Financial Engines' (FNGN) CEO Jeff Maggioncalda on Q1 2014 Results - Earnings Call Transcript

| About: Financial Engines, (FNGN)

Financial Engines, Inc. (NASDAQ:FNGN)

Q1 2014 Earnings Conference Call

May 6, 2014 05:00 pm ET


Jeff Maggioncalda – Chief Executive Officer

Ray Sims – Executive Vice President & Chief Financial Officer


Bob Napoli – William Blair

Hugh Miller – Sidoti & Company

Avishai Kantor – Cowen and Company

Mayank Tandon – Needham & Company


Good day and welcome to the Financial Engines’Q1 2014 Earnings Conference Call. I would now like to turn the conference over to Mr. Ray Sims, Chief Financial Officer. Mr. Sims, please go ahead, sir.

Ray Sims

Good afternoon and thank you all for being on today’s call. Before we get started I need to remind everyone that part of today’s discussion will include forward-looking statements such as statements regarding our operating metrics; anticipated costs and expenses; growth and growth opportunities; strategy; trends impacting our business; our competitive position; impact of new laws, regulations and schizophrenic tax policies; enrollment rates implementation and potential impact of enrollment enhancements and strategies; anticipated benefits, success, and impact of our services including our Income+, IRA management, Social Security Guidance and retirement income planning services; anticipated adoption of our products and services; anticipated benefits and the impact of customer experience enhancements; long-term objectives; and financial outlook for 2014.

These statements are based on what we expect as of this conference call as well as current market and industry conditions, financial and otherwise; and we undertake no obligation to update these statements to reflect events, circumstances or changes that might arise after this call. These forward-looking statements are not guarantees of future performance or plans and therefore investors should not place undue reliance on them. We refer all of you to our SEC filings for more detailed discussions of the risks that could impact our future operating results and financial conditions which could cause actual results to differ materially from those discussed in these forward-looking statements.

I also want to inform our listeners that we will make some reference to non-GAAP financial measures during today’s call. You will find supplemental data in our press release which reconciles our non-GAAP measures to our GAAP results. Now I would like to turn the call over to Jeff Maggioncalda, our Chief Executive Officer.

Jeff Maggioncalda

Thanks, Ray, and good afternoon everyone. Thank you for joining us today. I’m pleased to report that Financial Engines had a solid Q1. Let’s take a look at our numbers for the quarter.

Revenue increased 22% to $65.9 million in Q1 compared to $53.9 million a year ago. Non-GAAP adjusted EBITDA increased 32% to $22.0 million in Q1 compared to $16.7 million a year ago, and non-GAAP adjusted earnings per share increased 33% to $0.20 in Q1 compared to $0.15 a year ago.

In addition to our financial performance we report quarterly on some important operating metrics, including assets under management, assets under contract, total members, and enrollment rates. Please refer to our SEC filings for definitions of these operating metrics.

We had a solid quarter against each of these metrics. As of March 31st, assets under management reached $92 billion, a 30% increase from $70.8 billion a year ago. Assets under contract increased by 30% to $824 billion from $635 billion a year ago. Total members enrolled in professional management grew to more than 778,000 members and enrollment rates among employer plans where services have been available 26 months or more averaged 13%.

There are a number of fundamental forces driving our growth opportunities. As we’ve discussed previously, demographic trends continue to drive our business. By 2020 one in five people in the US will be 60 years of age and older, and this cohort holds a substantial amount of retirement assets. In 2010 US households 55 years of age and older held approximately $12 trillion in investable retirement assets. By 2020 the assets held by this cohort are projected to grow to $21.6 trillion based upon an analysis by [Limera]. The study estimates that almost two-thirds of these assets or more than $14 trillion will be used to generate income in retirement.

Over their careers, workers typically accumulate retirement assets across numerous accounts, each with different rules, calculations and complexities such as 401(k) plans with current and past employers; multiple IRAs, pensions, and personal savings. Holistic retirement income planning, which looks at the full retirement picture, is not widely available to individuals with modest retirement savings.

We believe there is a significant opportunity for Financial Engines to meet the needs of near-retirees as they transition into retirement by offering holistic retirement income planning that takes into account not only their 401(k) accounts but all the sources of income in retirement.

In addition to demographics, we believe another factor driving our growth is the increased reliance on defined contribution plans. According to a survey of large plan sponsors by Aon Hewitt, in 2013 77% of plans reported defined contributions as the primary retirement savings vehicle for their employees, compared to only 56% in 2001.

Financial Engines also continues to benefit from legal and regulatory tailwinds. In May, 2013, the US Department of Labor’s Employee Benefits Security Administration published an Advanced Notice of Proposed Rulemaking which could mandate a projected income forecast to be included in the annual benefit statements to participants. We believe that the DOL put it best when it stated in the proposal that “Managing finances in order to provide income for life for oneself and one’s spouse is a tremendously difficult but important task.”

Further, the 2014 Retirement Confidence Survey published by the Employee Benefits Research Institute took a look at the potential impact of this type of regulation on participant savings behavior. The survey asked respondents if seeing an estimate of how much a retirement plan will provide in monthly income for life would cause them to adjust their contributions.

17% of respondents replied that this information would lead them to increase the amount they are contributing. Of those that indicated they would increase contributions, 69% would increase the dollar amount by 10% and 13% would increase it by 25%. The expected adjustment translates to an average conditional increase in 2014 contributions of $927 per person.

