SEI Investments' (SEIC) CEO Alfred West on Q2 2016 Results - Earnings Call Transcript

| About: SEI Investments (SEIC)

SEI Investments Company (NASDAQ:SEIC)

Q2 2016 Earnings Conference Call

July 27, 2016 2:00 PM ET

Executives

Alfred West - Chairman and Chief Executive Officer

Dennis McGonigle - Chief Financial Officer

Joseph Ujobai - Executive Vice President, Head of Private Banking

Paul Klauder - Executive Vice President, Head of SEI Institutional Group

Stephen Meyer - Executive Vice President, Head of Investment Manager Services

Kathy Heilig - Vice President, Treasurer, and Controller

Analysts

Glenn Greene - Oppenheimer & Co. Inc.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Christopher Donat - Sandler O’Neill + Partners, L.P.

Christopher Shutler - William Blair & Company

Patrick O’Shaughnessy - Raymond James Financial, Inc.

Thomas McCrohan - CLSA

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the SEI Second Quarter 2016 Earnings Call. At this time everyone joining by telephone is in a listen-only or mute mode. And then, later we’ll have a Q&A session and instructions will be given at that time. [Operator Instructions]

As a reminder, the conference call is being recorded. I’ll now turn the meeting over to our host, Chairman and CEO, Al West. Please go ahead, sir.

Alfred West

Thank you, and welcome, everyone. All of our segment leaders, except Wayne Withrow, Leader of the Advisors segment are on the call; as well as Dennis McGonigle SEI’s CFO; and Kathy Heilig, SEI’s Controller. I’ll start recap by recapping the second quarter 2016. I will then turn it over to Dennis to cover LSV and the Investment in New Business segment.

And after that, each of the business segment leaders will comment on the results of their segments. Dennis will fill in for Wayne. Then finally Kathy Heilig, will provide you with some important company-wide statistics.

As usual, we will field questions at the end of each report. So let me start with the second quarter 2016. Second quarter earnings decreased by 6% from a year ago. Diluted earnings per share for the second quarter of $0.49 represent a 4% decrease from the $0.51 reported for the second quarter of 2015. We also recorded a 2% increase in revenue from second quarter of 2015 to second quarter of 2016.

Plus, during the second quarter of 2016, SEI’s cash asset balances under management - non-cash asset balances under management increased by $5 billion, while LSV assets were flat. In addition, during the second quarter of 2016, we repurchased approximately 1.5 million shares of SEI stock at an average price of $48.57 per share. That translates to over $73 million of stock repurchases during the quarter.

Finally, during the second quarter, we capitalized approximately $10.1 million of new technology development, of which approximately $8.5 million was for SEI Wealth Management development, and we amortized approximately $11.1 million of previously capitalized development.

Now, turning to sales, our net new sale - recurring revenue sales during the quarter were strong. Of the $29.1 million of net new sales events we generated, $23.4 million are recurring revenues. And each of the segment heads will address their second quarter sales activity.

We are very excited about our recent wins of large clients and the expansion of the markets we can now serve, all brought about by the investments we have made to date. But as we discussed in January, we need to increase our R&D spending through 2017. This need is primarily caused by growth. Growth evidenced by the large new clients in multiple markets.

All-in-all, our R&D spending, which for some time has run at 8% of revenues, ran at 9% of revenues for the first and second quarter of 2016. And will grow to approximately 12% of revenues by the end of this year. It will run at that range during the year 2017. Post 2017, we will be in a position to drop the R&D rate back to 8% to 10% of revenues, the right range we have historically targeted.

The increased R&D investments along with other anticipated expense increases will increase our total expenses by 4% to 6% in each of the next two quarters, then will increase at lower more normal rate in 2017.

The investment in banking, our largest investment is focused on preparing our solutions for Regions Bank and Wells Fargo Bank, in the markets they represent. They are marquee clients in both the large Business-as-a-Service and large Software-as-a-Service markets and meeting their needs will position us to win a lot more business in these large markets.

Joe Ujobai will elaborate on the importance of these investments. Now, on the advisory business we are investing in the migration of their 7,000 clients to SWP. They have been successful in migrating a number of larger clients to SWP, and are honing their ability to handle mass client-migrations. Also, they are adding to the front-end capabilities of SWP. Dennis, who is filling in for Wayne, will cover the Advisors segment.

In the Investment Managers segment we have had a number of large sales, one which occurred in the second quarter. These wins require large conversion projects causing us to spend ahead of the revenue we receive. Also investments are being made into new solutions. Steve Meyer will cover these investments.

In the Institutional Investors segment, our investments are aimed at our continued entry into the defined contribution marketplace and expanding our worldwide footprint to deliver fiduciary management services. Paul Klauder will cover these investments.

We have big opportunities in all our businesses to makes these investments the wise thing to do for long-term growth. As always, we will aggressively manage total company expenses while we make the necessary investments. And this concludes my remarks, so I’ll now ask Dennis to give you an update on LSV, the Investments in New Businesses segment and the Advisor segment. I’ll then turn it over to the other business segments. Dennis?

Dennis McGonigle

Thanks, Al. Good afternoon, everyone. I’ll cover the second quarter results for the Investments in New Businesses segment, discuss the results for LSV Asset Management and cover our Investment Advisors segment in Wayne’s absence.

