Manning & Napier's (MN) Q2 2016 Results - Earnings Call Transcript

| About: Manning & (MN)

Manning & Napier, Inc. (NYSE:MN)

Q2 2016 Earnings Conference Call

July 28, 2016 08:00 AM ET

Executives

Richard Yates - Chief Legal Officer

James Mikolaichik - Chief Financial Officer

Ebrahim Busheri - Director of Investments

Paul Battaglia - Director of Finance

Analysts

Adam Beatty - Bank of America

Will Cuddy - JPMorgan

Andy McLaughlin - KBW

Operator

Good morning. My name is Chrystal and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Second Quarter 2016 Teleconference.

Our hosts for today’s call are Richard Yates, Chief Legal Officer; James Mikolaichik; Ebrahim Busheri, Director of Investments; and Paul Battaglia, Director of Finance.

Today’s call is being recorded and will be available for replay beginning at 11 AM Eastern Standard Time. The dial-in number is, 404-537-3406 and enter Pin Number 46667052. At this time, all participants have been placed in a listen-only-mode and the floor will be opened for your questions following the presentation. [Operator Instructions]

It is now my pleasure to turn the floor over to Mr. Richard Yates.

Richard Yates

Thanks Chrystal. Good morning and welcome to Manning & Napier's conference call to discuss our second quarter 2016 results.

Before we begin, I would like to remind everyone that certain statements which are not based on historical facts made during this call including any statements related to the financial guidance may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. Manning & Napier assumes no obligation or responsibility to update any forward-looking statements.

During this call, some comments may include references to non-GAAP financial measures. Full GAAP reconciliations can be found in our earnings release and related SEC filings.

With that, I'll now turn the call over to Jim Mikolaichik. Jim?

James Mikolaichik

Good morning and thank you for joining us. As I am sure many of you are aware, I recently announced that I will leaving Manning & Napier in the coming weeks. And I wanted to take this opportunity to speak to all of you directly.

It’s with mixed emotions that I’ve decided to resign from the company to pursue another carrier opportunity. I’ve greatly enjoyed my time with Manning & Napier and I’ll certainly miss working with the team.

I would like to convey to all of you the great confidence I have in the finance department that I helped building oversea. With our talented bench strength and long-tenured in place, we are putting into place a team and plans that will allows for a seamless transition for the finance function.

This confidence extends well beyond the finance department and throughout the entire firm. We have wonderfully talented group of dedicated professionals who are constantly making sure we are doing right by our clients. No decision is ever made without that mindset. It is this level of commitment that has allows Manning & Napier to earn a client first reputation over the past 45 years and what will leave the firm in the decades ahead.

With that let me introduce three members of our senior management team joining me today to discuss our quarterly results and answer your questions.

As you just heard, Richard Yates, our Chief Legal Officer read our safe harbor statement. Like many individuals at the firm, Richard has significant industry experience 28 years and 16 years at here at Manning & Napier. Besides being our lead internal counsel, he is well versed and able to speak to many aspects of our business from an operational perspective.

Upon conclusion of my comments, I will turn over to Ebrahim Busheri, Director of Investments. We thought it would be appropriate for all of you to hear from Ebrahim concerning the implementation and subsequent results of the changes to our research function he began to put into place little over a year ago.

You’ve heard Patrick and myself talk about these changes and the ensuing uptick in performance, but today Ebrahim will take a deeper dive and answer specific questions about his department and the road ahead.

I am also pleased to introduce Paul Battaglia, our Director of Finance, who some of you met over the years. Paul has been with Manning & Napier for 12 years following time at PricewaterhouseCoopers and as served as one of my Chief Lieutenant as he arrived. He has been instrumental in helping me execute all aspects of our Investor Relations program. Paul is also an inner go part of the IPO process in 2011 and he is an invaluable research as you will soon learn from direct interactions with him going forward.

Last before turning the call over to Ebrahim and Paul, I would like to publically thank my fellow executives and the Board of Directors at Manning & Napier for giving me the opportunity to work in a franchise with the rich tradition of success. Additionally, I’ve enjoyed interacting, travelling and meeting with many members of the investment community. Thank you for your support during the past five years and I look forward to staying in contact with many of you in the years to come.

