Pzena Investment Management, Inc.
Q1 2016 Earnings Call Transcript

Published: 20 Apr 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q1 2016 Pzena Investment Management Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Gary Bachman, Chief Financial Officer. You may begin.

[Gary Bachman:]

Thank you, operator. Good morning and thank you for joining us on the Pzena Investment Management’s first quarter 2016 earnings call. I am Gary Bachman, 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 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 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. In a minute, I will turn the call over to Rich, but first I would like to review some of our financial highlights. We reported non-GAAP diluted EPS of $0.09 per share and $6.3 million in non-GAAP diluted net income. Revenues were $25.8 million for the quarter and our operating income was $10.3 million. I will discuss our financial results in greater detail in a few minutes, but let me now turn the call over to Rich who will discuss our current view of the investing environment.

[Rich Pzena:]

Thank you, Gary, and thank you everyone for joining us on our call. I’d like to share our observations on the investment environment particularly our disciplined value investment. As many of you know for the last five years value strategies have severely lagged growth strategies, raising questions in many investors' minds as to whether value as an investment style is dead. But there has been a recent and palpable shift in the conversation as to whether this is the time to increase exposure to value. Our view in a word is yes. The current down cycle in values started early 2011 before the prior up-cycle had a chance to play out. For the last 50 years, up until 2011, value has outperformed the broad market in every single economic cycle. But the most recent cycle beginning with the financial crisis in 2007 was a bust for value investors. But both financial stocks began their recovery in 2009, rebuilding capital, de-risking the balance sheet and cutting costs. The fall in interest rates to near zero level prevented banks from returning their earning to historical levels. As such, the recovery in value stalled and the next down cycle started to play out. Interestingly, the most recent five-year down cycle for value is completely tied to emerging markets. As the growth rate in emerging markets stalled, the profitability emerging market companies begin to falter. All of the decline was concentrated in the earnings of basic materials, energy and other capital equipment companies while the rest of the market continued on virtually on scale. These declines followed the unprecedented boom in capital spending to try and satisfy what was generally believed to be an insatiable demand from the emerging markets. As the fiscal stimulus began to be withdrawn in 2011, the markets faltered setting up the current cycle as investors moved their money into safer higher-yielding stable businesses. Valuation spreads between cheap stocks and the market moved to provocative levels. This pattern of boom followed by bust is typical of virtually every value cycle in the last 50 years. It is during the bust that value has typically reemerged as the successful strategy and we believe this time will not be different. In fact, this bust is very far along. Oil prices have collapsed along with most basic materials. Capital spending has fallen sharply, employment and profitability followed. The negative impact of these collapses on global economic activity are being felt right now. Interestingly though, the reduction in capital spending and the reduction in fiscal stimulus in China have been underway for quite some time. We believe that we're actually near the end of that decline as activity level has fallen below the level necessary to sustain supply. Managements have begun to take corrective action primarily by reducing costs. And so we have the first signs that the value cycle has started to turn in the last six weeks or so. We don't believe that the fall in the capital equipment sectors will contaminate the other sectors of the global economy, primarily because they never got excessive. Consumer spending, consumer debt levels, housing and autos never got to unsustainable level and so have nothing to really recess from. So the longest anti-value period in a generation maybe coming to an end. Will the recent events mark a turning point in the value cycle, only history will tell. We do know however that we're seeing opportunities across a number of sectors with some valuations approaching those last seen during the financial crisis. Valuations in the energy sector has collapsed broadly with exploration and production and service companies now finding their way into our portfolios. Investors have once again left banks for debt [ph], fearing contagion on energy commodity and emerging market exposures as well as continued drag from low interest rates. Yet loans to these sectors represent a tiny fraction of the exposure banks had to mortgage securities before the financial crisis and banks are hard at work improving profitability even if low rates persist. There is an unusually broad set of opportunities from which to populate our portfolios, which gives us multiple ways to add value. We're also excited about our business prospects and initiatives. Our mutual fund effort is moving ahead and we will be launching our fourth fund, a small cap value fund. Registration is expected to become effective next week. Our intermediary distribution team now is four full-time members focused on forming and expanding relationships in this channel. In addition, we now have four full-time members in London, focused on the UK and European investment communities where the reaction to our investment message has been encouraging. In summary, valuations today are very attractive. Historically, value has significantly outperformed over the next three to five years when we are in these environments. We believe we are at an opportune moment for valuing investing. We appreciate your continued interest and support. I'll now turn the call over to Gary Bachman, our Chief Financial Officer, who will provide this quarter's financial update.

