Nuveen Investments Inc. Q4 2007 Earnings Call Transcript

Nuveen Investments Inc. (JNC)

Q4 2007 Earnings Call

February 28, 2008, 11:00 am ET

Executives

Natalie Brown - Director of Investor Relations

Glenn R. Richter - Executive Vice President, Chief Administrative Officer and Chief Financial Officer

Peter H. D’Arrigo - Vice President and Treasurer

Sherri Hlavacek – Vice President and Corporate Controller

Analysts

A.J. Gould – Gould Inc.

J.P. Leasure - Pacific Life

Scott Grossman - Magnetar

Ron Speaker - (inaudible)

Eric Gold - StoneCastle

Operator

Good day, ladies and gentlemen, and welcome to the Nuveen Conference Call. (Operator Instructions). I would now like to introduce your host for today’s program, Ms. Natalie Brown, Director of Investor Relations.

Natalie Brown

Thank you. With me this morning are Glenn Richter, Nuveen’s Chief Operating Officer and Chief Administrative Officer; Pete D’Arrigo, Nuveen’s Treasurer; and Sherri Hlavacek, Nuveen’s Corporate Controller.

This conference call may include forward-looking statements regarding our expectations, plans that we believe to be reasonable but which are predictions and involve risks and uncertainties. Our actual future results may thus differ significantly due to numerous factors. The company assumes no obligation to update any forward-looking statements made during this call.

Please note that this call has been prepared to share commentary on our fourth quarter and full year 2007 results with our corporate debt investors. While we will provide a brief overview of the current auction-rate securities situation, this call is intended primarily to focus on our financial results.

However, we hosted an ARS Pacific call this past Tuesday, February 26, that provided a detailed updated on the current situation. And we would encourage you to listen to a replay of this call by dialing the published replay number.

We will begin our call with Glenn Richter, who will discuss our full year and fourth quarter 2007 financial and investment performance, and Glenn with then turn the call over to Pete D’Arrigo. I will now turn it over to Glenn.

Glenn Richter

Thanks, Natalie. Thanks for joining us today. Overall, we are very pleased with our 2007 results. Despite a very challenging set of financial markets in the second half of the year, our 2007 financial results were essentially in line with our expectations.

Full year operating revenue was $825 million, up 16% compared to the prior year, and adjusted EBITDA was $457 million, up 11%. For the quarter, our operating revenues were $210 million, up 7% from 2006, and our adjusted EBITDA was $109 million, up 4%.

Gross sales for the year were $26.2 billion, down 19% from the prior year, primarily due to a decline in retail managed accounts sales, as a result of accelerated sales in the prior year as we closed our popular Tradewinds International Value strategy to new investors in the second quarter of 2006.

Net flows for 2007 were $1.3 billion, a decline from the prior year as a result of overall net outflows in the third and fourth quarters, primarily due to outflows in our retail separately managed accounts business.

For the fourth quarter, total gross sales were $5.1 billion, a decline of 17% from the prior year. The quarter had net outflows of $2.2 billion, primarily driven by $2.1 billion in outflows in retail managed accounts compared with total net inflows of $2 billion in the fourth quarter of 2006.

We ended the quarter with approximately $164 billion in assets under management, up 2% from the prior year but down 4% from the prior quarter. The decline from the prior quarter was a result of market depreciation of $3.9 billion coupled with net outflows of $2.2 billion.

In January, a particularly weak month for equity markets, our AUM held up relatively well versus peers and declined only 2% to $161 billion. Despite the difficult market environment, we continue to make solid progress against our long-term strategic priorities of building out our institutional and mutual fund businesses.

In our institutional business, we delivered strong organic growth with a 12% increase in sales for the year as we continued to extend our investment offerings and expand our sales and service capabilities.

For the quarter, sales of $1.7 billion and net outflows of $0.2 billion were softer than previous quarters as a result of limited institutional market activity. As we have entered 2008, we have begun to see a steady increase in our institutional pipeline.

In mutual funds, 2007 gross sales were $6.1 billion, up 8% from 2006 as we continued a paced build out of our mutual fund business by introducing new products and focusing on cross selling our funds to advisors with whom we have existing retail separate account and fee-based relationships.

Net flows of $1.6 billion declined 55% versus 2006 on increased redemptions primarily in our high-yield municipal bond fund in the second half of the year as a result of the market’s more negative view of high-yield strategies.

