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Cohen & Steers, Inc. (NYSE:CNS)

Q2 2010 Earnings Call

July 22, 2010 11:00 a.m. ET

Executives

Salvatore Rappa - SVP & Associate General Counsel

Matt Stadler - CFO

Marty Cohen - Co-CEO

Analysts

Michael Carrier - Deutsche Bank

Alex Blostein - Goldman Sachs

Dov Hellman - Sidoti & Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Cohen & Steers' Second Quarter 2010 Financial Results Conference Call. During the presentation, all participants will be on a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions). It is now my pleasure to turn the conference over to Mr. Salvatore Rappa, Senior Vice President and Associate General Counsel. Please go ahead, sir.

Salvatore Rappa

Thank you, and welcome to the Cohen & Steers' second quarter 2010 earnings conference call. Joining me are Co-Chairman and Co-Chief Executive Officers, Marty Cohen and Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.

Before I turn the call over to Matt, I want to point out that during the course of this conference call we may make a number of forward-looking statements. These forward-looking statements are subject to various risks and uncertainties and there are important factors that could cause actual outcomes to differ materially from those indicated in these statements. We believe that some of these factors are described in the risk factors section of our 2009 Form 10-K, which is available on our website at cohenandsteers.com.

I want to remind you that the company assumes no duty to update any forward-looking statements. Also the presentation we make today contains pro forma or non-GAAP financial measures, which we believe are meaningful in evaluating the company's performance. For detailed disclosures on these pro forma metrics and their GAAP reconciliations, you should refer to the financial data contained within the press release we issued yesterday, and then our previous earnings releases, each available on our website.

Finally, this presentation may contain information with respect to the investment performance of certain of our funds. I want to remind you that past performance is not a guarantee of future performance. For more complete information about these funds, including charges, expenses, and risks, please call 1-800-330-7348 for a prospectus.

With that, I'll turn the call over to Matt.

Matt Stadler

Thanks, Sal. Good morning, everyone and. Thank you for joining us today. Yesterday, we reported net income of $0.27 per share compared to a loss of $0.15 per share in the prior year and net income of $0.21 per share sequentially. The second quarter of 2010 includes an $0.08 per share after tax gain resulting from recoveries on the sale of previously impaired securities. After adjusting for this item, earnings per share were $0.19.

The second quarter of 2009 included a $0.30 per share impairment charge on available-for-sale securities. After adjusting for this item, earnings per share were $0.15. We reported revenue for the quarter of 44.2 million compared with 26.4 million in the prior year and 41.3 million sequentially.

The increase in revenue from the prior year is attributable to higher average assets resulting primarily for market depreciation and institutional net inflows. Average assets for the quarter were 27 billion compared with 14.6 billion in the prior year and 24.9 billion sequentially.

Our effective fee rates for the quarter were 60.5 basis points, down from 61.5 basis points last quarter. The decline was primarily due to a higher proportion of institutional inflows from existing sub-advisory accounts which are lower fee-paying.

Pretax income for the quarter was 15.4 million compared with a pretax loss of 5 million in the prior year and pretax income of 13.5 million sequentially. This quarter's results include a 3.1 million recovery on the sale of previously impaired securities. After adjusting for this item, pretax income was 12.2 million.

The prior year's quarter included an impairment charge of 14 million on available-for-sales-securities. After adjusting for this item pretax income was 9.1 million. Excluding the 3.1 million recovery on the sale of previously impaired securities, our pretax profit margin for the second quarter was 28%.

Our operating margin remained at 30%, now we will review some changes in our assets under management. Assets under management decreased to 26.2 billion from 27.2 billion at March 31.

The decrease in assets under management was attributable to market depreciation of 2.2 billion partially offset by net inflows of 1.2 billion.

At June 30th, U.S. REIT common stocks comprised 45% of the total assets we manage, followed by international REIT common stocks at 25%, large cap value at 11%, preferreds at 8%, and listed infrastructure and utilities at 8%.

