Calamos Asset Management INC. Q4 2008 Earnings Call Transcript

Calamos Asset MGMT INC

Q4 2008 Earnings Call

January 27, 2009 5:00 pm ET

Executives

John P. Calamos - Chairman of the Board, Chief Executive Officer

Cristina Wasiak - Senior Vice President, Chief Financial Officer & Treasurer

Joe Poulos - Investor Relations

Mark Infanger - Vice President and Corporate Controller.

Analysts

Craig Siegenthaler - Credit Suisse

Robert Lee - Keefe, Bruyette & Woods

Cynthia Mayer - BAS-ML

Presentation

Operator

Good afternoon. My name is Jason and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter 2008 conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Mr. Joe Poulos, you may begin your conference.

Joe Poulos

Thank you. Good afternoon. From time-to-time, information or statements provided by us including those within this conference call may contain certain forward-looking statements relating to future events, future financial performance, strategies, expectations, competitive environment and regulations. Forward-looking statements are based on information available at the time those statements are made and/or management's good faith, belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performances or results to differ materially from those expressed in or suggested by the forward-looking statement. Such risks or uncertainties include, but are not limited to, loss of revenues due to contract terminations and redemptions, our ownership structure, catastrophic or unpredictable events, unavailability of third-party distribution channels, damage to our reputation, our interpretation of and positioning relative to the market, fluctuations in the financial market, and the competitive conditions in the mutual fund asset management and broader financial services sector.

For discussion concerning some of these and other risks, uncertainties and other important factors that could affect future results, the forward-looking information in management's discussion and analysis of financial condition for results of operations and where applicable risk factors in the Company's annual and quarterly reports filed with the US Securities and Exchange Commission.

With me today is John Calamos, Chairman, Chief Executive Officer and co-Chief Investment Officer; Chris Wasiak, Chief Financial Officer and Mark Infanger, Vice President and Corporate Controller.

With that I would now like to pass the call over to John.

John P. Calamos, Sr.

Thank you, Joe and thank you all for joining us on the Calamos Asset Management fourth quarter 2008 earnings call. We appreciate your interest in our Company and for taking the time to be with us today.

I will review some of the overall numbers for the quarter and make some comments about our overall business. Chris Wasiak, our CFO will then give greater detail on our financials prior to opening the conference call to questions and answers. Then before we open the call to the Q&A, I would like to provide a brief overview of our investment performance and our outlook on the current market environment.

On slide 4, we took decisive actions during one of the worst markets in history as we all know and it has affected us because primarily we are an equity manager. So, overall we have experienced the worst stock market collapse in 75 years. Following an extremely difficult third quarter major market index has declined even more severely causing one of the worst fourth quarters in history, much worst than we ever anticipated.

Starting as far back as January of 2008, we began to take defensive action to protect our investors and our capital structure while remaining well positioned for the future. Most recently at the end of 2008, we decided to be aggressive in further solidifying our capital structure and reduce our indebtedness by $400 million. In our press release, I talked about how a decline in our assets under management was beginning to put pressure on some of our debt covenants.

However we looked at the situation, we also realized an opportunity to reduce the debt even further at favorable terms and therefore committed more capital than otherwise necessary to relief the initial concern we had about the covenants. We believe that the present economic conditions are not that of a typical recession and the reducing leverage in this environment provides us with more financial flexibility. This was a strategic decision following several other actions to make sure our capital structure is properly aligned with our operation to maintain competitive operating margins.

However, I want to be clear that we believe Calamos has enough capital to continue funding growth opportunities in our ongoing investment strategies. Our cash and investment liquidity is approximately $300 million and we are prepared for both adverse and opportunistic market conditions that may lie ahead. In addition to the debt repayment, we announced a series of actions to maintain healthy operating margins and to position us for increase flexibility going into 2009.

Although our operating margins for the quarter was below our historic ranges, which I had mentioned was perhaps the worst ever in the fourth quarter in the US financial markets, we still finished a very tough year with a 40% operating margin. I think this is a testament to the efforts undertaken at Calamos in 2008. These include tight expense controlled measures beyond compensation cost and staff reductions such as delaying or canceling nonessential projects and evaluating outsourcing solutions to reduce fix cost, it is important to recognize that the core investment team was unaffected by this reduction and it remains focus on long term opportunities that we see in our various product areas.