Although the timing of a final rule is not known we believe that this potential ruling could increase demand for Financial Engines’ retirement income forecasting services and mandatory retirement income projections could increase the savings behavior of 401(k) participants. We also see a trend of planned sponsors providing more help to participants in 401(k) plans and that participants would welcome that help.

Financial Engines in partnership with Greenwald & Associates, a leading market opinion and public research company, conducted a national survey to understand near-retiree and retiree views on Social Security claiming. The full report was released in March and is available at Overall, the study found that respondents who are approaching the claiming decision do not fully appreciate how critical and complex claiming Social Security can be.

Another important finding of the survey is that Americans approaching the claiming decision welcome help with four out of five saying they would find it very useful to speak with an advisor who could give them personalized claiming guidance. The survey gauged interest in receiving assistance with Social Security decisions through the workplace. The top trusted help sources were 401(k) providers and experts selected by employers. The survey responses illustrate the important role employers play in vetting and selecting Social Security experts to help their employees make the most of their retirement income sources.

So our growth opportunities continue to benefit from demographic trends, an increasing reliance on 401(k) plans, legal and regulatory tailwinds, and demand for retirement help in the workplace. Now I’d like to discuss our strategy to take advantage of these growth opportunities and the progress that we’ve been making.

Our growth strategy continues to focus on enhancing our customer experience especially for near retirees with services like Income+, a retirement income feature that provides retirees with a steady monthly paycheck from their 401(k) to a checking account that can last for life. We continue to make progress deploying Income+ with our provider partners and plan sponsors. We are pleased to share that in Q1 Vanguard went live with an Income+ connection.

All seven provider partners who’ve committed to offer Income+ are now live and with this last connection we have Income+ connections with more than 95% of our AUC. With provider connections established we believe we can more effectively sell Income+ to plan sponsors. We are pleased that the rate of sponsors adopting Income+ is accelerating which we believe is due to having seven provider connections in place, sponsors taking comfort from growing adoption by their peers, and greater industry familiarity with our Income+ offering.

As of March 31, 2014, 65 plan sponsors had made Income+ available to 1.5 million participants representing $140 billion of assets under contract, an increase of 233% from $42 billion in Q1 2013. Also as of March 31, all signed contracts for Income+ represent 140 plan sponsors, 2.8 million participants and over $246 billion in retirement assets, an increase of 95% from $126 billion in Q1 2013.

We expect the larger benefit of a broader retirement income planning offer, including Income+ and IRA Management, will be realized over the longer term as the demographic wave of Baby Boomers retiring continues over the next two decades. With the broad adoption of Income+ we are putting in place the capabilities to provide a unique, personalized retirement income planning experience for all participants, especially for those nearing retirement.

Retirement income planning is a complex problem that becomes more urgent as Baby Boomers near retirement, and the responsibility for figuring out how to fund each year of retirement has shifted to individuals who are not prepared. Income+ serves as an integral capability that helps tie together additional capabilities like IRA Management and Social Security Guidance. We are finding that participants see Social Security as the primary foundation of retirement income and want help to maximize Social Security and supplement it with additional sources of retirement income, such as investments such as 401(k)s and IRAs.

We are committed to evolving and enhancing our customer experience to meet the needs of near-retirees as they transition into retirement by offering holistic retirement income planning that takes into account all the pieces of the retirement puzzle – not only their 401(k) accounts but also their IRA accounts, pensions, Social Security, Medicare, and spousal retirement accounts.

We’ve been executing on a long-term strategy to take advantage of the opportunity created by the needs of Baby Boomers nearing retirement. We’ve been developing new capabilities in a deliberate sequence in order to create a complete offering that brings together all sources of retirement income. In early 2011 we increased our focus on near-retirees with the announcement of Income+, a retirement income feature that is designed to provide steady, monthly payouts from a 401(k) that can last for life.

We designed Income+ to be easily adopted across our existing sponsor customer base, realizing that this methodology could not only create a standard for retirement income in the workplace but also enable us to integrate other income strategies such as IRAs and Social Security claiming. In 2012 we launched IRA Management, which includes the Income+ capability enabling us to manage accounts outside the 401(k) and to retain customers as they retire and leave the workplace.

At the end of 2013 we began offering personalized Social Security Guidance with Income+ sponsor clients. Social Security will represent the largest source of income for most near-retiree households, and it is becoming clear that Social Security is far more complex and important than most Americans realize. And for many individuals effective guidance could produce more expected value than the total amount of savings in their retirement accounts.

Social Security Guidance is currently available to about 1 million plan participants and is provided at no additional cost to participants in plans offering Income+. As additional plans enable the Income+ capability, Social Security Guidance will automatically become available not only to professional management members but also to all participants in the plan.

Social Security Guidance goes beyond education about claiming decisions, serving as the centerpiece of a broader retirement income planning service that provides near-retirees with a year-by-year plan of all sources of retirement income. Either online or with an advisor the income plan easily and quickly demonstrates how a participant can increase their benefits by delaying Social Security and how to use IRAs and 401(k) savings to help bridge that gap. We also have added the flexibility to hold some savings in reserve for individuals who want to hold aside an emergency fund that they don’t plan to spend.

We are seeing a favorable reaction to Social Security Guidance and the broader income planning services we’ve recently launched. Plan providers and sponsors appear interested in making these new services available to employees, especially as near retirees faced reduced pensions and health benefits.