I am pleased to now turn the call over to Ebrahim to lead the remainder of today’s discussion with Paul and they will also take your question upon conclusion of their formal remarks. Ebrahim?

Ebrahim Busheri

Thank you, Jim. It’s been a pleasure working with you. Thank you for everything. You will be missed.

The core demanding in the peer’s research approach has always been our investment strategies and pricing disciplines, our group based decision making process and our performance based compensation system.

When I took the role of Director of Investments last year, the goal was to bring increased focus around these principals. With the recognition that smaller teams are more effective at decision making, we went from one core team our portfolio management group to three dedicated core teams, one for the U.S., one for the non-U.S. and one for our multi-asset class accounts. And we reduced the size of our senior research group which oversees our investment strategies and pricing disciplines.

The core teams will pass of managing the portfolios with the focus on our strategy fits and using our monitoring points for process to accomplish that.

We have a deep research department made up of bottom of sector groups, top down groups and product base teams. Our economic review continues to call for a slow growth economy both in the U.S. and internationally and our portfolios reflect that.

For example, companies from secularly growing industries, consumer, technology and healthcare represent 75% of our U.S. equity portfolios as compared to 55% of the Russell 3000 and represents 79% of our non-U.S. equity portfolios compared to 41% of the MSCI ACWIxUS benchmark. We are managing high convection portfolios with our U.S. core equity accounts currently owning 47 stocks and our non-U.S. equity accounts owning 39 stocks.

Turning to performance. Reflecting our solid execution on the equity front, our U.S. equity product is outperforming the Russell 3000 by approximately 250 basis points this year, outperforming 99% of all other managers according to Morningstar. Over the past year, is outperforming the benchmark by approximately 150 basis points and outperforming 86% of all managers.

Similarly our non-U.S. equity product the world opportunities front, is outperforming the ACWIxUS benchmark by approximately 180 basis points this year, outperforming 91% of other managers and by 140 basis points over the past year, outperforming 80% of other managers.

On the fixed income side, we do believe there is much value in U.S. Treasury while finding more opportunities in the corporate side. While, this has led to a more measure performance in the short term, we believe it is a right positioning for the long term.

Our Pro-Blend Extended product that is a multi-asset based product is outperforming this year by approximately 60 basis points, but underperforming over the past year by approximately 300 basis points as a result of our fixed income performance.

In addition to a strong year thus far in our core U.S., non-U.S. and multi-asset based products, I’d also like to highlight that we have multiple teams that continue to execute well on many fronts. This includes our disciplined value, our global quality, our real estate, our top down manage international series, our growth, and our immerging market products. Each of these products is outperforming their peer group on a year-to-date and one year basis.

Our international series have a long track record and is outperforming 89% of all managers over the past 10 years.

Over the past five years, our real estate and disciplined value products are outperforming 93% and 69% of other managers respectively.

We have multiple superior track records in the fixed income side as well, including our unconstrained bond suits that is outperforming 67% on managers over the past year and it is in the top cortile over the past three, five and ten years. Our high yield bond product is also in the top cortile year-to-date and with past three and five years.

Manning & Napier is a high convection, highly active manager. It is my privilege to lead a deep dedicated research team that invest and concentrate portfolios that reflects our convection. It is an approach that I served our clients well over the long term but as inherent with an active management approach, we do not outperform in every time period.

In closing, I would like to acknowledge our performance challenges in 2014 and the early part of 2015. But as indicated today, following the changes made in the research department over a year ago, we have seen improved results on a year-to-date basis in our core U.S. equity, core non-U.S. equity and multi-asset class account. And we continue to have good long term track records of multiple other products that I have just highlighted as well.

That wraps up my remarks on the investment team. Thank you for your time this morning. I will turn the call over to Paul for additional remarks.

Paul Battaglia

Thanks Ebrahim, and thanks everyone for joining us today. I’ll provide an update on client flows and review the financials before opening the call up to your questions.