During the first quarter 2016, the Investments in New Businesses segment continued its focus on the ultra-high-net-worth investors segment through our private wealth management group and the operational development and testing of web-based digital advice offering.

During the quarter, the Investments in New Businesses segment incurred a loss of $3.8 million, which was flat through the first quarter of 2016. There has been no material change in this segment. Regarding LSV, our earnings from LSV represent our approximate 39% ownership ventures during the second quarter.

LSV contributed $30.3 million in income to SEI during the quarter. This compares to $29.2 million contribution for the first quarter 2016. Assets at LSV were essentially flat for the quarter. LSV did experience net positive cash flow, which offset by negative market valuations. Revenue at LSV for the quarter was approximately $95.8 million, of which approximately 1% was performance fee related.

Before I move on to the Advisors segment we’ll be happy to take any questions you may have at this point.

Question-and-Answer Session

[Operator Instructions] We’ll go to Glenn Greene with Oppenheimer. Please go ahead.

Q - Glenn Greene

Hey, Dennis.

Dennis McGonigle

Hey, Glenn.

Glenn Greene

I’ll ask the questions or so, as we obviously had the fourth quarter confusion on the increased expenses. So as it relates to Al’s comment of total expenses being up 4% to 6% in each of the next two quarters, can we get very granular and specific on that? Are we talking 4% to 6% increase from the $250 million of expense this quarter or relative to, call it, the $242 million in the third quarter of last year, how do we reference that?

Dennis McGonigle

Yes, it’s also the second quarter 2016 expenses, so sequential to this quarter.

Glenn Greene

And then do we go up another 4% to 6% on the fourth quarter from that higher level?

Dennis McGonigle

Yes, then it will kind of be more normal as we go into next year.

Glenn Greene

Right, so we’re talking north of $260 million of expenses in the third quarter and north $270 million on the fourth quarter?

Dennis McGonigle

Yeah, roughly in that range.

Glenn Greene

Okay. Thank you.

Dennis McGonigle

You’re welcome.

Operator

We have a question from Robert Lee with KBW. Please go ahead.

Robert Lee

Yes, hi, thanks. And maybe just kind of following up to that, the comment about the increased R&D spend going up to 12%, obviously that’s incorporated in some of your expense guidance here. But maybe get a sense of how much you expect of that’s going to be capitalized this year and into next year versus kind of flow through the P&L in the short-term?

Dennis McGonigle

Yes. Generally, over the course of the past - few years now we’ve been bringing down the percentage of capitalization across our technology development space. So I’d say, it will continue to be on the lower end of the range, probably in the 45% to 50% area.

So you saw capitalization tick up first and second quarter. Now, a little bit of that was just to be pure-related [ph] didn’t really tick up a whole lot, but it will tick up over the next couple quarters and into next year.

Robert Lee

Okay. And I guess we’ll go through some of the individual segments. But is this going to be mainly dominant - continuing to be dominant, I assume, in the Private Banks segment. And then, may be a little bit spilling over into the next segment you’ll talk about, Dennis, Investment Advisors?

Dennis McGonigle

Yes. It’s more - it’s definitely a private banking, because of the technology related investments associated with the two large markets that Joe is attacking and he’ll spend more time on that. But also it’s in the Investment Management - or manager - services segment, because some of the expenses are really operational in nature. As Steve builds out capacity to absorb a lot and some of the new business wins he has incurred.

So I would say, more impactful to those two segments, a little bit less so to advisor, and certainly little bit so to institutional.

Robert Lee

Great, thank you.

Dennis McGonigle

You’re welcome.

Operator

And we have a question from Chris Donat with Sandler O’Neill. Please go ahead.

Christopher Donat

Thanks for taking my question. Dennis, just wanted to ask one more on the expenses here. So this is going to be more in the category of like consulting and sort of temporary professional stuff, and then also some other technology. Like you said, it’s going to go away or decrease in 2017 or after 2017, right, it’s not…?

Dennis McGonigle

Right, so it’s more in that consulting line item and in the personnel line item. So, on the technology side, the development side it will be more in that consulting line item. But that will have some pick up in personnel, direct personnel, because we’re trying to hire some talent there. And in Steve’s market, it’s probably more on the personnel side, because he is adding employees to increase his capacity. And note, both of them can - will go further into it when they talk about their segment.

Christopher Donat

Okay.

Operator

Thank you. And we have a question from Chris Shutler with William Blair. Your line is open.

Christopher Shutler

Hey, guys, good afternoon. So, on the expenses I just wanted to make sure that we have this all straight. So Q3, you’re essentially saying 4% to 6% growth off of the $250 million. So that would be $260 million to $265 million in Q3; and then, 4% to 6% again in Q4, which would be $270 million to $281 million. Is that correct?

Dennis McGonigle

Yes.

Christopher Shutler

Okay. And then, holding that same sort of level, but whatever at Q4 level is holding that reasonably consistent over the course of 2017.

Dennis McGonigle

Correct.

Christopher Shutler

Okay. And then, just quickly on LSV, Dennis, could you just give us the net flow number specifically for the quarter?

Dennis McGonigle

It is positive cash flows of about $600 million.

Christopher Shutler

Okay. Thank you.

Dennis McGonigle

You’re welcome.

Operator

And we have no additional questions at this time. Please continue. I do apologize, we have one additional question. We have Patrick O’Shaughnessy with Raymond James. Please go ahead.