Plan sponsors appear eager to promote Social Security Guidance for a few reasons. First, it’s a near-universal problem that their participants face. Second, the value of a smart claiming strategy could exceed the value of many participants’ total lifetime savings. And finally, we are integrating Social Security Guidance as an enhancement to our existing service at no additional cost to the sponsor or the participant.

We are also seeing positive reactions from participants in terms of engagement and satisfaction. Social Security Guidance is driving high levels of engagement click-throughs among participants age 55 and older. We are seeing high levels of satisfaction among participants who experience the online or advisor screen sharing experience.

Participants value the opportunity to see their own personalized income plan that illustrates how all the pieces fit together. In some cases we’ve spoken with participants who are already deferring but did not realize that they are forfeiting thousands of dollars by simply not understanding that they are eligible to claim a spousal benefit while their spouse defers. Additionally, many participants are surprised and frankly delighted in many cases to learn that they can claim benefits on their ex-spouses even as they defer and grow their own benefits.

We are also testing new engagement strategies including on-site and online workshops focused on Social Security which is producing high levels of interest and satisfaction among attendees in these tests. We will continue to test and iterate the experience as well as develop programs to drive engagement with participants that we believe will lead to higher enrollment.

We believe that our near-retiree experience with capabilities like Income+, IRA Management, Social Security Guidance, and income planning with an advisor will differentiate us from target date funds and make it difficult for competitors to replicate our services. We also believe an increase in the value of our services will help mitigate the pricing pressure prevalent in the industry.

We believe that a strong near-retiree experience will drive growth along many dimensions. We believe it will drive AUC growth by appealing to new plan sponsors who are interested in a retirement income planning solution. We believe it will drive engagement and enrollment in AUM, especially among near-retirees who represent about two-thirds of our AUC. We believe the offering will increase retention by providing a solution to help near-retirees transition from the retirement savings phase to a retirement income planning phase and allow its financial engines to serve participants through retirement.

Now let’s look at our AUC and AUM net flows in Q1. I’ll start with assets under contract, which is the value of assets in retirement plans where professional management has been made available. Assets under contract rose to $824 billion by the end of Q1, up from $786 billion at the beginning of the quarter and up 30% over the last year. The year-over-year growth in Q1 was driven primarily by new employers making our services available, the positive performance of financial markets over the last year, and the steady contributions that participants and employers have been making into their 401(k) accounts.

Fee pressure continues to be prevalent in the industry and requires us to continue to demonstrate for plan sponsors and consultants the value delivered by professional help and guidance. Competitors, including new investment advisory firms and established players alike, continue to focus on providing managed accounts to the retail and 401(k) markets often at lower prices, contributing to the fee pressure.

We recognize that we’ll need to continue to broaden the scope of the services we offer and improve the customer experience in order to maintain our fees and further differentiate from target date funds and managed account competitors as we grow our AUC.

Financial Engines and Aon Hewitt will shortly release an updated version of our multiyear help study comparing those using professional management, online advice, and target date funds properly used against those investing without such professional help. The study provides considerable evidence of the value we offer plan sponsors and participants, finding that across multiple age groups workers who use professional help had median annual returns net of fees over 3% higher on average than those managing their 401(k) on their own. A detailed description of our methodology can be found on our website under “Research and Resources.”

We continue to focus our efforts on converting assets under contract into assets under management by improving enrollment. We drive new AUM primarily by offering annual print enrollment campaigns and by integrating ongoing electronic enrollment into our provider partner websites.

In Q1 2014 we added $3.9 billion of gross new AUM from enrollment. The growth in AUM was due to campaigns and ongoing increasing enrollment. As our installed base grows and matures it will be important for us to develop innovative methods of messaging plan participants. In addition to traditional enrollment campaigns we are pleased with the ongoing progress from our integrated enrollment efforts and continue to focus on non-campaign enrollment methods.

We are actively developing new content and testing the content with plan participants to drive higher levels of engagement and enrollment. We continue to make progress understanding what drives enrollment, designing more effective communication programs, and deploying these programs more broadly across our installed base.

Enrollment for employers rolled out 26 months or more averaged 13% at the end of Q1. From quarter to quarter we sometimes see fluctuations in the enrollment rate based on plan sponsors entering and leaving the cohort. As we mentioned last quarter a few large sponsors whose enrollment rates are lower than the cohort average entered the 26-month cohort in Q1, which temporarily dampened the enrollment rate by 0.1% for this cohort.

An attractive characteristic of our business model is the built in growth that comes from ongoing contributions from 401(k) participants. Every two weeks a part of most participants’ paychecks is deducted and deposited into their 401(k) account which is usually partially matched by their employer. In addition to AUM from new enrollment, we estimate that our AUM increased by approximately $1.5 billion more in Q1 due to member and employer matching contributions. For the trailing twelve months, contributions increased our AUM by approximately $5.6 billion.

We continue to focus on retention of professional management members. For Q1 2014 our average quarterly overall cancellation rate was 3%, which is in line with our historical cancellation rate. Our AUM decreased approximately $1.5 billion due to voluntary cancellations in Q1. A current area of focus for improving retention is with members in the first 90 days following a completed campaign, where we see a larger portion of voluntary cancellations occur.