Before I begin, I’d like to take a minute to acknowledge Jim’s contribution to our team. Jim has been a leader and mentor to those of us who closely with him over the past five year. I speak for our entire finance team they say while we’re disappointed to see him go, we look forward to the opportunity to help our firm to move forward. With that I’ll by addressing a few key metrics.

We ended the quarter with assets under management or AUM of $35.7 billion. Net client outflows in the quarter were approximately 2.4 billion. Revenue for the quarter were $67.5 million or 5% increase over the last year. And we reported second quarter economic net income for adjusted share of $0.17, slightly lower than the $0.18 per adjusted share in the first quarter and down from $0.24 per adjusted share in the second quarter of 2015.

Before addressing client flows, I wanted to remind everyone that during the second quarter, we acquired a majority ownership stack in Rainier Investment Management, a CO-based [ph] investment adviser with approximately $3 billion in assets at the time we completed the acquisition at the end of April. As majority owner, we have consolidated Rainier’s financials into our results for the quarter.

When reviewing our results, please keep in mind that Rainier’s AUM represents less than 10% of our firm-wide total assets. Rainier’s mix of business by portfolio and client type varies from that of Manning and as a result they have generally operated at lower levels of average fees and operating margins. In the near term, we expect revenue to range between 65 and 75 basis points of average AUM with operating margin of approximately 10% which is reflective of the minority interest retained by the Rainier management team.

With the help of our distribution team and integrated back office support, we expect that we will grow margins and achieve scale overtime to increasing AUM.

Now turning to AUM in net client cash flows, AUM increased by $1 billion during the quarter as net client outflows of 2.4 billion were offset by 530 million of market appreciation and $3 billion increase in AUM associated with the acquisition. When compared to June 30th 2015, AUM has decreased by $7.4 billion or 17%.

Our blended asset portfolios continued to be the most consisting generator of client inflows contributing approximately $900 million of our $1.4 billion of gross inflows for the quarter. This includes nearly $700 million of gross inflows into our lifecycle and retirement target products that are prominent in the client contribution space.

By vehicle, we had $810 million of gross inflows into mutual funds and collective trusts and $530 million in separate accounts. Gross client outflows were $3.8 billion for the quarter, an increase from the $2.7 billion we reported last quarter. The majority of our outflows are $1.9 billion were from our equity portfolios and we also have $1.7 billion in outflows from our multi-asset class products during the quarter.

By vehicle, we had $2 billion of outflows from our mutual funds and collective trusts and $1.8 billion of outflows from our separate accounts. Our rolling 12 months separate account retention rates stands at 87%.

Included in our outflows, a few notable platform relationship that partially redeemed positions in our equity portfolio, a large redemption from our prevalent funds and large institutional separate account relationship.

As of June 30th, our blended asset strategies made up 61% of our assets or $21.7 billion. Our various equity strategies represented 35% of our total assets, with the remaining 4% invested in our fixed income products. A slight change in our business mix from last quarter was driven by the acquisition which is concentrated in our equity portfolios.

Moving to our second quarter financial results, we reported revenue of $67.5 million for the quarter, a 5% increase sequentially, but down 22% from the second quarter of 2015. The changes in revenue are resulting from changes in average AUM compared to prior periods.

Overall revenue margins of 75 basis points in the quarter are in line with last quarter but down 77 basis points reported this time last year.

Operating expenses were $44.6 million in the quarter, an increase of $2.8 million or 7% from last quarter, but down $8.6 million or 16% from this time last year. The majority of the increase compared to the first quarter is due to the consolidation of Rainier.

Compensation and related costs for the quarter were $24.4 million, an increase of $2.4 million or 11% since last quarter but down 14% from this time last year. The increase compared to the prior quarter is attributable to Rainier related compensation as well as changes to variable incentives for sales, research and senior executives.

Our compensation ratio as a percentage of revenue was 36% in the quarter, up from 34% in the first quarter.

In looking ahead to the remainder of 2016, we expect that the compensation ratio for the firm will remain in the mid to upper 30% range, which is reflective of Rainier. Our expectations related to near term assets under management in revenue as well as fixed compensation costs.