Patrick O’Shaughnessy

Thank you for that, jumped in a little bit late. A question on LSV, so we saw, I guess, revenues ticked up a little bit. But the average AUM was up pretty substantially quarter over quarter. And as we’re calculating it, the average fee dipped a little bit. And it’s kind of been in decline last few quarters. Are they seen any material pricing pressure? Is that pretty much just noise?

Dennis McGonigle

Well, I would say, generally the market in the Investment Managers space is competitive from pricing perspective. So they’re not immune to kind of overall trends in the industry. But I would say relative to their more recent quarterly performance, I would say, it’s noise. They do a good job of holding the line on their fees and are very, I would say, protective in the sales process of their fees. But generally speaking, the whole industry is under fee pressure.

Patrick O’Shaughnessy

Got you. And then, I guess, to circle back on the expense question, so the increase in expenses in the back-half of this year that you’re talking about, are those increases that you kind of knew about, as you’re heading into this year? Are those kind of additional investments that really - you became aware of the need for as the year progressed?

Dennis McGonigle

Two things: one, certainly the costs associated with the Wells Fargo event and our need to deliver as a result of Software-as-a-Service solution, we’ve been talking about it for a year now, since we announced that event last year. So it’s not - those costs associated with that actively are not new. I would say, certainly there is some newness in the work we’re doing for that large Platform-as-a-Service market.

But it’s principally the changing dynamics that are occurring in the front-office technology space or application space, that not only our clients are looking for, but the market in general is looking for, and us making the decision and the commitment to invest more heavily in that front-office space.

And Joe can give you a little more color, when he talks about what we mean by front-office applications.

In the operational cost side, it’s really a result of growth and absorption of growth and it’s really a timing issue of expenses ahead of revenue matriculating when the clients go live. And that’s more - I would say, having a more of an impact on Steve’s business over the next couple quarters.

So while we are talking about expenses, we also do expect kind of modest revenue growth through the third quarter. And I would say, little bit stronger revenue growth in the fourth quarter will matriculate the new revenue associated with the sales activity. So hopefully that answers it for you, Patrick.

Patrick O’Shaughnessy

Yes. That’s helpful. Thank you.

Dennis McGonigle

You’re welcome.

Operator

We do have a follow-up question. We’ll go back to Chris Shutler with William Blair. Your line is open.

Christopher Shutler

Hi Dennis, I just want to follow-up on this one more time. So the - how much of this incremental expense in the back-half is permanent versus temporary?

Dennis McGonigle

Roughly, I would say that the temporary side is larger, because that’s more on the development side versus the operational capacity increment. So it’s definitely more on the temporary side, if you will. And that’s where Al talked about, how the R&D, overall R&D percentage will drop 3, 4 percentage points year-to-year as we get out of 2017. It’s kind of indicative of that.

Christopher Shutler

Okay. Thanks.

Dennis McGonigle

You’re welcome.

Operator

And we have no additional questions. Please continue.

Presentation

Dennis McGonigle

Okay. During the second quarter - I’ll now cover the Advisors segment. And during the second quarter of 2016 we posted good growth in our traditional business. At the same we continued significant progress towards the transformation of our business on to one supported by the SEI Wealth Platform and the growth opportunities that holds for us in the future.

Assets under management were $53.7 billion at June 30, a 2.4% increase for March 31. During the quarter, we had $717 million of positive net cash flow. Revenues for the quarter were $81.9 million, this compares to $76.7 million for the first quarter, a 6.8% increase. Contributing to this increase were net positive cash flow, positive market returns, improved yields on money market funds and a shift from lower revenue liquidity products to higher revenue equity portfolios.

Expenses for the quarter were flat compared to the first quarter, as expense management remained a focus of the unit. On the new business front, we signed 128 new advisors. While somewhat lower than our recent quarterly totals, we view this as just the timing issue. Our signings for the first six months of this year approximate the signings from the first six months of last year. And our pipeline of prospects remains very strong.

Moving on to the status of the SEI Wealth Platform, we completed another client migration at the end of April and now have about $10.5 billion in assets on the platform. We plan to migrate another $5 billion in assets in September of this year and expect to accelerate the pace of migrations next year, shooting to complete all this by the end of 2018.

In summary, we continue to recruit the advisors and gather net positive cash flow during the quarter. Our second quarter client migration for the SEI Wealth Platform was a success. And we expect an additional migration at the end of this quarter. The transformation of our business onto one supported by the SEI Wealth Platform remains on track and we all remain optimistic about our future prospects.

I’ll now take any questions, you may have on the Advisors segment.

Question-and-Answer Session

Operator

[Operator Instructions] We will go to Chris Donat with Sandler O’Neill. Your line is open.

Q - Christopher Donat

Hey, Dennis, we’ve seen for the segment operating margins expand over the last three quarters. We’ve seen some expenses roll away that had been elevated ahead of the migrations, or is there something else going on, on the expense side?

A - Dennis McGonigle

Well, one benefit we had in the early part of the year compared to, say, fourth quarter, and I would say, the latter part of third quarter, is that sales compensation in the fourth quarter, as you remember was somewhat elevated because of the really strong sales year we had last year and acceleration of - accelerators that some of our sales folks hit in their compensation plan. So that came back to, say, more normal rate so far this year. So that certainly has helped.

