Nuveen Investments, Inc., Q2 2008 Earnings Call Transcript

Nuveen Investments, Inc. (JNC)

Q2 2008 Earnings Call Transcript

August 14, 2008 11:00 am ET

Executives

Natalie Brown - VP & Director IR

Glenn Richter - EVP, Chief Administrative Officer, Principal Financial Officer

Analysts

Jeff Kirt - Oak Hill Advisors

Ron Speaker - eQuest

Paretash Sikia - Wachovia

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Nuveen second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Natalie Brown, Director of Investor Relations. Ms. Brown, you may begin.

Natalie Brown

Thank you. Good morning and thank you for joining us. With me today are Glenn Richter, Chief Operating Officer and Chief Administrative Officer, Bill Adams, Executive Vice President, and Sherri Hlavacek, Senior Vice President and 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. 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 second quarter results with our corporate debt investors. While we will provide a brief update on the status of our auction-rate preferred re-financings, this call is intended primarily to focus on our financial results.

I will now turn the call over to Glenn Richter, who will discuss our second quarter financial and investment performance.

Glenn Richter

Thanks, Natalie. Good morning and thanks for joining us this morning. For the second quarter, our operating revenue was $191 million, down 6% compared to the prior year. Adjusted EBITDA was $102 million, down 12%.

Our Assets Under Management of $152 billion declined 12% compared to a year ago and 1% compared to the prior quarter. Our slight AUM decline this quarter versus the prior quarter was the result of net outflows of $0.9 billion and market depreciation of $0.3 billion, as strong market appreciation in April and May more than reversed in June.

Gross sales for the quarter were $5.3 billion, down 32% from the prior year, but increased 25% compared to the prior quarter, primarily due to increased sales from mutual funds and in retail managed accounts.

Net outflows for the quarter were $0.9 billion, compared with inflows of $1.9 billion in the prior year. Importantly, despite negative flows in the quarter, the month-to-month net flow trends improved significantly versus Q1, with total net outflows decreasing by $2.1 billion.

Despite recent market challenges, we continue to make progress against our long-term strategic priorities of building out our mutual fund and our institutional businesses in order to drive future growth. Over the past several quarters, one of our top strategic priorities has been the steady build out of our mutual fund business by introducing new products and focusing on cross-selling our funds to advisers with whom we have existing retail separate accounts and fee-based relationships.

Overall, we have been pleased with the progress we have made, particularly in light of the difficult markets.

In mutual funds, we launched two new funds in the second quarter, the Symphony Large-Cap Value Fund and the Nuveen Preferred Securities Fund. We also secured 30 new mutual fund shelf spaces including six funds added to the Morgan Stanley Mutual Fund wrap program. And through the first half of the year, we have secured a total 55 new mutual fund shelf spaces.

In total, second-quarter mutual fund gross sales were $1.8 billion, flat to the prior year; and net flows were $0.7 billion, and increase of 20%. This increase is due in part to strong net flows in our Tradewinds Value Opportunities, Tradewinds Global All-Cap, and Tradewinds International Value Funds, which are all top-quartile performers for the one-year period.

This quarter's net inflow, net flow increase is also due to an increase in net flows in muni mutual funds, driven by our municipal high-yield fund, which had strong inflows in the second quarter in part as a result of portfolio reallocation of assets into the fund by one of our retail distributors.

Turning to our institutional business, our sales and net flows for the current quarter were down versus the prior year, but increased compared to the prior quarter. Total second quarter institutional sales were $1.4 billion, compared with $1.2 billion in the prior quarter and $2.6 billion in the prior year.

Institutional net inflows for the second quarter were $0.1 billion compared with net outflows of $0.6 billion in the prior quarter, and net inflows of $1.4 billion in the prior year, which included approximately $0.5 billion raised to distribution of a Merrill IQ fund.

The increase in net flows from the prior quarter is primarily due to increased net flows into our Tradewinds strategies, as a result of strong performance in recent quarters and increased client demand for global products.

Another factor contributing to this increase is higher flows into our Santa Barbara stable growth strategy, as improved performance has enabled Santa Barbara to benefit from increased investor demand for growth strategies.

In closed-end funds, the market for new issuance remains effectively shut down for the foreseeable future. As a result, there are no new closed-end funds issued in the quarter, nor do we anticipate any for the remainder of the year.

For our existing funds, we recently announced that the Board of Trustees for the funds has approved an open market share repurchase program for the funds. This share repurchase program provides each of the funds with the flexibility to repurchase up to approximately 10% of its outstanding common shares to support the secondary market. The funds are not required to buyback any shares and may or may not decide to do so.

