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Eaton Vance Corp. (NYSE:EV)

F1Q09 (Qtr End 01/31/09) Earnings Call Transcript

February 25, 2009 11:00 am ET

Executives

Dan Cataldo – VP of Financial Planning and Analysis

Tom Faust – Chairman, President and CEO

Bob Whelan – CFO

Analysts

Craig Siegenthaler – Credit Suisse

Dan Fannon – Jefferies & Company

Jeff Hopson – Stifel Nicolaus

Ken Worthington – JPMorgan Chase

Robert Lee – KBW

Cynthia Mayer – Merrill Lynch

Michael Kim – Sandler O’Neill

Marc Irizarry – Goldman Sachs

William Katz – Buckingham Research

Operator

Greetings, and welcome to the Eaton Vance first quarter 2009 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Dan Cataldo, Vice President of Financial Planning and Analysis for Eaton Vance. Thank you, Mr. Cataldo, you may now begin.

Dan Cataldo

Good morning, and welcome to our first quarter fiscal 2009 earnings call and web cast. With me this morning are Chairman and CEO, Tom Faust; CFO, Bob Whelan; and Laurie Hylton, our Chief Accounting Officer.

Tom and Bob will comment on the quarter and then we will address your questions. The full earnings release and charts we will be referring to during the call are available on our website, eatonvance.com under the heading Press Releases.

We need to begin with a reminder that today's presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our operations and business, including but not limited, to those discussed in our SEC filings. These filings including our 2008 annual report in Form 10-K are available on our website, on request without charge.

I now like to turn the call over to Tom.

Tom Faust

Good morning, and thanks everyone for joining us.

The first quarter of our fiscal 2009 was largely a continuation of what we saw in the latter part of fiscal of 2008, which I will describe a strong performance by Eaton Vance, amid the most challenging market and economic environment.

The US credit market showed improvement over the three months ended January 31, equity markets performed very poorly with the S&P 500 index down 15% and the Dow Jones Industrial Average down 14%. Against the backdrop of weak equity markets, global recession, and significant disruption in the financial services market place, Eaton Vance maintained positive business momentum and continued organic growth in the first quarter.

Highlights of the quarter include strong growth in net flows equating to an annualized internal growth rate of 11% or 15% before the effect of deleveraging, continued strong relative equity fund performance with 97% of our equity fund assets and funds that beat their peer group average over the past three years, 95% over the past five years, and 93% over the past 10 years.

A dramatic snap back in the performance of municipal bond funds as spreads versus taxable bonds narrowed from the unprecedented levels reached in mid-December, contributing to favorable absolute and relative performance for our line-up of municipal income funds and the rally.

Funding by Eaton Vance and our affiliates of a number of significant new institutional and sub-advisory mandates. The closing of the Tax Advantaged Bond Strategies acquisition brings this highly attractive and complimentary investment discipline into the Eaton Vance family, solid profitability, and the preservation of our financial flexibility.

As reported in our press release this morning, we earned $0.21 per diluted share in the first quarter of fiscal 2009, which compares to $0.28 in the fourth quarter of fiscal 2008, and $0.46 in the year ago quarter. Included in this quarter's earnings is approximately $0.01 of net realized, unrealized and impairment losses on our investments, which compares to a $0.13 charge in the fourth quarter of last year.

While revenues fell as a result of market driven asset declines, various asset-based and profit-based expenses also fell as expected, and we have started to see the benefits of our cost reduction initiatives. Bob will discuss our financial results in more detail in a moment, but given that market action has taken away one-third of our assets over the past 12 months, we were reasonably satisfied with how well our margins have held up.

Our ability to generate net new flows and the inclusion of $6.9 billion in new managed assets from the TABS acquisition has helped us maintain our managed asset levels. Assets under management of $121.9 billion at January 31, 2009 were down 1% from last quarter end, and down 20% from a year earlier. Average assets under management for the quarter, which is a key driver of our revenues were down 16% sequentially and 23% year-over-year.

Please refer to slides two through five, which provide additional color on the change in the breakdown in assets under management. Gross sales of $12.3 billion made the first quarter of fiscal 2009 our second best sales quarter ever, behind only the second quarter of fiscal 2007, which included $5.8 billion of closed-end fund flows through an initial public offering.

I do not know how many asset managers can say they had their second best sales quarter ever in this environment, but I doubt they are very many. Retail fund gross sales of $7 billion and institutional and high net worth separate account inflows of $3.4 billion led the way, followed by retail managed account sales of $1.9 billion, up slightly from recent quarterly highs.

Large-cap value continues to be a profitable investment style garnering about 40% of gross flows over the period. It is notable; however, that the diversity of our sales mix grew as the quarter progressed thanks to the recovery we have seen in the municipal and bank loan markets and the resulting favorable impact on our flows in those categories.

We generated positive net flows in the quarter of $3.3 billion representing 11% annualized internal growth rate. Similar to last quarter, this quarter included $1.3 billion in outflows related to reductions in leverage, primarily to maintain required asset coverage ratios as values decline; $500 million in closed-end funds, $500 million in privately offered equity funds, and $300 million in our structured bank loan product.

Backing out the effect of reduction in leverage our net flows yields an annualized internal growth rate of 15%, giving you a better sense of what we think of as our true internal growth rate from actions taken by our clients and customers. Please refer to slide six through nine with respect to our flows in growth rates.

Referring to slide 10 and 11, you'll get a sense of how flows in our retail product lines compared to prior quarters. Fund sales were on par with the best quarters in 2008, and we were encouraged by the improving trend in fixed and floating-rate income fund sales, reflecting the attractive spreads and bottoming of prices in most income categories.