Page 5, our operating income for the current quarter was $21.4 million which contributed $0.14 per share to diluted earnings. As we have said in the past, we believe that operating earnings are the best indicator of our core current performance due to the volatility especially in today's market of the non operating earnings. This compares to an operating income of $52.6 million in the fourth quarter of 2007 which contributed $0.32 per share and $44.1 million for the third quarter of 2008 which contributed $0.30 per share.

Non -operating loss was $216.4 million in the fourth quarter of 2008 reducing earnings per diluted share by $1.38. This relates almost entirely to the activities surrounding the restructuring of our debt covenants in the early retirement of $400 million. Chris will elaborate on this in her section. We declared a quarterly dividend of $5.05 per share for the quarter payable February 28, 2009 to shareholders of record as of February 13, 2009.

On slide 6, our assets under management as of December 31, 2008 were $24 billion, down 48% from December of 2007. This represents a decrease of 28% from the previous quarters' end. The majority of the decline in assets during the quarter resulted from market depreciation for about $6.7 billion which we had kept highlighted and we will continue to underscore for industry wide in 2008 and certainly over the last quarter.

Fourth quarter revenue is decreased $66.9 million, down 46% from the fourth quarter of 2007 and down 34% in the third quarter of 2008. The flow trend is on slide 7. Net redemptions during the fourth quarter were $2.6 billion. That compares to $1.4 billion in the third quarter redemptions. These numbers reflect some of the worst market events we have ever seen in industry wide both the third and fourth quarter were especially tough on outflows.

However, our business was impacted by two factors that were not experienced industry wide and deserve special attention. First, during the fourth quarter, the reduction of leverage used by our closed end funds relating to the auction rate preferred security refinancing negatively impacted outflows by $782 million. Second as Chris will expand on later, we also reduced leverage for the Company. To generate cash to repay the debt, we sold $277 million of investments in products that we manage, further skewing to fourth quarter outflows. Absent of these two items, our net outflows for the quarter were roughly $1.5 billion, or slightly higher than the third quarter activity.

On page 8 for our year perspective, here is our current asset and product mix. We are starting to see a shift more towards convertibles in the past few weeks as these strategies are providing more downside protection in the current market as well as experience positive flows since we had opened our convertible plan.

At this point, I will turn the call over to our CFO, Chris Wasiak, to review our financial results. Chris?

Chris Wasiak

Thank you, John and good afternoon to everyone. As John mentioned, the fourth quarter has been challenging with assets of $24 billion at the end of December which is down 28% from September 30^th and down 48% from a year ago. Average asset for the quarter was $25.3 billion which is a decrease of 34% compared to the $38.4 billion reported in the third quarter and a decrease of 46% compared to the $46.9 billion in the fourth quarter a year ago.

During the fourth quarter, we have seen our convertible assets increase to 17% of total assets from 13% at the beginning of the quarter with the equity of that assets accounting for the offset. This change is attributable to the convertible assets providing greater downside protection as John already discussed, as well as to the positive [other things] generated within the convertible strategy.

To recap the more detailed flow information previously presented by John, for the quarter, net redemptions were $2.6 billion compared to net redemptions of $1.4 billion in the third quarter and $59 million in net redemptions in the fourth quarter a year ago. Mutual fund net redemptions for the quarter were $2.1 billion. This compares to redemptions of only $1 billion in the third quarter and net redemptions of $253 million in the fourth quarter a year ago. Again as John mentioned, mutual fund net redemptions were adversely affected by the balance sheet deleveraging effort by the Company and by the auction rate securities component in our closed end funds which together increased the redemptions of mutual fund alone by $1.1 billion for the fourth quarter.

If you exclude the impact of these two factors, our net redemptions for the quarter are back in line with the third quarter results. Within our separately managed accounts, we had net redemptions of $491 million for the fourth quarter compared to net redemptions of $360 million in the third quarter and net purchases of $204 million a year ago. Our separately managed accounts were also somewhat affected by our deleveraging efforts on the balance sheet in December since we did reduce our partnership investments by $40 million.

Moving on to slide 11, our total revenues of $66.9 million for the fourth quarter of 2008 are down 34% over the third quarter of 2008 and down 46% over the fourth quarter of 2007 driven by the decrease in assets under management. Our management fee revenue was $47 million down 34% and 46% from the third quarter and fourth quarter of 2007 respectively. Our fourth quarter management fee rate however was 73.9 basis points and is relatively constant and inline with our short-term expectations.

