforts on U.S. and non-U.S. equity clients with our communication focused on the changes to our research team and the portfolio of positioning. I believe these efforts are having an impact. Just a few weeks ago, I met personally with an institutional client with more than $400 million in assets invested in a few of our equity strategies. It was a productive conversation and we certainly spent a great deal of time reviewing recent results and our recent organizational changes. In the end, this client complemented our organization in general, but our staff in particular stating that working with Manning & Napier was and I quote, "more than just a transaction". As we continue through this transition with our equity strategies, we know that maintaining this high level of service will be critical. We're confident in the changes we've made and the direction we're heading. The reality is that we continue to be in the transition phase with several of our equity strategies and this means our [floats] [ph] are likely to remain under pressure over the near term. From a sales standpoint, we're focusing efforts on products that maintained strong track records such as our global quality equity product, which we recently launched both retail and institutional mutual fund share classes. In addition, our life cycle strategies maintaining competitive peer rakings over the last three years and our dedicated DCIO sales team is focused on uncovering defined contribution opportunities. Earlier this month, a current defined contribution plan client that utilizes our target date funds as their qualified default investment alternative performed a reenrollment with their participants, which significantly increased the plan's allocation to our target date funds. I believe this is a prime example of the opportunity that exist for Manning & Napier given our long tenured and well rounded lifecycle product set. And with that as background, let me turn the call over to Jim. Jim?

[James Mikolaichik:]

Thank you, Patrick, and thank you, everyone for joining us today. Hopefully you've had an opportunity to review our earnings results which were released yesterday after market close. I'll take you through the financial highlights before opening the call to Q&A and as in prior quarters, some of my comments will include references to non-GAAP financial measures, but full GAAP reconciliations can be found in the earnings release and in related SEC filings. Starting with assets under management and client cash flows, we ended the quarter with $43.1 billion in assets under management, a decrease of $2.5 billion or 5.5% from March 31. The decrease included net client outflows of $2.8 billion, offset by approximately $300 million of market appreciation and when compared to the second quarter of 2014, AUM has decreased by approximately $11 billion or 20%. Gross inflows for the second quarter were just under $1.6 billion, down from the $2.1 billion of client inflows we averaged over the past eight quarters and gross client outflows, were $4.4 billion for the quarter. $2.7 billion of the outflows were attributable to our U.S. and non-U.S. equity products, primarily as a result of continued performance pressure. Our mutual fund and collective trust products had net outflows of approximately $1.7 billion for the quarter, with $1 billion of gross client inflows offset by $2.7 billion of outflows. And by portfolio, $1.4 billion of the outflows from our mutual fund and collective trust came from U.S. and non-U.S. equity products, while we had approximately $330 million of net outflows from our lifecycle products for the quarter. In our separate accounts, gross client inflows of $560 million were offset by $1.7 billion of outflows, resulting in net client outflows of approximately $1.1 billion for the quarter and our rolling 12-month retention rate remains at 93%. Blended asset strategies continue to represent more than half of our total AUM and gross client inflows into our blended assets were approximately $1 billion for the second quarter in line with the $1.1 billion we’ve averaged over the past eight quarters. And our non-U.S. equity products represent approximately 25% of our total AUM, down from 35% at this time last year due to net client outflows and market depreciation we have experienced over the last few quarters. U.S. equity strategies remain at approximately 15% of our AUM in line with prior period. Moving to our second quarter financial results, we reported revenue of $87 million for the quarter, down 16% from the second quarter of 2014 and down 4% from last quarter. The changes in revenue are resulting from decreases in average AUM compared to prior periods and