Pzena Investment Management, Inc.
Q4 2014 Earnings Call Transcript

Published: 11 Feb 2015

[Operator:]

Welcome to the Q4 2014 Pzena Investment Management Earnings Conference Call. My name is Steve and I will be your operator for today. [Operator Instructions]. I would like to turn the call over to Gary Bachman, Chief Financial Officer. Please proceed, Sir.

[Gary Bachman:]

Thank you, Steve. Good morning and thank you for joining us on the Pzena Investment Management fourth quarter 2014 earnings call. I'm 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 $0.13 per share and $9.1 million in non-GAAP diluted net income. Revenues were $28.6 million for the quarter and our non-GAAP operating income was $15.1 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:]

Thanks, Gary and thank you to everyone joining our call this morning. I would like to spend the next few minutes reflecting on our significant achievements in 2014 and some equally exciting developments we expect in the coming year. I'll then provide some comments on the investment environment and the challenges and opportunities it has created for us. I'm pleased to report that our assets under management ended the year at $27.7 billion, the highest year-end AUM in our history. This accomplishment resulted from a combination of gains in our U.S. strategies and a healthy level of inflows across both our retail and institutional channels. The biggest contributor in retail came from a growing relationship with the Vanguard group, who named us as a co-manager to their mid-cap selected value fund at the end of the first quarter. Our sub-advisory relationship with CIBC in Canada grew as well when they added our international expanded value strategy to their fund lineup. During 2014, we also won meaningful mandates from U.S. and European corporate pension plans in our global, international emerging markets and U.S. value strategies. Our sales team is busy and our pipeline of search activity continues to be strong. During 2014, we embarked on two important initiatives for the future of our firm, launching our own Pzena-branded mutual funds and opening an office in London. I have important updates I would like to share with you on both of these fronts. We recently hired two senior individuals with deep backgrounds in the UK and European investment communities that have been tasked with opening our office in London to build on the beachhead we have already established in that region. Ulrich [inaudible] Jensen joined us this week after spending the last 12 years at Nordea Bank in Copenhagen to take on the new role of head of Pzena Europe. Ulrich brings to us critical business experience, managing relationships with some of Nordea's top-tier clients, key distribution channels and business partners. Ulrich was a member of Nordea's executive management team for their European fund business which oversaw an excess of €200 billion. Our other new team member is scheduled to join us in March and is a recognized leader in the UK investment community with extensive experience in global investing and client relations. We have been steadily pushing forward with our mutual fund initiative, having launched the Pzena mid-cap focused value, emerging markets focused value and long short value funds this past April. Our sales team has been instrumental this past year in planting the seeds for the future of these funds and we're extremely close to announcing a leader for this business with extensive experience in the mutual fund industry. We couldn't be more excited about these additions and I look forward to updating you on our progress as we move forward. From an investment perspective, 2014 was a difficult year for active managers as investors sought out safety in yield. From our perspective, this has created a significant valuation opportunity in economically sensitive sectors that we're fully exploiting in our portfolio. The main issue on the forefront of investors' minds today is energy. Is the drop in oil prices a classic value opportunity or simply an adjustment to a more rational level of oil prices? Our investment team is working overtime researching the full range of companies in the industry including the major integrateds, exploration and production companies, servicers and drillers. We believe we have time on our side as our long-term view of oil prices of $60 to $80 per barrel is not out of line with consensus. Our view is that the plunge in prices was precipitated by an oversupply of oil, driven to a large part by U.S. shale production, which will take some time to adjust, given industry dynamics. We also believe that costs in the industry will decline from their boom-induced inflated levels of recent years. So as we wait for the cycle to play out, we're using the time judiciously, digging into each company to understand the nuances of their business models and financial strength. We're comfortable with our current positioning in the major integrated oil companies and may add to our portfolios opportunistically. We expect that investors will eventually turn away from safety and yield as the global economy finds firmer footing and propel valuations of businesses with leading franchises that have been left behind due to today's uncertainties. We're well-positioned to benefit and believe we have the ability to generate meaningful outperformance. The biggest opportunities are in financial services, energy and mature technology companies with Europe and emerging markets the most attractively valued regions globally. We're sticking to our knitting and are excited about our portfolios. Thank you for listening and now I would like to turn the call back over to Gary Bachman, our Chief Financial Officer, who will take you through fourth quarter and full year 2014 results.

