Gary Bachman - Chief Financial Officer
Rich Pzena - Chairman, CEO and Co-CIO
Rahul Nevatia - JPMorgan
Pzena Investment Management, Inc. (PZN) Q4 2012 Results Earnings Call February 13, 2013 10:00 AM ET
Good day, ladies and gentlemen. And welcome to the Fourth Quarter 2012 Pzena Investment Management Earnings Conference Call. My name is Aisha and I will be your operator for today. At this time all participants are in listen-only mode, later we will conduct a question and answer session towards the end of this conference. (Operator Instructions)
I would remind you this call is being recorded for replay purposes. I would now like to turn the call over to your host for today, Mr. Gary Bachman, Chief Financial Officer. Please proceed sir.
Thank you, operator. Good morning and thank you for joining us on the Pzena Investment and Management Fourth Quarter and Full Year 2012 Earnings Call. I'm Gary Bachman, Chief Financing 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 reference the standard legal disclaimer. Statements made in the presentation today may contain forward-looking information about management's plans, projections, expectations, strategic objectives, business prospects, anticipated financial results and other similar matters.
A variety of factors, many of which are beyond the company's control affect the operations, performance, business strategy and results of the company. And can cause actual results and experiences to differ materially from the expectations or objectives expressed in these statements.
These factors include, but are not limited to the factors described in the company's reports filed with the SEC which are available on our website and on the SEC's website at www.sec.gov.
Investors are cautioned not to place undue reliance on forward-looking statements, which speak only as to the date on which the statements are made. The company does not undertake to update such statements to reflect the impact or circumstances or events that arise after the date these statements were made.
Investors should however consult any further disclosures the company may make in the reports filed with the SEC. In addition, please be advised that because of the provision on selected disclosure, the company as a matter of policy does not disclose material that is not public information on their conference calls. If one of your questions requires the disclosure of material of non-public information we will not be able to respond to it, thank you.
In a minute I will turn the call over to Rich, but first I'd like to review some of our financial highlights.
We reported non-GAAP diluted EPS of $0.08 per share and $5.2 million in non-GAAP diluted net income. Revenues were $19.3 million for the quarter and our operating income was $9.5 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.
Thanks, Gary. As we head into the new year and the firm's 18th year in business, it feels like we maybe at an inflection point in the markets and investors' sentiment. The last six years have been a period dominated by crisis and flight from risk in investor portfolios.
Looking to avoid a repeat of the losses experienced during the financial crisis CIOs around the world adopted volatility reduction strategies and [mess]. For example, according to the UK Pension Protection Fund and Pension Regulator, the average UK pension now holds 38.5% of its assets in equities down from 61.1 % in 2006.
Investors were successful in reducing volatility in their portfolios. They executed the strategy well, perhaps too well. But the question is did they really reduce risk. Boards and Trustees are now asking how will plans reach their fully funded status in a world of 2% treasury yields. There are in essence only 2 real answers, add volatility or add money. Since making contributions could conflict with other priorities for cash I'll move back toward a more normal investment profile seems like a high probability, including adding volatility which is underweight globally.
As such our level of institutional activity continues to accelerate and funds flows have turned positive into our sub-advised accounts. We attribute part of this increase in dialogue to the decisions we made almost two years ago to expand our business development team. We now covered North America with three dedicated institutional sales professionals; Europe and the Middle East with two, each of whom speaks five languages; and Australia with one.
We also have an individual dedicated to covering the sub-advisory and defined contribution space. We are now evaluating how to best introduce ourselves in Asia and look forward to developing a thoughtful strategy in that regard. All of this is happening against an investment backdrop that is extreme. Bonds and equities with stable earnings or high-dividend yields are at or close to peak valuations, while many companies with cyclical earnings remain depressed.
As such that are traditionally considered safe, i.e.; U.S. treasuries or investment grade corporate debt have become more risky as interest rates plunged towards zero, while economically sensitive stocks have arguably become less risky as earnings improved, balance sheet strengthened and their valuations lag.
The opportunity to own assets deemed risky is exceptionally attractive relative to history, as risk appears significantly mispriced in today's markets. Nowhere is the opportunity more apparent than in financial services and in technology.
