Manning & Napier, Inc.
Q4 2015 Earnings Call Transcript

Published: 4 Feb 2016

[Operator:]

Good morning. My name is Christy and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Manning & Napier Fourth Quarter and Fiscal Year 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 11 a.m. Eastern Standard Time. The dial-in number is [phone] and enter Pin Number 24801340. At this time, all participants have been placed in 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, Kristy, and thank you everyone for joining us today to discuss Manning & Napier's fourth 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, allow me to introduce our Chief Executive Officer, Patrick Cunningham. Patrick?

[Patrick Cunningham:]

Thank you, Scott. Good morning and thank you all for joining us. For today's call, I'm going to give some brief comments on what we have accomplished in calendar year 2015 and the outlook of our priorities for 2016. Jim will provide you with details on flows and financials and then we'll open the call up for questions. Let's start with a recap of 2015. We took several steps over the last 12 months to enhance our product set and investment performance. Our game plan was twofold and included actions to strengthen our existing research capabilities while also diversifying these capabilities by adding new distinct research teams. At the end of the first quarter, we appointed a new Director of Investments and reduced the size of the portfolio management teams for several of our long-tenured all cap equity and multi-asset class strategies to increase focus and accountability and to sharpen decision making. These changes resulted in adjustments to our portfolios and we continue to monitor the impact of these decisions. It is worth noting however, that 2015 was a challenging year for equity investors with most major indices experiencing losses or only modest positive returns. In general, our investment returns were mixed for the quarter and lag for the year. Beyond the internal changes in the fourth quarter of last year, we announced our intent to acquire a majority interest in Rainier Investment Management, an active manager focused on capitalization-based equity strategies. Once the transaction is closed likely in the second quarter of this year, Rainier will be an independent subsidiary of Manning & Napier with their research teams operating independently of ours. This transaction will allow our sales team to gain access to additional products, including a five-star international small cap mutual fund and several capitalization-based U.S. equity funds. The U.S based funds in particular should be attractive in the defined contribution space where style and cap-based products are often the foundation of our participant menu and are also considered by advisors and consultants when building custom glide pass. The transaction also extends our geographic presence to the West Coast given Rainier Seattle headquarters. The work we completed in 2015 with respect to strengthening our internal research team and bringing on complimentary independent teams and products puts us in a better position going forward with respect to equity product diversification. As you know, our multi-asset class strategies are the building blocks of our firm and where we started back in 1970. These strategies continue to show long-term value aided track records that are highly differentiated within the defined contribution market as well as in advisor and high network channels. Multi-asset class products contributed the most to our inflows during 2015. I'm also happy to report an uptick and fixed income interest towards the end of 2015 and early on in 2016. We've had several more consultative opportunities that allow us to work with organizations on improving returns in a continued low-rate environment. We're early on in these conversations, but I am optimistic about the nature of these prospects. Looking ahead, we will continue our focus in 2016 on servicing clients in our long-tenured equity products and where our short intermediate term track records remain challenged. Last quarter I pointed out that nearly 80% of our current AUM is invested with us through separate accounts or funds where our sales reps have a direct relationship with the decision maker. This direct relationship has been and should continue to be advantage as we deliver our service message. From a new business standpoint, we will be focusing our sales efforts on products with competitive short and long-term track records such as our unconstrained bond and global quality equity strategy and once the transaction is complete, a five-star international small cap mutual fund managed by Rainier. In addition, our real estate, our emerging market and disciplined value equity mutual funds all ended the year with top quartile rankings. That as a background, let me now pass the call over to Jim to review our financials. 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 our earnings release and related SEC filings. Beginning with assets under management and client cash flows, we ended the fourth quarter with $35.4 billion in assets under management, a decrease of $1.7 billion or 4.7% from September 30. The decrease included net client outflows of $2.9 billion offset in part by $1.2 billion of market appreciation. And when compared to the fourth quarter of 2014, AUM has decreased by approximately $12.4 billion or 26%. Gross inflows for the quarter were $1.3 billion, down from $1.8 billion we reported last quarter and gross client outflows were $4.3 billion for the quarter, a modest improvement from the $4.4 billion reported last quarter. And by portfolio, we experienced $1.8 billion of outflows from our balanced portfolio, $2.3 billion from our equity portfolio and approximately $100 million from our fixed income products. Our mutual fund and collective trust products had net outflows of approximately $1.5 billion for the quarter with $1 billion of gross client inflows offset by $2.4 billion of outflows. And in our separate accounts, gross client inflows of approximately $390 million were offset by $1.8 billion of outflows, resulting in net client outflows of approximately $1.4 billion for the quarter and our rolling 12 month retention rate is 88.8%. Our multi-asset class strategies contribute to 60% of our AUM or $22.4 billion and these strategies continue to provide asset flow for the firm with $4.3 billion of gross client inflows during the year or 65% of the total gross inflows of $6.7 billion. Now U.S. and non-U.S. equity strategies now constitute 33% of our total assets with the remaining 3% invested in our fixed income products. Turning to our fourth quarter financial results, we reported revenue of $72.5 million for the quarter down 26% from the fourth quarter of 2014 and 7% from last quarter. The changes in revenue are resulting from decreases in average AUM compared to prior periods and overall revenue margins of 77 basis points in the quarter are consistent with last quarter, but down slightly from 79 basis points reported this time last year. Operating expenses were $46.3 million in the quarter, a decrease of 2% and 16% compared to the last quarter and the fourth quarter of 2014 respectively. Compensation and related costs for the quarter were $24.4 million, a decrease of 1% since last quarter and 7% from the fourth quarter of last year as a result of reduced incentive compensation due to lower revenue and client asset base compared to prior periods. Distribution, servicing and custody expenses including sub transfer agent fees and 12b-1 expenses associated with our mutual fund and collective trust offerings have decreased by approximately $1 million when compared to last quarter and by $6.1 million compared to the fourth quarter of 2014, which is consistent with the changes in average mutual fund and collective trust assets for their respective periods. Distribution expenses were approximately 32 basis points of mutual funds and collective trust average assets for the quarter in line with prior periods. And other operating expenses continue to be approximately $9 million per quarter. Turning to our operating results, we reported pretax income for the quarter of $26 million, a 5% increase from last quarter, but down 40% from the fourth quarter of 2014. And economic net income was $16.4 million or $0.20 per adjusted share and we reported economic net income per adjusted share of $0.21 last quarter and $0.30 this time last year. With that I'll summarize the full year results. Revenues were $327.8 million, which is a decrease of 19% compared to last year’s revenue of $405.5 million and our revenue margin for the year was 77 basis points compared to 79 basis points in 2014. The change in our revenue margin was as a result of a decrease in our non-U.S. equity mutual fund assets and overall changes in our business mix during the year. Operating expenses decreased 14% or $33.1 million to $199.3 million in 2015. Approximately $18 million of the decrease was as a result of a decrease in distribution, servicing and custody expenses, which was in line with the changes in mutual fund and collective trust assets. In addition, compensation and related cost decreased by approximately $50 million compared to 2014 and the decline was primarily attributable to reduced incentive compensation stemming from lower assets under management and performance headwinds throughout the year. We had non-operating loss of $7 million for 2015 compared to non-operating income of $1.9 million in 2014. The loss in 2015 was primarily attributable to net investment losses of $4.4 million and a onetime expense of $2.8 million related to amounts payable under our tax receivable agreement resulting from expected future tax benefits recognized during the year. This resulted in 2015 economic income of $121.6 million down 31% from $175 million in 2014 and our economic income margin is 37.1% for the 12 months ended December 31, 2015, compared to 43.2% this time last year. And economic net income for adjusted share was $0.92 for the 12 months ended December 31 compared to $1.22 per adjusted share last year. Now as of December 31, 2015, our adjusted share counts stood at $83.7 million adjusted shares with the Management Team continuing to own approximately 10% of the company. And with respect to the balance sheet, we continue to maintain a debt free capital structure with the cash balance of $118 million and approximately $30 million invested in seeded products as of December 31. Now as you're aware during the quarter, we declared a $0.16 per share dividend to our Class A shareholders. That concludes the formal remarks and I'll now turn the call back over to the operator and we look forward to your questions. Christy?

