Nuveen Investments, Inc. Q1 2008 Earnings Call Transcript

Nuveen Investments, Inc. (JNC)

Q1 2008 Earnings Call

May 15, 2008 11:00 am ET

Executives

Natalie Brown – Director Investor Relations

Glenn Richter – Chief Operating Officer, Chief Administrative Officer

Pete D’Arrigo – Treasurer

Analysts

[Sindar Adarjan] – Deutsche Bank

Bernie Casey – Fort Washington

Kevin Maloney – Blackrock

Presentation

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 conference, Ms. Natalie Brown, Director of Investor Relations. Ma’am, you may begin.

Natalie Brown

Good morning and thank you for joining us. With me today are Glenn Richter, Nuveen’s Chief Operating Officer and Chief Administrative Officer, Pete D’Arrigo, Nuveen’s Treasurer and Sherry Hlavacek, Nuveen’s Corporate Controller.

This conference call may include forward looking statements regarding our expectations and plans that we believe to be reasonable but which are predictions and involve risks and uncertainties. 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 first quarter results with our corporate debt investors. While we will provide a brief update on the status of our auction rate preferred refinancing, this call is intended primarily to focus on our financial results.

We will begin our call with Glenn Richter who will discuss our first quarter 2008 financial and investment performance. And Glenn will then turn the call over to Pete D’Arrigo. I’ll now turn the call over to Glenn.

Glenn Richter

Thanks Natalie and good morning everyone, thanks for joining us. For the first quarter, operating revenue was $197 million, flat compared to the prior year and adjusted EBITDA was $106 million, down 9%.

Our assets under management of $153 billion declined 8% compared to year ago and 7% compared to the prior quarter. Our AUM declined this quarter versus year end was primarily the result of market depreciation of $6 billion in equity assets and $2.2 billion in fixed income assets.

Net outflows for the quarter were $3 billion. However, as we entered the second quarter, we’ve seen improvements with April assets up $3.5 billion to $156.5 billion. The volatility in the financial markets this quarter contributed significantly to our soft sales and net flows.

Those sales for the quarter were $4.3 billion, down 48% from the prior year. Net outflows for the quarter were $3 billion, compared with inflows of $3 billion in the prior year. The outflows for the quarter were primarily driven by outflows in our retail managed accounts business.

This is a trend we’ve seen continuing through the last through quarters, with these outflows primarily coming from strategies at Tradewinds and NWQ that were previously closed to new investors. Despite the very challenging market environment, we continued to make solid progress against our long term strategic priorities of building out our mutual fund and our institutional businesses.

In mutual funds, we launched three new funds in the first quarter, the Tradewinds Global Resources Fund, a HydePark Enhanced Core Equity Fund, and a HydePark Enhanced Midcap Fund. We also secured 25 new mutual fund shelf spaces, including ten funds added to the UBS mutual fund wrap program.

In total, first quarter mutual fund gross sales were $1.4 billion, down 20% from the prior and net flows were $0.1 billion, down from the $1 billion level in the first quarter of 2007. The decline in mutual fund net flows was primarily driven by a decline in our municipal high yield fund net flows which were only about $100 million in the first quarter this year, versus nearly $700 million in the first quarter of the prior year.

We believe this decline was due to two factors: a significant decline in interest among investors in high yield products and our municipal high yield fund’s one year performance, dropping from the first quartile to the fourth quartile during 2007.

The fund’s performance ranking decline was primarily due to a higher mix of unrated issues as our municipal portfolio team utilized its extensive research capability in an effort to position the portfolios to take advantage of value opportunities in the municipal market, particularly with unrated issues.

During recent quarters, this positioning did not allow the fund to participate in stronger returns for higher rated munis. Some mutual fund performance highlights for the quarter include our five star Tradewinds Value Opportunities Fund, which is the number one performer in its category since inception and have over $100 million in net flows in the first quarter.

Our Nuveen Taxable High Yield Fund has a five star rating in its institutional class and has recently reached $100 million in assets. Also our Tradewinds International Value Fund was a top decile performer in the first quarter and has approximately $1 billion in assets under management. Finally, through the first four months of the year we have seen a steady month to month improvement in our mutual fund net flows.

