Pzena Investment Management, Inc.
Q2 2018 Earnings Call Transcript

Published: 23 Jul 2018

[Operator:]

Good morning and welcome to the Pzena Investment Management announces results for the Second Quarter 2018 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] I would now like to turn the conference over to Mr. Gary Bachman, Chief Operating Officer. Please go ahead.

[Gary Bachman:]

Thank you, operator. Good morning and thank you for joining us on the Pzena Investment Management second quarter 2018 earnings call. I am Gary Bachman, Chief Operating Officer and Acting Principal Financial Officer, while Jessica Doran, our CFO is on maternity leave. 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 we 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 reflects the impact of circumstances or events going forward. In addition, please be advised that due to prohibition on selected 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:]

Thank you, Gary. Perhaps the best way to characterize the second quarter is to say that the story continues. Markets remains high overall, driven by a handful of market darlings, the banks and BATs, and we see value spreads continue to widen resulting in an attractive opportunity set for value managers like us. As is always the case, we spend our lives looking into the stocks that the market leaves behind. And today those stocks are becoming more and more attractive all over the world. The theme is the same as it has been for the last couple of years only it is becoming more pronounced. The disruptors are the winners and all you have to do is buy those stocks to earn high returns. We see opportunities in the companies that are perceived to be the disruptees. These businesses often have often have decades long franchises, brands, and reputations that have earned customer loyalty and trust and are using the new technologies to reinforce and further secure their market positions. And they are selling for valuations that are extremely attractive. Consider a sector we have discussed many times before, the global banks. They have adopted technology at a dizzying rate, moving from tellers to ATMs to mobile transactions. These steps are driving cost out of the bank income statement and adding to customer loyalty leading to strong ROEs even in an environment of persistently low interest rates. We see the same story evolving in autos. Should you buy VW or Tesla? It seems obvious to everyone, Tesla is sexy, Tesla is new, Tesla has the environmental story, but they haven’t demonstrated the ability to mass produce cars. VW is the most efficient auto manufacturer in the world with leading brands and if consumer behavior leads to mass adoption of electric cars, we believe that the combination of VW’s strong brands and significantly lower cost structure will prove to be the winning formula, but the best part is you can buy VW stock with the market already perceiving it as the loser. So, the risk of being wrong is negligible. That’s what’s so great about the current investing environment. In sum, many existing franchises all over the world are selling at deep discounts whenever a hint of disruption walks through the air. And many of these franchises are actually poised to be the winners as the adopters of the disruptive technology. We are uncovering these opportunities all over the world and are excited about the prospects for our portfolios. Fortunately, there are enough institutions and individuals in the world that agree with us and believe that there is room in a portfolio for multiple investment disciplines. As a result, our pipeline of new business opportunities has remained strong and our business has held up in this environment. I’m happy to report that we’re starting to gain traction in our Pzena funds business with significant growth this quarter and during the beginning of the third quarter. As of today, our mutual funds have close to $300 million under management and we’re more than covering our direct costs. We continue to feel good about our long term strategic positioning and we believe the strength comes primarily from staying committed to our value discipline. Thank you for taking the time to attend our call and I look forward to hearing your questions. I will now turn the call back over to Gary Bachman, our Chief Operating Officer, who will provide this quarter’s financial update.

[Gary Bachman:]

Thank you, Rich. We reported diluted earnings of $0.20 per share for the second quarter, compared to diluted earnings of $0.20 per share last quarter and $0.15 per share for the second quarter of last year. Revenues were $38.3 million for the quarter and our operating income was $19.7 million. Our operating margin was 51.5% this quarter, increasing from 50.8% last quarter and from 48.7% in the second quarter of last year. Taking a closer look at our assets under management, we ended the quarter at $36.9 billion, down 2.1% from last quarter, which ended at $37.7 billion, and up 10.1% from the second quarter of last year, which ended at $33.5 billion. The decrease in assets under management from the first quarter of this year reflects market depreciation of $0.6 billion and net outflows of $0.2 billion. The increase from the second quarter of last year was driven by $2.9 billion in market appreciation and net inflows of $0.5 billion. At June 30, 2018, our assets under management consisted of $13.8 billion in separately managed account, $21.2 billion in sub-advised accounts, and $1.9 billion in our Pzena funds. Compared to last quarter, separately managed accounts assets decreased reflecting $0.5 billion in net outflows and $0.3 billion in market depreciation. Sub-advised account assets also decreased, reflecting $0.3 billion in market depreciation, partially offset by $0.2 billion in net inflows. Assets in Pzena funds increased from the end of last quarter, due to $0.1 billion in net inflows. Average assets under management for the second quarter of 2018 were $37.7 billion, down 2.8% from last quarter and up 15.3% from the second quarter of last year. Revenues decreased 2.3% from last quarter, primarily reflecting a decrease in average assets under management and increased 12.4% from the second quarter of last year, driven by the increase in average assets under management. Our weighted average fee rates was 40.7 basis points for the quarter, compared to 40.5 basis points last quarter, and 41.7 basis points for the second quarter of last year. Asset mix continues to be the most significant factor in our overall weighted average fee rates, although swings in performance fees and fulcrum fees also contribute. Our weighted average fee rate for separately managed account was 53.5 basis points for the quarter, compared to 53.4 basis points last quarter and 55.5 basis points for the second quarter of last year. The decrease from the second quarter of last year reflects a decrease in assets in our focused value strategies that generally carry higher fee rates. Our weighted average fee rate for sub-advised accounts was 30.3 basis points for the quarter, compared to 30 basis points last quarter and 29.4 [ph] basis points for the second quarter of last year. The increase from the second quarter of last year, primarily reflects an increase in performance fees recognized. Our weighted average fee rate for the Pzena funds was 62.4 basis points for the quarter, increasing from 59.9 basis points last quarter and decreasing from 66.6 basis points for the second quarter of last year. The decrease from the second quarter of last year reflects the adoption of the new revenue recognition standard during the first quarter of 2018, which requires expense cap reimbursements to be presented net against revenue. Excluding the impact of this revenue recognition presentation change, the weighted average fee rate for Pzena funds was 67.6 basis points for the second quarter of this year, increasing from 66.6 basis points for the second quarter of last year. This increase reflects an increase in assets in strategies that generally carry higher fee rates. Looking at operating expenses, our compensation and benefit expense was $15.2 million for the quarter, decreasing from $16.2 million last quarter and increasing from $14.3 million for the second quarter of last year. First quarter 2018 compensation expense include expenses associated with tax payments and our employee profit sharing and savings plans, which generally do not recur during the year. The increase from the second quarter of last year reflects an increase in compensation rates. G&A expenses were 3.4 million for the second quarter of 2018, increasing from $3.2 million for both the first quarter of 2018 and the second quarter of last year. The increase form last quarter and the second quarter of last year reflects an increase in business activities. Other income was a loss of $0.2 million for the quarter driven by fluctuations in performance of our investments. The effective rate for our unincorporated and other business taxes was 4.3% this quarter, compared to 3.7% last quarter, and 3.9% in the second quarter of last quarter. We expect the effective rate associated with the 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 27.8% this quarter, compared to 29.4% last quarter and 37.4% for the second quarter of last year. We expect this rate, excluding any share and unit impact, to be between 27% and 30% on an ongoing basis, reflecting the reduction in corporate tax rates, due to the enactment of the Tax Cuts and Jobs Act during the fourth quarter of 2017. The allocation to nonpublic members of our operating company was approximately 74.4% of the operating company's net income for the second quarter of 2018. This compares to 73.9% for the first quarter of this year and 74.7% for the second quarter of last year. This variance in these percentages is the result of changes in our ownership interest in the operating company. During the quarter through our stock buyback program, we repurchased and retired approximately 232,000 shares of Class A common stock and Class B units for $2.3 million. At June 30, there was approximately $30.1 million remaining in the repurchase program. At quarter-end, our financial position remains strong with a cash balance of $52.5 million at June 30. We also announced a $0.03 per share dividend for the quarter. Thank you for joining us. We’d now be happy to take any questions you may have.