Early indications from retention tests suggest that more personalized and concerted outreach during the first 90 days can reduce voluntary cancellations. And we continue to more broadly test these promising approaches. We also continue to test new features that allow members more flexibility and personalization in the way that we manage their accounts.

In addition to voluntary cancellations our AUM decreased by $1.2 billion in Q1 due to involuntary cancellations. In total, net new AUM was $2.7 billion in Q1 including $1.2 billion from net new enrollment. In addition to net flows our AUM increased by approximately $1.1 billion due to the positive movement of the markets in Q1.

In total assets under management rose to $92.0 billion at the end of Q1, up from $88.2 billion at the beginning of the quarter and up 30% over the last year. As of Q1, 20 of our 567 plan sponsors have more than $1 billion in plan assets being professionally managed by Financial Engines and our collected assets total more AUM than our closest managed account provider competitor.

We continue to expand the number of retirement plan sponsors we serve. At the end of Q1 we had 567 plan sponsors where professional management was available, representing $824 billion in assets and about 7.9 million plan participants. At the end of Q1 we were managing portfolios worth $92 billion for more than 778,000 members, and half of those members had less than $54,000 in their accounts. As of March 31, 2014, 149 of the Fortune 500 have hired Financial Engines to help their employees and our advice is available to approximately 9.1 million participants.

When I look at the fundamental trends driving our growth, the breadth and strength of our relationships and the quality, scalability and uniqueness of our services, I believe that Financial Engines is in an excellent position to take advantage of a growing opportunity to provide everyone with the independent, personalized retirement help that they deserve.

Now I’d like to turn it over to our CFO Ray Sims to discuss our financial results in more detail. Ray?

Ray Sims

Thanks, Jeff. As Jeff said total revenue increased 22% to $65.9 million in Q1 2014 compared to $53.9 million in the prior year period. The increase in revenue was driven primarily by growth in professional management revenue, which increased 26% to $57.1 million in Q1 2014.

Professional management revenue growth was driven by higher AUM which reached $92.0 billion at the end of Q1 compared to $70.8 billion ending the prior year period. This increase in AUM was the result of increased new enrollment from marketing campaigns and other ongoing member acquisitions, market performance, as well as contributions.

Platform and other revenue was up 5% to $8.8 million for Q1 2014 compared with $8.4 million for Q1 2013. Cost of revenue exclusive of amortization of internal use software increased 30% to $26.0 million for the quarter compared with $19.9 million for the prior year period due primarily to an increase in data connectivity fees as revenue increased; and to a lesser extent the modifications to a provider relationship which extended the initial term and made other changes intended to better align the respective interests of the parties. As a percentage of revenue, cost of revenue increased from 37% in Q1 2013 to 39% in Q1 2014 as data connectivity expenses grew at a faster rate than revenue.

As most of you already know, employee-related costs are our largest expense and include items such as wages, cash incentive compensation, noncash stock-based compensation, and benefits. The expense variance I will be talking about within each of the functional areas was driven primarily by increases in employee-related wages, benefits, and employer payroll taxes from growth and headcount and increased annual cash compensation as well as increases in noncash stock-based compensation expense as the result of the commencement of a performance-based long-term incentive program in May, 2013, and equity awards to certain personnel over the last year.

Research and development expense increased to $7.9 million for the quarter, up 4% from $7.6 million in the prior year period due primarily to an increase in noncash stock-based compensation as well as a decrease in the amount of internal use software capitalization as more developer hours were dedicated to updating and maintaining existing core services in the current period. These increases were offset by a decrease in cash incentive compensation expense. As a percentage of revenue, R&D decreased from 14% in Q1 2013 to 12% in Q1 2014 as certain employee-related expenses grew at a slower rate than revenue.

Sales and marketing expense increased to $11.9 million from the quarter, up 15% from $10.4 million in the prior year’s quarter. This increase was driven primarily by growth in wages, benefits and employer payroll taxes as well as an increase in noncash stock-based compensation. As a percentage of revenue, sales and marketing expenses decreased from 19% in the prior year period to 18% this quarter as certain employee-related expenses grew at a slower rate than revenue.

General and administrative expense increased to $5.9 million for the quarter, up 22% from $4.8 million in the prior-year quarter due primarily to increases in noncash stock-based compensation expense as well as wages, benefits and cash incentive compensation expenses. As a percentage of revenue general and administrative expense remained constant at 9% in Q1 2013 and Q1 2014.

Income from operation as a percentage of revenue increased to 19% for Q1 2014 from 18% in the prior-year period. The company’s effective tax rate increased to 39% in Q1 2014 from 35% in the prior-year quarter. The increase was due primarily to a decrease in disqualifying stock dispositions as well as a legislative change that resulted in recognition of the benefit related to a 2012 research and development credit in the prior-year quarter. The research and development credit was not reinstated for 2014. If this credit had been reinstated for the current quarter our adjusted earnings per share would have been $0.21.

Net income increased to $7.8 million in Q1 2014 compared with net income of $6.2 million in Q1 2013. As many of you know, we look at non-GAAP adjusted EBITDA as a key measure of our financial performance. Our earnings release has a table that reconciles our GAAP net income to adjusted EBITDA.

Adjusted EBITDA in the quarter increased to $22 million, up 32% from $16.7 million in Q1 last year. Adjusted EBITDA is one of the metrics we use to determine employee cash incentive compensation. We provide further information about the calculation of our non-GAAP adjusted EPS in today’s earnings release. Non-GAAP adjusted EPS was $0.20 in Q1 2014 compared with $0.15 in Q1 2013. In the prior-year quarter we had recognized the research and development tax credit which was not reinstated for F2014.