Turning to our institutional business, our sales and net flows for the current quarter were soft, primarily we believe due to two factors. First, in general, the overall level of institutional RFPs were somewhat limited due to investor caution as a result of increased market volatility. And second, we’ve seen investors reallocating assets from value to other strategies.

Total first quarter institutional sales were $1.2 billion compared with $1.7 billion in the prior quarter and $3.4 billion in the prior year. The $3.4 billion of the prior year includes $0.9 billion in CLO and CDO issuances. Net outflows were $0.6 billion compared to net inflows of $2.2 billion in the prior year and net outflows of $0.2 billion in the prior quarter.

While our institutional business has been off to a slow start this year, we have seen a relatively strong pickup in client RFPs in the last two months with solid improvement in sales and net flow trends.

In retail managed accounts, we have been in transition in recent quarters as we closed a number of our popular strategies to new investors in the first half of 2006 and are continuing to introduce new managed account strategies. We had sales of $1.7 billion compared to $2.8 billion in the prior year and $1.8 billion in the prior quarter.

And net outflows of $2.5 billion this quarter primarily due to outflows in our closed strategies at Tradewinds and NWQ. While our recent outflows have been higher than anticipated, we continue to maintain the second highest market share position in the retail managed accounts category and overall we have been pleased by the progress we have made this year in gaining new distribution opportunities in retail managed accounts.

To date, we have been approved for seven new shelf space opportunities with significant success for Santa Barbara, Symphony and Nuveen strategies. In addition we are working aggressively to secure additional new product distribution opportunities and in the coming quarters, we plan to selectively open our Tradewinds International Value ADR and our NWQ Large Cap Value strategies to new investors in retail managed accounts.

Finally, we have a number of new investment strategies in incubation that we plan to introduce in future quarters. Overall, we believe we are taking all actions necessary to return our retail managed account business to positive flows. However, it is inherently difficult to predict the pace at which new sales will translate into positive flows in our retail managed account business.

Looking at closed end funds, the closed end fund market has been effectively shut down since the second half of 2007. There is only one small new closed end fund offered by a competitor in Q1 and the near term outlook for new fund launches is doubtful.

Turning to investment performance, we were pleased with Q1 performance across our investment strategies as several of our larger strategies are off to a particularly strong start in 2008. Closed end funds which represent 33% of our AUMs performed very well in the quarter with approximately 75% of our closed end fund assets in the upper two quartiles of the Q1 Lipper rankings.

In mutual funds which represent 12% of our AUM, only 35% of our fund assets were in the upper two quartiles, primarily due to our largest fund, the High Yield Municipal Bond Fund, which remains below the second quartile. Looking just at equity mutual funds, approximately 70% of our equity mutual funds were in the upper two quartiles in the first quarter.

In managed accounts, approximately half of our assets were above the benchmark for the quarter. Year to date through April, we’ve seen very good performance across most of our investment teams with the Tradewinds International Value ADR strategy approximately 350 basis points ahead of benchmark, the Tradewinds Global All-Cap strategy approximately 170 basis points ahead of benchmark, the Santa Barbara Stable Growth strategy outpacing its year to date benchmark by over 400 basis points and Rittenhouse Growth Strategy over 200 basis points ahead of benchmark.

Lastly, Symphony has had a particularly strong year to date performance in all of its long only equity strategies, some of which are being incubated for future launch with all five strategies beating benchmarks by meaningful margins.

Looking to our income statement, operating revenue of $197 million in the first quarter was flat to the prior year as advisory fees increased 2% due to increased beginning of quarter assets under management which determine advisory fees for a large portion of managed accounts and due to one extra day of advisory fees in this quarter compared to prior year.

The increase in advisory fees was offset by a $2.9 million decline in performance fees and other revenue, primarily due to decreased performance fees on Symphony accounts. Adjusted operating expenses increased 10% for the quarter, primarily driven by an 8% increase in compensation and benefits expense as a result of increased headcount and annual salary increases.

EBITDA was $106 million for the quarter, down 9% compared to the prior year, with adjusted EBITDA as a percentage of revenue at 54% in the quarter. In our press release we included a schedule which reconciles income before taxes to adjusted EBITDA and details the add backs as defined by the credit agreement.