In January 2008, sales and redemptions improved on our high-yield municipal bond fund which had net inflows of approximately $100 million. For the quarter, mutual fund sales were $1.3 billion, a 7% decrease from the prior year, with zero net flows compared to $1 billion of net flows in the prior year.

In retail managed accounts, we have been in transition in recent quarters as we closed a number of our popular strategies in the first half of 2006 and are continuing to introduce new managed account strategies.

We had net outflows of $2.1 billion this quarter due to outflows in our closed strategies at Tradewinds and NWQ. The overall level of redemption in retail managed accounts has been higher than expected, particularly in NWQ’s Large-Cap Value strategy which we believe is a result of combination of two factors. First, investors in general reallocating assets from value to growth strategy, and secondly, more challenging third quarter performance for NWQ.

However, it’s important to note that for both the fourth quarter and the full year, NWQ’s Large-Cap Value strategy delivered very strong relative performance, outperforming its benchmark for the year by nearly 300 basis points.

Despite recent softness due to our transition to new strategies, our retail managed account AUM of $54.9 billion continues to represent the second largest share of the market in this product category.

Recently we have been focused on securing additional shelf space for several of our newer strategies, and we have been redeploying capacity generated through redemptions and strategies that are currently closed to new investors to higher fee institutional and private client opportunities.

We also have a number of new investment strategies in incubation that we plan to introduce in future quarters. All these being said, it’s inherently difficult to predict the pace at which new sales will translate into positive flows in our retail separate account business.

Turning to closed-end funds, the closed-end fund market has been effectively shut down since the second half of 2007. Due to a strong first half of the year, net flows for 2007 were $1.7 billion compared to $0.6 billion in the prior year.

In the fourth quarter, we launched a High Yield Municipal closed-end fund that raised approximately $200 million. There were a very limited number of new closed-end funds offered in Q4, and in near-term, outlook for new fund launches remains challenged.

Turning to investment performance, 2007 performance across our investment strategy was solid, with several of our larger strategies of to a particularly strong set of starts in 2008.

Closed-end funds which represent approximately 32% of our AUM performed very well with 70% of our closed-end fund assets in the upper two quartiles of the one year Lipper rankings.

In mutual funds, which represent 12% of our AUM, only 32% of our fund assets were in the upper two quartiles primarily due to our largest fund, our High Yield Municipal Bond Fund, dropping below the second quartile in the fourth quarter of 2007. However, on a three-year basis, over 60% of mutual fund assets were in the upper two quartiles of Lipper rankings.

In managed accounts, approximately 45% of our assets were both the benchmark for 2007 one-year period. As we start 2008 we’ve seen very good performance across nearly all of our investment teams.

In Tradewinds, our Tradewinds International Value strategy, with approximately $20 billion in assets, has outpaced its benchmark year-to-date by approximately 650 basis points, more than offsetting all of last year’s under performance.

The year-to-date performance in our Tradewinds Global All-Cap and Tradewinds SMID strategies also outpaced benchmarks by approximately 540 and 320 basis points respectively. Finally, our Santa Barbara Stable Growth strategy has also outpaced its year to date benchmark by approximately 370 basis points.

Operating revenue of $210 million in the fourth quarter increased 7% from the prior year. Driven by a 10% increase in advisory fees due to increased average assets under management, offset by $4.3 million decline in performance fee and other revenue, primarily due to decreased performance fees on Symphony fixed-income accounts.

Operating revenue decreased 2% compared to the prior quarter as a result of a $1.7 million or 1% decrease in advisory fee revenue due to slightly lower average assets under management and a $3.1 million decrease in performance fees and other revenue.

For the full year, operating revenue was $825 million, an increase of 16% from the prior year driven by higher advisory fees, due to increased average assets under management and a 35% increase in performance fees and other revenue primarily due to increased performance fees on Symphony equity accounts in the third quarter.

Adjusted operating expenses, in line with our expectations, increased 9% for the quarter and 21% from the prior year. The increases were primarily driven by an increase in compensation expense as a result of increased head count and increased profit sharing expense due to higher earnings.

Consistent with our expectations, adjusted EBITDA was $457 million for the year, up 11% compared to 2006, and $109 million for the quarter, an increase of 4% compared to the fourth quarter of last year. This increase is primarily due to increased operating revenues for both periods.

With that, now let me turn the call over to Pete to provide highlights on our year-end balance sheet and credit metrics and to discuss recent events in the auction rate preferred market.

Peter H. D’Arrigo

Thank you Glenn and good morning everybody. I’m going to begin with some comments on the balance sheet. At year-end 2007 we had cash and cash equivalents of $189 million. Excluding cash at the broker-dealer, cash and cash equivalents was $153 million, which is approximately $20 million higher than expected.