Our open-funds had assets under management of $6.6 billion at June 30th, a decrease of 363 million or 5% from the first quarter. The decrease was due to market depreciation of 538 million partially offset by net inflows of 175 million. Domestic portfolios had 121 million of net inflows while international and global portfolios had 54 million of net inflows.

Annualizing second quarter flows our organic growth rate for open-end funds was 10%. For the last 12 months our organic growth rate was 20%. Assets under management in our closed-end funds totaled 5.3 billion at June 30th, a decrease of 421 million or 7% from the first quarter. The decrease was primarily due to market depreciation.

Assets under management in our institutional separate accounts totaled 14.3 billion at June 30th, a decrease of 171 million or 1% from the first quarter. The decrease was due to market depreciation of 1.2 billion, partially offset by net inflows of 1.1 billion, virtually all of which were from sub-advised accounts into global and large-cap value portfolios.

Annualizing second quarter flows, our organic growth rate for institutional accounts was 29%. For the last 12 months our organic rate was 50%. Institutional separate accounts include 217 million of assets under management invested in our alternative global real estate long-short strategy.

Moving to expenses, on a sequential basis, expenses were up 7%, primarily due to higher employee compensation, distribution and service fees and G&A. Our compensation to revenue ratio for the quarter was 39%, the same as the first quarter and consistent with the guidance we provided on our last call. Generally, distribution and service fee expense will vary based upon the average asset levels in our open-end load or no-load mutual funds.

The sequential variance is in line with the increase in the average assets of our open-end no-load mutual funds, primarily from CSR, the Cohen & Steers Realty Shares Fund. G&A increased 5% from last quarter. The increase which was primarily due to higher levels of business activity is in line with the guidance we provided on our last call.

Before I review our financial condition and provide some thoughts about the second half of the year, I thought it would be helpful if I spent a few minutes explaining the captions used in non-operating income. We utilize three main captions to classify our firm investments. Gain or loss from trading securities, gain or loss from available-for-sale securities and equity and earnings or losses of affiliates.

The caption gain or loss from trading securities is used to record the total realized and unrealized trading gains and losses in seed investments where we have a controlling financial interest and as a result must temporarily consolidate the investment.

The $371,000 loss for the quarter-ended June 30th, 2010 represents the realized and unrealized loss on our seed investments in the Cohen & Steers preferred securities and income fund which was launched in May of this year. The results for the first quarter of 2010 and the second quarter of last year represent the consolidated realized and unrealized gains from our investment in the global real estate long-short funds.

The caption gain or loss from available for sales securities is used to record realized trading gains and losses and certain seed and corporate investments. The caption is also used to record any impairments and recoveries on the underlying securities. The 3.3 million gain for the quarter ended June 30th, 2010 is primarily due to recoveries reported on the sale of previously impaired investments. Results for the second quarter of last year are primarily due to impairments recorded on certain available-for-sale securities.

And finally the caption, equity in earnings or losses of affiliates is used to record the economic results from seed investments where we exert significant influence but we do not have financial control and as a result we do not consolidate the investment. The 1.4 million loss for the quarter ended June 30th, 2010, represents the economic loss associated with our seed investments in the global real estate long short funds and the Cohen & Steers global listed infrastructure funds.

Turning to the balance sheet, our cash, cash equivalents and investments totaled 241 million, compared with 237 million last quarter and stockholders equity was 289 million, compared with 288 million at March 31st and we remain debt free.

Let me briefly discuss a few items to consider for the second half of 2010. The effective tax rate of 24.6% for the quarter includes discreet items, the most significant of which is attributable to the sale of previously impaired securities. Excluding the discreet items, the effective tax rate was 34%. We estimate that our tax rate will remain at 34% in each of the third and fourth quarters. We expect compensation to remain at the 39% compensation to revenue ratio and with respect to G&A we expect the third and fourth quarters to remain at second quarter levels.

Now I'd like turn it over to Marty.