Significant add backs for the first quarter include $10.1 million in non-cash compensation related to new equity plans put in place in 2007 and local equity plans at our affiliates, $4.5 million related to severance, recruiting and retention expense as defined by the credit agreement and $52.5 million in debt and investment related expenses of which $49 million represents a non-cash mark to market on our debt related hedging activity.

The remaining $3 million of this add back is primarily the result of expenses related to the CLO that we are required to consolidate under GAAP. With that, now let me turn the call over to Pete to provide highlights on our first quarter balance sheet and to provide an update on our progress in refinancing our closed end fund, auction rate preferred leverage.

Pete D’Arrigo

Thank you Glenn and good morning everybody. Let me start with a few comments on our balance sheet. At quarter end, consolidated cash and cash equivalents were $91 million. Excluding cash held at the broker dealer, cash and cash equivalents were $74 million.

These cash balances exclude a consolidated investment vehicle in which Nuveen has no economic interest. The consolidated investment vehicle is a CLO that Nuveen manages that was funded by Madison Dearborn Partners, our controlling shareholder. Although Nuveen has not economic interest in the CLO, under GAAP rules the vehicle must be consolidated with Nuveen’s financials due to Madison Dearborn’s ownership.

As is typical for our business, we expect the March 31 cash level to be the lowest point for the year and we expect to build up cash flow from operations through the balance of the year. Quarter end gross debt was unchanged at $3.65 billion. As we mentioned last quarter, 98% of gross debt is fixed or capped for up to five years and interest expense for 2008 is projected to be $274 million.

I’d also like to briefly update you on the progress of our closed end fund’s refinancing of their auction rate preferred leverage. For the taxable leveraged funds we have announced plans for five funds to redeem at par and refinancing with debt $1.4 billion of the $4.3 billion in auction rate preferred leverage.

This $1.4 billion is scheduled to be completed by the end of May. We continue to make progress in completing debt financing arrangements for our other leverage taxable funds. For additional details on the redemptions already announced and for future announcements, please refer to press releases in the media center section of our website, nuveen.com.

We are also continuing to make progress on the development of a new form of preferred stock, variable rate demand preferred which we have also referred to as money market preferred as a potential leverage alternative for our municipal and taxable funds.

The new security we are developing would be eligible for purchase by money market funds. Refinancing the closed end funds auction rate preferred shares remains a very high priority and we are focused on developing a solution that will both reduce the relative cost of leverage for the funds and provide liquidity at par to the current auction rate preferred shareholders.

Now I’ll turn it back to Glenn to provide some conclusive remarks.

Glenn Richter

Thanks Pete, just a couple of closing comments before we open up to your questions. We’ve had a much more difficult start to the year than we had originally planned in large part due to a very challenging market environment. As a result, our assets under management ended the quarter lower than we had planned. However, as I mentioned earlier, we recovered some of the decline in April as markets rebounded.

In addition, more importantly, investment performance in most of our strategies has been strong. We’ve also achieved significant success in new distribution platform opportunities for mutual funds in retail managed accounts, we are selectively reopening our Tradewinds International Value ADR and our NWQ Large-Cap Value strategies in retail managed accounts and we have seen our institutional new client pipeline improving.

All of these actions position us well to return to positive net flows. That being said, in light of the recent market environment, we’ve also taken actions to identify expense reduction opportunities, including a more paced reinvestment approach, streamlining the organization where appropriate and reviewing all discretionary expenses.

With that, we’ll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from [Sindar Adarjan] – Deutsche Bank.

[Sindar Adarjan] – Deutsche Bank

Starting off on the mutual fund side you talked about your performance being impacted by one of the municipal high yield fund where you kind of repositioned your portfolio to unrated securities. Could you give us a sense for how much assets under management were there in that particular fund and how do you see that kind of playing through during the remainder of the year from a performance perspective and how will that impact year over year comps for the rest of the year?

Glenn Richter

The product we were speaking to was the muni high yield fund which represents, it’s about a $4 billion in terms of the size of the fund, so it’s $4 billion out of our $18 billion plus in kind of mutual funds. As I mentioned in my comments, in general we’ve seen a kind of a nice pick up month to month in our mutual funds, we’re now running in excess of $100 million of net inflows per month and its pretty balances.