from a reduction in the average revenue margin on our mutual fund and collective trust products. The revenue margin on our mutual funds and collective trust was 83 basis points in the quarter, down from 85 basis points in the first quarter and 87 basis points at this time last year. The decrease is attributable to changing business mix of our mutual fund and collective trust with outflows predominantly from our higher fee U.S. and non-U.S. equity funds. However, overall revenue margins of 77 basis points in the quarter are down only slightly from 78 basis points reported both last quarter and Q2 2014. Operating expenses were $53.2 million in the quarter, an increase of 1% and a decrease of 13% compared to last quarter and second quarter of 2014 respectively. Compensation related cost for the quarter were $28.3 million, an increase of $1.5 million or 6% since last quarter. The increase was a result of stock-based compensation expense on equity awards we issued during the quarter. And for the quarter compensation related cost represented 33% of revenue or 30% if excluding stock-based compensation and compared to the second quarter last year, compensation related cost have decreased by $4.6 million as a result in reductions in variable incentive comp caused by a net client outflows in absolute and relative performance through June 30. Distribution, servicing and custody expenses including sub-transfer agencies and 12b-1 expenses associated with our mutual fund and collective trust offerings have decreased by $1 million when compared to last quarter and by $4.1 million since the second quarter of 2014, which is consistent with the changes in average mutual fund and collective trust assets. Other operating costs of $9 million increased by 1% compared to last quarter and by $470,000 or 5% compared to this time last year. And other operating costs were approximately 10% of revenue for the quarter, which is consistent with what we had previously communicated given that we continue to invest in the business. And our non-operating losses were $1.5 million in the quarter compared to non-operating income of $750,000 during the first quarter. Turning to our operating results, we reported pretax income for the quarter of $32.3 million, a 16% decrease from the first quarter and down 26% from the second quarter of 2014 and economic net income was $20.3 million or $0.24 per adjusted share and we recorded economic net income per adjusted share of $0.28 last quarter and $0.30 for the second quarter of 2014. With that I’ll summarize the mid year results, revenues were $177.4 million down from last year's revenue of $202.3 million and year-to-date revenue margins of 77 basis points are down slightly from 78 basis points reported at this time last year. Operating expenses decreased $11.9 million to $105.8 million in 2015. Approximately 65% of the decrease or $7.6 million is related to compensation related cost and specifically variable incentive compensation. Distribution, servicing and custody expenses decreased by $5.7 million from last year, while other operating expenses increased by $1.5 million and non-operating losses were approximately 750,000 for the six months ended June 30 compared to non-operating income of $3.3 million in 2014. This resulted in year-to-date 2015 pretax income of $70.9 million compared to $88 million this time last year and our economic income margin is 40% for the six months ended June 30 compared to 43.5% last year and economic net income per adjusted share was $0.52 for the six months ended June 30 compared to $0.61 per adjusted share this time last year. As you’ll recall, last quarter we completed the 2014 vesting process by repurchasing and subsequently retiring $2.5 million Class A units of Manning & Napier Group. Subsequently during April, we issued approximately $1.3 million restricted stock and restricted stock unit awards as part of our long term incentive plan. After these transactions were completed our adjusted shares outstanding have decreased from approximately $88.1 million at December 31 to $83.8 million and with respect to the balance sheet, we continue to maintain a debt free capital structure with a cash balance of $95.7 million and approximately $34 million invested in seeded products as of June 30. As you are aware, Manning & Napier Group distributed $31.3 million in cash to its members for the quarter. This distribution resulted in a quarterly dividend of $0.16 per share, which is consistent with the quarterly dividend that we have provided to shareholders in prior periods. That concludes my formal remarks and I'll now turn the call back over to the operator and we look forward to your questions.