Year-end gross debt was $3.65 billion, which represents $550 million in pre-existing senior notes, $785 million in new senior notes and $2.3 billion in new floating rate term loans. The new debt was issued in relation to the privatization transaction of Madison Dearborn, which was completed in November 2007.

Of the $2.3 billion of floating rate debt, we swapped $1.5 billion from floating to fixed rate debt in the fourth quarter. In addition, $750 million of the remaining $800 million is locked into a floating rate collar.

Effectively, 98% of gross debt is fixed or capped for up to five years, which will result in a $30 million reduction in our interest expense for 2008, compared to our expectation back in October.

Interest expense for 2008 is projected to be $274 million. On a pro forma basis, due to lower interest expense, our projected EBITDA to interest ratio for 2008 is 1.64 versus the original projection of 1.59.

Before Glenn’s closing comments, I’d like to address the situation in the auction rate securities market. As you know, these markets have experienced significant stress over the last few weeks.

The market for auction rate securities is estimated to be about $350 billion of which preferred shares used to provide leverage for closed-end funds account for about 20% of the total.

A significant number of auctions across the broad variety of auction rate security types have recently failed, with failure rates for the overall market reaching as high as 80% on a given day and even higher for securities related closed-end funds.

The broad scope of these failed auctions suggests that this is a broad-based liquidity issue, which is not specific to closed-end funds.

We currently have 100 leverage closed-end funds representing $45 billion of our approximately $52 billion in total closed-end fund assets under management.

Of this $45 billion, approximately $15 billion represents assets related to auction rate preferred equity with approximately $11 billion related to municipal closed-end funds and approximately $4 billion related to taxable closed-end funds.

When an auction fails, our auction process requires the fund to pay a maximum or penalty rate to the preferred shareholders. This rate is calculated as 110% of the higher of two reference benchmarks: either the AA composite commercial paper rate or the taxable equivalent of the short-term municipal bond rate as published by J. J. Kenny for the municipal funds.

For the taxable funds, the penalty rate is the higher of one month LIBOR plus 125 basis points or 125% of one month LIBOR.

As we discussed on a conference call on Tuesday, we are actively considering various alternatives to address the lack of liquidity in the auction rate market. To listen to a replay of that conference call, please call 1-888-266-2081 and enter conference code 1207768.

At this point, we have no further comments on this situation. And I will turn the call back to Glenn to wrap things up.

Glenn Richter

Thanks, Pete. Just a couple of closing comments before we open it up to questions. Again, we feel good about 2007 financial results, particularly in light of significant market volatility in the second half of the year.

While assets ended the year lower than expected, EBITDA was right on plan; year-end cash was better than plan, and we significantly strengthened our balance sheet by fixing or capping 98% of gross dept and lowering annual interest expense by $30 million for 2008.

As we look out into 2008, the current market challenge makes it extremely difficult to call the year. While we have seen signs of improving sales and net flows in our mutual funds and institutional business, for the near term we expect continued outflows in our retail separately managed accounts business and we expect little to no new closed-end fund activity.

In light of this environment, we are very focused on managing expenses and pacing the re-investment back into the business.

With that, we will be happy to take your questions.

Question-and-Answer Session

Operator

Our first question comes from Eric Gould - StoneCastle.

Eric Gold - StoneCastle

Quick question for you, if there was a de-leveraging or a need to de-leverage in any of the closed-end funds, how would that impact your fee revenue and EBITDA?

Glenn Richter

At this point, Eric, we don’t contemplate any kind of immediate de-leveraging. As we’ve mentioned on Tuesday’s call, we are exploring a full range of options to help the existing market or find alternatives to existing leverage.

The simple math, though, is $15 billion, roughly 55 to 60 basis points fees on that. Clearly, in that type of environment, we would significantly review expenses; there are some natural reduction in compensation expenses that would occur relative to that. But we would have to scrub the entire P&L and take a look at that.

So, of that fee reduction or revenue reduction, there would be clearly offsets relative to expense lines.

Eric Gold - StoneCastle

And that leverage should come back up again if the market re-opened?

Glenn Richter

Presumably, yes, under that scenario.

Eric Gold - StoneCastle

Okay. And lastly, if you cannot roll these things, as most of these have failed, it goes to a reset rate, but for how long before there’s actually a maturity under these preferred securities?