We’re seeing improvement in munis broadly, progress in our taxable high yield product and also progress in our equity funds, most notably across a couple of our newer Tradewinds launches that we have in place. So I think in general we’re going to continue to see a trend for the balance of the year across our total mutual fund platform.

[Sindar Adarjan] – Deutsche Bank

Kind of a net $100 million per month increase in assets?

Glenn Richter

I think that’s reasonable to maybe a slightly conservative view based on where the trends are.

[Sindar Adarjan] – Deutsche Bank

And how would that compare with what you probably did last year, what was the average per month last year?

Glenn Richter

Well we were much higher because of the high yield munis, the high yield muni product actually delivered a lot of kind of inflows primarily in the first half of last year, so our net flows were very, very strong in the first two quarters of last year and in mutual funds they were basically flat in the third and fourth quarter and part of that was basically give back on the muni side. So what we’re seeing in the first quarter and particularly the last couple months is a pretty nice improvement of what we saw in the back half of last year.

[Sindar Adarjan] – Deutsche Bank

And on the retail side, managed accounts side, you know kind of in retrospect, it seems like, do you think that your strategy that you know you were king of planning to kind of scale back on the retail managed accounts and to focus more on the institutional side, you know, is that kind of cleared out the way you thought it should.

You know you said you were selectively opening some accounts back, is that a reflection of a change in strategy and more importantly, you know, at least in the last couple of quarters assets under management there’s been you know a double digit decline year over year basis, when do we see that moderating based on where we are right now?

Glenn Richter

That’s the question I ask every day. And I tell you the view is a couple things, one is the strategy was and continues to be the right strategy, that is redeploying assets from some very strong managers from lower fee business which is typically in the 40 or less basis points either into funds or into the institutional clients.

What we’ve seen over the last couple quarters is frankly a slightly higher runoff on the wrap and slower inbound activity on the institutional so we had to some extent the starts aligning against us in the back half of last year where wrap was running out a little bit faster than we had anticipated and the institutional pipeline was not as strong. Wrap historically is lumpy because it’s concentrated in primarily in the wire houses, they’re big books of business and it can come in and go out pretty rapidly.

So it’s hard to moderate the pace of the outflows relative to the new institutional business. And as a byproduct of that, we are going to be selectively reopening across some of our key relationships, both the Tradewinds International ADR and the NWQ Large-Cap strategy. But that we should view as a way to sort of moderate the current trends to use some of our existing capacity and as the institutional pipe builds back up, we do expect over time to basically continue to redeploy that capacity in institutional.

It’s just difficult obviously to control both of those levers in perfect coordination with the outflows on the inflows on the institutional space, but we’re still committed to making sure that that, we’re still committed that that is the right strategy for the business.

As it relates to the flows for retail managed account on the balance of the year, we’ve seen throughout the first four months, while each of the four months have had outflows in retail managed accounts, each month it has improved. We will be reopening later in this quarter and early third quarter as mentioned with our comments, we have a number of strategies across Santa Barbara, Symphony, Nuveen that we have gotten on platform in recent months.

All of that I think points to a slowdown of the outflows and then a move towards a positive momentum in the second half of the year. But it’s very difficult for us to call a particular month or even for that matter sort of a number for a particular quarter, just given that there’s so many moving parts in terms of reopening a new strategy to the market.

[Sindar Adarjan] – Deutsche Bank

And on the closed end fund side, how much of the softness in the market would relate or would you attribute to the impasse we have with auction rate securities versus just the overall market conditions and again at least the market seems to be stabilizing now and clearly what do you see as the prospects going forward, do you have stuff in the pipeline that you’re trying to do?

And just to kind of remind us, how many new funds on average did you guys launch last year at least when the market was good in the first half and just to give us some kind of comps as to where we stand there.

Glenn Richter

Prior to the current ARP situation, the market basically had shut down because of the rate environment in the second half of the last year. To answer your last question, in the first six months of last year we had funds in five of six months. We have a very strong pipeline of products that are keyed up for the markets.