For example, one of the major market anomalies today is in the valuations of the large commercial banks or improved fundamentals have not been anywhere near fully reflected in share prices despite strong returns in 2012. These institutions have made significant progress towards achieving higher capital targets while restoring underlying profitability yet still trade well below fair value.
We also continue to find outstanding value in the technology sector, [names] where the perception is that their products are being made obsolete by new technologies. Today, the sector which has undergone a decade plus of de-rating trade at the discount to the broad market and has a wealth of companies with leading businesses and strong cash flows, where the future appears much brighter than valuations suggest.
Looking to our deep value discipline, our portfolios are dominated by a broad range of holdings in these sectors, unlike many of our value brother. For example, financial services and technology make up 55% of our U.S. large-cap value portfolio today versus 32% for managers identifying themselves as large-cap value and 33% for the Russell 1000 Value Index.
More than ever 2012 demonstrated the importance of being exposed to deeply undervalued securities before prices adjust to a new consensus view. At the beginning of the year, conventional wisdom had Europe tethering on the verge of collapse, the financials years away from even anemic recovery and the housing sector, particularly in the U.S., hobbled by falling prices and lack of mortgage lending.
12 months later the MSCI Europe Index has advanced 19% in U.S. dollar terms, financials turned in strong double-digit returns around the globe and the housing-related holdings soured, some more than doubling, as both housing prices and new home construction in the U.S. turned up.
In this environment, most of our strategies beat their benchmarks, particularly those with European exposure and highlighted the importance of being positioned before the turn. Notwithstanding the better market climate of late, many of our portfolios continue to be among the cheapest in our history and we are excited by the current market depth of opportunities for our deep value approach.
Our clients know that we will not deviate from true value investing and that such commitment is necessary to achieve long-term investment success.
Thank you. And I look forward to answering your questions, but first let me turn the call over to Gary Bachman, our CFO, who will review our quarterly financial results.
Thank you, Rich. I'll start out by discussing our assets under management, fee rates and revenues. Our average assets under management were $16.8 billion during the quarter, up 30.5% from last quarter and up 27.3% from the fourth quarter of last year. We ended the quarter with $17.1 billion of assets under management, up 1.8% from the end of last quarter, which ended at $16.8 billion and up 26.7% from the end of fourth quarter of last year, which ended at $13.5 billion.
The $0.3 billion increase from last quarter was due to $0.7 billion in market appreciation, partially offset by $0.4 billion in net outflows. The $3.6 billion increase from the fourth quarter of last year was driven by $2.7 billion in market appreciation and $0.9 billion in net inflows.
At December 31, 2012 our assets under management consisted of $11.2 billion in institutional accounts and $5.9 billion in retail accounts. Assets in institutional accounts were flat during the quarter as a $0.5 billion increase in market appreciation was offset by net outflows. Compared to last quarter, retail assets were up $0.3 billion due to market appreciation in net inflows.
Revenues were $19.3 million for the fourth quarter of 2012, up 2.4% from last quarter and 2% from the fourth quarter of last year. The increase from last quarter and the fourth quarter of last year was primarily due to higher weighted average assets, driven by our appointment as advisor to 28% of the Vanguard Windsor Fund in the beginning of August of this year, partially offset by lack of performance fees recognized during this quarter.
Our weighted average fee rate was 46.1 basis points for the fourth quarter of 2012, compared to 50.8 basis points last quarter and 57.3 basis points for the fourth quarter of last year. The decrease from last quarter and from the fourth quarter of last year reflects the full quarter impact of advisory fees associated with the Vanguard appointment, which carries lower fees. The decrease from the fourth quarter of last year is also attributable to the lack of performance fees recognized this quarter.
Our non-GAAP income statements adjust for the recurring valuation allowance and tax receivable agreement items. I'll address the current 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 benefits expense was $7.9 million for the quarter, up 2.5% from last quarter and down 1.6% from the fourth quarter of last year. The increase from last quarter and the decrease from the fourth quarter of last year were primarily driven by changes in discretionary bonuses.
G&A expenses were $2 million for the fourth quarter of 2012, up 11.3% from last quarter and down 3.7% from the fourth quarter of last year. The increase from last quarter was primarily as a result of fluctuations in various expense categories, while the decrease from last year was driven by reductions in real estate expenses associated with the sublease of excess office space in the fourth quarter of last year.
