Pzena Investment Management, Inc.
Q4 2018 Earnings Call Transcript

Published: 7 Feb 2019

[Operator:]

Good day and welcome to the Pzena Investment Management Fourth Quarter and Full Year 2018 Conference Call. [Operator Instructions] Please note this event is being recorded. At this time, I would like to turn the conference over to 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 fourth quarter 2018 earnings call. I am Jessica Doran, Chief Financial Officer. 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 2 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 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:]

Thank you, Jessica. As 2018 closed and we began the new year, we felt mixed emotions. We felt the pain of what we hope for the final throws of anti-value market bias of the past decade coupled with a long-term opportunity we see embedded in historically wide valuation spreads. Such as the life of a value investor, pain begets opportunity and success breeds fear. The anti-value bias dominating the markets for most of the past decade has led to passive strategies gathering all of the net flows and growth strategies appearing to be the only logical approach in a world dominated by technology and disruption. On top of these longer term trends, the fourth quarter was driven by fear and uncertainty depressing markets all over the world. Fortunately, our investor base understands very well what we do and expect the investment results that we delivered in 2018. In fact, the 12.6% annualized gross performance we delivered over the past decade in our flagship focused value product would be considered top notch in most environments. Even though it was stopped by the S&P 500’s 13.3% annual return and we are quite proud of that return. The professional investment community that we served understands full well that a portfolio construction cannot only be dominated by what is the hot idea of the moment. There is room for other strategies that are thoughtful and well-executed, particularly when they perform as well as ours have. As such, we had our lowest level of gross outflows in the past decade during 2018 and had positive net flows of $1 billion. Given the environment that we faced, we are quite proud of those numbers. We attribute this business performance to one thing. We stick to our netting and offer our clients and prospects certainty of style purity and no risk of style drift. Many of our competitors find it difficult to do that in the phase of such overwhelming market pressure. The bottom line is that our pipeline remains robust and we are hopeful that positive net flows can continue. We entered 2019 with a portfolio filled with stocks valued at levels that we haven’t seen in quite some time and so far the current year is off to a good start. I will 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. Our results for this quarter and the fourth quarter of last year adjusted for certain tax receivable agreement items and the impact of the tax cuts and jobs act enacted in the fourth quarter of last year. I will address the current tax related adjustments at the conclusion of my remarks but for now I will focus on the non-GAAP information. We reported non-GAAP diluted earnings of $0.16 per share for the fourth quarter compared to $0.22 per share last quarter and $0.19 per share for the fourth quarter of last year. Revenues were $36.4 million for the quarter and operating income was $19 million. Our operating margin was 52.1% this quarter compared to 50.9% last quarter and 53.8% in the fourth quarter of last year. Taking a closer look at our assets under management we ended the quarter at $33.4 billion, down 14.1% from last quarter which ended at $38.9 billion and down 13.2% from the fourth quarter of last year which ended at $38.5 billion. The decrease in assets under management from the third quarter of this year reflects market depreciation of $5.6 billion partially offset by net inflows of $0.1 billion. The decrease from the fourth quarter of last year was driven by $6.1 billion in market depreciation partially offset by net inflows of $1 billion. At December 31, 2018, our assets under management consisted $12.6 billion in separately managed accounts, $18.8 billion in sub-advised accounts and $2.1 billion in our Pzena Funds. Compared to last quarter assets under management across all channels decreased with separately managed account assets reflecting $1.9 billion in market depreciation and $0.1 billion in net outflows, sub-advised account assets reflecting $2.4 billion in market depreciation and assets in Pzena Funds being $0.3 billion in market depreciation partially offset by $0.2 billion in net inflows. Average assets under management for the fourth quarter of 2018 of $6.1 billion, down 5.7% from last quarter and 1.9% from the fourth quarter of last year. Revenues decreased 8% from last quarter and 6.5% from the fourth quarter of last year primarily reflecting the decrease in average assets under management. During the quarter we recognized $0.3 million of performance fees on our sub-advised accounts. Our weighted average fee rate was 40.4 basis points for the quarter compared to 41.3 basis points last quarter and 42.3 basis points for the fourth quarter of last year. Asset mix continues to be the most significant factor in our overall weighted average fee rate although swings in performance fees and fulcrum fees also contribute. Our weighted average fee rate for separately managed accounts was 54.1 basis points for the quarter compared to 54.7 basis points last quarter and 56 basis points for the fourth quarter of last year. The decrease from last quarter and the first quarter of last year reflects an increase in large client relationships that generally carry lower fee rate. The decrease from the fourth quarter of last year also reflects the decrease in performance fees recognized this quarter. Our weighted average fee rate for sub-advised accounts were 28.9 basis points for the quarter compared to 30.2 basis points for both last quarter and the fourth quarter of last year. The decrease from last quarter and the fourth quarter of last reflects the decrease in performance fees recognized this quarter. In addition the weighted average fee rate for the quarter reflects the reception in the base fees of certain accounts related to the fulcrum fee arrangements of one client relationship. These fee arrangements require a reduction in the base fee if the investment strategy underperforms its relevant benchmark or allows our performance fees, the strategy outperforms this benchmark. These fees are calculated quarterly and compared relative performance over a 3-year performance record of these accounts. To the extent of 3-year performance record of these accounts improved relative to their benchmark. We will expect them to earn the full base here in the future. Our weighted average fee rate of Pzena Funds was 64.4 basis points for the quarter, decreasing form 66.8 basis points last quarter and from 73.7 basis points for the fourth quarter of last year. The decrease from the fourth 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 were 69.2 basis points for the quarter, decreasing from 70.3 basis points last quarter and from 73.7 basis points for the fourth quarter of last year. The decrease from the fourth quarter of last year reflects the decrease in performance fees recognized during the quarter. The fluctuation from last quarter is driven by the timing of flows in certain of our funds. Looking at operating expenses our compensation and benefits expense was $13.9 million for the quarter, decreasing from $16.1 million last quarter and from $14.2 million for the fourth quarter of last year. The decrease from last quarter and the fourth quarter of last year reflects the decrease in compensation rates. G&A expenses were $3.5 million for the fourth quarter of 2018 compared to $3.3 million last quarter and $3.8 million for the fourth quarter of last year. Non-GAAP other income was a loss of $2.9 million for the quarter driven primarily by the performance of our investments. The effective rate for our unincorporated and other business taxes were 4.8% this quarter compared to 2.1% last quarter and 3.7% in the fourth quarter of last year. This increase from last quarter primarily reflects the tax benefit associated with the reversal of uncertain tax position liabilities recorded in the third quarter of this year due to the closer of the statute of limitations on the prior tax year. Excluding any future reserve reversals 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 non-GAAP effective tax rate for our corporate income taxes ex UBT and other business taxes was 26.3% this quarter compared to16.9% last quarter and 33% for the fourth quarter of last year which was prior to tax reform. We expect this rate excluding any adjustments to our deferred tax assets or the impact of excess benefits or determents associated with non-cash compensation to be between 23% and 25% on an ongoing basis. Our non-GAAP income tax expense for the quarter adjusted for changes in the deferred tax asset associated with the changes in expected tax benefit. Our non-GAAP other income and income tax expense for the fourth quarter of 2018 adjusted for the impact of tax cuts and jobs act resulting in a re-measurement of the deferred tax asset and associated liability to selling and converting shareholders as well as the prior year adjustment to the deferred tax assets and corresponding liability to selling and converting shareholders. The allocation to the non-public members of our operating company was approximately 74.8% of the operating company’s net income for the fourth quarter of 2018 compared to 74.8% last quarter and 74.6% for the fourth quarter of last year. The 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 have repurchased and retired approximately 162,000 shares of Class A common stock and Class B units for $1.4 million. At December 31, there was approximately $26.6 million remaining in the repurchase program. To take advantage of higher interest rates we made cash equivalents and short-term investments during the third quarter of 2018. Although most of these cash investments have durations less than a year and are short-term in nature those with durations over three months are classified as investments on our balance sheet. At quarter end our financial position remained strong with $38.1 million in cash and cash equivalents as well as $30 million in short-term investments. We declared a $0.49 per share year end dividends last night. Thank you for joining us. We would now be happy to take any questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Ken Worthington of JPMorgan. Please go ahead.