Marty Cohen

Thank you Matt and thank you all for listening this morning. Clearly the story for the quarter and for that matter the past year has been our net inflows. Overall as a company, we enjoyed an 18% organic growth rate in the second quarter and excluding closed-end funds that number was 23%. And the 12 months number is as well industry leading. As a result our decline in AUM during the quarter was relatively modest when you consider that the market head wins were quite severe.

Our benchmarks declined anywhere from 4 to 11% in the second quarter. I'd also like to note however that it appears that our asset in global diversification is working well for us as the co-relation of our assets under management to just the U.S. REIT Indexes continued to decline.

Since the quarter, we have already added about 425 million in institutional assets that have either already funded or will do so shortly and in addition third quarter performance has started out quite well with benchmarks up in the 4 to 7% range reversing some of the deterioration that we had in the second quarter.

There are two areas that we think are worthy of discussing in greater detail. The first is the breadth of our distribution. The majority of our assets and net flows have been in a category we call institutional separate accounts. We have approximately 100 accounts directly with pension and endowment funds and the like. A large amount of assets in this category however, is in sub-advisory mandates. We treat them as institutions since the relationship is directly with the sponsors of these funds. They range from consultants to banks, insurance companies and other financial institutions. They exclude broker-dealers and registered investment advisors which we categorize as retail.

We have upwards of 20 such sub-advisory relationships and many of these sponsors offer several funds and strategies that we manage for them. These relationships give us access to an extremely large number of investors, both in the United States and internationally. We are particularly enjoying great penetration outside the U.S. with success in Japan, Australia and Continental Europe. The cost of this of course is that these relationships tend to be lower fee paying.

The second point is that the growth we are experiencing is not just a coincidence. Foremost it is the result of the strong performance and brand that we've established. It's also the result of the progress we continue to make in enhancing and broadening the reach of our marketing and client service efforts.

We have brought on several key people, including a new head of marketing, Tony Ialeggio, who comes to us from AllianceBernstein and have also added new key accounts personal, all of whom are well regarded and well known in their respected channels. We have new heads of marketing communications and product development, also individuals with great depth of experience.

Our commitment to Asia continues to grow as well. We have established a new position in business development and client service with Anton Chang in our Hong Kong office, as well as increased support for our Japanese clients. Our Hong Kong office is bustling and is our fastest growing as we have added new real estate analysts and a new infrastructure analyst there as well.

Whereas our asset levels are below there peak of 2007, the scope and complicity of our business are significantly greater. As I mentioned, the relationships and platforms on which our services are offered continue to grow, but with that so do the number of customized portfolios that we manage. This complexity is amplified as both our clients and the assets that we mange for them are increasingly non-U.S. Management's challenge as always is to maintain adequate profit margins in this business model. So far we're pleased to have accomplished this.

Finally on the product side, the only thing new to report is that we have launched our open-end preferred securities fund. This is our first open-end fund launch in five years and early indications with respect to sales are promising. We think this is a timely offering in light of the low interest rate environment that prevails and which may prevail for some time to come and the premium yield that these securities deliver.

With that I'd like to open it up to questions

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Michael Carrier of Deutsche Bank. Please proceed with your question.

Michael Carrier - Deutsche Bank

Alright, thanks guys. Just on the distribution side, you called on the institutional separate accounts. When your talking to those clients, where is the most interest in terms of products and then, in terms of the penetration in the different markets whether it's the U.S., you mentioned, Europe, Japan, Australia. Like how much more do you have to go when you look at the landscape there in terms of the number of accounts that you have relationships versus what you consider the market opportunity? And then just one the fee rate, a last one for Matt, is relative to the fund business, what are these fee rates coming in at just so we can gauge the realization rate going forward.

Marty Cohen

Well taking into confidence one at a time, Japan has been very successful for us with our relationship with Daiwa Securities and Daiwa Asset Management. We think there is room to grow there. There is a great deal of interest in global real estate investing. We have continued flows and based on a competitive analysis we think there is room there.

In Australia as everyone knows there is a great deal of demand for investment products with respect to the superannuation funds and we've got a pretty good presence there. We think there is a lot of room to grow in Australia. And in Continental Europe it's been somewhat -- some platform investing. There has also been some separate accounts directly with institutions.