So when the market rebounds and opens back up, we’ll be well positioned to basically take advantage of that. Currently though it’s a combination of the general market environment and the ARPs issues that we believe are contributing to the market being closed at this point in time.

And while the general market conditions are moving in the right direction, there still needs to be in our view kind of significant progress against resolving the open issue with ARPs before we think the market is going to come back in any meaningful way for the balance of the year. And as a byproduct of that, we’re sort of cautiously, our outlook for the balance of the year, we’re really not anticipating any new fund launches for the balance of the year at this point in time.

[Sindar Adarjan] – Deutsche Bank

And then finally, moving on to the expense side, you guys highlighted the compensation expenses being up 8% but when I look at every line item I think it’s up 5-7% year over year, any specific actions that you’re taking other than kind of general tightening of the belt and do you expect any kind of, can you give us some guidance as to where those numbers should trend in on a absolute dollar basis over the next few quarters?

Glenn Richter

Yes, there have been year over year expense increases across other items besides compensation, although compensation represents the vast majority of our expense structure. Most of the other items have been more related to specific projects and investments around operations, IT and compliance initiatives. So those are where most of the other increases outside of compensation.

We are looking basically and in the process of implementing three sets of activities and I’m not in a position to really provide a specific number but we’re obviously cognizant of where the top line is and want to be smart in terms of the overall management of our expenses. One, as it relates to any new hires, we’ve effectively shut down new hiring with the exception of some select positions.

We’re continuing to look at opportunities to sort of streamline the organization and then third, any discretionary items such as our advertising and promotion items, any projects are being reviewed in terms of timing and some are being pushed back, others are being cancelled. [K&E] is under review for basically modification and changes in terms of the balance of the year. So we’re scrubbing through line by line of the P&L.

We’ve effectively completed that over the last couple of months and as you move into the second quarter and beyond we’re in the process of implementing those.

[Sindar Adarjan] – Deutsche Bank

As it relates to headcount, it’s not almost I would say what two quarters since you guys did this transaction, has there been any kind of turnover as it relates to any key fund managers or any updates there in terms of how well you’ve been able to retain all the top talent six months into the transaction.

Glenn Richter

Yes, turnover has been fairly de minimis. We’ve had a couple of if you will probably more senior teams, say the top 100 out 1,000 people in the firm, but frankly it’s no more representative than any sort of normal two quarter period in terms of changes. So people are very focused, very motivated and everyone in this type of environment has their head down and kind of focused on driving the business.

[Sindar Adarjan] – Deutsche Bank

And finally, on the balance sheet side could you give some clarification on what you were talking about in terms of the cash balance, you said part of it is in the broker dealer and just for the year over year, and could you kind of give us a reference point what those two numbers were at the end of the year?

Glenn Richter

Yes we had about $90 million of cash but that includes around $20 million of cash that’s segregated for our broker dealers. So from a year end, that’s where we were at the end of the quarter. For the end of the year we were basically at about $175 in aggregate, the BD was about the same. So about $175 at year end which would include about $20 of broker dealer at year end as well. That $20 is pretty consistent quarter to quarter.

Operator

Your next question comes from Bernie Casey – Fort Washington.

Bernie Casey – Fort Washington

Did I hear you give a number of assets under management subsequent to the end of the quarter early on?

Glenn Richter

Yes that’s correct, the month of April we had a $3.5 billion increase in assets, so we ended April at $156.5.

Bernie Casey – Fort Washington

And could you give any color as to market appreciation, sales.

Glenn Richter

Essentially the $3.5 was essentially all market. We were kind of net zero as it relates to overall flows. And that was a function of mutual funds continue to pickup, our institutional business did better and there was a slowdown of our outflows on retail managed accounts.

Bernie Casey – Fort Washington

Now you guys have said that you’re reopening some of your retail managed strategies?

Glenn Richter

Our two largest, both were effectively closed in 05-06, the NWQ Large-Cap Cap Value strategy and the Tradewinds International ADR strategy.

Bernie Casey – Fort Washington

What leads to the decision to close a strategy and then reopen it?

Glenn Richter

The biggest driver is our capacity. These strategies can only be managed to a certain scale effectively. We had very rapid inflows in 05 and 06 and building each of those strategies and there were effectively closed to make sure that they could be managed appropriately.

