Pzena Investment Management, Inc.
Q1 2015 Earnings Call Transcript

Published: 22 Apr 2015

[Operator:]

Good day, ladies and gentlemen. And welcome to the Quarter One 2015 Pzena Investment Management Earnings Conference Call. My name is Emma and I will be your operator for today. [Operator Instructions]. I would now like to turn the call over to Mr. Gary Bachman, Chief Financial Officer. Please proceed, Sir.

[Gary Bachman:]

Thank you, Emma. Good morning and thank you for joining us on the Pzena Investment Management first quarter 2015 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 $0.12 per share and $8.1 million in non-GAAP diluted net income. Revenues were $28.7 million for the quarter and our non-GAAP operating income was $13.3 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:]

Thanks, Gary. The loan awaited value recovery continue to elude us in the first quarter of 2015. Using history as a guide, by now we should have been enjoying the fruits of the value themes that were created during the global financial crisis. Instead, we are contending with sluggish economic activity and interest rates near zero caused by a continuing unwillingness to invest in developed economies and a retrenchment from the excess investment in emerging markets and the related commodity and energy infrastructure. Without any clear resolution of the cycle, investors continue to be attracted to the equities that are bond substitutes low volatility, strong cash flow, strong balance sheet businesses that appeared to be less risky. As active managers often shunned these overvalued stocks, they have produced the worse string of relative performance in years. This causes investors to prefer a passive strategy which keeps the process self-sustaining. Of course, it can’t go on forever. In the end, the value of an equity must bear some resemblance to the future opportunity set that represents. But until there is either a change in the economic environment that propels interest rates higher or a change in attitude towards risk the current conditions are likely to continue. Against such a backdrop, we modestly underperformed our benchmarks in the first quarter. While much of that underperformance has been restored since the end of the quarter, the fact that we are not yet in the recovery -- the fact remains that we are not yet in the recovery stage of the value cycle. Since the end of 2009, deep value has underperformed the cap weighted value indices such as the Russell 1000 value. While we generally have done well against the deep value benchmark, we have not excelled against broader market indices. This is the first value cycle in nearly 50 years where eight years past the prior peak and value has still now not outperformed for the full cycle. The natural question is a different this time. Thus, this era of low interest rates presage something permanently different this time. While we, of course, don’t know the answer for sure, we believe that the odds of such an outcome are low. Certainly, batting on it seems unreasonable. Stocks are priced as if the current environment will continue indefinitely. We have consumer staples and healthcare stocks trading on average at 20 times earnings and five times book value, while these stocks aren’t often thought of as value, they actually comprise 20% of the Russell 1000 Value index. When you add real estate investment trust and utilities to the mix, you’ve an index that is really hard to call value. While many investors including institutional investors are shifting towards passive strategies, there’s still a reasonable minority that continues to believe that you can add value with research and that having a true value component as part of their plan is sensible. In that vein we had a respectable quarter with net flows of $200 million. Inflows have been trending up over the past few years and the activity level causes us to believe that the trend will continue. Our win rate has stepped up as well as we move further and further away from the poor performance period of 2007 to 2008. We're obviously investing heavily in the belief that value will remain a dominant market for us as it has for almost all of the last 50 years. As you know, we’ve launched a series of mutual funds and are planning to open a London office this summer. We’re excited about the professionals we have attracted to head this business initiatives. There are experienced industry leaders and they’re now on Board and becoming acclimated to the Pzena culture. We expect their efforts will be rewarded over the coming years. As we build the team, our expenses have accelerated over the modest growth that we’ve had during the past few years. While we don’t expect instant results from these new distribution initiatives, we obviously are optimistic that over the long run they will add value. I’d now like to turn the call back over to Gary.