On the fee side, they vary. I think Matt can give you a little color on that. Understand, we talk about fees, we're talking about net fees to us and there is a lot of costs and it's not as simple as that but we can give you some color on that.

Matt Stadler

Sure. With respect to open-end and closed-end, we haven't really seen too much movement. Closed-end is going up because of fee waivers but essentially they've been pretty static. Most of the flows that we've been getting as we said in our remarks have been sub-advisory and as sub-advisory relationships in general has become a bigger proportion of the overall institutional assets that we manage. There has been an adjustment to the fees. So, what we are seeing coming in now is more in the mid-30 range on the sub-advisory basis blended. And that's which we really are having the effective bringing the effective fee rate down. You know, we see maybe a slight reduction in the third and the fourth quarter from second quarter levels but not as much as we saw from the first quarter to second quarter.

Michael Carrier - Deutsche Bank

Okay. That's helpful. And then just on the expense side. In terms of the comp ratio and just given the level of business activity, I guess where we would, you know, the asset levels have to be or where would revenues have to be, just balancing all the investment and that kind of stuff that you're doing, but where we would could see that start to trend down and then we could see the operating leverage start to pickup in the model?

Marty Cohen

Yeah. I think what we believe that for the rest of this year, at least where we see it today, 39% is the right number. But, everybody's got a model. So, we would think that in 2011, the comp ratio would start to tick down a little bit, and we have it coming down anywhere from, 3 to maybe like 10%, 10 to 12%, 15% reduction in 2011 from where it is now.

Michael Carrier - Deutsche Bank

Okay. Thanks a lot.

Matt Stadler

You mean like 3 points, the ratio?

Marty Cohen

It's going to come down 5%, 10 to 15% down from where it is now. So, it is maybe like the 35%, 34% ratio for next year.

Michael Carrier - Deutsche Bank

Okay.

Matt Stadler

You know, that is a lot of assumption there of course.

Marty Cohen

Appreciation of flows.

Matt Stadler

If the trends continue, that's where it maybe headed.

Michael Carrier - Deutsche Bank

Okay. Thanks a lot.

Operator

(Operator Instructions) Our next question comes from the lines Alex Blostein of Goldman Sachs. Please proceed with your question. Mr. Blostein, your line is open. We cannot hear you. Please verify the mute function on your phone or pick up your handset please.

Alex Blostein - Goldman Sachs

Sorry about that. Good morning, guys.

Matt Stadler

Good morning.

Alex Blostein - Goldman Sachs

Do you hear me now? Is it possible to get a little more granularity on this usual business and I guess which strategy specifically you have been seeing the most in flow, I guess, for the first of year and the pipeline that you mentioned little bit over of $100 million? So, which strategies are getting more traction then and how much of that is coming from you versus the requirements?

Matt Stadler

Well, we didn't catch all of that question; you were breaking up a little. But, with respect to which strategies were driving growth, there is no simple answer there. In the U.S. for the first half of the year, large-cap value was really the leading asset growth category for us. Outside the U.S., in Japan it's all about REITs and Australia REITs but also lifted infrastructure, we've made some gain significant mandates there. In Europe, it's mainly REIT. I would say more recently global REITs infrastructure and our long-short fund have had good momentum, large cap value seems to be doing fine but not with as much momentum as we saw earlier in the year.

And in the open-end side, we've been seeing the majority of the flows coming into U.S. REIT fund such as CSR.

Alex Blostein - Goldman Sachs

Got it. And then on capital management, you guys have one of the best balance sheets of say in aforementioned space and the cash balances continue to grow, any plans to either any other buyback or dividend or any other capital plans you could highlight?

Marty Cohen

Well, we have said in the past there are four, we didn't have a lot of cash, there is four things we can do. One is nothing, two is buyback stock, three is making acquisition and four is making distribution and right now we've not made any decisions on anyone of those other than number one which is at the moment maintain our balance sheet as it is.