[Gary Bachman:]

Thank you, Rich. I will start out by discussing our assets under management, fee rates and revenues. Our average AUM was $27.1 billion during the quarter, up 1.1% from last quarter and up 13.9% from the fourth quarter of last year. As Rich mentioned, our assets under management ended the quarter at $27.7 billion, up 4.9% from $26.4 billion last quarter and up 10.8% from the fourth quarter of last year, which ended at $25 billion. The $1.3 billion increase from last quarter was due to $0.8 billion in net inflows and $0.5 billion in market appreciation. The $2.7 billion increase from the fourth quarter of last year was driven by $1.4 billion in market appreciation and $1.3 billion in net inflows. At December 31, 2014, our AUM consisted of $15.6 billion in institutional accounts and $12.1 billion in retail accounts. Assets and institutional accounts increased $1.3 billion from the end of last quarter due to $1.2 billion in net inflows and $0.1 billion in market appreciation. Compared to last quarter, retail assets were flat due to $0.4 billion in market appreciation, offset by $0.4 billion in net outflows. Revenues were $28.6 million for the fourth quarter of 2014, down 3.5% last quarter and 0.7% from the fourth quarter of last year. The decrease from last quarter and the fourth quarter of last year was primarily due to a decrease in performance fees recognized during the fourth quarter of 2014. We recognized $1.2 million in performance fees during the fourth quarter of 2014 compared to $2.1 million in the third quarter and $3.1 million in the fourth quarter of last year. In general, our performance fees are calculated on an annualized basis over a three-year measurement period. Approximately 65% of the performance fees recognized during the fourth quarter of 2013 represented fees calculated over a shorter measurement period. These fees did not recur in 2014. Our weighted average fee rate was 42.2 basis points for the fourth quarter of 2014. This compared to 44.2 basis points last quarter and 48.4 basis points for the fourth quarter of last year. Our weighted average fee rate for institutional accounts was 55.4 basis points for the fourth quarter of 2014, that's down from 58.2 basis points last quarter and from 62.7 basis points from the fourth quarter of last year. The decrease from last quarter and the fourth quarter of last year primarily reflects the decrease in performance fees recognized this quarter. Our weighted average fee rate for retail accounts was 26.2 basis points for the fourth quarter of 2014, compared to 27.1 basis points last quarter and 25.4 basis points for the fourth quarter of last year. The decrease from last quarter primarily reflects the addition of assets in our U.S. value strategies which generally carry lower fee rates, while the increase from the fourth quarter of last year reflects the addition of assets and strategies which generally carry higher fee rates, as well as an increase in retail performance fees recognized in the fourth quarter of 2014. Our non-GAAP income statement adjusts for certain deferred tax asset adjustments as well as the recurring valuation allowance and tax receivable agreement items. During the fourth quarter of 2014 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'll focus on the non-GAAP information. Looking at operating expenses, our compensation and benefit expense was $10.7 million for the quarter, that was relatively flat from the last quarter and up 16.3% from the fourth quarter of last year. The increase from the fourth quarter of last year reflects an increase in compensation and headcount. GAAP G&A expense was $3.1 million for the fourth quarter of 2014, up approximately $0.8 million from both last quarter and the fourth quarter of last year. During the second quarter of 2014, we entered into an 11-year lease agreement for our new corporate headquarters in New York City. We took possession of this space in October of 2014 and plan to occupy the space during the second quarter of 2015. During the fourth quarter of 2014 approximately $0.4 million in lease expense associated with our new corporate headquarters is reflected in G&A expenses. During the quarter, we adjusted our non-GAAP results for approximately $0.4 million related to our current office space that will not recur once we moved to our new corporate headquarters. We expect an incremental increase in quarterly depreciation expense associated with furniture and leasehold improvements of approximately $0.2 million when we occupy the new space. The increase in G&A expense from the fourth quarter of last year also reflects costs associated with our mutual funds during 2014. The non-GAAP operating margin adjusting for these non-recurring expenses was 53% this quarter compared to 56.2% last quarter and 59.8% in the fourth quarter of last year. Net of outside interest, other income expense was income of $0.1 million this quarter and expense of $0.4 million last quarter and income of $0.5 million in the fourth quarter of last year. These fluctuations arise generally as a result of the performance of the firm's investments. The effective rate for our unincorporated business taxes was 4.3% this quarter and last quarter, compared to 5.4% in the fourth quarter of last year. The decrease in this rate from the fourth quarter of last year is driven by the impact of tax sourcing of receipts. We expect this rate to be between 4% and 5% on an ongoing basis. The effective tax rate for our corporate income taxes ex [inaudible] was 34.2% this quarter. This compared to 41.4% last quarter and 33.6% from the fourth quarter of last year. The decrease in our effective rate this quarter was driven by tax benefits from employee share and unit vesting and option exercises that occurred during the fourth quarter of this year. The increase from the fourth quarter of last year reflect a variance in the impact of employee share and unit vesting. The majority of our employee unit grants vest annually during the fourth quarter of each year. In March 2014, New York State changed its tax law for receipts beginning at the start of the 2015 tax year. Once this tax law is effective we expect our annual corporate effective tax rate, excluding any share in unit vesting, to be between 37% and 39%. The allocation to the nonpublic members of our operating company was approximately 80% of the operating company's net income for the fourth quarter of 2014 compared to 80.1% for the third quarter of 2014 and approximately 81.2% in 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 and program, we repurchased and retired 264,060 shares of Class A common stock for approximately $2.5 million and 38,364 of our operating company's Class B units for approximately $360,000. At December 31, there was approximately $18.5 million remaining in the repurchase program. Before we turn it over to questions I would 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. During the fourth quarter of 2014 we also recognized the change in our deferred tax asset associated with changes in expected future tax benefits. We recognized a $0.9 million net benefit associated with changes to our deferred tax asset valuation allowance and liability to our selling and converting shareholders. These adjustments, along with the adjustment for non-recurring lease expenses, comprise the majority of the differences between our fourth quarter 2014 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 evaluation allowance and tax receivable amounts I just discussed, we reported GAAP basic EPS of $0.19 per share and GAAP diluted EPS of $0.14 per share for the quarter. At quarter end our financial position remains strong. Our cash balance was $39.1 million at December 31 and we declared a $0.32 per share year-end dividend last night. Thank you for joining us, we now would be happy to take any questions you may have.