[Gary Bachman:]

Thank you, Rich. As I mentioned, we reported non-GAAP earnings of $0.12 per share for the quarter, down from $0.13 last quarter, but up from $0.11 during the first quarter of last year. The decrease from last quarter primarily reflects an increase in operating expenses, while the increase from last year is driven by increased asset under management and revenues. 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 first quarter of 2015 and the fourth quarter of 2014 our non-GAAP income statements also adjusted for certain non-recurring charges recognized in operating expenses. I’ll adjust the current tax related adjustments at the conclusion of my remarks, but for now, I’ll focus on the non-GAAP information. Our assets under management ended the quarter at $27.9 billion, up slightly from $27.7 billion last quarter and up 9.8% from the first quarter of last quarter, which ended at $25.4 billion. In the first quarter of this year, we had net inflows of $0.2 billion. The $2.5 billion increase from the first quarter of last year reflects $1.6 billion in net inflows and $0.9 billion in market appreciation. And March 31, 2015, our assets under management consisted of $15.9 billion in institutional accounts and $12 billion in retail accounts. Assets in institutional accounts increased $0.3 billion from the end of last quarter due to $0.2 billion in net inflows and $0.1 billion in market appreciation. Compared to last quarter, retail assets were relatively flat. Our average AUM was $27.6 billion during the quarter, up 1.8% from last quarter and up 11.7% from the first quarter of last year. Revenues were $28.7 million for the first quarter of 2015 relatively flat from last quarter reflecting a decrease in performance fees recognized, offset by the increase in average AUM. Revenues increased 8.7% from the first quarter of last year driven by the increase in average assets. We recognize $0.4 million in performance fees this quarter that compares to $1.2 million in the last quarter and $0.3 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 41.5 basis points for the first quarter of 2015. This compares to 42.2 basis points last quarter and 42.7 basis points for the first quarter of last year. Our weighted average fee rate for institutional accounts was 53.6 basis points for the first quarter of 2015. That was down from 55.4 basis points last quarter and 54.2 basis points for the first quarter of last year. The decrease from last quarter primarily reflects the decrease in performance fees recognized this quarter. While the decrease from the first quarter of last year reflects an increase in assets in our expanded value strategies, which generally carry lower fee rates. Our weighted average fee rate for retail account was 25.6 basis points for the first quarter of 2015. This compares to 26.2 basis points last quarter and 25.1 basis points for the first quarter of last year. The decrease from last quarter primarily reflects the addition of assets on our expanded value strategies, which generally carry lower fee rates. While the increase from the first quarter of last year reflects a slight increase in retail performance fees recognized in the first quarter of 2015. Looking at operating expenses, our compensation and benefit expense was $12.1 million for the quarter up 12.8% from $10.7 million last quarter and up 20.1% from $10.1 million for the first quarter of last year. The increase from last quarter and the first quarter of last year reflect increases in compensation and headcount. GAAP G&A expenses were $3.6 million for the first quarter of 2015 up approximately $0.5 million from last quarter and $1.3 million with the first 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 in October of 2014 and we’ll be moving to the new space next week. During the first quarter of 2015 approximately $0.5 million in lease expenses associated with our new corporate headquarters is reflected in G&A expenses. Last quarter approximately $0.4 million of such expenses were included in our results. During the first quarter of 2015 and the fourth quarter of last year, we adjusted our non-GAAP results for approximately $0.4 million related to our current office space that will now reoccur once we move to our new corporate headquarters. We expect an incremental increase in quarterly depreciation expense associated with furniture and leasehold improvements of approximately $2 million when we occupy the new space. The increase in G&A expense from last quarter and the first quarter of last year also reflects an increase in operational expenses and professional fees and other expenses associated with our growth initiatives. The non-GAAP operating margin adjusting for these non-recurring expenses was 46.5% this quarter compared to 53% last quarter and 53.1% in the first quarter of last year. Net of outside interest other income expense was relatively flat this quarter and the first quarter of last year, compared to income of $0.1 million last quarter. These fluctuations arise generally as a result of the performance of the firm's investments. The effective rate for unincorporated business taxes was 4% this quarter compared to 4.3% last quarter and 5.6% in the first quarter of last year. The decrease in this rate from the first quarter of last year is driven by the impact of 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 UBT was 35.6% this quarter compared to 34.2% last quarter and 44% for the first quarter of last year. Our effective rates this quarter and the fourth quarter of last year reflect tax benefits from employee share and mew investing as well as option exercises. The decrease from the first quarter of last year reflects the New York State law change from the sourcing of receipts effective at the beginning of 2015. We expect this rate excluding any share and new investing to be between 37% and 39% on an ongoing basis. The allocation to the non-public members of our operating company was approximately 80.4% of the operating company’s net income for the first quarter of 2015, compared to 80% for the fourth quarter of 2014 and approximately 81.3% 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 94,447 shares of Class A common stock for approximately $825,000 and 4,388 of our operating company Class B units for approximately $42,000. At March 31, there was approximately $17.7 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’ve recognized adjustments as a result of the revised estimates of future taxable income and our ability to utilize our deferred tax asset. During the first quarter of 2015 we also recognized the change in our deferred tax asset associated with changes and expected future tax benefits. We recognized a $0.1 million net benefit associated with changes to our deferred tax asset valuation allowance and liability to our selling and converting shareholders. These adjustment along with the adjustment for non-recurring lease expenses comprise the majority of the difference between our first quarter 2015 non-GAAP and GAAP net income. On a quarterly basis, we will record adjustments to the valuation allowance and our ability 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 economy interest in it. Inclusive of the effect of the valuation allowance and tax receivable agreement amounts I just discussed, we reported GAAP basic deluded and EPS of $0.12 per share for the quarter. At quarter end, our financial position remained strong. Our cash balance was $21.1 million as of March 31 and we declared a $0.03 per share yearend dividend last night. Thank you for joining us on the call. We'll now be happy to take any questions you may have.