[Operator:]

Thank you. The floor is now open for questions. [Operator Instructions] Thank you. Your first question is coming from Adam Beatty of Bank of America.

[Adam Beatty:]

Thank you and good morning. Just wanted to get your thoughts on the liner integration and some initial response maybe from your clients or their clients and what you might expect in terms of some attrition in terms of the AUM? Thank you.

[Patrick Cunningham:]

Good morning, Adam. So far it's been well received by the client basis on both sides. So when you ask about attrition we mean clients -- we’ve heard nothing on their end other than positive remarks regarding how their clients are perceiving this. And because this will be a separate investment team based in Seattle, there will be -- we’re not going to be utilizing any of their products within our products. They’re going to be largely autonomous. They will work -- it will be a subsidiary that will operate with the exception of perhaps some mutual funds with co-brand they will continue to upgrade under their existing brand. We think it’s obviously a good transaction because there is not overlap in terms of our product set. We’re an all cap manager, a multi-asset class manager, they’re a predominantly capitalization and style based manager and so we think that it's going to give us opportunities in the defined contribution space where those type of mandates are much more prevalent. And we also have a very robust as you know distribution force in the DC space and this will give our reps more ammunition to go out there and sell. So we think it’s a -- we think it’s obviously good match between the two organizations and we believe they have an international small cap product that has very little assets in it. Relatively speaking that will be a big benefit to our intermediary distribution group as well as our institutional sales reps.

