Pzena Investment Management, Inc.
Q1 2019 Earnings Call Transcript

Published: 18 Apr 2019

[Operator:]

Good morning, everyone, and welcome to the Pzena Investment Management announces First Quarter 2019 Earnings Conference Call. All participants will be in a listen only mode. [Operator Instructions] Please also note that today's event is being recorded. At this time, I would like to turn the conference call over to Ms. Jessica Doran, Chief Financial Officer. Please go ahead.

[Jessica Doran:]

Thank you, operator. Good morning, and thank you for joining us on the Pzena Investment Management first quarter 2019 earnings call. With me today is our Chief Executive Officer and Co-Chief Investment Officer, Rich Pzena. Our earnings press release contains the financial tables for the periods we will be discussing. If you do not have a copy, it can be obtained in the Investor Relations section on our website at www.pzena.com. Replays of this call will be available for the next two weeks on our website. Before we start, I need to remind you that today’s call may contain forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from today’s comments. Please note that we do not undertake to update such information to reflect the impact of circumstances or events going forward. In addition, please be advised that due to prohibitions on selective disclosures, we do not, as a matter of policy, disclose material that is not public information on our conference calls. Now, let me turn the call over to Rich, who will discuss our current view of the investing environment.

[Rich Pzena:]

Thanks, Jessica. It has been just over 90 days since I last offered some thoughts about opportunity in the markets for a value investor. Last quarter I said the anti-value bias dominating the markets for most of the past decade has lead to passive strategies gathering all the net flows and growth strategies appearing to be the only logical approach in a world dominated by technology and disruptions. It seems to me to be something artificial about speaking to investors or clients for that matter every three months with an expectation that there are brand-new insights that have suddenly appeared to illuminate the cloudiness that is an investor's lot in life. However, here we are at the beginning of the second quarter of the year, and the statement I will make today are not that different from the ones I made just over 90 days ago. The first quarter was one where growth strategies again held sway over value. And yet again, our strategies performed reasonably well in that environment and earned solid returns. With recent history, as primary proof text, the chorus that deep value no longer works is getting louder again. We've heard these refrains before. Prior to this cycle, it was during the Internet boom bust of the late 1990s. I mentioned this similarity to a client recently and they correctly observed that this time the growth stocks in question are earning money. True I said, but that makes it possible to estimate the fair value of these high growth businesses and compare them with the valuations being offered to the more cyclical holdings that dominate our portfolio. And we find that the spread between deep value and high flying is at the second widest point in the last 50 years. Further, just as we found in the late 90s, the deep value stocks are not impaired by heavy financial leverage or other clear threats to their survival. Our portfolios are filled with industry leaders with solid balance sheets, many with attractive growth prospects and representing a wide range of industries and geographies. In other words, it's a good time to be a value investor. And fortunately, April is looking much better so far. Interestingly, while the markets have not yet embraced deep value as the winner, we generated positive net flows again this quarter across each of our distribution channels and now show positive net flows in eight of the last 10 quarters. Further, our pipeline of potential new business remains robust as consultants and prospects have indicated that several of our competitors are drifting away from their value approaches. As an example, one consultant recently described a major global competitor that is buying Netflix for their portfolio. We've seen this movie before and have learned that staying the course reaps significant dividends and we continue to do just that. I'll now turn the call over to Jessica Doran, our Chief Financial Officer, who will provide this quarter's financial update.

[Jessica Doran:]