We did a slowing of retail managed account sales in the quarter, primarily in Parametric’s tax managed core equity products. In the retail managed account space, we are encouraged by the flows into the TABS income product, since we acquired that business at the end of December. Sales there should accelerate as we place the TABS product on more platforms, which is happening in the second quarter.

The sales success we have seen in our open end fund is evident in the strategic in sight data on slide 12, which ranks fund sponsors in terms of their long-term fund net inflows in the nonproprietary distribution channel for 2008, and the preceding three years. Eaton Vance ranked number three in long-term net flows for 2008 consistent with our second, third and fourth placed finishes in the prior years.

If you look at the site carefully, you will note that Eaton Vance is the only fund company that is ranked in the top five or even the top 10 for every period presented. This is the true measure of success in our core fund business and a testament to the strength of our distribution organization, the appeal of our funds, and our continued ability to bring innovative value-added products to market.

Slide 13 shows our ranking among all fund managers in terms of long-term fund assets under management as of the end of the fiscal quarter and recent year-end, highlighting the steady progress we have made advancing our market share in recent years. According to strategic insight, Eaton Vance now ranks as the 13th largest manager of long-term fund assets in the US. We believe we have lots of room for growth and good prospects for continuing to move up the page.

Our retail distribution organization has gone through a lot of changes over the past two years; changes that we believe have strengthened the organization and importantly strengthened relationships with our key distribution partners. You are in no doubt aware of the drastically changing distribution landscape in financial services. For example, only two years ago Merrill Lynch, Wachovia, AG Edwards, Wells Fargo, Bank of America, Morgan Stanley, and Smith Barney were each distinct and important product distributors for us. Those seven funds are now in the process of being brought down to just three.

In addition to firm consolidation, registered reps are switching firms more now than they have ever before. These changes bring uncertainty as relationships are disrupted and firms and advisers re-evaluate the asset managers with whom they do business. There will be winners and losers. We firmly believe that Eaton Vance will be one of the winners.

The reason, our independence is a big plus. We have not been involved in any scandals. We have had very strong relative equity performance at a time when selection decisions are being made. Our credit products are poised for accelerated performance as those markets recover, and we can offer unique products and services tailored to the high net worth advisor. In short, we are positioned and focused in a way that should make Eaton Vance one of the go to product providers through this downturn, and most importantly as we come out of it.

Turning to institutional distribution, like the rest of our business, we carried the momentum from fiscal 2008 into the first fiscal quarter of 2009 generating $2.5 billion in gross and $2 billion in net inflows across Eaton Vance Management and our affiliates. Led by Eaton Vance large-cap value and Parametric’s structured emerging market discipline, we also saw inflows into EV small cap bank loan and high yield disciplines.

Additionally, Atlanta Capital had a very strong quarter, posting inflows to their quality large cap growth, small cap, and fixed-income disciplines. Slides 14 and 15 show the breakdown in our institutional assets under management by discipline and by company.

Our relative investment performance has held up well through the market downturn. At January 31, 2009, we had 17 equity funds with overall Morningstar Ratings of four or five stars for at least kind of shares. These funds are listed on slide 16. The strong performance covers a broad cross-section of equity disciplines including growth in value, large cap and small cap, US and international, tax managed and non-tax managed, general-purpose and specialty.

Slide 17 shows our equity funds composite performance against their peers group averages as of the most recent quarter end. We are quite proud of the strength and consistency of these numbers.

Looking at the performance of our income products, we have reason to be optimistic. As I mentioned earlier, both relative and absolute performance of our municipal bond funds have begun to come back with the narrowing of what we considered unsustainable muni taxable spreads. Our flagship national municipal fund is up 27% on a price basis since it bottomed in mid-December.

Although, it is not our practice to focus on short-term performance, there is no question that the move of this magnitude highlights a severe dislocation experienced in the long-term municipal markets late last year, and the tremendous value that we believe still exists there. We have seen a similar trend with our bank loan funds, where our flagship fund has seen a 10% price recovery since mid-December.

In the diversified income category, our strategic income fund ranks in the first Lipper Quintile over each of the past of one, three, five and 10 years as a four star Morningstar Rating and now has grown to $1.3 billion. By any measure it is a formidable competitor in this large and growing asset class, which has been attracting more attention as the equity markets continue to sag and investors are looking increasingly to fixed-income.

We do believe industry flows in the income products will accelerate as we saw in January. Our broad line-up of taxable fixed-income, tax rate municipal income and floating rate and bank loan products should serve us well in this environment.

That covers my comments on the business. I will now turn the call over to Bob Whelan to review the financial results in more detail.

Bob Whelan

Thank you, Tom. Good morning, everyone. I want to provide you a sense of how we are navigating these challenging markets by speaking about three main topics. First, our earnings and the drivers behind both the year-over-year and sequential earnings declines; second, our progress on managing expenses while continuing to grow the business; and lastly, to comment on our balance sheet and capital planning efforts.

As Tom has outlined, our first-quarter results were impacted by the market declines that began in the fourth quarter of 2008 and continues through the first fiscal quarter of 2009. Over the past six months the markets have taken away $43 billion of managed assets, $32 billion in Q4 and another $11 billion in this fiscal quarter. Despite the volatile market conditions, we continue to offset part of these market-related declines with continued strong and diversified growth in net flows.

We began the first quarter with $123.1 billion in AUMs. We generated $12.3 billion gross sales, a record if you exclude closed-end fund sales from prior periods. We had client outflows of $7.7 billion and $1.3 billion in deleveraging, bringing our net flows to $3.3 billion. We added $6.9 billion in AUM through the TABS acquisition at the end of December.