[Adam Beatty:]

Thank you, Patrick. It sounds like a positive tone and then just to follow-up on the defined contribution space, obviously you haven’t necessarily come to market with renew yet, but maybe give us an update on the efforts there? Thank you.

[Patrick Cunningham:]

Sure. We have when you say I could talk about the distribution force briefly, we have over 20 direct sales reps who are calling on sponsors around the country. We have five external wholesalers dedicated to the DCIO space and two internal wholesalers who are dedicated to that space. So everyday day in and day out, they're calling on intermediaries who are -- have control over menus for defined contribution space. We've additional teams that work -- our portfolio strategies group has specialists in lifecycle space who call on both consultants who specialize in the DC space and we also have several individuals who are marketing to the platforms directly to the record keepers and administrators directly. So I said, we've been -- we were considered pioneers in lifecycle. We've been marketing lifecycle products since the 80s into DC space and so it's a very important part of our history and a very important part of our future.

[Adam Beatty:]

In terms of platforms going to open, architecture has there been more opportunity there?

[Patrick Cunningham:]

Yes. As we've talked about in prior calls, the scrutiny that's been placed on lifecycle funds by regulators and by politicians dating back five years now or so or even longer has -- it used to be that it was the record keeper and as you know it's Vanguard, Fidelity and [Hero] who are the major record keepers in most of that space, they have the largest market share. It used to be that the lifecycle fund was again -- and it was embedded into the pricing of the service as well. Now that the whole record keeping pricing has opened to full disclosure and now that the advisors have to put as much scrutiny, if not more scrutiny on the lifecycle funds because they are the QDIA. They're getting the lion's share of the assets. So we believe that that bodes well for firms like us who are DCIO specialists and have a long tenure track record in the space.

[Adam Beatty:]

Thank you, Patrick. Appreciate the color. Thanks for taking my questions.

[Patrick Cunningham:]

Thank you, Adam.

[Operator:]

Thank you. Your next question comes from Michael Kim with Sandler O'Neill.

[Andrew Disdier:]

Hi guys. This is Andrew Disdier sitting in for Mike. Thanks for taking our questions today. So first it's coming up on about a year since you've implemented the changes in terms of the portfolio manager teams and the investment process. So just wondering if you could give us any color as it relates to the performance attribution changes as well as clients willingness to maintain relationships at this point in light of return trends following those changes.

[Patrick Cunningham:]

Sure. Andrew, first of all we appointed Ebrahim Busheri as Director of Investments in March of last year. And it took once the teams were reconstituted and if you recall the major change we made was to give greater focus and accountability meaning that we took what was a team of eight or nine people who were responsible for our U.S. equity, our non-U.S. equity and our multi asset class portfolios. So those individuals who were responsible for all of those portfolios and had to review all of the securities that were being purchased in those portfolios. We've built that up with the three teams of four and each of those teams of four then went on a mission of reviewing every stock in the portfolio and that took months. That doesn’t happen overnight. They were literally working day in and day out to do that and the result was that during that time, some of the securities hit their sell price and were sold. As you know when we buy a stock we establish a buy and a sell pricing before the purchase. So some stock just hit their sell price. Others were voted out of the portfolio because they were not considered as good a strategy fit but all in all we saw a decrease in the -- more of a concentration in the portfolio is pretty much across the Board with our legacy product. So that happened over the course of the second and even into the third quarter of last year. So we've really only had this newly reviewed portfolio in place for now a quarter and a half of so. So I am encouraged. I am confident that the changes we made will improve the execution and the proved execution will result in better performance. It's very hard to predict exactly when that would occur.

[Andrew Disdier:]

Got it. Thanks for the color and then maybe a question for Jim. I know much of the expense base is variable but just given the AUM -- that AUM and revenues continue to decline, has your thinking shifted at all as is relates to investment spending and what might the implications be for margins as we look for next year?