Thank you, Rich. Our earnings release discloses both GAAP and non-GAAP adjusted financial results. We did not make any non-GAAP adjustments to our results during the first quarters of 2019 or 2018. However, our comparative results for the fourth quarter of last year adjust for certain tax receivable agreement items. We've reported diluted earnings of $0.17 per share for the first quarter compared to non-GAAP diluted earnings of $0.15 per share last quarter and $0.20 per share for the first quarter of last year. Revenues were $37.4 million for the quarter and operating income was $16.2 million. Our operating margin was 43.3% this quarter, decreasing from 52.1% last quarter and from 50.8% in the first quarter of last year. Taking a closer look at our assets under management, we ended the quarter at $37.1 billion, up 11.1% from last quarter, which ended at $33.4 billion and down 1.6% from the first quarter of last year, which ended at $37.7 billion. The increase in assets under management from the fourth quarter of this year was driven by market depreciation of $3.2 billion and net inflows of $0.5 billion. The decrease from the first quarter of last year reflects $2.3 billion in market depreciation partially offset by net inflows of $1.7 billion. At March 31 2019, our assets under management consisted of $13.8 billion in separately managed accounts, $21 billion in sub-advised accounts and $2.3 billion in our Pzena Funds. Compared to last quarter, assets under management across all channels increased with separately managed accounts reflecting $1.1 billion in market depreciation and $0.1 million in net inflows, sub-advised account assets reflecting $1.9 billion in market depreciation and $0.3 billion in net inflows and assets in Pzena Funds being $0.2 billion in market depreciation and $0.1 billion in net inflows. Average assets under management for the first quarter of 2019 remained unchanged from last quarter at $36.1 billion, but were down 7% from the first quarter of last year. Revenues increased 2.8% from last quarter and decreased 4.7% from the first quarter of last year. The increase from last quarter reflects an increase in weighted average fee rates and the decrease from the first quarter of last year primarily reflects a decrease in average assets under management. During the quarter, we recognized $0.4 million of performance fees on our sub-advised accounts. Our weighted average fee rate was 41.4 basis points for the quarter compared to 40.4 basis points last quarter and 40.5 basis points for the first quarter of last year. Asset mix continues to be the most significant factor in our overall weighted average fee rate, although swings in performance fee and fulcrum fees also contribute. Our weighted average fee rate for separately managed accounts was 55 basis points for the quarter compared to 54.1 basis points last quarter and 53.4 basis points for the first quarter of last year. The increase from the fourth and first quarters of 2018 reflects some increase in assets in non-U.S. strategies that generally carry higher fee rates. Our weighted average fee rate for sub-advised accounts was 29.5 basis points for the quarter compared to 28.9 basis points last quarter, and 30 basis points for the first quarter of last year. The increase from last quarter reflects an increase in assets in non-U.S. strategies that generally carry higher fee rates, while the decrease from the first quarter of 2018 reflects the decrease in performance fees recognized during the quarter, partially offset by the increase in assets in non-U.S. strategies. In addition, the weighted average fee rates for the quarter reflects the reduction in base fees of certain accounts related to fulcrum fee arrangements of one client relationship. These fee arrangements require a reduction in the base fee if the investment strategy underperform its relevant benchmark or allows for our performance fee as the strategy outperforms its benchmark. During the first quarter of 2019 and fourth quarter of 2018, we've recognized a $0.3 million and $0.2 million reduction in base fees, respectively related to one client account. A reduction in base fees was not recognized during the first quarter of 2018. These fees are calculated quarterly and compare relative performance over a three-year measurement period. To the extent that three year performance record of this account fluctuates relative to its relevant benchmark, the amount of base fees recognized may vary. Our weighted average fee rate for Pzena funds was 67.9 basis points for the quarter, increasing from 64.4 basis points last quarter and from 59.9 basis points for the first quarter of last year. The increase from the fourth and first quarters of 2018 reflects a decrease in fund expense cap reimbursements recognized during the first quarter of 2019. These fund expense cap reimbursements are presented net against revenue. The remainder of the increase from the fourth and first quarters of 2018 reflects an increase in assets and products that generally carry higher fee rates. Looking at operating expenses, our compensation and benefits expense was $17.2 million for the quarter, increasing from $13.9 million last quarter and from $16.2 million for the first quarter of last year. First quarter 2019 and 2018 compensation rates include expenses associated with tax payments and our employee profit sharing and savings plan, which generally do not recur during the year. The remainder of the increase from last quarter and the first quarter of last year reflects an increase in compensation rates. G&A expenses were $4 million for the first quarter of 2019 compared to $3.5 million last quarter, and $3.2 million for the first quarter of last year. Fluctuations were primarily driven by changes in the level of professional fees recognized during the period. The increase from the first quarter of last year also reflects an increase in data and systems expenses. Non-GAAP other income was $1.7 million for the quarter, driven primarily by the performance of our investments. The effective rate for our unincorporated and other business taxes was 3.9% this quarter compared to 4.8% last quarter and 3.7% in the first quarter of last year. We expect the effective rate associated with unincorporated and other business taxes of our operating company to be between 3% and 5% on an ongoing basis. Our effective tax rate for our corporate income taxes, ex-UBT and other business taxes, was 30.6% this quarter compared to our non-GAAP effective tax rate of 26.3% last quarter and 29.4% for the first quarter of last year. The fluctuation in these effective rates reflect tax benefits and expenses from employee share and unit issuances investing, and a onetime adjustment to our deferred tax assets and liabilities. We expect this rate, excluding these items, to be between 23% and 25% on an ongoing basis. The allocation to the nonpublic members of our operating company was approximately 74.1% of the operating company's net income for the first quarter of 2019 compared to 74.8% last quarter and 73.9% for the first quarter of last year. The variance in these percentages is a result of changes in our ownership interest in the operating company. During the quarter, through our stock buyback program, we've repurchased and retired approximately 629,000 shares of Class A common stock and Class B units for $5.3 million. At March 31, there was approximately $21.3 million remaining in the repurchase program. At quarter end, our financial position remains strong with $14.7 million in cash and cash equivalents as well as $15.6 million in short-term investments. We declared a $0.03 per share of quarterly dividend last night. Thank you for joining us. We'd now be happy to take any questions.