In terms of cash resources, as of March 31, 2014, we had total cash, cash equivalents and short-term investments of $259 million compared with $192 million as of March 31, 2013. On May 1, 2014, Financial Engines Board of Directors declared a regular quarterly cash dividend of $0.06 per share of the company’s common stock. The cash dividend will be paid on July 3, 2014, to stockholders of record as of the close of business on June 13, 2014.

Now on to our outlook for 2014: based on financial markets remaining at May 1, 2014 levels, we estimate 2014 revenue to be in the range of $276 million to $281 million, and 2014 non-GAAP adjusted EBITDA to be in the range of $94 million to $96 million. Using only the S&P 500 Index as a benchmark for equity markets we estimate that from May 1, 2014 market levels, a sustained 1% change in the S&P market index on May 1st through the end of 2014 would impact our 2014 revenue by approximately 0.46% and our 2014 non-GAAP adjusted EBITDA by approximately 0.84%, all else being equal.

While we have historically provided sensitivity based on the S&P 500 for simplicity, we encourage investors to utilize the percentage breakdown of our aggregate portfolios provided in our earnings release to run more accurate market sensitivities as international equity and bond market performance may deviate substantially from the S&P 500’s performance. The recommended indices are the Russell 3000 for domestic equities, the MSCI EAFE Index for international equities, and the Barclay Capital US Bond Index for bonds.

With that, Operator, we’d like to open it up for questions.

Question-and-Answer Session


Thank you, sir. We will now begin the question-and-answer session. (Operator instructions.) The first question we have comes from Bob Napoli of William Blair. Please go ahead.

Bob Napoli – William Blair

Thank you. Good afternoon, guys. First question I guess would be, I mean your assets under management growth was very strong but we were looking for a little more revenue. And I know the revenue yield tends to bounce around a little bit depending upon some timing issues, but the revenue yield this quarter was below the last two years – kind of in line with where it was in ’10 and ’11. Jeff, you talked a lot about industry pricing pressures – did you adjust pricing in any way, shape or form in the quarter? Were there some timing issues relative to the revenue performance? I think there’s a one day per month that you kind of measure, anything on that front, Jeff or Ray, on pricing?

Jeff Maggioncalda

Maybe, Ray, you talk a little bit about the actual Q1 results and then, Bob, I’ll give you a little bit more color on what we’re seeing industry-wide with respect to pricing pressure. Ray?

Ray Sims

Yeah, there’s a bunch of moving parts here and I don’t mean to complicate it but I think I need to complicate it a little bit to answer the question. There’s obviously mix during each quarter between direct and sub-advise, and as you know the direct comes in gross of fees; sub-advise comes in net of fees. The AUM number is a snapshot at the end of a quarter. If you divide that by revenue depending on the mix the apparent basis points could move a little bit.

In the quarter we had about 52% come from sub-advise – it’s been running about 50/50 in terms of our AUM. So a little more AUM than historically was the case came in from sub-advise. Probably more important during the quarter was the timing issue that you alluded to. If you look at what the S&P 500 did between Valentine’s Day when we gave our last outlook and May 1st where we gave our current outlook, it was up about 1.8% during the period.

In February the domestic equities piece, the Russell 3000 was up 1.4% but we accrue earlier, on the 22nd of the month with one of our providers – and because of volatility it was only up 0.1% on the 22nd. So we took a snapshot at fees when it was up 0.1% instead of 1.4% - that made kind of a noticeable difference. Also the EAFE Index was closer to the S&P this quarter at 2.1% but we did take a snapshot at one provider when it was only up 1.5%.

And in March the Russell matched the S&P at 1.8% but for the bulk of our providers we accrued the last Friday of the month and then the gain was only 0.9%. And for the MSCI EAFE, it was up only 0.4% on the last Friday of the month and actually down 1.5% for the provider who we accrued for on the last Friday.

So what you’re seeing is when these numbers are very small the percentage change can be quite large during the course of a quarter. That made far more of a difference than the impact we had referred to earlier of some sponsors hitting their enrollment threshold and some individuals hitting the tiering effect on their account size, which is well to the right of the decimal point on basis points.

Jeff Maggioncalda

Yeah, so that’s a pretty detailed answer. More broadly, Bob, obviously in the script we’ve been talking for quite some time, years actually about the pricing pressure in the industry. A number of people probably say The Economist article that came out in May on fund management. It says the business of managing other people’s money is being commoditized, asset management prices are clearly falling especially in the large plan market.

And when the fee disclosure regulations came out there were a lot of questions about what the impact of that might be. There were certainly disclosure obligations with respect to participants and frankly, we’re not seeing a whole lot of participant sensitivity. That’s not really what’s going on. I think indirectly though what we saw is a lot more attention by plan sponsors being paid for investment management and other service fees.

What they’ve done over the last year or so is to get pension consultants more involved, put more plans and more services out to bid and really make sure that companies are proving out and justifying the value for the fees that are being charged. And so our recurring sort of theme which continues and is as important now as ever is to say look, we’ve got to add more value, justify the value for the fees that we’re charging and the value that we’re providing, and differentiate from these increasingly less expensive investment options.