Markets decline of almost $11 billion in quarter brought our ending AUM to $121.9 billion. We are reporting earnings of $0.21 per diluted share in the first quarter of 2009 versus $0.46 in the first quarter of 2008. The year-over-year decline in earnings was driven by a 23% decline in average AUMs from $157.9 billion in Q1 2008 to $121.6 billion in this fiscal quarter.

Revenues declined from $289.8 million to $209.5 million or 27.7%. Our advisory and administrative effective fee rate, which has averaged 53 basis points over the last 5 quarters declined slightly from 53.4 basis points in Q1 2008 to 52.8 in this fiscal quarter.

Operating expenses declined 17.4% to $157.5 million from $190.7 million one year ago, largely due to the lower compensation expenses, declines in distribution and service fee expenses that change in line with changes in assets under management, and lower amortization expense.

Compensation expense alone dropped from $82 million to $70 million or 15% at a time when average headcount actually increased by approximately 11%. Days and benefits component increased by approximately 10% year-over-year, while the incentive component, which includes bonus accruals as well as sales incentives for our various products, fell 36% year-over-year.

These savings quarter-over-quarter were somewhat offset by an increase in other expenses, which predominantly relate to facilities expenses for our home office relocation, which will be completed in the second fiscal quarter.

Our effective tax rate in the first quarter was 39.7% versus 39.1% in the first quarter of 2008, net income decreased to $25 million in the first quarter compared to $58 million in the same quarter last year, and our fully diluted share count was helped by a lower average stock price for the quarter, which reduces the dilutive effect of outstanding options.

And total headcount for Eaton Vance and all of our affiliates at the end of the first quarter was 1079 employees versus 980 last year, an increase of approximately 10%.

On a sequential or linked-quarter basis, average assets under management declined by $23.2 billion from $144.8 billion to $121.6 billion or 16%. Revenues declined 16.1% from $249.8 million to $209.5 million. Our administrative and advisory effective fee rate remained steady at 52.8 basis points and lower distribution revenues were offset by $6 million positive swing in other revenues.

Remember that investment gains and losses in consolidated funds are included in other revenue and last quarter included $7 million of investment losses compared to $1 million in losses this quarter.

Total operating expenses declined 9.2% sequentially from $173.4 million to $157.5 million in Q1 2009. Compensation expense increased from approximately $66 million to $70 million due to the fiscal fourth quarter of 2008 bonus accrual true-ups that reduced Q4 number and the sequential increase in stock-based compensation that routinely occurs in the first fiscal quarter, due to immediate recognition of options expense for awards for retirement eligible employees.

Distribution expenses and service fee expenses, both of which vary with changes in AUM levels, declined by 24% in line with the decrease in assets subject to those fees. Other expenses declined by approximately $3 million in Q1 2009 versus Q4 2008 due to lower information technology and consulting services.

The financial challenge we face, given the recent market declines impact on our revenues is in maintaining our margins given the negative leverage in the business model when markets are going down.

Our GAAP margin declined year-over-year from 34.2% to 24.8%, and our adjusted operating margins from 38.4% to 30%. Over that time frame, we have seen approximately $51 million of market depreciation, offset by $21 billion of net flows and acquired assets.

Let me comment on our expense structure, and progress on expense management. As you know, we benefit from having a cost structure that is flexible in nature and that a significant portion of our total operating expenses vary with either AUM, sales, or overall earnings. With the decline in AUM, we are seeing declines in distribution and service fee expenses.

With declines in earnings, we are adjusting our bonus accruals accordingly. However, with very strong growth in net flows, we continue to bear the expense of adding assets. A good expense to have with a short-term impact on earnings. In addition, we are managing expenses actively. As noted, our total compensation expense declined $12 million or 15% quarter-over-quarter, while total headcount has increased 10% and average headcount 11% over the same period.

Primarily through natural attrition, we have seen our overall employee base shrink slightly now for the second consecutive quarter. Net of the TABS business acquired, our headcount fell by 19 employees or 2% in the first quarter.

We are also seeing progress on other expense management initiatives with declines sequentially in a number of discretionary areas, most notably in the other expense category, which declined approximately $3 million in the quarter. We expect relief from our current double rent situation related to our pending move to take full effect in Q3, in which we will begin realizing rental cost savings of approximately of $1.5 million per quarter.

We have had number of expense management initiatives currently underway at Eaton Vance and among our affiliate firms.

So, we benefit from a flexible cost structure, we are focused on expense management, and we continue to look to capitalize on market opportunities with the full intent of emerging from this challenging time very well positioned.

Lastly, our balance sheet and financial position continues to be strong and allows us to invest in and grow our business. Cash and cash equivalents and short-term investments decreased to $318 million at quarter end from approximately $367 million at October 31, 2008. The decline reflects, in part the acquisition of the Tax Advantaged Bond Strategies unit at the end of December as discussed earlier.

Related to the TABS acquisition, we recorded $44.8 million of intangible assets representing clients and relationships acquired, which we will amortize over a ten-year period. We also recorded a long-term liability of $16.7 million representing the contingent purchase price liability.

In addition to our strong cash position, we have an untapped line of credit of $200 million with an option to increase that to $300 million. Our ending equity and tangible equity levels are quite strong. We continue to maintain our strong investment grade ratings. Our $500 million of debt does not come due until 2017. Given the market storm, we continue to pause on share repurchases in this period to preserve financial flexibility, which is important for the ongoing strength of our business.

I will now like to turn the call back over to Tom.