Distribution, servicing and custody expenses have increased by approximately $600,000 since the last quarter, but a decrease by $2.9 million compared to the second quarter of 2015, which is consistent with changes in average mutual fund and collective trust assets under management.

Distribution expenses continue to be approximately 31 basis points of fund and collective average assets.

Other operating expenses were $8.2 million for the quarter, down from $8.5 million last quarter and the $9 million we reported this time last year.

As a result, we reported pretax income for the quarter of $23.2 million, 3% decrease from last quarter and 28% decrease from this time last year.

Our adjusted tax rate increased to 39% for the quarter, up from 37% used in prior period due to impacts of previously issued equity awards. We expect the rate to be 38% for the full year. Economic net income for the quarter was $14.2 million or $0.17 per adjusted share.

Turning to equity ownership, we have 81.4 million adjusted shares outstanding as of June 30th. With respect to the balance sheet, we continue to maintain a debt free capital structure with a cash balance of $118 million and approximately $80 million invested in seeded products as of June 30th.

And finally as you are aware, during the quarter we declared a $0.16 per share dividend to our Class A shareholders.

That concludes our formal remarks. And we’ll now turn back over to the operator and look forward to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Thank you. Your first question comes from the line of Adam Beatty with Bank of America.

Adam Beatty

Thank you and good morning. Question for Richard, it’s great to have and Ebrahim on the call. In regard to the compensation some of the discussion there, just wanted to ask about number one, Rainier and you know Manning is distinct I guess for its compensation approach, is Rainier being folded into that or will continue on a separate kind of comp arrangement? And also I think you mentioned some changes to management in census, maybe you could elaborate on that? Thanks.

Richard Yates

Sure Adam, Richard here. I’ll take that first. Rainier is being run independently, so the Rainier research function is not being primarily research is not being folded into any aspect of the home office here. So we’re getting synergies out of back office support and things of that nature. But the Rainier research team and their compensation program is running as of has.

Ebrahim Busheri

So I think on the research side there is no integration what so ever.

Adam Beatty

Got it. And then on changes to management census, do I hear that right or I am not sure?

Paul Battaglia

Adam, this is Paul. I think that was my comment. The compensation structure is as always been described. The changes in the quarter are more related the changes that we’ve discussed previously, you know comp moving in conjunction with AUM, the research is moving in conjunction with both absolute and relative performance. So there are - I didn’t mean to imply they are running in change, a structural changes of the comp plan everything is running as we’ve described previously.

Adam Beatty

Got it, that makes sense. And then maybe you know backing up a little bit and looking at the overall expense structure, AUM is down and what have you and I know you’ve - you know the firm has made some adjustments around that and you’ve given some guidance on expenses going forward. Do you feel right now given normal markets and you know no GAAPs down or what have you in the market environment, do you feel as through your expense pace is kind of where it should be and you are going to weather it run or are there more, you know maybe more adjustments to come? Thank you.

Paul Battaglia

This is Paul. There are no planed adjustments. You know we continue to mindful of AUM levels and you know we’ve managed headcount accordingly, we’ve seen some attrition. You know we’ve added Baxter [ph] in compensation through the acquisition of Rainier you know and they retain a minority interest which you know will be immaterial sort of hit to competition as well. But we think you know we continue to be mindful of where we are. We think for the at least the rest of this year that compensation ratio will be in that you know mid to upper 30% range. Expenses will be running you know low teens. I think 10% to 13% of revenue is where we’ve been in the last few quarter.

And I guess I will say that you know from an expense standpoint and from a headcount standpoint, the changes - and any changes up until this point have really been on the back office side. We haven’t had any changes or any plan changes to sales or research. We continue to prioritize the talent in those areas that’s in the best interest of our clients and are best interest of the shareholders. And so we really look to hold the line well creating efficiencies in the back office of the business.