So I do see continued pressure and I think that pressure and the investigation of fees continues to increase. I would say that it seemed to be affecting more commodity-like services a lot more than ours but we feel it, which is one of the reasons why we’re running so hard on adding services like Social Security, like Income+ and broadening out the customer experience at really no additional fees for the participants.

Bob Napoli – William Blair

So is it fair to say that there has been little adjustment to your pricing as you’ve added these services? Obviously you’re giving more for the price but you have not had much of an adjustment in prices?

Jeff Maggioncalda

I think that’s fair to say. Now again, this is a longer-term trend and we’ll see how the balance sort of weighs out but we’ve been quite successful so far.

Bob Napoli – William Blair

Then just a follow-up question: obviously JP Morgan is a big provider of yours and they are being sold to Great West Life. And I mean that adds some risk and maybe some opportunity, but I don’t know if you can talk about that to any extent? I think that Great West does use Morningstar and Ibbetson and I think T Rowe is one of your other sponsors that does the same thing. What risk does this have and does it open up any opportunities, and how would you see… Give us a little color on any conversations you’ve had with Great West.

Jeff Maggioncalda

Yes, great. So without getting into anything obviously confidential, I think generally speaking your characterization’s correct. JPM is a fairly large record keeper. They have a decent sized large plan corporate business. Great West Life is big in the 457 space which is the government versions of 401(k) plans. And by this purchase they’re getting themselves into the large plan space.

Especially with large plan sponsors continuity of service and really good, competitive services at really competitive prices is an essential ingredient to success. And there has been a very strong focus on making sure that the continuity of service is there. And so I think in the near term there’s not going to be much change; I think that generally speaking both the acquiring party and the acquirer are thinking hey, let’s make this a very smooth transition for our customers.

In the longer term I think you’re right – I think it could certainly be an opportunity, it could certainly be a threat. It’s possible that they continue to bifurcate the two services, large plan and sort of mid plan/small plan with the Morningstar/Ibbetson service. It is also possible that one of the two players emerges as the standard. Frankly we feel pretty good about our position. We think we have great services; they’re very different from what is being offered we believe from the Morningstar/Ibbetson service, and they are really tailored to those large plan sponsors that demand pretty unique solutions.

And so if there’s going to be more of a standardization we feel pretty good about the position that we’re in, but of course any change brings potential risks.

Bob Napoli – William Blair

Great, thank you.


Next we’ll have Hugh Miller of Sidoti.

Hugh Miller – Sidoti & Company

Hi, good afternoon. So I guess I had a question also on the other segment of the revenue line with the platform revenue and kind of seeing also a trend down relative to the member base, and just coming in a touch lower than what we were looking for. Can you just talk about that and whether you’re seeing anything in that regards to pricing pressure or anything that would have been a timing differential that would have kind of caused that compression?

Ray Sims

So Hugh, we normally look for mid- to low-single digit growth in platform fees. There’s a few dynamics that go on there. One is as we add new plans and new participants that often brings u the amount of revenue we get from platform fees . Where sponsors are willing to go fully or partially to passive enrollment we frequently lower or waive the platform fees. And in an environment where prices are quite competitive, given a choice we would trade lower platform fees for higher expected variable charges for managing assets. Those all kind of play into the mix and I think going forward we’d expect the same low- to mid-single digit growth rate on the platform line of revenue.

Jeff Maggioncalda

The only other thing, Hugh, I’d add is if you think about the platform revenue, it might not be obvious to everybody. The asset management revenues paid by the participants who have chosen to have us manage their portfolios, it actually gets deducted from their accounts. The platform fee is more of like more of a general planned expense that covers the provision of our services to all members, things like the retirement evaluation, the online advisory services,

Doing things like Social Security Guidance that’s available to everybody at no additional fee, and other services that we’re thinking about we think could be important ingredients for helping sponsors feel comfortable charging these more general plan-level fees across the full participant base.

Hugh Miller – Sidoti & Company

Okay, great color there, it’s helpful. And then as we look at kind of the reduction from Q4 in the R&D costs, is that primarily a function of stock-based compensation being lower or are there any other reasons why the R&D costs are kind of coming in where they were?

Ray Sims

It’s mostly people-related expense. We hired a bunch of people last year so over the course of the year they’ve gotten somewhat more productive. It is a very competitive environment for engineers right now in all the places that we have engineers. So we’ve lost some people to other employers and we have a fair number of req’s open. And the accrual for variable cash compensation, what the rest of the world calls “bonus,” was a little bit lower this quarter than it was last year.

Hugh Miller – Sidoti & Company

Okay, great. And then the last question I had was just with regards to the cancellation rates, seeing a nice tick down in the involuntary cancellation rates and then the voluntary kind of comes in where I was looking for them. And I realize there was some volatility in the quarter – we’ve always talked about how that can play a factor and the new user experience, and obviously some of your other efforts as well that you’re making to try and improve the new user experience and improving engagement levels. And I was just wondering if you can talk about kind of whether or not you see the potential for a meaningful improvement from where we are at this point now given some of those efforts to improve engagement and improve that user experience.

Jeff Maggioncalda

This is Jeff. When you look at our 2014 outlook there are factored in very modest improvements over the course of the year – that’s based on things we’ve been doing where we have through testing evidence that we can improve those rates. A lot of the game becomes can you deploy those innovations through various provider partners and sponsors. Frankly as we mentioned in the script some of the stuff is pretty basic – it’s getting in touch with folks, helping set expectations and letting them know kind of the way we’re going to be managing their portfolio at the outset when they sign it up.