Tom Faust

To close out, we are clearly in the midst of a period of intense uncertainty and challenge in the asset management industry, but also a period that presents opportunities for certain companies to emerge in a stronger competitive position. Our AUMs levels have suffered as asset values have declined, and so have our profitability and stock performance. What has not suffered though is the strength of our business and our competitive standing. In fact, I feel we are more competitive today than we have ever been, and this quarter's results support that.

We have a broad range of demonstrated investment capabilities. We have a leading reputation in outstanding partner relations. We have invested to strengthen our distribution team and have a history of successful innovation and timely product introductions. I continue to believe that no other investment manager is more capable of emerging from this difficult period as a stronger and better company than Eaton Vance.

With that, we will close and take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question today will be coming from the line of Craig Siegenthaler of Credit Suisse. Please go ahead with your question sir.

Craig Siegenthaler – Credit Suisse

Thanks and good morning. Just a few questions here, first for Tom on Parametric, we are seeing a little bit of a tale of two cities with institutional channel driving strong flows with some deterioration here in the retail corporate accounts channel, can you provide a little bit of commentary on the divergence?

Tom Faust

Well, I think it relates to the specific products. The institutional success that we are seeing today is largely in emerging market equities equity products. That is not a product that they offer in the SMA channel, the SMA channel products they have consist of tax-managed core equity and overlay products. The weakness that they have seen or we have seen, are seeing, really relates primarily to their tax-managed core product, which in essence is the way to purchase data to the stock market as well as a way to generate tax losses. You think about where we are today, where equity market data is not something that many people are looking for and where, at least for the time being, tax losses of not something that many people see it having great value, probably not a surprise that they have seen somewhat of a decline in that business, but on an overall basis, Parametric continues to be very strong.

Craig Siegenthaler – Credit Suisse

Understood. And then just a follow up here for Bob. Just looking at your distribution service fee revenues, I believe distribution revenues are really earned off of just B and C class shares, and it is earned off the AUM, and the service fees are really earned off of A, B and C class AUMs. But when I track that sequentially, I came to kind of 15% decline. But the declines in revenue is actually a little greater, it is actually a little bit about 20%. Just wondering if there is anything unusual which would have caused an unusually low decline in those revenue items or is my math wrong?

Dan Cataldo

I think – this is Dan Craig, conceptually, it sounds like you have got it right. The distribution and service fees are largely driven by the fund AUM that pay those fees. So, I would go back and double check the math and take a second look, because I wouldn't expect to be much variability between the average AUM levels in those funds and those fees. There is one component of the distribution fees which is sales based, and that is underwriting fees, but that is a fairly small component of that.

Craig Siegenthaler – Credit Suisse

I actually probably saw sales, probably sales driving like you said, but that only is a component of sales and not revenues? Or excuse me expenses and not revenues?

Dan Cataldo

On the underwriting fees, it is a function of sales. And be careful not to include high shares in either one of those calculations because they do not pay either distribution or service fees.

Craig Siegenthaler – Credit Suisse

Got it. Thank you for taking my questions.

Operator

Thank you. Our next question is coming from the line of Dan Fannon of Jefferies & Company. Please go ahead with your question sir.

Dan Fannon – Jefferies & Company

Good morning, and thanks for taking my questions. Tom, you mentioned a strong improvement in both the muni and bank loan markets and your products in terms of performance since mid-December. Can you talk about the flow dynamic and what you guys are seeing in those products since that improvement?

Tom Faust

It has been good. It has been positive. We are in positive flows for both, and I would say particularly strong positive flows on the muni side. We have got, I think, an exciting time in the development of our muni business, I think, as you know, as we talked about, we acquired the TABS business from MD Sass at the end of December. So, now we have really quite two distinct and complementary muni capabilities at a time when investors are really craving high-quality income yielding investments, and where munis are today still trading at very high spread levels over treasuries in terms of current yield. So, we love the fact that we have expanded our muni capabilities right at a time when that sector is apparently coming into significant favor.

Dan Fannon – Jefferies & Company

Okay, that's helpful. And in terms of the balance sheet investments, it was a surprise you guys didn’t take a bigger mark on some of those investments considering what happened last quarter. Can you update us on kind of the remaining carrying value of the CDOs and some of the other investment you guys have on your balance sheet?

Bob Whelan

Sure, we did take a $1000 payment on CDOs. As you know, we almost took 13.2 in Q4; the remaining carrying value is $4 million.

Dan Fannon – Jefferies & Company

Okay, and then – all right. Thank you.

Tom Faust

I think the other thing is fixed-income markets actually performed fairly well through the quarter. So to the extent our seed capital is invested in income product, you're not going to see the same type of market declines as we saw in the fourth quarter, which income products are pretty hard hit.

Dan Fannon – Jefferies & Company

Okay, that is helpful. Thanks.

Operator

Thank you. Our next question is coming from the line of Jeff Hopson of Stifel Nicolaus. Please go ahead with your question.

Jeff Hopson – Stifel Nicolaus

Okay, thank you. Just curious about the institutional pipeline, if that is still fairly active end of Q4, and in particular, you mentioned the fixed-income products on the retail side but can you comment on the institutional interest in some of your fixed-income areas?

Bob Whelan

As you point out Jeff, we had a very good quarter in terms of institutional business. I would say that as it is normally the case with that business, it tends to be quite lumpy. We had some mandates that funded primarily in November and December that were very helpful to the quarter's flows. January and February have been a little lighter in terms of actual funding. I think, if you would, if you will imagine institutional investors are at this point, I think a little slow in terms of actually funding new mandates. So, we have seen a bit of a pause in funding. February flows are positive in the institutional side, but not at the same level as we saw in average in the months of the fourth quarter. So, we are seeing a bit of a slow down there really across the board. In terms of institutional flows into income products, our primary institutional products – among income products is bank loans. There again we have seen something of a pause. This is a market that, as you know, has been significantly impacted by market dislocations throughout 2008 and we are seeing a bit of a recovery, but frankly we are probably too early in that recovery to see significant flows. So, I think they are fairly slow I would say in terms of institutional interest in bank loans today, and the balance of our institutional income business is relatively small.