[Operator:]

[Operator Instructions] The first question comes from Ken Worthington with JPMorgan. Please go ahead.

[Ken Worthington:]

Hi, good morning. Thanks for taking my questions. I guess maybe first on SMAs there was a pickup in gross redemptions in SMAs and we’ve had about four quarters of outflows. So, maybe first an update on what you are seeing in the separately managed accounts and what you’re hearing from those clients?

[Rich Pzena:]

Well, this quarter the outflows of separately managed accounts were really concentrated in one very large reduction. One of our big clients is moving to more passive and more easing of their liabilities. So, it is more of the same. It just happened to a big chunk in the first quarter. So, I don’t think that the mantra is no different. This is what’s going on among the defined benefit plans.

[Ken Worthington:]

Okay, thank you. And then, can we get a breakout of the performance fees just by the different buckets.

[Gary Bachman:]

Yes, sure. For the quarter Ken it was all in our sub-advisory, it was $900,000.

[Ken Worthington:]

Okay. I think that is the same thing that happened last quarter as well. So, okay, perfect. Then maybe on emerging markets, how is the deep value strategy kind of holding up in the more challenging emerging markets? And it seems to be holding up better based on what we can track, but how is the marketing of sort of value and deep value for emerging markets going? I would think it would be going well, but what are you guys hearing?

[Rich Pzena:]

Yeah, I mean it’s – I tell you that it’s not that different than what it’s been. We’ve had the pitch that we’ve made for the last decade as basically been value works great in emerging markets. Value actually works better in emerging markets than historically than it’s worked in the developed markets. And for most of our active time managing these accounts, that’s actually proven to be the case. So, when you get some fluctuations based on relative performance in a quarter or two, it doesn’t seem to have any influence. And the pipeline stays strong. So – and actually the flows are good, with the exception during this quarter, the big account loss that I referenced earlier happen to be in emerging markets.

[Ken Worthington:]

Interesting. Okay. Okay, thank you. And then in years past you went through a period of bigger sub advised wins, Vanguard and others were sort of expanding and hiring you. Is there a pipeline of new relationships at this point or how are the dialogue, how is the dialogue going with potential new sub-advised clients?

[Rich Pzena:]

Well we did, we actually won a new relationship in the quarter, it hasn’t funded yet, but we’ve been hired by IB funds to manage international value and we expect the funding to begin in the third quarter, this quarter, current quarter. I mean, they come once in a while, they don’t come regularly. So, it’s lumpy like the institutional business is lumpy, and so we continue to be very aggressive trying to find these and when we do they tend to be sizeable and we have the product suite that’s broad enough to attract a wide variety of different potential partners.

[Ken Worthington:]

For the one you won, yes, I think you said it was IV, how big is that, can you disclose it, or…?

[Rich Pzena:]

We really don’t know exactly how big it is going to be and the funds probably come in over time. So, we will get in an initial allocation that it will be reasonable, but I can’t tell you the exact numbers.

[Ken Worthington:]

Okay. Good. You know what, that’s it from me. Thank you so much.

[Rich Pzena:]

Sure. Thanks Ken.

[Operator:]

Okay. [Operator Instructions] Seeing no further questions in the queue, this concludes our question-and-answer session. And our conference call today has now concluded as well. Thank you for attending today’s presentation. You may now disconnect.