[Operator:]

[Operator Instructions] The first question comes from the line of Ken Worthington with JPMorgan. Your line is open. Please go ahead.

[Ken Worthington:]

Hi, good morning. First, could you talk about the pipeline both on the sub advice side and the institutional side of the business? How things are looking, pipeline building up, staying flat, shrinking any other color would be great?

[Rich Pzena:]

Hi, Ken. The pipeline is I would describe it as reasonably flat. The pipeline built nicely through really the beginning to middle of 2014 and it's been flat since then.

[Ken Worthington:]

Okay. Is it on both sides or.

[Rich Pzena:]

Yes. It's on both sides. It's on both sides. We don’t exactly break it out that way but there is opportunities on both sides.

[Ken Worthington:]

Okay. On the institutional business gross sales were high, gross redemptions were also elevated. Can we walk through any takeaways from the quarter that you saw was kind of a bunch of money coming in and bunch of money kind of going out?

[Rich Pzena:]

Yes, the bunch of money coming in obviously is one, the distance that we put since the financial crises and two, through the investment that we made couple of years ago on expanding our basic institutional distribution headcount. Obviously that's why we will continue to expand because we want to be able to drive that number even further and we believe that there is a correlation. The outflows are remaining -- in most part there were a couple of large rebalancing where the client was either recognizing that our performance had outperformed their plan and they were rebalancing back to plan or they were shifting towards a reduction in equities or more passive. I don’t think there was any cited where they were worried about our performance. So it’s the same phenomenon that we've seen that when you do reasonably well, you get rebalanced away from and the trend continues towards reduction in equity exposure and move towards passive.

[Ken Worthington:]

Got it. Okay. Last one and then I'll re-queue, but you talked about hiring sales people, believe your headcount going from memory, but went up by five or maybe seven in this quarter. Assuming that my memory is correct what roles for these people filling I assume some of them were in sales any other themes that you're filling out. Are you starting to hire in London already and what were the hires.