Going on to the operating income and margin, operating income for the fourth quarter was $21 million, a 52% decrease when compared to the third quarter of 2008 and a 59% decrease from the fourth quarter of '07. Decline is driven, as you would expect, by the decrease in assets and corresponding revenues that we already noted.

Total operating expenses were $45 million for the fourth quarter of 2008 which is a 21% decrease from the third quarter of 2008 and a 37% decrease from the fourth quarter of 2007. Again consistent with our OEM story, distribution expenses were the largest contributor to the expense savings falling $8 million, or 36% from the prior quarter and $13.8 million or 50% from the fourth quarter of 2007. Compensation and benefit expenses also contributed significantly to lower operating expense versus prior year and we are down $10.4 million or 42% from the fourth quarter of 2007 primarily reflecting reductions to performance-related expenses as well as lower staffing level. It should be noted that these are net of a $2 million nonrecurring severance related cost that were associated with our IT reorganization.

As noted in our third quarter queue, we had taken a number of steps to reduce our operating expenses going forward aside from staff reductions discussed here earlier and also in the recent press release that were effected in early January. The beneficial impact of the efforts to reduce non compensation expenses is already beginning to take hold in the fourth quarter. As John alluded too earlier, in addition to the severance cost already noted as far as the IT projects prioritization, capitalized projects were also written down which will clearly reduce our expense run rate.

Our operating margin was 32% in the fourth quarter of 2008 and decrease from 43.3% for the third quarter of 2008 and from 42.2% for the fourth quarter of 2007. The increase pressure on our operating margins extends from the drop in our average assets and while we have reduced our 2009 expense structure to be inline with our current asset base, we expect the margin pressure to continue towards 2009. Having said that, it should be noted that our 2008 full year operating margin is at 40.6%.

Moving on to slide 13, during the fourth quarter of 2008, we did reduce our outstanding long-term debt by $400 million to remaining $125 million. We generated cash through the sale of $379 million of investments from our corporate portfolio. In negotiating this prepayment, our goals were to alleviate concerns with respect to meeting certain financial covenants going forward and to align our capital structure with the current size of our business. Another important goal for us was to main sufficient liquidity to provide the ongoing flexibility to see new products and to execute our long-term growth initiative. We feel that we were successful in all fronts.

Further, we were able to negotiated very favorable terms during a difficult time in the capital market. In addition to gaining flexibility on covenants, we negotiated the repayment of $150 million of debt with contractual make-whole payment of $34.9 million which is reflected as debt extinguishment cost in our financial statements and we are able to negotiate an additional $250 million of debt repayment at par, in other words, with no make-whole payment.

We estimate that the costs recorded in the fourth quarter as the result of the debt repayment were approximately $216 million and were comprised of net realized losses on the sale of investment, the make-whole payment and debt issuance cost. The total impact of this cost reduced diluted earnings per share for the quarter by $1.37. On the next slide, we provide more detail on the non-operating result.

While largely beneficial to the long-term stability of the Company, you can clearly see that the debt prepayment had a significant impact on our fourth quarter non-operating results driving the net realized capital losses in the quarter and the debt extinguishment cost. It should be noted though that this realized losses have minimal impact on our net worth since virtually all these amounts have been reported in OCI and disclosed in the investment security footnote in our last 10-Q. Potentially, it is the re-class from the balance sheet and to the income statement.

Our non operating activities reduce income by $216.4 million in the fourth quarter of 2008, reduced income by $51 million in the third quarter of 2008 and increased income by $17.6 million in the fourth quarter of 2007. During December, our ownership in the offshore funds dropped below 50% eliminating the need for us to consolidate the results of these funds with our own. This means that going forward we expect this to reduce much of the volatility that resulted from the market fluctuation experienced during 2008.

Moving on to the next slide, it displays the impact that our operating and non operating activities had on earnings per share. While our operating income has decreased from prior periods, our non-operating activities represented by the dark blue bar chart are the cost of the fourth quarter loss for diluted share. In dollar terms, net loss for the quarter was $26.1 million compared to a net loss of $800,000 with the third quarter of 2008 and net income of $9.3 million for the fourth quarter of 2007. This resulted in a loss of $1.24 per diluted share for the fourth quarter, down $1.19 per share from the third quarter of 2008 and down $1.56 per share from the fourth quarter a year ago.