Adam Beatty

Great, thank you, Paul. I appreciate that clarification. And now for Ebrahim, just on the kind of the investment results which are greatly improved. Is this - I guess we’ve been working for a while for you know if you will a stock picker’s environment or an environment that’s more favorable to high conviction investing like at Manning, do you feel as though we’re entering I mean entering in environment like that. I usually look at correlation among stock returns as an indicator there, but I am not sure if you look at something else. And you know if you are or where not, you know what would be the kind of indicator in the environment that would suggest that Manning can continue to outperform? Thank you.

Ebrahim Busheri

Thanks Adam. This is Ebrahim. I do believe that we have already actually entered believe that environment. And what - I would as we conviction that is the case is I think that when we typically have the equity markets for example going up in a relatively straight line, going up kind of year after year which we had for quite a few years coming out of the downturn many years ago. I think it’s difficult in that environment as we have seen for high conviction equity managers, active managers to outperform.

But when we enter periods where there is more volatility where returns are more subdued which is what we’ve started to see over the past year. I think it gives highly active managers, active managers and opportunity to differentiate themselves to position the portfolio, take advantage of this in the market place. So that’s what gives us confidence that we are in that environment currently.

Adam Beatty

Great, thanks very much for taking all my questions.

Operator

Your next question comes from the line of Ken Worthington with JPMorgan.

Will Cuddy

Good morning. This is Will Cuddy sitting in for Ken. So first separately managed accounts, which are outlook for the reminder of the year for flows, how it’s going in that channel?

Paul Battaglia

Yeah. This is Paul. I mean I think that you know we are still - we’ve talked previously about a service environment and I think we’re balancing servicing of existing client relationships with new business opportunities. You know in terms of what we’re looking for the second half of the year, we are excited about some of the conversations we’re having in the fixed income space. We think we’re able to provide or offer a consultative approach to fixed income that maybe is a differentiator for us. That’s probably an institution of separate account type opportunity. We continue to have conversations on international - Rainier’s international small cap which is both available as a separate account and a find.

I mean that’s been one where you know there is good institutional interest on the separate account side. The find is five star rates fund. So we think the outlook there is bright and we sort of - as it does settles form the acquisition, we are hoping that we’ll see some of that start to come through. And then you know we continue to have our direct sales force that is you know concentrated in the mid-market regional space with the long term growth, multi-asset class products, balanced products that we’ve offered in the past.

So balancing both the service aspects of as we continue to more away from the 2014-2015 performance, the strong performance that Ebrahim has put forward this year, his team has put forward this year has been helpful, but we’re still - we’re still working our way through it.

Will Cuddy

Great, thanks. On share counts, so share counts dips a little bit, was the - and you retirement in 2Q or is there anything coming up in the next couple of quarter that’s going to change share count dramatically?

James Mikolaichik

Not to our knowledge. I think the changes in the second quarter were retirements and were partially offset by divesting of some of the previously issued awards. But there is no anticipated changes in the adjusted share counts the rest of the way.

Will Cuddy

Great, thank you for taking our questions.

Operator

[Operator Instructions] Your next question comes from line of Andy McLaughlin with KBW.

Andy McLaughlin

Hi guys, good morning. Thanks for taking my question. You said that comp should stay a little bit, the comp ratio should stay a little bit elevated over the course of 2016 around that you know high to mid-30s, but I that has - you’d previously guidance that has the strong 2013 funds build off, we kind of steer or return to more normal level, is there an updated more normal levels that you can guide to given the additional there?

Paul Battaglia

Well, hi, this is Paul. Thanks for your question Andrew. I think the guidance that we have right now is that we’re thinking that we’re going to be in the mid-30s for the rest of this year, you know with the research bonus because you made reference to 2013, we are adding back on strong, absolute and relative so far this year in the one year component of the research bonus formula carries more weight than the three year component. So I think that is something you want to keep in mind as well. And obviously it’s also a function of revenue and as revenue goes that ratio will move some of our fixed costs now including Rainier those have flat and really the changes that you are going to see now we’ll be contingent on sales and how that impacts revenue and then just keep an eye on our performance the rest of the way.

Andy McLaughlin

Okay, great, thank you.

Operator

This does conclude today’s teleconference. Please disconnect your lines at this time. And have a wonderful day.

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