[Operator:]

[Operator Instructions] Thank you. Our first question is coming from Ken Worthington of JPMorgan.

[Ken Worthington:]

Hi good morning. Maybe first in light of performance, can you share with us anything you can in terms of maybe you've won and haven't yet funded or possibly redemptions that you’ve been made aware of that didn’t hit this quarter?

[Patrick Cunningham:]

Yes, good morning, Ken. As far as the pipeline is concerned I would say that the pipeline we have lots of opportunities. We -- as Jim mentioned, we closed the inflows in the quarter with $1.5 billion that's less than it has been in prior quarters of about $2 billion and frankly that's been a result of the performance that we saw in the prior three quarters to this quarter. So that is having some impact, but we still maintain a healthy activity level in terms of new business.

[Ken Worthington:]

Okay. Revenue was under some pressure this quarter, it looks like it probably will be under further the next quarter, what does this mean for compensation? It obviously ratcheted down, how much flexibility I guess do you continue to have in or willing to use there to kind of protect margins and then on the non-comp side, how much flexibility do you have there?

[James Mikolaichik:]

Yes, Ken, the analysts comp and the sales incentive comp, variable comp does flex reasonably in line with the assets under management because both of them are based on revenues essentially and a percentage of revenues in terms of the variable comp. So there is a direct correlation between those. The analyst comp, which is a little bit more variable also its tied obviously to performance that we've talked about on many occasions and that ebbs and flows with absolute performance and relative performance being triggers and has the one, two and three-year metric in there. So you saw a comp come down the past few quarter as a result of negative performance meaning negative absolute and also negative relative performance. It ticked back up a little bit this quarter due to the fact that we had a pretty good quarter on an absolute and relative return basis, which we were happy to see and happy to pay people on. So I think we're going to continue and I know we're going to continue the compensation model that we have in some form on those specific comp areas. The non-sales non-research folks, we have done a little bit of trimming in terms of compensation on that side largely through attrition and just reorganization in areas that we had been hiring into on the infrastructure side or administrative side. So we do have some ability to make some moves there as we move forward and we have done so, but it's not wholesale. We know that we’ll come out the other side of this and so we're not making drastic moves. On the other operating costs, the sub-TA really just runs in concert with the mutual funds assets so again it’s a direct tie to the mutual fund move. So we have seen that come down reasonably in line with AUM and another operating expenses while we've not gone out of our way to start new projects I did say that we're going to finish the things that we’re working on and we’re going to make sure that we're still supporting the front office function with the portfolio of systems and tools that we’re putting in place as well as the sales systems. So that may stay elevated for a little while, but then come back in line as we move forward.

[Ken Worthington:]

Okay. Great. Last question just how are the equity portfolios positioned for the next six months? What are the bets that you’re making and what are the things that you’re betting on and not betting on?

[Patrick Cunningham:]

Sure, the primary positions in the equity portfolio I’ll talk about U.S. equity primarily, but this is also somewhat true in the non-U.S. are consumers stocks particularly media and also technology stocks. So those are the two over-weights and you call it a bet, we call - these are -- we buy these stocks, individual stock by stock that meets our criteria and our pricing disciplines, but those are where the bottom up process has positioned the portfolio and the greatest over-weights.

[Ken Worthington:]

Okay. Great. Thank you.

[Operator:]

Our next question comes from the line of Michael Kim of Sandler O’Neill.

[Andrew Disdier:]

Hey guys. Good morning. This is actually Andrew Disdier sitting in for Michael. So first I understand your commitment to active management, but just given the ongoing demand for ETFs really curious to get your thoughts on potentially partnering with a third party firm to come to market with an actively managed ETF vehicle.

[Patrick Cunningham:]

Good morning, Andrew, we have products that are actively managed ETF products using third party ETFs. We have them in place for five years or so. We also have what we call goal life cycle funds and these are once again all based on using ETFs and an active asset allocation strategy. So we have embraced that, obviously some clients are more interested in a fee sensitive type of product and in a passive product, but we believe that our active asset allocation experience and the resources that we have devoted to that will allow when the opportunities present themselves to us allow us to take advantage of that.

[Andrew Disdier:]

Okay. Thanks for clarifying and maybe to piggyback off of Ken’s question, I understand there is a number of moving parts as it relates to the comp ratio line, but just assuming both absolute and relative returns are flat over the next year, how would the comp ratio trend over the next few quarters relative to the 32.5% and 33% ratio we saw this past quarter.

[James Mikolaichik:]

It's tough to say precisely as you pointed out with the number of moving pieces, but I think it largely should come down some and if you take this stock-based comp that was issued, which was basically a reissuance in some fashion of the unvested shares that we bought back at a preferred rate and provided to up and coming talent in the firm. It has come down and I would assume that if you don’t have absolute returns or relative returns going forward you would continue to see that ratio come down. It may trail the revenue drop because that was maybe slightly faster and we did have some outperformance in Q2, but if you start to roll off 2013, which is a tremendous up year and an outperformance year for us in [indiscernible] market that moves back in the calculation you should see it start to come back down.

[Andrew Disdier:]

Great. Thank you. And then just finally, I am just wondering if you could give us an update on your initiative to broaden distribution reach here in the U.S. in terms of both the direct channel as well as the broker dealer in 401-K platforms.

[Patrick Cunningham:]

Sure, we continue to have - add representatives, we have compared to the end of last year, we've added an additional two representatives as of June 30 to our direct and IVG sales team. And so we were doing that opportunistically and when I say opportunistically, we're looking to increase our representation particularly West of the Mississippi, but if we find because our sales reps are also the service representatives and they service their accounts independently by and large because of the regional direct reps, they have to be able to have look and act like an analyst but at the same time have the good, good sales people good consultative sales people, and so when we find someone who fits that bill, we will generally find a place for them to represent the firm regardless of location. Yes, we're continuing to, I would say, in a measured fashion, to increase our distribution exposure.