[Unidentified Analyst:]

Good morning. This is [indiscernible] filling in for Ken. So, Pzena Funds continue to have solid inflows despite the solid quarter in 4Q. Could you please just update us on your retail initiative and outlook for sales growth? What’s the latest there would be helpful?

[Rich Pzena:]

Okay. Yes, we have been encouraged by the flows in the fund, particularly in our emerging markets fund, where the performance has been quite strong. We are planning to add one additional salesperson to the team during 2019 hopefully earlier in the year rather than later we are actively looking. We have also beefed up our support team by. We added a rider towards the end of or towards the middle of 2018 and we added a content management person early in 2019 and that’s the investment we are planning. So, it’s continued growth and expansion of the team at a measured pace.

[Unidentified Analyst:]

Thanks. So Jessica on compensation, can you remind us how you think about the incentive compensation, so that the tick down mix in 4Q, but could you just remind us how you think about that pool and how it evolves, I mean, especially as we think about the rebound so far this year, how we should be thinking about compensation?

[Rich Pzena:]

Well, I think let me answer that question, because when we set our budgets for the year on compensation, we set it based on our expectation of the market conditions. It’s not a formula per se. It’s a bonus pool. And when the markets fell apart in the fourth quarter of the year we concluded that we had over-accrued during the first 3 months of the year and reversed accordingly. We still had pretty significant compensation growth if you did it on a comparable employee by employee basis, but we had over-accrued in the first parts of the year and this was really not a formula based decision, it was the judgment of our executive committee as to the level of bonuses that we needed to pay.

[Unidentified Analyst:]

Got it. That makes sense. And then on the fulcrum fees, could you share how far underwater they were for performance spend of the year especially in light of the bounce back that we had so far, how could we thinking about that evolving now?

[Jessica Doran:]

Sure. Really, primarily one of the accounts and its overall relationship is that has the fulcrum fee structure. And I would say that for the fourth quarter, we were actually in a – we were not in the maximum loss position. So, to the extent that performance gets worse, there could be additional losses. However to the extent that performance improves, there could be an adjustment back, but there is for those funds that we are in a negative position where we had a reduction in base fees we were not at the maximum negative position. So, there could be additional offers to the extent performance does not improve.

[Unidentified Analyst:]

Okay, that’s helpful. Alright. Well, thank you for taking our questions.

[Operator:]

Ladies and gentlemen, this will conclude the question-and-answer session and also conclude the Pzena Investment Management fourth quarter and full year 2018 conference. We thank you for attending today’s presentation. You may now disconnect your lines.