When we think about cancellations we think about kind of participant-related cancellations, voluntary cancellations where the participant cancels and stays in the plan as well as participant cancellations in the involuntary category where they leave the plan. Broadly speaking our order of priority is participant voluntary cancellations in the first 90 days and we think we’ve got a pretty good understanding of the kinds of things that cause folks to cancel and the ways that we might mitigate that or at least make improvements in mitigating that. That’s a lot about outbound communication; it’s a lot about allowing people to personalize and exert a little bit more control over the way that we’re managing the portfolio.

There’s also participant voluntary cancellations for folks beyond 90 days – people who’ve been members for a while and after some longer period of time they say “You know what? I’m out.” Generally speaking that’s caused by the markets. We’ve had pretty good markets; that’s helped our voluntary cancellation rate as we’ve said in prior quarters, and we think that the domain of innovations that will help mitigate longer-term voluntary cancellations have to do with better ongoing reporting of performance and value add – making sure people understand what we’re doing to help their portfolios to perform well and to adjust those portfolios as the markets change.

And then the third priority is really thinking about participant involuntary cancellations, and that’s participants leaving the plan, money disappears, we lose all the money. And the two key pieces there, and we’re building up on that now, are basically Income+ and IRA. The Income+ capability allows us to extend the time horizon of the value proposition from the growth phase where people are accumulating to the spend down phase where people are actually spending. It’s a longer horizon value proposition that we think will help in terms of longer-term involuntary cancellations.

And then the other piece is IRA, which is when people leave the plan, they take their money – we used to lose every dollar. So those two capabilities wrapped together with this income planning is our current effort on trying to mitigate the participant-based involuntary cancellations.

Hugh Miller – Sidoti & Company

That’s helpful, thank you very much.


Avishai Kantor of Cowen.

Avishai Kantor – Cowen and Company

Thanks guys. I want to go back to Bob’s question on pricing and there’s a couple of things there. And I know that many investors will focus on that topic post earnings call. So one, is there any way to quantify the impact of what we call pricing pressure on margins this quarter? What’s embedded in your guidance for the year? Will that change your long-term margin targets or EBITDA targets for the business? And then I also want to be clear to understand whether the new business that’s coming onboard is already coming in at those lower rates, and if there’s any color on that I think that’s going to be helpful.

Ray Sims

So I’ll start with the easiest question, Avishai. Everything that we know as of the release is incorporated into the outlook. So our view on pricing going forward, our view on mix going forward… I made a mention of one provider where we had a contract modification. There was some friction which wasn’t helpful to anybody in terms of how we were interacting. We modified and extended the deal. The likely implication is slightly lower revenue this year; probably higher revenue and higher margins in future years.

In terms of the gross margin, as we’ve mentioned there are really two components to gross margin – the amount that we pay providers and everything else that’s in cost of goods sold. And that total of cost of goods sold subtracted from revenue is what gives us our gross margins. And in terms of gross margins we said we expected those to be toward the lower end of the range, probably hovering around 60% - they came in at 61% for the quarter. I think we view that in the 60% to 61%, maybe low 60%s during the rest of the year.

And the opportunities for improvement, which again are incorporated in our outlook for adjusted EBITDA, come from having the expense items below the gross margin line continue to grow more slowly than the revenue or the gross margin dollars grow. As I also pointed out in the call there was an anomaly similar to what we saw in 2012 where the R&D tax credit expired, the government took about a year to reinstate it. If they don’t then we will live with a higher tax rate; if they do that would have made a difference of about… It would have rounded up to $0.21 in the current quarter.

And to the extent that that’s reinstated at some point in the future there’ll be a catch up on tax rate. The two numbers which we can kind of look at that’s pretty much what you see is what you get is the AUM number of $92 million and the cash generation number, which is when all is said and done how much net cash the business is throwing off.

Jeff Maggioncalda

[Moshie], you asked another question that I’ll just quickly give some color on which is the new business and to what degree would pricing pressure be reflected in new business being signed on at lower rates. Generally speaking I think one of the headwinds that we have faced in AUC growth, when many people look at the size of our installed base of Fortune 500 clients and they say “Why don’t you have all the Fortune 500? You know, the company’s not even really paying, that’s a good benefit offer via a lot of other employers,” my answer is usually “Hey look, a lot of folks who aren’t yet hiring us aren’t doing it because they see too much similarity between the services that we provide and the targeted funds that are already in the plan, often at very cheap prices.

To the extent that we can really broaden and differentiate ourselves from target date funds and demonstrating much higher value than what’s being offered by those target date funds, I think it’ll help pick up the AUC. So what we are seeing is, although there is a lot of pricing pressure, we are seeing sponsors take a look at this broader retirement income focus and the value of things like Social Security, Income+ which is often compared to an annuity which are very expensive; and we are seeing some success in actually demonstrating that our services do provide different sorts of value than target date funds.

And in the help study that I mentioned, a nice data point in the recent update is that net of fees – net of fees – our services are providing above 3% median annual average returns compared to people doing it on their own. So I think as a fiduciary if you get this report it’s good evidence that says when people sign up for these types of services you can justify pretty demonstrably over a long period of time and a lot of people this is worth the price.