Peter D’Arrigo

The preferred securities related to our closed-end funds are perpetual; they’re equity securities, so there is no maturity related to those shares.

Eric Gold - StoneCastle

So it’s simply going to be reduced carry until you can lock in more cost-effective financing, then? There is no need to de-leverage then in essence?

Peter D’Arrigo

I’m not sure what you mean by the cost of carry. For the fund, yes. If the funds are paying a higher reset rate on the preferred shares, then yes, what you’re saying is right. The common shareholders would experience a higher cost of carry on the leverage of the fund.

Eric Gold - StoneCastle

Okay. But then there would be no need ever to de-lever if there’s no maturity to those securities; the leverage element of them?

Peter D’Arrigo

There’s no contractual need to de-lever based on a maturity in the security. Again, it would be more of an economic decision based on the cost of carry.

Eric Gold - StoneCastle

All right, great. Thank you.

Operator

Our next question comes from A.J. Gould - Gould Inc.

A.J. Gould - Gould Inc.

Just a follow-up to the last question regarding the preferreds. Now, there is no contractual reason due to maturity, but there is a covenant in most of those preferred docs. Is that correct? Saying like if the asset value falls below a certain point, that there may be a liquidation? Am I reading that correctly?

Peter D’Arrigo

If the asset coverage level falls below a certain level, in some of those docs, that can have an impact on that. But that again goes to the credit of the underlying portfolio of securities.

A.J. Gould - Gould Inc.

Okay, so how many of your docs actually have a covenant such as that? Do you know, just a ballpark?

Peter D’Arrigo

I would think the vast majority of them do. All of them do, actually.

A.J. Gould - Gould Inc.

Given the fall in some of the muni assets, are you in the range, or close to tripping that covenant in any of your funds, do you know?

Peter D’Arrigo

No, we’re not. The range of the coverage ratio in our funds is still in excess of 250% or more. The ‘40 Act requirement is a coverage ratio of 200%. So there would need to be a significant decline in the value of the underlying assets before we get close to that ratio.

Glenn Richter

And recognize that you wouldn’t be required to de-leverage it all, simply de-leverage to a point of not triggering the covenants.

A.J. Gould - Gould Inc.

Okay. So if you trip it, you don’t have to pay off the preferred, or they can’t force you to liquidate; all you have to do is get in compliance with the covenant?

Glenn Richter

Yes.

Peter D’Arrigo

That’s right.

A.J. Gould - Gould Inc.

Okay, that’s it. Thanks.

Operator

Our next question comes from Ron Speaker - (inaudible).

Ron Speaker - (inaudible)

Quick question on your debt structure, are there any requirements to pay down debt in 2008? And do you have any requirements to term out some of that floating rate debt in the next few years?

Peter D’Arrigo

We have a 1% amortization requirement of the high-yield notes, which is an annual amount. So, we’ll be paying down roughly $5 million I believe it’s the second quarter. In terms of terming anything out, we do not have any requirements for that.

Ron Speaker - (inaudible)

Now, how long is the floating rate obligation? Is it five year?

Peter D’Arrigo

No, I believe it’s seven years. Or it’s six or seven years. It’s a little longer than five years.

Ron Speaker - (inaudible)

And then do you expect to be paying down any nominal debt at all next year, possibly buying back some of the bonds at a discount with your free cash flow, or do you expect to have free cash flow next year?

Glenn Richter

Yes, I think at this point relative to next year, it’s too early to tell at this point in time.

Ron Speaker - (inaudible)

And then just final question, could you just give me a perspective on your capital structure with your leverage currently and in the market environment we’re in, are you comfortable where you are? Would you like to take debt down a bit if you have the chance?

Glenn Richter

I think at this point we are in a comfortable position. We feel that we have adequate capacity to continue to reinvest back in the business. And there’s still capacity for targeted M&A activity to help support the growth of the business. So, we’re fine where we are.

Ron Speaker - (inaudible)

Okay. And then on your largest muni fund, what was your performance on the year last year? Your high-yield muni that you mentioned that had a good start to ‘08, what was your rate?

Glenn Richter

We were in the lower quartile on a full year basis for the high-yield muni product.

Ron Speaker - (inaudible)

And you said you started the year strong this year?

Glenn Richter

I was actually referencing our managed account strategies for Tradewinds, Santa Barbara, and other strategies.

Ron Speaker - (inaudible)

And what were the net inflows/outflows on that, your largest high-yield fund?