[Andrew Disdier:]

Great. Thanks for taking our question

[Patrick Cunningham:]

Thank you.

[Operator:]

Our next question comes from the line of Steven Schwartz of Raymond James.

[Steven Schwartz:]

Hey good morning, everybody. A couple first, Patrick maybe you could talk about the blended asset portfolios. I noticed outflows there relatively high versus your history yet. As you pointed out, your performance in that area has been pretty good. So maybe you could talk about what’s going on there.

[Patrick Cunningham:]

Sure. The performance has weekend somewhat. They are not in the top ranks in the shorter time periods and I think there are clients who have started with us in recent years, so if you started with us in recent years like last three years, you got the third-quarter of 2011 plus the last quarter of 2014 and the first quarter of 2015. And so I think there is some pressure on some of the planned relationships that are shorter term and that’s what's impacting primarily the outflows. The clients who have been with us for longer time periods have experienced this type of performance pattern in the past and they know that when we go through periods like this it's typically followed by some good strong performance and I think those clients are certainly being patient about it. I think some of the shorter term clients have been less patient.

[Steven Schwartz:]

Okay. And then continuing on, just I know a lot of the bundled asset goes to pension funds and the like, I asked this last quarter, it was too early, but do you have any thoughts on the DOL proposal?

[Patrick Cunningham:]

Yes, the DOL proposal as you know it’s getting tremendous activity, but the last I saw there were 400,000 letters or emails that have already gone to the DOL. They're having their hearing on August 10, and then thereafter there will be a 30-day public comment period. So we're going to comment during that period. I think it’s a -- there is a lot of obvious, there is a lot activity going on around that. Right now it’s difficult for me to see what aspects of that might be positives for our business and which aspects might be negative, but we’re certainly -- we're going to keep track of that and as that becomes more clear, we'll be -- Steven will be able to talk definitely about how we think it impacts our business.

[Steven Schwartz:]

Okay. And then one for Jim, Jim could you walk us through the calculations, the extra one point, I think its $1.4 million on the incentive comp, how that went from 0.5 to 1.9?

[James Mikolaichik:]

Yeah, so you’re talking about the stock grants. So, those in my last comment in the formal remarks, we had approximately 2.5 million shares or units that were legacy units and as you know we’re carrying a non-cash GAAP charge that we removed from our adjusted basis because there are preexisting shares coming into the offering that were going to reinvest over a three-year period and 2.5 did not end of vesting and so we bought those back I think it rate of about $0.50 per share at a book value. Part of that process was with our Compensation Committee was to find with half of those shares about $1.3 million to find up in eCommerce in the firm and basically, they moved from legacy shareholders more seasoned and senior folks to some of our younger folks and as a result that comp charge came through -- started coming through in the second quarter. So what you’re also seeing is this is the third year of our long term incentive plan essentially layering in. So we’ve had restricted stock unit grants in each of the last couple years and they will start to roll off starting next year. So this was in essence a full loading now on three year vesting periods to basically put that into the comp structure. So, you’re actually witnessing it for the first time in this quarter because of somewhat we do with the vesting and just the third trench.

[Steven Schwartz:]

Okay. How should we think about this that expense going forward?

[James Mikolaichik:]

I would think that it’s a little bit -- also a little bit more episodic. We do still treat our equity grants more as a partnership concept than a steady just granting process, but I would expect that we would continue to have equity grants in some meaningful way coming through the compensation structure because we've always believed in that partnership process. Will it be as large as they were this year? I would think probably not, but I think we'll still have equity grants as we move forward. This was more a case of the unvested equity in some fashion having some reallocation to it and whereas we move forward, we will have new equity grants that are likely to not be as wide spread.

[Steven Schwartz:]

Okay. What I am getting at is I guess the sanction that you took this quarter, this is reflected one-time in expense or this continues on?

[James Mikolaichik:]

It continues on.

[Steven Schwartz:]

Okay, all right. Thank you.

[James Mikolaichik:]

And what I am saying is you just may not see as large of a one-time grant. When we move to next year, you'll see something similar to what we had in prior years possibly.

[Steven Schwartz:]

Okay. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from the line of Adam Beatty of Bank of America Merrill Lynch.