Avishai Kantor – Cowen and Company

Alright, so that leads be to the next question – and again, some of it may be a bit new to me. You’re saying on a relative basis one of the overhangs of your ability to penetrate into other organizations has to do with the differential in pricing. So would that impact 50% of your market in your view, your potential market? Is there any way to kind of quantify that because obviously that, market penetration is a big deal here and that’s one of the most significant drivers for the story.

Jenn Maggioncalda

Yeah, so there obviously still remains a considerable market opportunity. Our AUC growth at this point is at $824 billion as of the end of Q1, so it’s getting big as a percentage of the overall market. But the 401(k) market is I don’t know, in the $4 trillion sort of number and so there’s still a lot of space there.

I kind of look at it as a relative question of are the improvements in the differential value of our services, as compared to target date funds, moving faster than the reduction in price of those alternative solutions; i.e., target date funds? One of the things that you do see is that target date funds in the larger plans are kind of hitting a point where they can’t get a lot cheaper, so there’s something of an [acentote] there. On the other hand, we are finding many ways to create a lot more value over and above what we were doing when we were simply managing a single 401(k) during the growth period.

So we remain pretty optimistic that there’s a lot of room for us to create services that truly deliver a lot of value to participants in a way that target date funds can’t match. And over the longer term we might be able to at least keep up with that differential pricing that you talked about and improve the size of the market that we can penetrate. So I’m still feeling pretty good that sponsors are excited about what we’re doing and as we continue to expand that we continue to increase the opportunity to penetrate that larger market.

Ray Sims

Yeah, I’d add two things: one, it’s pretty well documented that the overwhelming majority of participants in target date funds don’t use them properly which is to say they do not put most of their assets in them; and they also tend to leave the target date fund after a number of years. If you saw last weekend’s Wall Street Journal they talked about a comparative performance of target date funds with the same terminal year. And so the 2020 target date funds had a high and a low of like 5:1 because of the asset differences.

So there’s an increasing awareness that target date funds are not necessarily a simple set it and forget it solution, and we’re moving beyond into holistic services. And the fees for those services are dramatically less than you would pay a retail advisor if a retail advisor was even interested in taking on an account size at the average level let alone the median level of our members.

Avishai Kantor – Cowen and Company

Alright, thanks for the color, thanks.


Next we have Mayank Tandon of Needham & Company.

Mayank Tandon – Needham & Company

Thank you, good evening. Jeff, I wanted to start with just a broad question on how the relationships with Schwab and TD Waterhouse are progressing. And if maybe you can talk about the IRA opportunity in general and what the economic profile would look like versus your 401(k) business.

Jeff Maggioncalda

Yeah, with respect to the economic profile as we have sort of mentioned before they’re pretty attractive as compared to the 401(k) business. The large majority of our cost of goods sold is actually data connectivity fees paid back to providers so it’s a pretty high rent in order to plug into those systems. Because the IRA market is considerably more competitive, gaining access to custody platforms on the IRA side which Schwab and TD can be much less expensive.

Our pricing is at the 75 basis point kind of range and so you have a reasonably healthy revenue item and pretty low cost of goods sold if you will on the connections side relative to the 401(k) business. So the unit economics look good and we may very well play around with those a bit, but there’s a lot of space to do that.

In terms of the size of the opportunity you know, we continue to experiment with different ways to use these capabilities. I will say that the IRA AUM does not represent a meaningful portion of our AUM today. But as we look at Income+, Social Security, retirement income we are hearing very clearly people say “I want to look at the whole picture. I want to see how all this stuff fits together.” And as we think about Baby Boomers aging and even just holding onto current customers, having that capability is going to be an important part of it.

So I would say that the IRA capability is not yet driving meaningful growth. I think it’s a capability that will play an increasingly important role over the coming years and really enhances things like our Social Security claiming and retirement income planning services – which I wouldn’t say they’re inconceivable without the idea of IRA management in Income+ but it would be really hard to do a good job helping someone manage their year-by-year retirement income from all sources if you didn’t have the ability to manage an IRA and the ability to have something like Income+.

Mayank Tandon – Needham & Company

Great, thank you for the color. And then just one last question: going back to the attrition, is it possible to isolate the impact from Income+ - not the last quarter but really taking a look over the past 18 to 24 months. Are you able to isolate the impact to see what benefit you’ve seen from the launch of Income+ on the attrition rate?

Jeff Maggioncalda

Yeah. We are definitely still in the deployment phases and people can be in an income portfolio without taking the payouts. One of the things we have discovered is that when people think about payouts from their 401(k) they think about them in a number of years after their retirement – most people don’t think I’m going to immediately start spending my 401(k) the day that I retire.

And so there’s a value proposition with the lifetime payouts that is a little bit beyond where people are when they’re three to five years before retirement. That has influenced the retention capacity of Income+ if you will and doing the income planning is an important part of helping people see if not today when in the future will they want to start these types of payouts?

So I’d say that so far we’ve not seen a major contribution improvement in retention from Income+; however it is certainly an important ingredient and seems to be generating a lot of satisfaction as people go through the income planning experience. And so like IRA I think it’s a pretty important capability that really comes together in this near-retiree income planning experience.

Mayank Tandon – Needham & Company

Great, thank you Jeff.

Jeff Maggioncalda



That is all the time that we have for questions today. The conference call has now concluded. We thank you all for attending today’s presentation. At this time you may disconnect your lines. Thank you and have a great day, everyone.

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