Operating margins were 49% this quarter, compared to 49.9% last quarter and 46.9% in the fourth quarter of last year. Net of outside interest, other income was $0.2 million this quarter and last quarter and $0.5 million for the fourth quarter of last year. These fluctuations arise generally as a result of the performance of firm investments.
The effective rate for unincorporated business taxes was 6.6% this quarter, up from 6.2% last quarter and from 6% in the fourth quarter of last year. The fluctuations in these effective tax rates are driven by certain expenses, that are primarily nondeductible for UBT purposes. We expect this rate to be between 5% and 7% on an ongoing basis.
The allocations in non-public members of our operating company was approximately 82.7% of the operating company's net income this quarter, compared to approximately 83.4% last quarter and approximately 83.6% in the fourth quarter of last year. The variance in these percentages is a result of changes in our ownership interest in the operating company.
The effective tax rate for our corporate income taxes ex-UBT was 43.5% this quarter, compared to 42.9% last quarter and 40.8% for the fourth quarter of last year. The increase in our effective rate this quarter is a result of adjustments associated with the tax effect of (inaudible) non-cash compensation. The increase from the fourth quarter of last year is also due to the effect of one-time prior period adjustments recognized in the fourth quarter of last year.
Our expectations are that our corporate effective tax rate will generally be between 42% and 43%. As a result we reported basic and diluted non-GAAP EPS of $0.08 per share for the fourth quarter.
During the quarter through our stock buyback program, we repurchased and retired 127,576 shares and units for approximately $668,000. At December 31st there was approximately $9.1 million remaining of the $10 million repurchase program authorized during April of this year.
Before we turn it over to questions, I'd like to briefly walk through the valuation allowance and tax receivables adjustments. In the fourth quarter of 2012, we recognized the adjustments that arose as a result of revised estimates of future taxable income and our ability to utilize our deferred tax assets.
We recognized $8.4 million decrease in our valuation allowance and a $0.3 million increase in our liability towards selling and converting shareholders for the quarter. The net effect of these adjustments comprised of the majority of that difference between our fourth quarter 2012 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 we extend our projections out in future quarters. 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 the tax receivable agreements I just discussed, we reported GAAP basic EPS of $0.9 per share and diluted EPS $0.08 per share for the quarter.
At quarter end our financial position remains strong. Our cash balance was $32.6 million at December 31st and we declared a $0.16 per share yearend dividend the last night.
Thank you for joining us. We are now happy to take any questions.
(Operator instructions) Your first question comes from the line of Ken Worthington with JPMorgan. Please proceed.
Rahul Nevatia - JPMorgan
Hi. This is Rahul Nevatia speaking for Ken this morning. Ken apologizes for not being in the call today, but he's on a flight. But I do have couple of questions. Has the Vanguard relationships changed the conversations with other current and potential customers?
If in fact has the number of this conversations has increased quite significantly. And I think, the nature of the (Inaudible) the quality endorsement that we've received as a result of such a prestigious institution choosing to hire us. Really simulate a question of why and we're getting this question not just here in the U.S. but all over the world and I think people are talking a look.
Rahul Nevatia - JPMorgan
Makes sense. So you think the RFP activity has increase in the New Year. Last year RFP activity increased but didn't necessarily -- money necessarily didn't move. So do you think 2013 is going to be different or you think institutional investors will wait and will see how the year goes?
These are the imponderables. Obviously, we always come into this with hope that we will have a better conversion into money into the accounts, I mean so far I would say it's encouraging but and you saw the flows that we had in January. I don't know if those are going to be indicative of what happens throughout the year. But it certainly feels better and in January than in 2012.
Rahul Nevatia - JPMorgan
Okay. And just another quick question, just for modeling. Is the estimated fee rate now for the fourth quarter is that a good run-rate going forward.
Rahul Nevatia - JPMorgan
Okay. Great. Thank you.
(Operator instruction) There are no further questions in the queue at this time. I would now like to turn the call over to Mr. Gary Bachman for closing remarks. Please proceed.
Thank you, Operator. And thank you, everyone for joining us on today's call.
Thank you for your participation in today's conference. That concludes the presentation. You may now disconnect and have a great day.
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