Finally, I would like to conclude my comments with the review of our investment portfolio which is reflective of the financial strength and stability of our Company. After using the portfolio as the primary funding source to repay $400 million in debt, our portfolio's investment was valued at nearly $275 million at yearend. These investments continued to be comprised of highly liquid investments and provide us with the stability to weather difficult market and the flexibility to support our long-term growth initiative. We continue to hedge our portfolio to minimize our downside exposure but allowing for participation in up market.

On the final note, we recently filed a 14C which essentially removed the one for one relationship between CAM outstanding common shares and its ownership of Calamos Holdings LLC membership unit. This change is beneficial to the CAM Class A common stockholders and that it provides for asset specifically owned by CAM such as the deferred tax asset and associated cash build up to accrue only to those shareholders. We expect this change to be effective in March of 2009.

Now, I would like to turn the call back over to John for a discussion of our investment performance and market outlooks.

John P. Calamos, Sr.

Thank you, Chris. On slide 18, we will talk a bit on some bullet points about our overview and outlook and as you all know, there is quite a bit of action by the governments around the world to fight deflation and we were hopeful that that specially with the amount of money putting in that that will get the banking system working again and the economy working again. We were affected probably a bit more because of two asset classes; one is growth stocks. Our growth stocks, even though they were not in financials or housing stocks, took what we consider an abnormal hit during the fourth quarter like a lot of asset classes. It is creating, in our mind, tremendous opportunities. Our growth stock today, our price is as if they will never grow again. In fact, growth stocks are priced at virtually the same multiple as value stock. So, we view this as a terrific opportunity for investors that can see beyond the current crisis.

Convertibles also are of course one of our core competency and a large asset base for us. Convertible has got caught up in the massive deleveraging by the hedge plans that employ convertible arbitrage on leverage. We feel that therefore selling made convertibles extremely undervalued here. This is the first time that I have seen in a recessionary area where convertibles did not hold up as well as we would have thought they would because of their bond attributes and that is a result of the forced deleveraging by the hedge plan community.

So, in both those areas we are seeing a good opportunity and as we outlined on page 19, we did open up our convertible fund and we are getting positive flows in the convertible fund and the convertible fund is well ranked as well as some of other convertible opportunities, strategies both offer less volatile ways to be in the equity market. We also have a market neutral fund that offers a hedge strategy in a 1940 Act fund so we feel that is also well positioned for the coming year. I think more and more investors will be looking for investments that will have less volatility in what is to be a very volatile market.

We think experience matters as we look at our longer term track records. They are very favorable positioned and we feel with the current valuations in growth stock, that our growth plan is also very well positioned here in the marketplace.

On page 20 or slide 20, it really talks about our risk adjusted returns over the long term and as you know the place you want to be is in the northwest quadrant typically risk adjusted returns and you can see that most of our strategies are in that place over the long term and I think as investors look forward, they will be looking at those risk adjusted returns for experience managers.

On page 21, it shows our institutional strategies over the long term going back as far back as 1979 on the convertible strategy and as new as April of 2007 on our global equity strategy, as you can seen they are relative to their appropriate benchmarks, we are well positioned in that categories as well.

On page 22, again it is the long term look at our mutual fund line up and the convertible fund there goes back to 1985, one of the first open ended convertible funds so it has a good long term track record as does our growth in income, growth plan, global growth in income in our other products.

So on page 23, actually page 23 and 24, we look at both those strategies or all those strategies over the last 12 months, in other words the performance for 2008 in a very difficult year and as you can see in many of our products, we were very competitive on a relative basis.

So, at this point, I would like to open it up to the Q&A. Joe, will you help me up?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Craig Siegenthaler - Credit Suisse.

Craig Siegenthaler - Credit Suisse

I just wanted to know after the restructuring here, I guess you had about $115 million left. Can you walk us through what debt covenants you have remaining, on the $150?

Chris Wasiak

Yes, we have a net worth covenant that requires us to keep a $150 million.

Craig Siegenthaler - Credit Suisse

Is that of cash and investments or is that just cash?

Chris Wasiak

It is net worth covenant so it is not cash or investments. It is a straight net worth calculation. We have an interest coverage ratio as to most of what we had had before with then at the minimum ratio of 3.0. There is a debt leverage ratio consistent again with what we have had before that has a ratio of 3.0 that in calendar year 2009 that has been dropped down to 2.75. It is just where it has been before and an investment coverage ratio that is the ratio of the investment portfolio plus cash to the total amount of debt which is actually 1.25 and that has minimum ratio of 1.175.