Jeff Hopson – Stifel Nicolaus

Okay, and if I can follow up on the tabs deal, can you give us a sense of what the kind of internal or legacy flows are from that business and how long would you expect it to take for you to get some traction with it now part of Eaton Vance.

Tom Faust

I think we are seeing really already pretty good traction. We had about $100 million of net flows over the month of January, which was the really the only month that we owned TABS and reflected inflows into our consolidated numbers. Things are happening in the retail channel. This business has traditionally been offered only through Merrill Lynch. We have signed contractor in the process of introducing TABS retailed managed account product in at least two if not more major distribution systems really as we speak. So, the TABS story is very much rolling out today. We have also filed and will be launching soon a retail mutual fund, which we – Tax Advantaged Bond Strategies Fund is what it will be called and managed by the TABS group, that really becomes the way to complement our retail managed account products with a fund product, managed by the same people in the same side. So, we are quite optimistic that given the overall attractiveness of the muni market, the prospects for enhanced distribution and the really outstanding relative performance record of the TABS products in those channels that we are positioned really for a very strong performance for TABS in terms of business growth rate right out of the gate.

Jeff Hopson – Stifel Nicolaus

Okay, great. Thank you.

Operator

Thank you. Our next question is coming from the line of Robert Lee with KBW. Please go ahead with your question sir.

Robert Lee – KBW

Thanks. Good morning everyone.

Tom Faust

Hi Rob.

Robert Lee – KBW

Real quickly on the closed-end fund business and obviously it has been pretty dormant, but we saw today that actually Nuveen managed to get a small fund, unleveraged muni fund done. Maybe talk a little bit number one, just your general thoughts on, you know, I think that’s maybe you can open up the window a little bit at least to that product set, and number 2, you know, what your capability is, you know, it's somewhere down the road or when somewhere down the road hopefully, you know asset values stabilize or improve of actually releveraging some of the funds we could leverage down.

Tom Faust

Yes, a couple of things there. We did note as well that Nuveen had a small but successful muni offering in the closed-end fund space this month. You may have seen that Eaton Vance filed a muni fund, what I would characterize as fairly generic muni closed-end funds. We have not as yet scheduled a launch time for that fund, and certainly are watching the market and talking to potential distribution partners about that, but really have no plans at the moment but we are watching the space. We are aware of what is happening there. We think there will be a time when closed-end funds come back into vogue. Perhaps, we're still little early yet in terms of broad interest into the category. There are still pretty meaningful discounts in certain classes of closed-end funds, and certainly also the memory of the dislocation in the auction preferred market, I would say carries – brings a taint for that asset class generally in the eyes of financial advisers that have been – and clients that have been affected by that. In terms of the leveraging of our closed-end funds, you have noted that we have seen continuing deleveraging in our closed-end funds both in the fourth quarter and now more in the first quarter.

I think it is $500 million of deleveraging just in closed-end funds alone in the first quarter. Most of that is – almost all of that would be driven by requirements to maintain asset coverage requirements. It is certainly not unreasonable to expect that if asset values improve and things like bank loans and munis and equities that we will want to relever those funds, and will certainly do that to some extent. But that has not happened yet, but I think it holds a reasonable prospect if market conditions improve. Most of those funds continue to maintain the ability to add ongoing leverage, some types of leverage for the auction preferred. One you lose them, it is not easy to replace them but on an overall basis, generally we have flexibility to add that leverage to the funds where we have been forced to take that off.

Robert Lee – KBW

Great, thank you very much.

Operator

Thank you. Our next question is coming from the line of Cynthia Mayer of Merrill Lynch. Please go ahead with your question.

Cynthia Mayer – Merrill Lynch

Hi good morning. I am just wondering if you could talk a little about the revenue yields, which I guess stayed the same sequentially. I was a little surprised by that considering markets and considering MD Sass. So, I'm wondering what the outlook is for that and just within institutional, what percentage of those build on previous quarter versus average and could that have affected it?

Bob Whelan

You know, our administrative and effective fee rate, Cynthia this is Bob. Over the last 5 quarters has averaged – it has been very steady of 53 days at this point. We also have another effective fee rate that includes all of our revenue categories that has declined a little bit, and the decline there is mostly because we are seeing B share assets decline, which typically yields more. The MD Sass piece, as you know came on the books in January. So it is only that, you know, part of the mix for one month and that has a lower effective fee rate, $7 billion at roughly 30 basis points. When you combine that in this quarter when you see the full effect, we would expect that overall effective B rate to decline by maybe 1 plus basis points.

Cynthia Mayer – Merrill Lynch

Okay, great.

Tom Faust

Let me just add. There are a couple of – if you think about the mix in terms of our sales growth. Two important product categories that continue to be sources of net flows for us, one is large cap value funds, which is an above-average C – slightly above-average C and another one is emerging market equities, which is also above-average C. So, in terms of flows we've got some product categories such as the TABS business that come in below that average fee rate, but we also continue to book new assets at a higher than average fee rate. Another thing to keep in mind is many of our products certainly; I'd say really all of our funds have break points in the free schedule. So that the fee rate on incremental assets goes down as the funds get bigger. It works the opposite when assets are going down either because of outflows, or in our case because of market value decline. So there is – within a given fund typically as asset values decline the average fee rate on those assets will go up.

Dan Cataldo

Cynthia with respect to your question on the billing, generally the institutional accounts are billed on average assets over the period.