[James Mikolaichik:]

Yeah as you know and mentioned it is variable in terms of much of our competition expense specifically with the sales team and the research team. What you have happening right now is probably bit of a mismatch or a timing element that's coming into play with our margins and we had some downward pressure on the margins given the client asset outflow and corresponding revenue drop mismatched against the way we pay our research team, which is largely absolute return oriented. And we're coming off of a relatively robust multiyear run in the markets and our research team did quite well in '12 and quite well again in '13, which was a very outsized up market. '14 is really where we experienced a bit of downturn as you recall on the investment performance and we’re working through the process that Patrick just mentioned right now. So we're starting to see those absolute returns roll out. We had more difficult markets last year and the beginning of this year has been quite volatile. So as those absolute returns start to push their way out of the compensation structure, which is a three-year rolling period, you should start to see more alignment with the comp structure that would push our margins upwards some. But in the near term, we would likely have some continued contraction just given the fact that we're rolling through those absolute returns and we still had some pressure on the client flows as we hit the beginning of this year. So, we’re not really changing our mind in a dramatic way with respect to investment spending. We're continuing to push forward with the projects that we had on the docket. We are being mindful though of headcount. Our headcount has come down some not through any dramatic moves, but we are allowing attrition to take place and we’re not replacing it as quickly. So we’re mindful of the revenue drop, but we’re also mindful of the fact that we need to continue to spend in this business to deliver the best service and products for our clients.

[Andrew Disdier:]

Great and then just one final question, how are you thinking about the dividend and the payout ratio in the context of a strong balance sheet, but also kind of the ongoing pressure on earnings?

[James Mikolaichik:]

Right, the dividends are quarterly decision with our Board. We've paid $0.16 or better every quarter since going public and we did that again last quarter. Given the flexibility that we have on the balance sheet and also getting further flexibility early last year with an extended line of credit that we raised, we got quite a bit of flexibility we feel and very strong cash flow generative position in our business. We have had the pressure on the revenue side and we just talked to the expenses. So I think we’re going to continue to look and prioritize our spending on the capital side, but we’ve always had an emphasis on capital returns to our partners, when we were a partnership prior to going public and we've continued to do that in the public arena. So I think we’re going to be mindful of the spending and the flexibility, but we have had and would think we would continue to have a desire to return capital to our investors.

[Andrew Disdier:]

Great. Thanks Patrick, thanks Jim.

[Patrick Cunningham:]

Thank you.

[Operator:]

Thank you. Your next question comes from Ken Worthington of JPMorgan.

[Will Cuddy:]

Good morning. This is Will Cuddy standing in for Ken. Sorry. So separate account redemptions have picked up, how does the pipeline look both for sales and for redemptions moving forward?

[Patrick Cunningham:]

Let’s talk about the redemptions or the flows to begin with, we had -- just by the way let me preface out by saying that the net outflows that we saw in 2015 was pretty close to exactly what we expected. We were a little less than we expected, but almost there on. So weren’t surprised on the upside or the downside by that. The mandates that we -- that have been impacted the most throughout the year were our U.S. equity and non-U.S. equity portfolios. That's true in terms of outflows and it's also true in the reduction of inflows that we saw in the fourth quarter. Our multi-asset class, blended asset, lifecycle funds, balance and whatever term you want to use, the legacy products that we have, we have continued to see consistent inflows into those products. For example, the lifecycle mutual funds and collective trust the multi-asset class portfolio saw inflows of around $700 million per quarter last year. So we -- performance as you know get flows and we still have challenges with some of our legacy products in terms of performance. So we suspect that's going to have a negative impact on flows in the short term. I say that -- I do have -- regarding flows I think we are like a typical firm who has $35 billion or $40 billion and has a small institutional sales force where they're working almost exclusively through intermediaries. We have -- I think there are a few things that give me more optimism. First is that this is not the first time we've been through a downturn and performance like this. So we've run this playbook before. Second, most of our assets are still in the multi-asset class accounts. We have asset allocation discussion in addition to the security selection discussion and so there are several ways that you could add value even if one portion of the portfolio either the equity selection, fixed income selection or the asset allocation is not doing optimally. So that's the second. And the last is we have as I mentioned in my comments, we have direct relationships with the majority of the decision makers for our client. So it's -- we have the ability to tell the story and obviously, have been doing that. I think the longer term relationship clients have been very patient, continue to be patient, but we have to turn the performance around and hopefully, that's going to happen relatively soon.

[Will Cuddy:]

Okay. Thank you. And is there additional opportunities to fill the product suite? So we have the acquisition of Rainier. Is there anything else that would be interesting do you think?