Craig Siegenthaler - Credit Suisse

Got it and when I look at slide 16 where you show your simple assets on your balance sheet, that delta there that really comes from two actions - one is realized losses on the partnership and investment funds which you used to repay the debt and the other is the marks kind of minus the hedge, is that correct?

John P. Calamos, Sr.

Yes, effectively yes it is the liquidation of those securities more than just the unrealized gains too.

Craig Siegenthaler - Credit Suisse

Was the hedge pretty effective in this quarter because I think you put it on in early October? It was in October but it looks like with the underlying mark down by only about $20 million?

Chris Wasiak

The hedge was very effective. We did not get it on unfortunately until the, after the first week of October but has proven very effective since then.

Craig Siegenthaler - Credit Suisse

Got it and when we think about the markets in the first quarter of 2009 with equity market sinking like down to the single digits, it should probably meet almost all those losses, is that right?

Chris Wasiak

In our investment portfolio, yes. It has proven to be very effective in the first quarter, yes.

Operator

Your next question comes from the line of Robert Lee - Keefe, Bruyette & Woods.

Robert Lee - Keefe, Bruyette & Woods

If we look at current expense levels, G&A, compensation, do those reflect pretty much all the cost initiative you took in Q4 or is there, it was like is that kind of front end or back end loaded so we have not really seen the more recent steps fully in the run rate?

Chris Wasiak

The one feature missing yet is the last reduction enforced that we announced in January, the severance expense for that, we will see that in the first quarter of 2009. So, you will see the full impact of that final reduction in the second quarter of 2009.

Robert Lee - Keefe, Bruyette & Woods

Okay. Is that going to be of similar magnitude to what was in the Q4?

Chris Wasiak

Yes.

Operator

Your next question comes from the line of Cynthia Mayer - BAS-ML.

Cynthia Mayer - BAS-ML

Can you tell me how much leverage is left in the closed end?

John P. Calamos, Sr.

We continually reduce leverage over that period so I do not have, remember we have five plots so we financed over 80% of the auction rate preferred so we only have less than 20% for the auction rate preferreds. So, the funds are maintaining the 1940 Act leverage ratios but I do not have that exact amount.

Cynthia Mayer - BAS-ML

In terms of, sorry for the cold, in terms of cost hedge, if the margin introduced turn downward, how confident you feel that you could find more cost hedge and what sort of areas would they come from? Would you perhaps cut product areas where you do not have scale?

John P. Calamos, Sr.

Well, we continue to look at that. We think through what we have done throughout the past few quarters here that we should be in good shape for 2009, of course, nobody knows what is going to happen next week or next month or next quarter but we feel that at the present asset levels that we still have healthy margins going forward in 2009 and we can maintain that. We have taken the steps to make part of our expenses more variables, Cynthia, which they were not before. So that and we continue to work on that so that would be a positive that those expenses on the operational side would be variables instead of assets.

Cynthia Mayer - BAS-ML

You mean by outsourcing or...can you elaborate on that?

John P. Calamos, Sr.

Yes, well we reduced our IT, our information technology commitment which was a fixed expense and we are in the process, on the operational side, in conjunction with the IT side making that much more of a variable expense to our asset base and we hopefully, midyear is our target for that.

Cynthia Mayer - BAS-ML

Okay and last question I guess, maybe you answered this already, but in this quarter's comp, how much of that number is the reversal of incentive comp? How big was that?

John P. Calamos, Sr.

Yes, it is really not all that different than our run rate has been for the third quarter so you are not going to see like a big reversal or a through up in this quarter as you might expect. We have been managing to the long-term expectations throughout the year and those expectations have not changed significantly quarter over quarter.

Cynthia Mayer - BAS-ML

So, is that a decent run rate?

John P. Calamos, Sr.

Outside of the fact that as Chris had indicated, we have got additional costs and severance coming through in the first quarter and as you know, Cynthia, we pay our bonuses in the first quarter too. So we always have that spike for the incentive comp or, I am sorry, for the spike expenses and profit sharing related cost.

Operator

At this time there are no further questions. Are there any closing remarks?

John P. Calamos, Sr.

Well, we want to thank you all for joining us on our call and if you do have any questions, feel free to give us a call. Thank you very much for your time this afternoon.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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