Cynthia Mayer – Merrill Lynch

Okay, great. That helps a lot. And also just a quick question on the equity and net income. Your affiliates, I guess that is primarily Lloyd George. Anything caused the loss there in particular and you know, what is the outlook?

Tom Faust

You know, we had a gain last year with (inaudible) and this just reversed this time around.

Cynthia Mayer – Merrill Lynch

So, it's just a one-time kind of thing?

Tom Faust

There was some movement in our investment in the private partnership, positive in the fourth quarter, negative in the first quarter.

Cynthia Mayer – Merrill Lynch

Okay, thanks.

Operator

Thank you. Our next question is from the line of Michael Kim of Sandler O’Neill. Please go ahead with your question sir.

Michael Kim – Sandler O’Neill

Hi guys good afternoon.

Tom Faust

Hi, Michael.

Michael Kim – Sandler O’Neill

Just to start off with in terms of compensation, I understand there is a variable component involved that will adjust down sales and overall profits slow, but on the other hand it seems like relative performance remains generally strong and it seems like you need to continue to allocate resources to client servicing and compliance areas. So, and I guess my question is as you’re thinking on headcount change that all more recently, particularly given the fact that the equity markets continue to decline.

Bob Whelan

I think it has been noted in the fourth quarter we had, if you adjust for the TABS acquisition, our headcount was reduced by about 19 people or about 2%. We said in previous calls that we do not anticipate reductions in staffing to be significant source of cost savings for us going forward. Certainly, we’d look at staffing levels across all of our businesses. On an overall basis, we think we're appropriately staffed. If you look at companies with similar asset levels, in many cases you will find substantially larger companies in terms of headcount. So, we think we're pretty efficient, pretty lean. We also, just if you look at our organic growth, our business is growing. The fact that revenues are shrinking because the asset values are declining, obviously puts pressure on revenues, but it doesn't mean we have less work to do around here. Our overall posture is the same, but just we do not expect to have major layoffs. We do not expect that to be a major source of cost saving. We'll say at the same time however, that as you point out, conditions generally have worsened in the market, and we continue to take a very hard look and making sure that we are operating in the most efficient way, and that does include examining staffing levels and in function throughout the company.

Michael Kim – Sandler O’Neill

Okay, and then just maybe to follow up on a prior question. Can you just give us an update on the residual AUM at risk to further deleveraging, and then maybe talk about any potential losses thus far this quarter?

Tom Faust

Yes, we have about, I think, $7.4 billion of remaining leverage in various closed-end and private and other vehicles on which we are paid a fee. We've seen a little bit of deleveraging in the month of February, not a lot, certainly not on the scale that we saw in either the fourth quarter or the first quarter. Let us say you can calibrate that, about half of that $7.4 billion is in equity related products and the balance is in income products. And so, if you think of the general trend in our income product, bank loans, munis being primarily up in price over the last several weeks, really since the middle of December, we have really little or no pressure to deleverage, and in fact may have as Rob Lee’s question suggested may have opportunities to add back leverage there. However, about half of that is in equity funds where you know, you can be sure that if equities continue to decline, we will have some continuing deleveraging of those funds, but from a level that has been pretty meaningfully reduced already, and you know we're certainly hopeful, and I am not going to call the market bottom. But we are certainly hopeful that the pace of decline in equities or if there will be a decline will certainly be not consistent with what we saw in the first quarter.

Michael Kim – Sandler O’Neill

Okay, that's helpful. Thanks.

Operator

Thank you. Our next question is from the line of Marc Irizarry of Goldman Sachs. Please go ahead with your questions.

Marc Irizarry – Goldman Sachs

Oh great, thanks. If you can just talk a bit more on your comments about the retail managed account channel narrowing, you know, as you probably battle for shelf space, and obviously performance speaks for itself, but how are you thinking about cost as it relates to growing the RMA business and then, you know, maybe you can talk about how acquisitions might play into your strategy to grow RMA?

Tom Faust

The big opportunity we see in RMA short-term relates to the TABS acquisition we had, we just completed. I think there is a question about RMA sales and assets generally as it relates to funds, sales and assets generally. I believe there has been a recent trend where the SMA business has declined relative to the fund business. But that reflects at least in my judgment in large part the fact that that RMA is historically primarily an equity business, and funds are just proportional weighted to income products and money market products relative to SMA, where those are relatively small parts of the mix, but it was not surprising that as equity performance comes off and as equity sales for many organizations decline that has a disproportionate effect on retail SMA as opposed to fund business. In our case, the big thing we have going on, we've talked a little bit about the decline in Parametric’s tax managed core business, which is not surprising the tax management’s core equity has come off, but the big thing we've got going on is TABS, where as I mentioned a couple of times, we think there is a tremendous opportunity to grow our retail SMA sales in the muni business, both TABS and Eaton Vance muni products. Munis are attractively priced. These are assets that clients can understand. They can understand the appeal of and particularly with the TABS acquisition, we think we've got an unsurpassed market position and look to grow that business in an accelerated pace in 2009.

Marc Irizarry – Goldman Sachs

As we don't foresee the need to, to may be add headcount to further penetrate the channel; this is more about getting deeper in RMA?

Tom Faust

That's right. We're going to fully staff sales effort covering both funds and managed accounts. We have a consolidated sales team that now covers both fund products and separate account products supported by a specialty unit that focuses on high-end products for high-end advisors. We don't see a need to add staff at this point. We think we've got a product line that gives those guys a lot to work with in today's market.

Marc Irizarry – Goldman Sachs

Okay, and then just on comp in the first quarter, I guess there's a little bit, was there a little bit of a seasonal uptick from options expense. I think you called out, you know that new ones there. Can you quantify that?