[Gary Bachman:]

Thank you, Rich. As I mentioned, we reported non-GAAP diluted earnings of $0.09 per share for the quarter, down from $0.12 per share for both last quarter and the first quarter of last year. Our non-GAAP income statements adjust for certain deferred tax asset adjustments as well as the recurring valuation allowance and tax receivable agreement items. During the first quarter of 2015, our non-GAAP income statements also adjusted for certain non-recurring charges recognized in operating expenses. 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. Our assets under management ended the quarter at $26.1 billion, relatively flat from last quarter and down 6.5% from the first quarter of last year, which ended at $27.9 billion. In the first quarter of this year, we had net inflows of $0.2 billion, partially offset by market depreciation of $0.1 billion. The $1.8 billion decrease from the first quarter of last year reflects $1.6 billion in market depreciation and $0.2 billion in net outflows. At March 31, 2016, our AUM consisted of $14.5 billion in institutional accounts and $11.6 billion in retail accounts. Compared to last quarter, institutional assets decreased reflecting $0.3 billion in net outflows and $0.1 billion in market depreciation. Assets in retail accounts increased from the end of last quarter due to $0.5 billion in net inflows. Our average AUM was $25.1 billion during the quarter, down 4.9% from last quarter and 9.1% from the first quarter of last year. Revenues were $25.8 million for the first quarter of 2016, a decrease of 6.6% from last quarter and 9.8% from the first quarter of last year. These decreases primarily reflected the decrease in average AUM and lower performance fees recognized during the first quarter of 2016. We recognized $0.1 million in performance fees this quarter that compares to $0.6 million last quarter and $0.4 million in the first quarter of last year. In general, our performance fees are calculated on an annualized basis over a three-year measurement period. Our weighted average fee rate was 41.1 basis points for the first quarter of 2016 compared to 42 basis points last quarter and 41.5 basis points for the first quarter of last year. Our weighted average fee rate for institutional accounts was 53.9 basis points for the first quarter of 2016, up from 53.2 basis points last quarter and from 53.6 basis points for the first quarter of last year. The increase from last quarter and the first quarter of last year reflects the increase in assets in certain of our non-US strategies that generally carry higher fee rates. Our weighted average fee rate for retail accounts was 24.7 basis points for the first quarter of 2016, down from 26.6 basis points last quarter and 25.6 basis points for the first quarter of last year. The decrease from last quarter and the first quarter of last year primarily reflects the decrease in retail performance fees recognized this quarter. Looking at operating expenses, our compensation and benefit expense was $12.5 million for the quarter, up 13.5% from $11 million last quarter and up 3.5% from $12.1 million for the first quarter of last year. GAAP G&A expense were $3 million for the first quarter of 2016, down approximately $0.6 million from both last quarter and the first quarter of last year. During the first quarter of 2015, we adjusted our non-GAAP results for non-recurring expenses of $0.3 million associated with our former headquarters. Excluding these one-time adjustments, GAAP G&A expenses decreased $0.2 million or 6.5% from the first quarter of last year. The non-GAAP operating margin adjusting for the non-recurring expenses was 39.8% this quarter, which compares to 46.9% last quarter and 46.5% in the first quarter of last year. The changes in non-GAAP operating margin during the quarter reflected decrease in revenue combined with an increase in compensation and headcount during 2016, partially offset by a decrease in G&A expense. Net of outside interest, other income was income of $0.2 million this quarter, which compares to $0.6 million last quarter and less than $0.1 million during the first quarter of last year. These fluctuations arise generally as a result of the performance of firm’s investment. The non-GAAP effective rate for unincorporated business taxes was 4.4% this quarter compared to 4.1% last quarter and 4% in the first quarter of last year. We expect this rate to be between 4% and 5% on an ongoing basis. The non-GAAP effective tax rate for our corporate income taxes ex-UBT was 36.2% this quarter compared to 34.5% last quarter and 35.6% for the first quarter of last year. These effective rates reflect tax benefits from employee share and unit vesting and option exercises. We expect this rate excluding any share in unit vesting to be between 36% and 38% on an ongoing basis. The allocation to the non-public members of our operating company was approximately 77.4% of the operating companies’ net income for the first quarter of 2016 and the fourth quarter of 2015 compared to approximately 80.4% in the first 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 repurchased and retired 100,518 shares of Class A common stock for approximately $0.8 million and 2,207 of our operating company Class B units for less than $0.1 million. At March 31, there was approximately $10 million remaining in the repurchase program. Before we turn it over to questions, I'd like to briefly walk through the non-GAAP income tax expense items. We recognize adjustments as a result of the revised estimates of future taxable income and our ability to utilize our deferred tax asset. We recognized a $0.2 million net benefit associated with changes to our deferred tax asset, valuation allowance and liability to our selling and converting shareholders. These adjustments comprise the majority of the dividends between our first quarter 2016 non-GAAP and GAAP net income. On a quarterly basis, we will record adjustments to the valuation allowance and our liability to our selling and converting shareholders as necessary. The ultimate amount of these adjustments will depend on our estimates of the future taxable income of the operating company and the level of our economic interest in it. Inclusive of the effect of the valuation allowance and tax receivable agreement amounts I just discussed, we reported GAAP, basic and diluted EPS of $0.11 and $0.10 per share for the quarter respectively. At quarter-end, our financial position remained strong. Our cash balance was $20.5 million at March 31 and we declared a $0.03 per share quarterly dividend last night. Thank you for joining us on the call, we would now be happy to take any questions you may have.