[Operator:]

[Operator Instructions]. First question which comes from the line of Ken Worthington with JPMorgan. Please go ahead.

[Will Cuddy:]

This is Will Cuddy, covering for Ken this morning. Thank you for taking our questions. First, so institutional is very good in the fourth quarter. I know you touched on some mandates and global emerging markets and U.S. value, what does the pipeline look like and what does the concentration by client look like going forward?

[Rich Pzena:]

I'm not sure I understood the last question but let me answer what I thought I understood. The pipeline is about the same as it was throughout all of last year which is strong. It's not bigger, but it's about the same level as it was a year ago. So, that means there is a lot of activity. In 2014, we had our best gross inflow year since 2007 and so the pipeline remains pretty interesting. When I look across the pipeline by product, it's fairly diversified. It's probably the largest activity is outside the U.S., with evenly spread among emerging markets, Europe only, global and international and then the U.S. ones are smaller. But we have search activity in every one of our strategies going on right now. When you ask me the -- I'm not sure what your last question was.

[Will Cuddy:]

So to sort of phrase it, with the inflows in the fourth quarter is that affecting your concentration by client in the institutional channel because of the large inflows?

[Rich Pzena:]

No, it's not actually. They are pretty much -- I think in the fourth quarter, almost all were new clients on the institutional side rather than contributions to existing clients.

[Will Cuddy:]

And on retail in the fourth quarter, can you give some more color about the redemptions that occurred?

[Rich Pzena:]

Yes. I think probably the biggest redemption came out of John Hancock Classic Value Fund, which I believe reflected a rebalancing of one of the large shareholders in the fund where they run a model portfolio. So we can attribute a big share of that outflow to one client decision.

[Operator:]

And your next question comes from the line of John Dunn from Sidoti & Company. Please go ahead.

[John Dunn:]

You guys talked about a shift to U.S. value in the quarter. Do you think that's in 2015 a temporary shift, or you expect the non-U.S. to start getting more steam? And if it is not just temporary, do you think the fee rate we're running at now is sort of the outlook for 2015?

[Rich Pzena:]

You know, there really wasn't a shift. The shift to U.S. value that occurred in 2014 was mostly investment performance rather than client-driven assets. So in 2015, without forecasting performance because I have no idea, I would guess based on the pipeline that the shift would be actually more towards the non-U.S which generally speaking, carry higher fee rates. So I think the sort of deterioration that you've seen over the course of time in our institutional weighted average fee rate is probably going to flatten in 2015 rather than continue. But obviously it totally depends on where we get client assets. So it's a very hard one to predict.

[John Dunn:]

Understood. Can you give us an update on your mix of international clients versus U.S. clients? And if you have any sort of long-term target about where you would expect -- you would want that mix to end up?

[Rich Pzena:]

Sure. Let me do it in two ways. Let me do it by where the money is invested and then where the clients are located. So right now our split is approximately 60% domestic and 40% international on our assets under management. So where the money is invested and our split is 67% U.S. clients and 33% non-U.S. clients.

[John Dunn:]

And is that sort of in the ranges where you would like to keep it or was there one you would like to diversify more or you don't have a view?

[Rich Pzena:]

For me, wherever someone wants to give us money we're very happy to take it. So it's hard to have a view. I guess the only view I would have is to say that the activity level outside the United States probably would suggest that our client base will diversify more away from the U.S. over time. That's what's been happening and that's what I would expect would continue to be happening, particularly since we're staffing up our office in London where we're adding two senior professionals to focus on a marketplace that has been good for us but where we've never had a local presence. And while I don't really expect that to bear fruit in 2015, I'm pretty sure it will bear fruit beyond that point. So, we're clearly investing more resources together assets outside the United States because that's where we think the opportunity is.