Alex Blostein - Goldman Sachs

Got it, thanks.

Operator

Our next question comes from the line of Dov Hellman with Sidoti & Company. Please proceed with your question.

Dov Hellman - Sidoti & Company

Hi, guys. The first question I have actually on the retail distribution side, where are you seeing most of the traction is that still IRAs or broker-dealers are coming in, where are you seeing there, I guess, the inflows from?

Matt Stadler

It's still mainly the IRAs and the broker-dealer market as shown a little bit of incremental strength but it seems to have been flowing short-term trends in the marketplace frankly, so the IRA channels, I think, has continued to be the area where we see steady inflows.

Dov Hellman - Sidoti & Company

Got it.

Matt Stadler

We're -- we as, Marty mentioned, we did launch our preferred fund, it's early yet and it's not in every system that we'd like to be in but that's a relatively high yielding fund for us and we're seeing some good initial response there.

Dov Hellman - Sidoti & Company

Okay and then also now in terms of institutional, looking at the large CapEx, I think you talked that kind of still having good flows but you talked that it's lower than it was I guess in the beginning of the year. Is that in anyway, and looking this performance obviously the one year and year-to-date, it has unperformed at least the benchmark, what are the discussions there I guess and what is also in terms of I guess the positioning of the portfolio, what is done, I know this exposure to financials there and energy, if there are any changes in terms of I guess, the portfolio as well?

Marty Cohen

Well, we probably are not going to comment on we've what are the changes in the portfolio but again I think the strength in large cap value is on the separate account area, there hasn't been a lot of traction there in retail land and you're correct that the performance over the last 12 months a relative performance is below what we expect from that, from that portfolio and I think it's a combination of the relative performance but also just our senses that investors are just not putting a lot of money into loan only strategies right now on the institutional side.

Dov Hellman - Sidoti & Company

Makes sense and just lastly in terms of I guess your long/short portfolio, your long/short read portfolio the global long/short, what -- I don't know if you care to comment me on just the performance there and also I guess what is now the -- your share of the investment of that portfolio.

Joe Harvey

Sure, this is Joe. For the year-to-date through June on a net basis the fund was down a little less than 2% and that's in line with the average long/short equity fund universe, I'm sure your well aware it's been a very difficult environment just from a volatility perspective if you look at it day-to-day movements in the market, but we're still very optimistic about the strategy and what the teams performance will be.

Dov Hellman - Sidoti & Company

Got it, perfect.

Joe Harvey

Our investments are about 35 million and were about 43% of the fund.

Dov Hellman - Sidoti & Company

Thank you, that's it.

Operator

Our final question comes from the line of Cynthia Mayer with Bank of America/Merrill Lynch. Please proceed with your question.

Unidentified Analyst

Thanks, good morning. This is Adam [Bede] in for Cynthia, in the context of the new preferred fund you mentioned the potential for a prolonged sort of low interest rate environment, in general on the institutional side as you've won some of these mandates and other expressions of interest, have you seen already investors searching for better income generating in investments or is it more of just now occasion to the real estate asset class and particularly on the real estate side, do you feel that your gaining market share again similar funds or is the market just expanding as more institutional investors allocate to real estate?

Marty Cohen

We haven't really seen institutional investors looking just for yield and I would say that preferred fund is aimed largely at retail investors and the institutional money coming into real estate or reads is including the hedge fund is largely a real asset allocation and they are looking for both attractive real returns, weather it's in a low inflation, low interest rate environment, but also, hedging themselves against the possibilities of higher interest rates and inflation and that's I think very much driving our rising allocations to real asset strategies such as real estate.

Unidentified Analyst

Got it, thank you that's all I have. That's helpful. Thank you.

Operator

This concludes our Q&A session today. Now I'll turn the conference back over to our presenters.

Marty Cohen

Thank you for listening in again and we look forward to speaking to you next quarter.

Operator

Ladies and gentlemen this does conclude the conference call for today, we thank you for your participation and ask that you please disconnect your lines.

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