[Adam Beatty:]

Thank you and good morning. Wanted to ask about some of the reorganization that you did in the research department with Ebrahim's new role etcetera and that's had a good confluence with some improved performance. Is that playing out the way you expected and have you considered any further changes or tweaking? Thanks very much.

[Patrick Cunningham:]

Sure. Good morning. Just to put a little bit of history in place, we experienced a bad third quarter last year and that was a result of not having gotten out of our energy position. It was fast enough and efficiently and when that happened in the fourth quarter, I actually the process was that I asked Ebrahim who as you know started with us in 1988 at a college. He stayed with us until 2001. He was the Co-director of research at that time. So he had experience in management and went on to management roles in other locations and then came back to us in 2011. And I thought he was the ideal person to our strategies. They’re part of his -- in his veins. He knows many of you very well and at the same time he ran the process for a period of time. So I sent an email to all of research saying that based on that performance in the third quarter I’ve asked Ebrahim to sit down and to look at all aspects of research to see where we might have some execution issues. He did that. We had -- that started at the end of the fourth quarter and extended into the first quarter and he was involved in all of the performance reviews for the analysts in the first part of the first quarter and so he was a license to ask any question that he wanted to. And in conjunction with the existing Co-Director’s research, they identified the areas that we felt where we had some execution problems. Probably the simplest way to put it was that we were asking the team that was making the decisions on all of the portfolios, all of the core portfolios the U.S. the non-U.S., the multi-asset class portfolios was a team of eight or nine people that had grown over time. And one of the primary conclusions was that these people were spread too thin and we needed to focus we needed to reduce the number of people for making these decisions meaning voting on the stocks and because we had well over 150 securities that were in all the portfolios combined. So what we did was we said okay we’re going to identify four people who are going to be the core team for our U.S. equity portfolios, four people who will be the core team for our non-U.S. equity portfolios, four people who will be the core team for our multi-asset class and goal portfolios. And that’s what we implemented. So that there will be more robust conversation, more debates, more challenging the underlying -- well how well the stock fit the strategies. And I can tell you I've been in dozens of meetings where for each of these core groups and I was at one yesterday in that we -- I believe that the quality of the outcomes is higher. I’m very pleased frankly with the way it has progressed so far. Are there going to be tweaks to it? I think there will always be tweaks to what we do. We have -- we regularly -- we have missed opportunity meetings, we have where we say hey we could have owned that stock, why didn’t we own it? It could have fit one of our strategies. Why didn’t we identify it? We obviously look at the securities in the portfolio that aren’t progressing and asking what do we do wrong here. So it’s a constant I would say introspection process that I think once again we have done this before whenever we've underperformed the market for whatever reason and we take it to the degree we have and when as an active manager and you know we’re very active. We have very active share 85 to 95 high active share typically across our portfolios. We don't beat the benchmark by 30 basis points or trail it 25 basis points. It’s usually much broader than that and that’s why historically we’ve been able to outperform coming out of periods like this. But to answer your question, which was am I pleased with the way things are progressing? Absolutely. Do I think that we’re going to be tweaking along the way? Probably. We have no plans right now, but we’re going to try to make sure that we have the best execution with the best people.

[Adam Beatty:]

Thank you. It sounds like good progress. And then just a follow-up, bit of a hybrid question on the macro environment, I know your process is primarily bottom up driven, but question on how your process incorporates events and potential risks in places like China or Greece and how that's affected your actual positioning at this point? Thanks.

[Patrick Cunningham:]

You know back decades since we see crisis around 9/11 right, we go back almost every few years there’s something that happens that shocks the markets. We view those as opportunities frankly. Volatility is our friend. When you have kind of a market that where all stocks are moving up and moving up gradually, there’s not the same type of opportunity for an opportunistic manager like we are. So those are -- if you buy a good company and you buy it when it's undervalued, when the market gets shocked, two things happen. Number one, the company typically doesn’t go down as much as the market does and if you look at our history, particularly in 2008, look at our multi-asset class portfolios, the drive-down was significantly less than our competitors and were back home within six months, whereas some took up to a couple of years to get back. So that, if you buy undervalued it doesn’t go down and it typically comes back faster. So volatility and global shocks are part of the current environment and frankly I think that while it may cause short term volatility, it ultimately is an opportunity for us and our clients.

[Adam Beatty:]

Makes sense. Thank you for taking my questions.

[Patrick Cunningham:]

Thank you.

[Operator:]

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