And in addition, strategically the decision was made and actually still is in place is as the retail managed account rolls off, we’ve been redeploying that capacity into higher margin business which is a combination of mutual funds that we have a mutual fund product of the same managed account strategy and into institutional clients as well.

The decision to reopen, and I’d emphasize, selective reopening, we’re not across the board sort of opening up to all clients and [inaudible] in terms of where to reopen and how much capacity to allocate is that the runoff in capacity over the last year plus has been somewhat higher than anticipated and the institutional offset of that has been a little bit slower over the last couple of quarters so we feel we have some capacity that we can selectively deploy in retail managed accounts.

Bernie Casey – Fort Washington

Now I guess it looks like the outflows have been the greatest in retail managed accounts. Is there any flexibility in the headcount there or the costs in that particular business unit?

Glenn Richter

It’s really a product category and it’s not a business unit. Our retail managed account is supported by our retail organization. That retail organization also sells mutual funds, it sells closed end funds when there are closed end funds to market. So we have a really shared platform in our retail customers. As it relates to overall cost reduction, as I mentioned a few minutes ago, we’ve gone back and we’ve scrubbed our costs and we are making select reductions in various areas to recognize the current economic realities.

Operator

Your next question comes from Kevin Maloney – Blackrock.

Kevin Maloney – Blackrock

On distribution channels, have they changed much in the last several months and also have you changed pricing in any particular products?

Glenn Richter

No in both cases. Our channel really mix is basically pretty similar to where it’s been the last couple of quarters and the way we serve to the channels is basically the same and our pricing strategies have not been modified either.

Kevin Maloney – Blackrock

How do you pick who you’re going to open up new products to, what channel, whether it’s the wire houses or say Merrill Lynch versus Wachovia or whatever, what’s the process?

Glenn Richter

It’s a fairly dynamic and complex process. It includes depth of relationship, existing size and book of business, fee structure ultimately plays a role on the decision in terms of where [inaudible] also. We also look at the broader relationship in terms of other products that might be queued for distribution as well. So all those factors are put together and in consultation with our investment teams and our distribution teams, we figure out what the right mix is.

Kevin Maloney – Blackrock

Was any particular channel responsible for the majority of the outflows?

Glenn Richter

The majority of the outflows are in our retail managed account business which is largely concentrated in the wire houses.

Operator

Your next question comes from Bernie Casey – Port Washington.

Bernie Casey – Fort Washington

You gave a cash balance at year end, did I hear that correctly, $175 million?

Glenn Richter

That’s correct.

Bernie Casey – Fort Washington

Does that compare with the $91 million at the end of this quarter?

Glenn Richter

That is correct.

Bernie Casey – Fort Washington

Okay so was there an $80 million cash burn?

Glenn Richter

Q1 is our biggest use of cash because all yearend bonuses are paid in Q1 and in addition we have certain [how LC] arrangements with some of our investments teams that also are paid out in the first quarter. So as we had mentioned, the end of the first quarter is always our low water mark in terms of cash.

Bernie Casey – Fort Washington

Is the company able to tread water from cash for the rest of the year at the current level of EBITDA?

Glenn Richter

We have more than enough cash to run the business, we’re going to continue to build that through the balance of the year and we’re in fine shape.

Operator

Your final question comes from [Sindar Adarjan] – Deutsche Bank.

[Sindar Adarjan] – Deutsche Bank

Given that you expect to build cash during the remainder of the year, could you talk about what your acquisition strategy might be for the rest of the year? Are you planning to use any of that liquidity that you expect to generate for acquisitions or are you just going to conserve liquidity and build cash from the balance sheet?

Glenn Richter

Our priority order for cash is one is be organic and the principle investments would really be around seeded capital strategies, so we continue to incubate new strategies in place. Second, with the right opportunities, we would use the cash for acquisitions.

We typically have acquired smaller entities, $100 million or less in terms of scale, ones that have been a few billion dollars of assets under management that we can grow through our distribution capabilities. And third, we’ll continue to build and preserve cash and pay down debt.

Operator

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

Glenn Richter

Thank you very much.

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