[Operator:]

[Operator Instructions] And our first question today comes from Ken Worthington from J.P. Morgan. Please go ahead with your question.

[William Cuddy:]

It's Will Cuddy filling in for Ken. Rich, thank you for the commentary on deep value. When you look at your different sectors, what areas do you think have the most attractive investment profiles at this time?

[Rich Pzena:]

There's a number of factors. First, and this we've been saying this probably for 10 years, so maybe it sounds old. Its financial services, the big banking franchises continue to produce spectacular returns and are not fairly valued in the marketplace. So we can maintain a large exposure there. But I can say that's true in some of the big asset management franchises as well, as well as some of the insurance company franchises. So financial services is a big component. Second, I would say are more cyclical sectors. In energy, we're particularly focused in oilfield services way more so than in oil. And that's been a shift over the last couple of years. As we believe that the industry is not spending enough in aggregate to support the demand that we see globally, and feel like there's big upside here, and keep going on and on. There is industrial cyclicals and consumer cyclicals. They all tend to have a cyclical orientation. But that's -- and it's not surprising given the market fears about an economic downturn. Interestingly, when you look at historical performance records of these kinds of factors, they tend to bottom somewhere between 12 and 18 months prior to recessions because that's when the fear gets the highest, and we clearly saw that capitulation in the fourth quarter of last year, and really continued somewhat into the first quarter, and now that seems to be reversing a little bit, but that's where we're exposed.

[William Cuddy:]

So another good quarter for flows. And I know you've been investing in financial intermediary distribution. Can you maybe elaborate on where the sources of the flows are coming from?

[Rich Pzena:]

Pretty much across the board, actually. So I'd still say there was more of a bias into the non-US strategies into global and emerging markets. But across the distribution channel, it's been pretty uniform. So we've seen it in traditional defined benefit plans that are more government-oriented than they are corporate-oriented. It's very geographically diverse. But in sub-advisory, there were no new relationships, but the existing relationships on average had positive flows, because we're affiliated with partners that where there are businesses, particularly in the professionally managed, centrally managed model portfolio structure are gaining share. And then our own funds, which have started to reach critical mass and critical track records of five years are seeing positive flow. So it's pretty encouraging.

[William Cuddy:]

And then on expenses -- thanks for the perspective on G&A, and how should we be thinking of the growth of G&A from here?

[Rich Pzena:]

We're making some pretty big investments in our data infrastructure to really position us for more -- for better supporting an increasingly complex Pzena Fund operation. So when we look at our Pzena funds, it's not just the 40 act funds that we have in the United States but it's also usage funds that are outside the United States, they're in multiple countries with requirements for multiple language, data, reporting and we're in the process of automating a very manual process. And that will take us the next year probably to be fully implemented and so there's some costly investments in IT infrastructure and consultants that are underway right now. So I would expect the growth rate would moderate in the future. But the level of these expenses will probably stay where they are, I don't expect them to go back down again. And then on the compensation side, we actually are continuing to invest in a gradual methodical way in distribution and actually our number of employees in distribution now exceeds, I think probably it’s the first time in our history the number of people that we have on the investment side. And we see that growing indefinitely as long as they're productive in producing net flows and so far that's been the case.

[William Cuddy:]

Great. Thank you for that. And that's all our questions. Thank you for taking the questions today.

[Rich Pzena:]

Great, thank you for your interest.

[Operator:]

[Operator Instructions] And ladies and gentlemen, and showing no additional questions we'll end today's conference call. We do thank you for joining today's presentation. You may now disconnect your lines.