I think the comment in the commentary about expense management, it applies in this segment, applies across the company frankly, but in this segment. Wayne and his team continue to focus on spending where strategically necessary and cutting back in areas where it’s not so strategically important. And even with the commentary we had just few minutes ago on overall expenses, that will hold true really across the company as we go forward.

Q - Christopher Donat

Got it. Thanks.

A - Dennis McGonigle

You’re welcome.

Operator

[Operator Instructions] I have no additional questions, so please continue.

End of Q&A

Presentation

Alfred West

Thank you. I am now going to turn it over to Joe Ujobai to discuss our Private Banking segment. Joe?

Joseph Ujobai

Thanks, Al. I’ll start with the financial update on the second quarter for the Private Banking segment. Second quarter revenue of $115 million was up $1.5 million from the first quarter. Operating profit of $12 million was up over $2 million in the first quarter. Net sales events for the quarter were $4.4 million, of which $750,000 is recurring investment processing revenue. And the remaining $3.7 million is professional services related to our investment processing business.

Recurring sales event this quarter includes two new clients in the UK, and indicates we have restarted new business sales there in conjunction with solid client, net cash flows to the platform. SWP sales activity remains robust in both the U.S. and UK, and has been fueled by the recent sales success and progress towards delivering our large scale operating models.

Recurring sales were negatively impacted by the loss of two smaller TRUST 3000 clients. Modest client loses had been tied to merger and acquisition activity and extremely competitive pricing at some of our smallest legacy clients.

Over the past year, we have successfully re-contracted all UK SWP clients and have begun to re-contract the early SWP adopters in the U.S. Our total signed, but not installed backlog for the SEI Wealth Platform is $45 million in net new recurring revenue. We expect half to install by the end of 2017 and the remaining to install in later years. As always, we are focused on expense management and over the last several quarters have we had kept spending within a tight range.

As Al discussed, increased investment has been triggered by sales to very large firms, and will help us grow our business in some of these large and growing market segments. We are investing in our Software-as-a-Service or as you have known is the past ASP operating model. As the very largest wealth managers look to place legacy technology to drive growth and scale, this model meets the needs of a substantial market opportunity.

Wells Fargo will be the first large scale U.S. Wealth Management firm to adopt this model. In the model we provide technology and infrastructure services and our clients typically run their own operations. We are targeting our largest ASP clients and other very large wealth managers in the U.S. and globally. To install Wells Fargo and access this market opportunity, we are primarily investing in development to further scale core investment processing and streamline integration to the platform.

We’re also investing in enhanced risk solutions with disaster recovery and data security. We’re also investing in our Business-Processing-as-a-Service or as you would have known formally as BSP operating model. As other wealth managers consider technology consolidation, combined with back-office outsourcing, this is another large and growing market opportunity. Regions Bank will be the largest U.S. wealth management firm to utilize this model.

In the model, the platform will be consumed in a fully integrated capacity, including wealth advisory services and client experience, securities processing and back-office operations. We are targeting our largest BSP clients, some ASP clients and other large wealth managers in the U.S. and around the world.

To install Regions Bank and access this market, we are primarily investing in enhancing our comprehensive integrated front-office solution. This includes end-client websites, mobile apps and other tools to drive advisor productivity and investment management efficiency gains.

In the UK, in addition to signing the two new clients, net cash flow from current clients to SWP was approximately $1.6 billion for the quarter. Assets under administration are now approximately $38 billion. Our asset management distribution business had a challenging quarter given market and currency volatility. Assets under management were relatively flat at $18.4 billion. We have a growing diversified pipeline of new distributors and expect to see growth over time.

In summary, we have much work to do, but we are making good progress, as we enhance the solution to grow the business. Are there any questions?

Question-and-Answer Session

Operator

[Operator Instructions] And we’ll go to Robert Lee with KBW. Please go ahead.

Q - Robert Lee

Yes, hi, Joe. Quick question, just curious on - your posts are pretty good in the quarter. But I’m curious if you have any color around how it was kind of immediate leading up to and then may be post all the trauma in the UK around Brexit. How do you feel that’s going to impact in all the wealth managers you have as clients?

A - Joseph Ujobai

So I mean, I think so far Brexit - I mean, certainly we had currency decline and that impacts our financials. I was really proud, frankly, the way the platform operated, because we did see some uptick in volatility and trading, the first couple of days afterwards. And the team in London, the operation team in the platform all did very, very well and we were very happy. Not happy about the situation and nor did we expect that was going to happen, but we did have a solid plan in place.

I think what we’re seeing from our clients is there is definitely some asset allocation, a reallocation of assets. Certainly, UK real estate, most firms have tried to get their clients out of UK real estate and some of those funds have closed for redemptions. Again, the platform has done a great job in administering that. So we have seen some asset allocation.

We’re seeing people that generally stay invested in the market. And then from a - I think from a prospect perspective, certainly, in the large advisory space and the private client space I think we’re so far so good. We are not seeing decisions being slowed down. It’s pretty early also. I think the question will be how do the larger banks respond once this thing really shakes up. There is obviously a fewer months to determine what’s really going to happen.

So far so good, but we’ll see with the larger opportunities what’s going to happen when I think they feel more comfortable with the true outcome.

Q - Robert Lee

Okay. And then, maybe going back to expense question that pose through your segment, I mean, given the guidance about total company expenses going up the 4% to 6% route, since that will be concentrated in your business as well as I guess Steve’s, I mean, are we looking - just to make sure I understood this from a modeling perspective correctly, are we looking at something like a 10% sequential increase in expenses in your specific segment given how you report?