Glenn Richter

The net inflows, as we’ve mentioned for the month of January, they bounced back, and we’ve had $100 million of net inflows. So, it’s symptomatic of actually the strengthening of the product as we’ve entered this year.

Operator

Our next question comes from Scott Grossman - Magnetar.

Scott Grossman - Magnetar

When you were on the road, I think you went out with 447 of LTM EBITDA and now it seems like you are at 457, despite a $4 million delta in the quarter. Just want to understand how you bridge the gap from 447 to 457? Or maybe my 447 is wrong.

Glenn Richter

I think we’re all drawing a blank relative to the 447.

Scott Grossman - Magnetar

Okay. What was the number you went on the road with at Q3?

Glenn Richter

The 457 is the number that we were out there with.

Scott Grossman - Magnetar

Okay, perfect. And a follow-up question…

Glenn Richter

Scott I’m sorry. I think you were talking about Q3 versus Q4. I think 447 was the end of the third quarter, not the end of the year.

Scott Grossman - Magnetar

That’s right.

Glenn Richter

Yes, so the 457 is the end of the year, the fourth quarter.

Scott Grossman - Magnetar

That was my question. So you were at 447 at the end of Q3, and 457 at the end of Q4, how do you bridge that gap if the Q4 last year over this year was a $4 million delta?

Glenn Richter

I’d rather get back to you, Scott.

Scott Grossman - Magnetar

Sure, no problem. And the follow-up question, I think you had mentioned there was a 1% amortization on the high-yield notes? Is there also amortization on the senior secured, or no?

Peter D’Arrigo

Yes, I think I misspoke on that one. The amortization is on the loans and not on the high-yield notes.

Scott Grossman - Magnetar

Okay, perfect.

Operator

Our next question comes from J.P. Leasure - Pacific Life.

J.P. Leasure - Pacific Life

For your muni funds, do any of those funds have any ratings-driven liquidation requirements on the underlying securities? In essence, if you target a AA portfolio, with the MBIA, Ambac situation, I guess that’s no longer imminent let’s say. But if that doesn’t play out as expected, and those ultimately get downgraded, what does that do to your muni portfolios, or your funds?

Peter D’Arrigo

No, there’s no liquidation requirement, but obviously the underlying credits in the portfolio will trade more to the credit of the issuer than the credit of the insurer, that has historically had the rating ascribed to it. So if there is a downgrade, it’s more likely to trade at the quality of the underlying issuer.

J.P. Leasure - Pacific Life

So if the underlying portfolio ends up being let’s say a BBB portfolio, there’s no forced unwind of it?

Peter D’Arrigo

There are investment guidelines within the fund that we would obviously follow. I can’t answer in particular for any funds right now. But if there is something, we obviously adhere to what needs to happen according to the charter of the fund.

J.P. Leasure - Pacific Life

Okay, thanks.

Operator

Our next question is a follow-up question from A.J. Gould - Gould Inc.

A.J. Gould - Gould Inc

I just want to make sure I’m understanding the documents right. When I go through them, I see that there is a requirement that the funds be rated, but not necessarily AAA. Is that how I should be reading it?

Peter D’Arrigo

Are you talking about the preferred shares?

A.J. Gould - Gould Inc

Basically just the closed-end funds, if they need to be backed by MBIA or Ambac, but that doesn’t necessarily mean it has to be a AAA rating. Is that right?

Peter D’Arrigo

There are two things. With respect to the preferred shares, there’s a certain rating that they need to maintain, the preferred shares that the funds issue. There’s also then investment guidelines with respect to the various funds that we offer, that we seek to remain in compliance with, with respect to the overall portfolio holdings of the funds, but there’s not a liquidation trigger, which I think goes to the earlier question.

A.J. Gould - Gould Inc

Okay.

Operator

I’m not showing any further questions at this time.

Glenn Richter

Thanks once again for joining us today. We appreciate it, and we’ll be back next quarter. Thanks.

Operator

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.

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Comments

[swindled:]

The perpetual nature of these funds makes owning the preferreds very problematic. There is no legal obligation to de leverage and get the preferreds liquid. Why can't the fund issue new preferreds to replace the current ones that have some type of mechanism that say if the auctions fail like 5 times in a row (or some number of failures) that there is a put available to the preferred holder. After all since these are very safe if most people knew there was an out they probably wouldn't all want to sell at the same time and they would bring balance back to buyers and sellers. I, personally did not know there was any possibility of these becoming illiquid. Somehow Nuveen has to do something because holding these forever, no matter what the rate is completely unacceptable.

2008 Mar 04 11:31 AM