[Patrick Cunningham:]

In terms of our organic products, we have our global quality equities is a very strong product. It's got good track record, good performance, unconstrained bond and our real estate funds were just given the five-star rating by Morningstar. And as I mentioned earlier, we're seeing a big uptick in activity in the fixed income space. The disciplined value product is once again it's outperformed last year. It is a -- it's an equity strategy that has lots of appeal. So we have a suite of products that we've -- that we have developed ourselves over the course of the years. In addition, with the Rainier products, I think their international small cap product is a -- it's got about at least somewhere just over $100 million in mutual fund and just a few hundred million total AUM including the separate accounts and that's a product that has billions of capacity and we have a sales force that is very much interested in marketing, now particularly institutionally and also with our intermediary distribution group. For the high net worth marketplace direct, they generally don't -- there is not a great demand for those products; but from an intermediary standpoint and from an institutional standpoint, there is great demand. And we're doing obviously everything we can from a sales standpoint to make sure that these products get all the support from marketing and other support groups to make sure that they are effectively sold in the marketplace.

[Will Cuddy:]

Great. Thank you. Very helpful. Thank you for taking our questions.

[Patrick Cunningham:]

Sure. Thank you.

[Operator:]

[Operator Instructions] Your next question comes from Robert Lee of KBW.

[Andy McLaughlin:]

Hi guys. This is actually Andy McLaughlin standing in for Rob Lee. Two of my questions were asked already, but I was just wondering if you could give any color, any more recent color on Rainier in terms of asset levels, flow levels, kind of what you're expecting over the next year?

[Patrick Cunningham:]

Sure. We've seen -- if you look at their performance, essentially every mandate that they have outperformed last year, outperformed the indices. So that's a positive. They went through a period of redemptions that we obviously were well aware of and wanted to see what we considered to be a leveling out and perhaps a turnaround. So we've seen -- and correct me if I'm wrong, Jim, we've seen positive flows for the past several months with Rainier in general. Is that correct?

[James Mikolaichik:]

Yes. They've essentially leveled out their flow dynamics. The impacts were more in some of the large cap products and their SMid product. But we've started to see a balancing out there and the small cap international product has been positive for several months. So we think the trajectory that they're on, once we get through the transition and the close, I think as was pointed out a little earlier, you'll likely always experience some small asset outflow during the transition process of parties that you don't want to be party to the transaction and would rater wait for it to close and see the integration happen appropriately and make sure that there are no changes. But we expect that we'll be very successful in maintaining the asset base that's there now and as we push forward, we think there are couple of really exciting spots in the international side and U.S. SMid domestic that will be immediate sales and then we'll look to push them to the larger capitalizations as well.

[Andy McLaughlin:]

Okay. Thanks a lot.

[James Mikolaichik:]

Sure. Thank you.

[Operator:]

Your next question comes from Carl-Harry Doirin of Raymond James.

[Carl-Harry Doirin:]

Hey, good morning everyone. Most of my questions have already been answered, but I'll add one more. Pat, you've mentioned that outflow for 2015 was about what you expected. And about a year ago, you've also reduced the size of your research team. And it seems like the team for 2015 was getting smaller before we get bigger. My question is do you see more of that -- should this be the team for 2016? Do you feel like you're at that point where we'll start getting bigger?

[Patrick Cunningham:]

Yes, I just want to make sure that you understand what we did last year. It wasn't a question of small or bigger at all. We had -- it was a question of focus. So we didn't -- we did not have major personnel changes in terms of attrition. We did not slash headcount in research. We just made sure that people's positions were much more well defined and focused and that the group, when you work as a team there are optimal-sized teams and over time, the team that was making the decisions grew to the point. And back when we started in the most optimal-sized teams is somewhere between three and five people and so we wanted to make sure that we had people who could concentrate and focus on the specific mandates that are the that are the legacy mandates for the firm. So we didn't have intentions of getting smaller and we don't have any intentions of getting bigger at this point in time. So it's more a matter of making sure that people's positions were very clear and there was high degree of accountability associated with that and our ability to execute was enhanced and improved. And I believe I've seen that in terms of the composition of the portfolio, we've started to see that in performance and I'm confident that going forward, the changes that we made will be enough to -- are sufficient to get the performance where it needs to be. That said, this always change, we have an 80 person research department and when you have that number of people there are going to be changes and we're going to optimize it. But the major structuring that we think is important that I think is important for future success has already taken place. And just to put clarity on what was said earlier, we have had some reduction in overall headcount, but it wasn’t in the research area and largely not in the sales area. We continue to maintain staff in all of our front office focused areas, but we had some contraction in the headcount in some other areas just acknowledging lower asset base and being mindful of the expense structure versus what we’re doing on the client side. So just to make sure that was rounded out.

[Carl-Harry Doirin:]

Okay. Well, thank you for that.

[Operator:]

Thank you. There are no further questions at this time. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.

[Patrick Cunningham:]

Thank you very much. Have a good day.