A - Joseph Ujobai

We’re not disclosing that. And I think what we did is we try to give some information around - from a corporate perspective. But we, as Al said, where you’re going to ramp up and then it will flatten out a bit. And then we think it will trail-off at the end.

Q - Robert Lee

Okay. Thank you.

A - Joseph Ujobai

Yes, as Al and others said, it’s going to impact me the most.

Q - Robert Lee

Right, thank you.

Operator

And we have a question from Patrick O’Shaughnessy with Raymond James. Please go ahead.

Q - Patrick O’Shaughnessy

Yes, just a quick one on the asset management distribution business. What was the net cash flow this quarter?

A - Joseph Ujobai

It was about flat.

Q - Patrick O’Shaughnessy

Okay, great. Thank you.

A - Joseph Ujobai

One of the things that’s very different than ours, say, Advisors business in the U.S. is that the clients are largely non-U.S., and so we have seen more volatility in those markets and some of them are higher net-worth and those clients going to just stay on the sideline a bit.

Q - Patrick O’Shaughnessy

Got you. Thank you. And then, I guess circling back to expenses, so just as we think about the evolution of SEI Wealth Platform over the last decade plus, there has been a lot of investment spending for a number of years. And I think from a lot of investors’ perspective it kind of felt like you had infrastructure in place. Now you’re starting to land some big contracts. And so I think it comes as a little of surprise that there is kind of another round of investment spend.

So can you just kind of walk us through, and I know you already have a little bit on the prepared comments, but you can just walk us through a little bit more about why there has to be another ramp at this point in time?

A - Joseph Ujobai

I mean, I think there are three things we’re spending money on as I said. One is some development to scale this thing to some fairly substantial numbers, and also deliver it in an ASP over Software-as-a-Service environment versus BSP where we do the operations. So there are some investments we recognized. We always knew that there will be some investments to change the operating model.

And we are working in host-partnership with Wells Fargo as the lead client in that space. And we are - and that’s a decent size investment to do that and to drive some very, very substantial scale. Frankly that will grow SWP. We’ll be able to grow SWP even larger than our TRUST 3000 business.

The second area, where we have created some, I’d say, enhanced or advanced services particularly around disaster recovery and around data security. And so we have enhanced the solution there. We are charging premium prices for those solutions, but that’s an investment in infrastructure that is required to service these very, very large national or global kinds of organizations.

And then the third area, which I mentioned before was this, what we call the front-end. And we built from back to the front, so we believe - well, and we still believe when we started this, that in order to be able to provide enhanced advisor and client experience. We needed to build a very modern and robust backend, because the way banks and the way their clients use this kind of platform, there’s lot more access and a lot more desire to pull up data and to turn that data into information.

So we started in the back and we more recently had begun to develop the front-end side. And we’re doing that certainly in partnership with some of our clients and with some of our largest prospects. But I think that was sort of a natural evolution. So these are things, we think three very important investments for us to grow this business and to certainly sell this at a premium to either our legacy solution or to competitors.

Q - Patrick O’Shaughnessy

Got it, that’s very helpful color. Thank you.

Operator

And we will go next to Tom McCrohan with CLSA. Your line is open.

Q - Thomas McCrohan

Hi, with these incremental investments, Joe, can you give us a little sensitivity around the pricing going forward, how dollar revenue on, say, TRUST 3000? What you might expect to get on the new platform given these changes that you are making?

A - Joseph Ujobai

Yes, I think we have - so I think again we have lots of levers now to - we have a much broader set of levers to grow revenue on the SEI Wealth Platform relative to TRUST 3000. TRUST 3000 was largely a business model that was account based. We are building financials that we believe will help Advisors and Private Banking grow their business things like portfolio or proposal generation tools, very robust end-client websites.

So we make - we grow our business certainly as those clients grow their business based on the AUA part of the business model. There are things as I mentioned some of these advanced infrastructure things that we can now charge at premium for, or we can actually even charge for, than in the past were really part of the TRUST 3000 bundle. So there are opportunities there. And then sort of in the core of TRUST given what we’ve built from efficiency around processing, we’re able to charge a premium, so the TRUST 3000 to SWP core.

So those sort of three or four examples of where we have either new revenue levers or we have an opportunity to charge a premium based on a more robust solution.

Q - Thomas McCrohan

Okay, thank you. And then, in terms of the different type of clients that you’re going after, I mean there is a perception out there that the client which is great client to have, is a pretty complex client as opposed like Regions, which may be arguably less complex. So lots of these changes seem to be directed for everybody, but arguably supporting a really complex client like Wells Fargo. So can you just give us a sense for how many more Well Fargo size prospects do you have in your pipeline, so people will get comfortable that, not just building this just for one client that you can’t replicate with other prospects.

A - Joseph Ujobai

We have a lot of very large clients already on TRUST 3000. So those firms would all be very important prospects of ours. So I don’t want to name, but I think you all know that we have a big business at the high-end here in the U.S. And those clients would all be - are all very good prospects for us. But also some firms that either cobbled together legacy system and sort of manage that technology themselves. So there are other large firms that maybe because we didn’t have the strongest global capabilities pre-SWP that maybe have built some of their own things or have run their businesses on other technologies.