Bob Whelan

Yes. From the 66 to 70, approximately $2 million of that was an increase in the bonus accrual, and $2 million of that was an increase in stock-based compensation, and there is a seasonal impact. You know, we would expect that to decline in the second quarter in that million to $2 million range for stock-based.

Marc Irizarry – Goldman Sachs

Okay, great. Thanks.

Operator

Thank you. Our next question is from the line of William Katz with Buckingham Research. Please go ahead with your question.

William Katz – Buckingham Research

Thank you, good morning. I saw you comeback to the revenue yield discussion just a moment. Just, I guess I'm struggling a little bit with the sequencing here. If your average assets are down sequentially and you deleverage some, but I think are relatively high yielding in the scheme of things but you're adding in some high yielding emerging market and other prices you called out, and your mix has worsened, and TABS brings it down. I'm just surprised there is a little bit more pressure going on. How much, I guess there must be a very big add back on the price breaks. How much did the price breaks in itself add to the fee rate?

Tom Faust

What did you mean by price breaks?

William Katz – Buckingham Research

You mentioned you have on the way down you have you can call back some of the price increases that you give up on the way. You know, when you are asked to go up you said you have fee waivers on your AUM levels.

Tom Faust

Now, just to be clear, what I was referring to, maybe this wasn’t clear, was that if you look at a typical mutual fund advisory fee schedule, it pays let's say 70 basis points on the first $500 million of assets. It pays $68 billion on the next $500 million, it pays $66 billion on the next billion of assets, and the point I was making is that the math of that, once you are into those breakpoints as asset values come down, the blended fee rate goes up relative to the asset. The overall fee obviously comes down, but the fee comes down at a lesser rate than assets because the blended fee rate is going up. I don't think we have a number in the room here. We can certainly work with you to try and figure that out, but we don't have a number on what that contributed to the average fee rate over the period.

William Katz – Buckingham Research

Okay, I apologize (inaudible) sort of interesting data point. No other company has put that out, you know, as the fourth quarter among the names that we follow.

Tom Faust

That is not unique to us. Almost every mutual fund company would have significant breakpoints in their fee schedule, I mean maybe we are the first company to record after a period in which we've seen declines that we are seeing in asset levels, but it is not anything that is unique to Eaton Vance.

William Katz – Buckingham Research

Okay, that's helpful. The second question, just back in the retail managed account platform. Can you size the tax managed and the Parametric funds, where you saw the slowdown relative to the size of TABS?

Tom Faust

I guess I'm not sure what you are referring to.

William Katz – Buckingham Research

You mention that you know, you see an opportunity. I'm just trying to counterbalance the opportunity with TABS, which is off to a nice start in January.

Tom Faust

Well, I think if you look at our slide 11, you can see on the grey bar there. That's Parametric business that is all tax managed core and overlay business. So, the size of their sales that you can get a sense of there, sales at TABS, which shows up in the Eaton Vance piece, just for the month of January was about $100 million. Hope that will help you to see all those businesses.

William Katz – Buckingham Research

Thanks very much.

Bob Whelan

Yes and that was for TABS. Our growth was in excess of $200 million. So that should give you a sense.

William Katz – Buckingham Research

Thank you.

Operator

Our next question is coming from the line of Ken Worthington of JPMorgan Chase. Go ahead with your question sir.

Ken Worthington – JPMorgan Chase

Hi, good morning. First, on the closed-end funds again, you guys have been an innovation leader historically, and it seems like there is a tremendous amount of demand in credit products right now. So, I'm not sure to what extent you have really extended into credit in the past, but is that something that you are thinking about maybe for the future. And to what extent do you have the credit expertise, and may be the more exotic credit products. I guess that is something that you have or you have interest, you need to buy it or can it be developed internally, just any thoughts there?

Tom Faust

Yes, we have been as you point out, a leader in product leader including in closed-end funds but also in other places. I think you are probably referring to the emerging opportunity in various heights of distress income assets, whether they will be bank loans or high yields or even what were investment grade bonds that have become troubled and are now available at distressed prices. We have so many capabilities in all of those areas. We don't have really, what I would characterize as capabilities in deeply distressed or restructured type products. We certainly get involved in that in conjunction with running high yield portfolios and bank loan portfolios that we don't have dedicated today. Do not have any dedicated distress products. Whether or not we have the skills to come out with such a product, I think is unclear. I do think there will be opportunities there certainly for retail audiences, I would say that it seems kind of early to be dabbling there. We have seen a bit of a recovery, as we discussed in the bank loan market and high yield as well. But obviously the fundamentals of credit and default rates will be rising certainly it seems like at least through the balance of 2009 if not somewhat beyond that. So we look at it. There is a possibility, I would say that we would want to add to our capabilities in distressed investing, but it is not really an area of current focus. Certainly, we do think that for sophisticated investors who have multi-year time horizons, we continue to believe that credit generally, bank loans, high yields specifically, remain very attractively priced. But there is some rest to those markets certainly in the short run, and you know, it takes us, it takes a special kind of client to step up today.

There are many of those products historically have been – have been leveraged, and sometimes quite aggressively leveraged. And I think, as you know, available to leverage, and certainly average at attractive prices is quite limited today. So anything we would do, or anyone else would do today would likely be on an unleveraged basis, but nothing in the plans. But I think it is an interesting area where we are focusing on some attention on potential new products.