[Operator:]

[Operator Instructions] And our first question comes from Ken Worthington from JP Morgan, your line is open.

[Ken Worthington:]

First on retail sales, they picked up for the quarter was substantially, one of the best quarters we've seen outside of those where you’ve won some big sub-advise mandates. So what - where were the sales coming in this quarter or can you just give us little more information about why this quarter was so good?

[Rich Pzena:]

Well, they were positive flows into our existing strategies and I think what they reflect, first of all is our relationship with Vanguard that we’re managing the mid-cap value of products for them, they call it the Vanguard Selected Value fund. And that - we’re benefiting from getting the flows that come in from that. So they had good flows in the first quarter and we were the beneficiary of that. I mean, then in Europe, we - as you know, with ABN AMRO, we’d been managing a European value fund for them. That had positive flows and we really have started more aggressively managing our US focused value strategy with ABN AMRO, which also had a good quarter in flows. So it was - it’s pretty broad.

[Ken Worthington:]

Okay. Excellent. So what I track, the naive value strategy is starting to perform much, much better here. You guys, or Richard, you seem more enthusiastic about kind of classic value strategies than I've heard in a long time. So to what extent are you seeing this kind of resonate with investors? So as your team sits down, does it start to be - is it starting to sink in? Are you starting to see the pipeline build, or are the clients now starting to believe that we are actually seeing the value strategies outperform?

[Rich Pzena:]

Well, I don’t know that I would go that far, but I would definitely say the interest level is high in having discussion. And so we’ve been hosting lunches now in various cities and we’re getting attendance probably 2x what we would normally expect to get. And I don’t think that there are people who are lining up to put money in to value strategies, but they’re all talking about this question, because not only has it been the longest anti-value cycle in 50 years, but it’s - there are other strategists who have come out and said, now, we think it’s time for value. And then you have a little bit of a run here and so all of a sudden, the interest level picks up. So the answer is, yes, our pipeline is building a little bit. It’s not an overwhelming flood, but it’s building a little bit and we’re feeling pretty good, some of the - and I think the reason that we feel good about this value cycle is because it’s not a financial crisis induced value cycle, but a classic economic cycle that’s obvious. We went nuts on commodities and now we’re unwinding it and the impact on the global economic activity is substantial, could create concerns. It widens spreads, and by the time people start learning about the expansions of the other sectors, they’re almost over with the part that caused the problem. So this is exactly what happened in prior - in four of the last five cycles other than the most recent one. So, that’s the source of the excitement. Now, does that guarantee that this is going to be one of those cycles? Of course, not. The people jump in first six weeks that they see something happening, not the masses. But the dialog is starting.

[Ken Worthington:]

Okay, great. Gary, just on G&A, 4Q had a bunch of noise in it. How does 1Q seem as a run rate here in terms of unusual items?

[Gary Bachman:]

There is a lot of timing on how the run rate works. I would expect us to increase on a run rate basis going forward, look more like the fourth quarter with the first quarter coming in a little lower than usual.

[Ken Worthington:]

Okay. So when we talk about it kind of increasing, does it - should expenses ramp throughout the year or should expenses kind of ramp going into 2Q?

[Gary Bachman:]

I would think that we will see - and again we’re not talking a huge ramp, but you’ll see an increase probably just based on timing and probably hold at that level. So to be more consistent with what you saw in the fourth quarter.

[Ken Worthington:]

Got it. Okay. Great. Thank you very much.

[Operator:]

[Operator Instructions] And I’m showing no further questions. I would now like to turn the call back to Gary Bachman for any further remarks.

[Gary Bachman:]

Well, thank you all for joining and we look forward to talking to you again in the future.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone, have a great day.