So that’s really sort of the top, if you look in the U.S., is probably talking certainly a decent amount of the top 20 banks. And then there are so many other types of wealth managers. Historically, we haven’t called on outside of bank trust department that are very big. And that Software-as-a-Service solution would be an ideal operating model for them.

So it’s clearly not - Wells is a great lead client for us, but it’s clearly for market, it isn’t for one client.

Q - Thomas McCrohan

My last question, and I’ll jump back in the queue. The timing for implementing Wells, has that change that all?

A - Joseph Ujobai

No. It haven’t change at all. We continue to meet all the milestones working closely together with them and that hasn’t changed.

Q - Thomas McCrohan

Thank you.

Operator

[Operator Instructions] We go to Chris Shutler, William Blair. Your line is open.

Q - Christopher Shutler

Hey, Joe, so on the spending, is the fundamental issue that there are new items or functionality that you find yourself needing to build or is it that you simply underestimate the amount of expense?

A - Joseph Ujobai

Yes, we offer the platform in as we call Business Processing as a Service. So the initial clients, initial lot of 20 or 30 clients, Wells delivered in that way. A lot of the spending is tied to delivering it in the more ASP like service. We knew that would require additional investments and I think we’ve made some good decisions that we moved forward to get that done. And I think on the front end, we just, we were - we hadn’t gotten to that yet. So we got closer to it and then we’re really focusing on that.

And we are finding a lot of interest in integrated front-end. So a lot of these prospects and clients have gone out and bought a lot of different pieces of software or have tried to build their own advisor type tools in the front-end. And because it’s not very well integrated there is a lot sort of swivel chairing. And we’ve I think have designed and are in the process of building again with in this case with Regions as a lead client, a very unique and integrated front-end that we think has a pretty strong competitive advantage for us.

Lot of our firms are [basically however] [ph] try to pool that together and keep it up to date. And we think we’re the only ones who can really provide that kind of integrated solution.

Q - Christopher Shutler

Okay, thanks.

Operator

Thanks. We have no additional questions at this time.

End of Q&A

Presentation

Alfred West

Thank you, Joe. And our next segment is Institutional Investors segment. I’m going to turn it over to Paul Klauder to discuss this segment. Paul?

Paul Klauder

Thanks, Al. Good afternoon, everyone. I am going to discuss the financial results for the second quarter of 2016. Second quarter revenues of $74.7 million, increased 3% compared to the first quarter of 2016. Capital markets performance and net new clients funding of $725 million during the quarter positively impacted revenue for the second quarter of 2016 compared to the first quarter.

Quarter end asset balances of $78.6 billion, reflect a $2.6 billion increase compared to the first quarter. The unfunded client backlog at quarter end was $900 million. Second quarter 2016 operating profits of $38.1 million increased 2% compared to the first quarter. Second quarter 2016 margins were 51.1% less than a 1% decrease from the first quarter.

Client signings for the second quarter of 2016 were $900 million, including a new large market defined contribution investment client. We anticipate making continued investments in executing our strategy to grow our DC business and expand our global footprint into incremental markets that will embrace fiduciary management, OCIO or standalone investment strategies.

We are pleased with the continued growth of our fiduciary management, OCIO business across our focus market segments. And we continue to see an increase appetite for delegation by institutional investors. Thank you very much and I’m happy to entertain any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] We’ll go to Robert Lee with KBW. Please go ahead.

Q - Robert Lee

Thanks. I guess, just want to clarify the 725, that was a net client funding, right?

A - Paul Klauder

Correct, Robert.

Q - Robert Lee

Okay. And as you enter the - or build out the DC capability and enter that market, your margins in this business have held up and pretty steady kind of bounce around this 51% level. So is there any reason to expect at least in the short-term some pick-up in spend here just to kind of prepare for getting larger in that new business segment?

A - Paul Klauder

I think we’ll see just a little bit of incremental spend around thought leadership and public relations, probably, in couple of key resources and then just the execution, and going to market and making sure we’re getting the number of appointments that are necessary in order to drive a pipeline. So we can be successful, all the same way we’ve been successful defined benefit area of the marketplace.

Q - Robert Lee

Okay. That was all I had. Thank you.

A - Paul Klauder

Thank you.

Operator

And we have no additional questions.

End of Q&A

Presentation

Alfred West

Thank you, Paul. Our final segment today is Investment Managers. I’m going to turn it over to Steve Meyer to discuss the segment.

Stephen Meyer

Thanks, Al. Good afternoon, everyone. For the second quarter of 2016, revenues for the segment totaled $70.9 million, which was $1 million or 1.5% higher, as compared to our revenue in the first quarter of 2016. This quarter reported increase in revenue was primarily due to new client fundings. Revenue growth was somewhat muted this quarter, due to negative revenue events, including some client liquidations and redemptions.

Industry wide, we saw alternative managers experience record outflows and liquidations this past quarter. Our quarterly profit for the segment of $24.0 million was approximately $600,000 million or 2.6% lower than the first quarter of 2016. This decrease in profit quarter-over-quarter was driven by an increase in our expenses, primarily due to implementation cost associated with our new client, as well as an increase in sales competition.

As I mentioned previously, we continue to invest in and increase our infrastructure ahead of large new business activity to support such growth. As Al mentioned, we expect that looking forward our expenses will uptick modestly in the next three quarters, as we implement previous sold business and bring on additional new business.