Ken Worthington – JPMorgan Chase

Okay, thank you. And then a follow up, hoping for some perspective about the muni fund business. I know that the bonds are attractive versus the taxable rate products. But we are hearing budget problems in California and New York, how do budget shortfalls and may be economic downturns impact muni fund sales, is this – I know this is probably an unusual time period for all fixed income, but I would think that under normal circumstances muni bonds, or muni bond funds wouldn't be particularly attractive right now, but maybe I am completely wrong. Obviously, they are one of the best returning asset classes this year. I'm trying to figure out is that a temporary phenomenon offset by the attractiveness versus the taxable or there is just the budget in the economic concerns really aren't a muni fund issue?

Bob Whelan

Yes, I will take a stab at that. We certainly believe that munis are attractive today in that belief is apparently shared by many financial advisers and many investors. We are seeing significant inflows into muni products today. That reflects a few things. One is, as we have discussed and you have observed, prices of munis are today attractive. We have seen a significant rally since the middle of December, but nonetheless if you compare munis to treasuries or even taxable bonds generally, they represent a very good deal on an after-tax basis for anyone that is a high tax bracket. The other side is – I have been looking at it is from a credit perspective. The muni asset class goes back to, I believe, predates the great depression in the 1930s. So, we have got a very long time line of how faith in municipalities have historically and their general obligations and specific securities have fared in previous economic downturns. And there have been very, very few losses to default through the history of the muni market, at least in terms of general obligation and, what I call non-revenue bonds. Certainly, there is heightened risk for special-purpose bonds for specific municipalities that are having financial trouble, but the long history of the muni market over many, many economic cycles is that general obligation muni bonds are money good. And, we think that will be the case here as well. So, we think muni bonds are attractive on a yield basis, on a relative spread basis. We think they are also attractive in terms of what history tells us about reasonable expectations even in very difficult economic times like we are going through today.

Ken Worthington – JPMorgan Chase

So the attractiveness over the taxable more than trumps the economic conditions we are in. I think it is what you are trying to say?

Bob Whelan

Right, but if you were to compare munis to almost anything other than treasuries or direct government obligations in the taxable sector, I think even on a credit basis they look to be lower risk. You may recall that sometime last year there was an initiative that was pursued by the rating agencies to bring muni ratings and taxable bond ratings on to a comparable scale. Municipalities and issuers of muni bonds have never liked the fact that a certain default experience for muni bonds will put you in a much lower rating than a comparable default experience and expectations for taxable bonds. Why shouldn't they be on the same scale? I think that moment got maybe pushed aside because of market actions in the second half of last year, but the fact remains that through long periods of history, default rates among comparably rated muni bonds have been significantly lower than taxable bonds with the same rating.

Ken Worthington – JPMorgan Chase

Okay, thank you very much.

Bob Whelan

Thank you.

Operator

Thank you. Our next question is a follow-up from the line of Craig Siegenthaler of Credit Suisse. Please go ahead with your question.

Craig Siegenthaler – Credit Suisse

Thanks, first one just for Tom real quick. Can you talk about the consolidation of the major brokerage houses and how this is impacting the asset manager industry? You know, we know relative fund performance is probably a strong differentiator here, but can you talk about maybe size and scale and maybe some other characteristics?

Tom Faust

Yes, Craig I think, for the most part it is really too early. The big consolidation in Merrill and BoA are really just going to happen, Wachovia is going to like under Wells. We still don't know much about that, and obviously the Smith Barney and Morgan Stanley combination is mostly somewhere in the future. So, most of what we can do here is speculate and respond to what we are seeing in the early days, primarily in the Merrill and BoA consolidations. The big challenge for us in Merrill and BoA is that we have two different field sales organizations, one that focuses primarily on the national broker-dealer, the so-called wire house firm [ph], and the other one that focuses on banks and independent financial advisors. As Merrill and BoA come together, it is a question for us is what is the right coverage model for that new entity. Will it remain two different broker-dealers, I think the indications we are getting is that it will not. Will that effectively be one channel or two? We think the evidence is that it'll be one, and so we will have to cover it likely on a consolidated basis. But the best way to do that, we really haven't figured out yet. So, I think generally it is pretty hard to comment specifically on what the implications are. I do think it is logical that as these businesses consolidate they will also want to work with a smaller group of firms than the two organizations separately. I think that is just common sense, and it also makes sense that these bigger organizations, at least by my way of thinking, will want to focus on firms that have brought product lines and good performance, and good reputations, and where their historical business relations have been very good. So, we are hopeful that we will come out of this in an enhanced position, but that is really at this point more of a hope than an experience to date.

Craig Siegenthaler – Credit Suisse

And then Bob, just real quick, you know, I may have missed this one. I am just wondering with the big delta in the cash balance this quarter, was that simply just MD Sass? And on MD Sass, how were the earn outs scheduled in that, on the purchase price?

Bob Whelan

Yes, for the most part the first quarter is always a challenge in terms of cash balances. This quarter we had 30 million that was allotted to the TABS acquisition, and then we pay our bonuses out in the first quarter. So that is the two components of why cash went down. In terms of the TABS acquisition, we bought 100% of the equity day one, we paid for 40% of it, which represents $30 million cash payout in this first quarter. There are contingent payments that go out actually eight years from now. The financial seller MD Sass will be out of the equation in four years, and then we skip a year. And then there are three more sets of contingent payments.

Craig Siegenthaler – Credit Suisse

Great. Bob and Dan. Thanks a lot for the color.

Bob Whelan

Thank you.

Operator

I will now turn the floor back over to Dan Cataldo for closing comments.

Dan Cataldo

Thanks for joining us this morning. I hope you agree that this is a very strong quarter, amidst a very difficult environment. And we look forward to speaking with you again next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Eaton Vance Corp. F1Q09 (Qtr End 01/31/09) Earnings Call Transcript
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