[Rich Pzena:]

There were actually four hires this quarter. We went from 81 to 85. Three of the four were senior sales people. Two co-heads of London and one head of our mutual fund distributions. So, yes, we were very pleased with the quality of the people that we were able to attract. They were long searches as you know and they are all here. They are all working. We plan to formally launch London in the middle of the year with an office and by the end of the year we think we'll be fully staffed and up and running. Mutual fund same kind of timeframe and then that was three of the four and then the fourth hire was the Head of HR, which was a new position for us.

[Ken Worthington:]

Okay. Great I will re-queue. Thank you.

[Rich Pzena:]

Okay, I just wanted to make one clarification from the discussion -- from the prepared remarks. I think Gary when he said that the depreciation expense would be rising by $2 million, he meant to say $0.2 million and I just want to make sure that we got that clarified.

[Operator:]

[Operator Instructions] Okay. We have another question from Ken Worthington of JPMorgan. Your line is open. Please go ahead.

[Ken Worthington:]

Thank you. Okay, guess I should have just stayed on. Okay. So next on pipeline for new products, you launched a number of funds, are there plans to continue to launch or are you reasonably happy with your build out thus far and are going to let those season grow before the next round comes.

[Rich Pzena:]

The later. We're going to let them season and grow before the next round comes. Once we have the team fully in place and we have a sense of the market and where we stand in the market, we'll revisit that, but at this point, we're happy with our lineup.

[Ken Worthington:]

Okay, G&A you had about $3.3 million, there are gives and takes there. There is -- I assume its double rent kind of coming off as you move to your new facility. You've got London kind of ramping up. How should we generally expect gives and takes to flow through the G&A part of expenses through the year?

[Rich Pzena:]

The first quarter is elevated because we had an error that we had to eat in something -- in one of our client accounts and so it's likely that the G&A will be lower in each of the next three quarter than it was this quarter.

[Ken Worthington:]

Okay. Good. Performance fees, performance fees kind of come down, based on what’s rolling off of the funds that chart performance fees, where do they go over the next couple of quarter? Are they on their way back to zero? Do you have some bad quarters rolling off so that may be they perk up a little bit? What's the -- are they going to higher or go lower from here just again based on what’s rolling off?

[Rich Pzena:]

What I can tell you is that if performance stays exactly where it is, at this point because that's the only way we could calculate, it will still have substantial performance fees for the year and let me just -- hold on for one second.

[Ken Worthington:]

Yes.

[Rich Pzena:]

We actually expect the performance fees for 2015 to be somewhat above the 2014 performance fees.

[Ken Worthington:]

Really. Okay. And its backend loaded like 3Q, 4Q?

[Rich Pzena:]

That's correct.

[Ken Worthington:]

Okay. Okay. Float, so it's a little bit of a different question, but the float is still something you're investing in the business, you're growing it. How do you think about being a better stock for investors to own? Would you consider what options are on the table? Is it priority? Is it a priority, but down the line, the push back I get from trying to recommend the stock is you're a smaller company and you and the Management Team own the majority of it. So how do you make it better for us kind of outside investors?

[Rich Pzena:]

Yes, I don't really have a good answer to your question. We think about it a lot. The problem is that the people that are insiders that own the stock don't want to sell their stock because we see more upside going forward and the actual and I think you're aware of this that we allow our employees who own stock to sell their shares when they leave the firm or if they have a need. None of the senior people have engaged in that other than for charitable giving purposes and the actual dollar amount, the number of shares outstanding to the public has gone up reasonably significantly since our IPO. We probably have twice as many shares in the public accounts as we did during the IPO and it hasn’t translated into twice the volume. So I am not sure what to do. We're very open to suggestions, but I am not sure.

[Ken Worthington:]

Okay. Okay. Great. I think that gets me through my agenda. So anyway appreciate it. Thank you so much.

[Rich Pzena:]

Thanks Ken.

[Operator:]

I would now like to turn the call back over to Gary Bachman for closing remarks.

[Gary Bachman:]

Thank you, operator and thank you all for joining us on today's call. That concludes our call for today.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.