Third party asset balances at the end of the second quarter of 2016 were $419.1 billion. Approximately, $18.6 billion or 4.6% higher as compared to asset balances at the end of the first quarter 2016. The increase in assets was primarily due to net new client fundings of $13.2 billion combined with market appreciation of $5.4 billion.

And turning to market activity, during the second quarter of 2016, we had a record sales quarter. Net new business sales events totaled $17.1 million in annualized revenue. These events were comprised of new name business and expansion of existing business with current finds across all our segments. These events included a competitive win of a large U.S. based global investment management firm, who will be outsourcing their entire alternative business to us, as well as a competitive win at the global managers platform expansion into Europe.

While, market volatility Brexit and other factors have provided a headwind for Investment Managers, we still see good opportunity for growth. We see ongoing demand for our core outsourcing solutions, as well as our regulatory and compliance solution. The Investment Management industry is evolving and changing rapidly.

Innovation is key for continued growth in this market. We continue to invest in our solutions and increase our technology and data services to be at the forefront of the emerging needs of the industry. This bodes well for our future growth.

I’ll now turn it over for any questions you may have.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We will go to Chris Donat with Sandler O’Neill. Please go ahead.

Q - Christopher Donat

Hi, Steve, just I am trying to reconcile something. I thought you said you had record redemptions, but then also record sales quarter. Can you give a sense of what the trends are that are across purposes there?

A - Stephen Meyer

Well, when we talked about the liquidations or redemptions that is obviously within specific clients’ or managers’ funds, where they are seeing investors either to move to other products or redeem. We are still seeing though a demand among these managers, even ones that are out there, large, medium, small but do have pressure on their business. They are also looking to add - getting into new markets, add infrastructure, and then they look to partner with someone else for that.

So I think in a way the tough markets, while providing a headwind in one side are providing still an opportunity for us to grow and capitalize on the needs of these managers.

Q - Christopher Donat

Okay, thanks.

A - Stephen Meyer

Sure.

Operator

And let’s go to Robert Lee with KBW. Your line is open.

Q - Robert Lee

Yes, hi. Hey, Steve, how are you?

A - Stephen Meyer

Good. How are you, Rob?

Q - Robert Lee

Good. Thanks. I mean maybe just follow-up to that, just make sure understood it, because numbers go by pretty quickly. So annualizing the business sales were $17 million in the quarter?

A - Stephen Meyer

$17.1 million net revenue.

Q - Robert Lee

Right, and then net cash flows were $13 billion, or is that the negative?

A - Stephen Meyer

Yes. That’s $13.2 billion net.

Q - Robert Lee

Okay. And then, what’s the pipeline, I guess, if you include that $17 million then, what’s the pipeline of one business that hasn’t converted yet? I think like 35 at the end of last quarter. So where does that stand today?

A - Stephen Meyer

Okay. So that’s not pipeline, that’s backlog. Backlog at the end of Q2 is $46 million, which we include a majority of the deals we sold in Q2.

Q - Robert Lee

And generally, you expect of that kind of funds over kind of a year-and-a-half period?

A - Stephen Meyer

Yes. I think, we say 12 to 14 months. I think we are expecting for a large portion of what we sold in Q2 that will happen in a shorter timeframe, but I’d say looking out over the next 12 months.

Q - Robert Lee

Okay. And then, maybe last question. Just on the - I guess, the theme of the day on expenses. Some uptick expected, and my sense was from prior comments that’s in your segment at least some of that would be fairly more - I don’t know, might be more temporary in nature, it will kind of pick up Q3, Q4. And then either kind of stabilized or then maybe kind of fade away a little bit or how should we think of that?

A - Stephen Meyer

Yes. I think, you can expect a modest uptick in expenses I think in the range that Al gave in the beginning. And I think, there are really two portions of that expense uptick. One which is the larger is obviously with winning the large deals within this quarter and previous quarter, the uptick of expense, especially around operations and people. I think we are going to see that going up a little Q3 and Q4, again further range out with it. And then, I think we’ll see that level off.

But the good news is this is all, and as Dennis said, part of growth. And what we should start to see is, then the revenue come in that will help offset this expense and help margin.

Q - Robert Lee

Great, thank you.

Operator

Thank you. And we will go to Tom McCrohan with CLSA. Your line is open.

Q - Thomas McCrohan

Hi, Steve, just a quick question, what percent of revenue in your segment is derived from mostly traditional hedge funds?

A - Stephen Meyer

So I would answer it saying kind of alternative versus traditional, sits about 55%, 45% - 55% versus 45% traditional long-only products.

Q - Thomas McCrohan

Thanks for that.

Operator

And we go back to Robert Lee, KBW. Please go ahead.

Q - Robert Lee

Thanks. I just had one quick follow-up, Steve. If I think of - and maybe this isn’t necessarily how you think of revenue, but I guess one way we think of it is kind of obviously looking at AUA and AUM and thinking of kind of a fee rate. And if I kind of think of that over the last couple of years, it’s been kind of a downward trend as the mix changes. So is there any reason to think that that isn’t going to continue just as you sign on more of these large clients or is it - should we think there may be some stabilization that we should expect?

A - Stephen Meyer

Well, I think, I would expect that it’s stabilized. I think, some of the things that you’re seeing have been product mix over the years. I think, they go into larger fee, higher fee more complex products or more lower-fee products. I’ll use this quarter as an example, the 13-point-some billion in uptick an assets. If you look at that, a lot of the inflow we got two things happened. One, a lot of that was in some of our lower fee products that we service, and a lot that came towards the end of the quarter. So we didn’t get a full quarters worth. So I think that muted the results a little bit.