[John Dunn:]

Last one from me, my recollection is on past conference calls you talked about on the institutional side, you know call it $300 million or so per quarter, that's the level you would be happy with maybe 3 million to 4 million. Has that changed -- first of all is that true, has it changed considering the new clients you're looking at and maybe just give it a context of when you look back, what do you think is a good quarter in institutional net flows.

[Rich Pzena:]

In terms of net flows for the quarter? Yes. I'm going to give that on an annual basis rather than a quarterly basis because it is virtually impossible to predict quarterly flows and it's highly lumpy. Just like you saw last year, we tend to add outflows more towards beginning of the year and inflows more towards the end of the year. And that sort of is the pattern, although it's hard to say that with certainty. But if I was going to look on average over the last five or six years, the inflows tend to be more in the second half of the year and outflows tend to be more in the first half of the year. Having said that, this was a good year. I would hope to match 2014 or perhaps do even a little bit better in 2015. Our goal is to do better, but if we matched, we would be happy.

[Operator:]

[Operator Instructions]. And your next question again comes from the line of Ken Worthington from JPMorgan. Please go ahead.

[Will Cuddy:]

It's Will again for Ken. So, a couple more questions. On the mutual funds, congratulations on launching the funds earlier in 2014. How are you doing on the sales infrastructure and what's your approach to the sales and outlook for this year?

[Rich Pzena:]

We have struggled to find a leader for that channel because we set extremely high standards for ourselves to bring in somebody that was not only an experienced and sophisticated mutual fund business person, but to find somebody that's of the caliber and quality of the people that we've hired over the years and so we've had some fits and starts with that. We're really not going to have an aggressive marketing campaign launched until that person is present. I have my fingers crossed that that will be fairly soon. We've identified somebody that we really think is spectacular and we're trying to close that deal. And so, I would be disappointed if I couldn't announce that to you on the next quarter. But I've learned that guaranteeing that is probably or getting your hopes too high is probably a difficult thing to do. Given that somebody experienced, we're asking somebody experienced to effectively come in in a start-up role for us in the mutual fund business. So our plan, once that we have somebody in place would then be to gear up on the distribution and marketing of our strategies which obviously involves spending some money. We've already started the process of getting ourselves -- I don't know what the right word is -- registered on various platforms. And so the infrastructure is happening and not waiting for the person, but the idea that we're going to actually have any flows until we have a coordinated leader is probably not realistic. And it will probably take at least a year once that person is here before you actually can even notice anything in our results. So this is not a 2015 flow discussion. Again, same as Europe and the UK, but we're hopeful it's a 2016 discussion.

[Will Cuddy:]

Further returns, especially in January. We know January was a big month for value. Could you elaborate on some of the positions or positioning that you have taken that [inaudible] that performance recently?

[Rich Pzena:]

Yes. I mean it's hard to talk specifically about a month because if you looked at it today we've gained almost all of that underperformance from January back. So I would tell you that if you wanted to know the one factor that led to this, it was collapse in interest rates. That sort of led more money flows into the dividend yield save stuff and undermined the views of the banking/economically cyclical companies. It's hard for me to point to anything in particular in our portfolio other than that broad view of the world which rapidly reversed when it looked like we saw the first sign of any inflationary pressure in the U.S. and interest rates went back up and now all that underperformance has mostly reversed. So obviously we're tied to somewhat economically sensitive companies that are pro-cyclical with interest rates. And you know, the ideal world for our portfolio would be a rising rate environment. But who knows whether that's going to happen right now? But I think that's what described the portfolio issues towards the end of 2014 and early 2015.

[Will Cuddy:]

And another question from the retail sub-advisory channel, are there conversations being had on extending some of the relationships that you have?

[Rich Pzena:]

Absolutely, from two different perspectives. It's the existing relationships that we have trying to add more mandates and we've had some success doing that, and that continues. And we're also seeking more broader new partners that are in markets that we're not in or in areas of our own product where we're choosing not to be in on the retail front. So the answer is yes, we're seeking to grow that business.

[Will Cuddy:]

And would you characterize the pipeline as -- I mean, it's more robust than it was this year, similar to the color you gave on institutional sales?

[Rich Pzena:]

I guess I would call it similar, but you have to realize we had some big, big wins in the last few years which will be difficult to repeat. The relationship with Vanguard that we've established over the last few years has led to a lot of inflow with Vanguard and the idea that we're going to have another one of that size and magnitude is probably unreasonable. But having said that, there is a lot of discussions going on. So we're hopeful at the margin that it's positive.

[Operator:]

There are no further questions at this time. I now would like to turn the call back over to Gary Bachman for closing remarks.

[Gary Bachman:]

Great. Thank you, operator and thank everyone for joining us on today's call. This concludes our call.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Thank you very much and have a very good day.