But I think, across the board, we mentioned this year, pricing is - there is a competitive market out there. Pricing is getting more in the focus of managers, but we really been able to augment that and not really reduce our pricing so to speak out in the market, because of the premium solution we offer.

Q - Robert Lee

Okay. Great. Thanks for taking my follow-up.

A - Stephen Meyer

Sure. Thanks, Rob.

End of Q&A

Operator

We have no additional questions. Please continue.

Presentation

Alfred West

Thank you, Steve. I would now like Kathy Heilig to give you a few company-wide statistics. Kathy?

Kathy Heilig

Thanks, Al, and good afternoon, everyone. I have some additional corporate information regarding this quarter. Our second quarter 2016 cash flow from operations was $81.4 million or $0.49 per share. Year-to-date cash flow from operations is $159.1 million. Second quarter free cash flow $66.9 million or $0.41 per share, and year-to-date free cash flow of $130.9 million.

The capital expenditures for the second quarter excluding capitalized software were $4.4 million, but we expect the remaining 2016 capital expenditures to be an additional $25 million. The tax rate - the annual tax rate is projected to be close to what it is now, around 35%. We would like to remind you that many of our comments are forward-looking statements and are based upon assumptions that involve risk and that the financial information presented in our release and on the call is unaudited.

Future revenues and income could differ from expected results. We have no obligation to publicly update or correct any statements herein, as a result of future development. You should refer to our periodic SEC filings for description of various risks and uncertainties that could affect our future financial results.

And now, please feel free to ask any other questions that you may have.

Question-and-Answer Session

Operator

[Operator Instructions] We’ll go to Glenn Greene with Oppenheimer. Please go ahead.

Q - Glenn Greene

Hey, Dennis. I just want to go back to the expenses, sorry. But one way to think about it - at least how I’m thinking about and I want you to sort of clarify, or correct me. On an annual basis, sort of figuring fiscal 2017, so generally people are modeling, call it, $1.5 billion of revenue. I’m asking for guidance on the revenue, that’s relevant. But the 3% dealt on the R&D would equate to roughly $45 million of incremental expenses, which result about $0.20 or less than that, but that’s I’m thinking about it.

And then you’re suggesting post-2017, you get back to that 9% or so R&D range. So that $45 million or as equal, kind of moderates into 2018. Is that the way to think about it?

A - Dennis McGonigle

Yes. I mean, I can’t get through all that math in my head that quickly, but and I’m assuming your netting on capitalization.

Q - Glenn Greene

I wasn’t.

A - Dennis McGonigle

Okay. So that will be one element to you that’s to factor in as well.

Q - Glenn Greene

So - the 3% increase on R&D includes capitalized spending. How much is going to hit the P&L then, I guess…

A - Dennis McGonigle

Okay, that’s gross - and the questions was asked earlier on the call about what percentage are we capitalizing of that incremental spend and its roughly in that 45% to 50% range.

Q - Glenn Greene

Okay. So all those equal with my math on the $0.20 we’re talking about half of that will hit the P&L, which seems to be like something like $0.10 and then that even moderates into 2018?

A - Dennis McGonigle

Yes.

Q - Glenn Greene

Okay. Thank you.

A - Dennis McGonigle

Yes.

Operator

And a question from Chris Shutler, William Blair. Please go ahead.

Q - Christopher Shutler

Hi, Dennis. I only got a follow-up on that last one. And just I think that I’m more clear now that you answered that question. But I just want to confirm. In 2017, if I’m doing the math, so you’re saying actually for Q3 the 4% to 6% increase, that was - that’s total expenses, right, so that’s the $250 million of expenses in Q2, times 1.04, times 1.06; same thing going into Q4 over Q3, 4% to 6% increase that gets you to $270 million, $280 million. And then you’re off of that. If we hold that rate flat that would equal about $1.1 billion of total expenses next year. Is that too high? It sounds like what you just said that that is too high, but I want to better understand.

A - Dennis McGonigle

If you look at - I’m just going through that real quick in my head.

Q - Christopher Shutler

Sure, not it’s important. Take your time.

A - Dennis McGonigle

Thank you for that. Yeah, so I think it about $1.1 billion, roughly off the mat.

Q - Christopher Shutler

Okay.

A - Dennis McGonigle

The total expenses.

Q - Christopher Shutler

Okay.

A - Dennis McGonigle

Yeah, maybe a little bit, but that would vary for sure, but…

Q - Christopher Shutler

Okay.

A - Dennis McGonigle

I’ll go bearing on the downside, but just off the mat it’s probably in that range.

Q - Christopher Shutler

Okay. Thank you.

Operator

And we have no additional questions.

End of Q&A

Alfred West

Well, thank you again. So, ladies gentlemen, we feel that 2016 is off to a good sales start and the implementation of our large client wins are going well. And looking ahead, we’ll keep our focus on developing and implementing the solutions needed for capturing the enormous opportunities that we see in all of our markets. Now, thank you for joining us today and have a good afternoon.

Operator

Thank you. And ladies and gentlemen, this will conclude our teleconference for today. Thank you for your participation and for using AT&T Executive Teleconference. And you may now disconnect.

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