In retail managed accounts, we continue to be in a transition period, 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 $2.1 billion for the second quarter compared to $2.3 billion in the prior year and $1.7 billion in the prior quarter. And net outflows of $1.8 billion this quarter, which represents an improvement from the level of outflows in the two previous quarters.

The improvement is the result of our aggressive efforts to secure additional new product distribution opportunities in retail managed accounts. Year-to-date, we have been approved for 16 new shelf space opportunities, with significant success for Santa Barbara, Symphony, and Nuveen strategies. These new shelf space opportunities also include the selective reopening to new investors our two largest retail managed account strategies, our Tradewinds International Value ADR and our NWQ Large-Cap Value strategies.

Lastly, we have also a number of new investment strategies in incubation that we plan to introduce in future quarters. While recent outflows in retail managed accounts have been higher than planned, Nuveen continues to maintain the second highest market share position in the retail managed account category, and we believe that we are taking all actions necessary to return our retail managed account business to positive flows, with the recent quarter-to-quarter trend improvement encouraging.

Turning to investment performance, we are pleased with the year-to-date performance across our investment strategy, as most of our equity strategies are beating benchmarks by meaningful margins.

Approximately 75% of our managed account assets are above the respective year-to-date benchmarks. In closed-end funds, just over half of our assets were in the upper two quartiles of the year-to-date Lipper rankings.

In mutual funds, however, only about 25% of our fund assets were in the upper two quartiles of the year-to-date Lipper rankings, primarily due to our largest fund, the High-Yield Municipal Bond Fund, which remains below the second quartile.

However, within equity mutual funds, which we anticipate will be a major source of future growth, over 70% of our equity fund assets were in the upper two quartiles of the year-to-date Lipper rankings.

Year-to-date through July, we see very good performance across most of our investment teams, with the Tradewinds International Value ADR strategy approximately 700 basis points ahead of benchmark; the Tradewinds Global All-Cap strategy approximately 1,000 basis points ahead of benchmark.

The Santa Barbara stable growth strategy outpacing its year-to-date benchmark by over 700 basis points, and the Rittenhouse Growth strategy over 250 basis points ahead of benchmark.

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

Moving to our income statement, operating revenue of $191 million in the second quarter is down 6% from the prior year, as advisory fees declined 7% primarily due to lower AUM levels.

The decrease in advisory fees was partially offset by a $2.3 million increase in performance fees and other revenue, primarily as a result of increased performance fees on Symphony hedge fund accounts.

Adjusted operating expenses increased 2% for the quarter, primarily driven by a $2.4 million increase in outside and professional service expense due to increases in information technology and electronic information expenses, as we consolidate operational platforms and continue to provide our investment teams more tools to better manage their portfolios.

This increase was partially offset by a $1.1 million decline in advertising and product promotion expense.

Minority interest expense, which results from key employees at our affiliates having been granted non-controlling profit interest in their respective businesses, declined $1.6 million.

Lower revenues, combined with the slightly increased adjusted operating expenses, resulted in adjusted EBITDA of $102 million for the quarter, down 12% compared to the prior year. Adjusted EBITDA as a percentage of revenue was 53% in the quarter.

In our summary financial information filed in a Form 8-K yesterday, 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 second quarter include $10.2 million in non-cash compensation related to new equity plans put in place in 2007, to local equity plans at our affiliates, and $14 million related to severance, recruiting, and retention expense as defined by the credit agreement.

The reconciliation also includes $50.5 million for debt and investment-related activity, of which $49 million represents a non-cash mark-to-market gain on our debt-related hedging activity. This amount represents a reversal of a $49 million loss in the prior quarter for the same hedging activity.

As a reminder, in 2007, we entered into a series of hedge arrangements that effectively converted $3.1 billion of our floating-rate debt to fixed debt. As a result, 98% of gross debt is fixed or capped for up to five years.

I will now provide some highlights on our second-quarter balance sheet and a brief update on our progress in refinancing our closed-end fund auction-rate preferred leverage.

At quarter end, consolidated cash, cash equivalents, were $223 million. Excluding cash held at the broker dealer, cash and cash equivalents were $180 million. These cash balances exclude a consolidated investment vehicle in which Nuveen has no economic interest.

This consolidated investment vehicle is a CLO that Nuveen manages in which Madison Dearborn Partners, our controlling shareholder, is the primary equity holder. Although, Nuveen has no economic interest in the CLO, under GAAP rules the vehicle must be consolidated with Nuveen's financials due to Madison Dearborn's ownership in Nuveen.

Quarter-end gross debt was $3.6 billion. Again, 98% of gross debt is fixed or capped for up to five years. Interest expense for 2008 is projected to be $274 million.

Finally, I would also like to briefly update you on the progress of our closed-end funds' refinancing of their auction-rate preferred leverage.

For the taxable leverage closed-end fund, seven funds have redeemed at par and refinanced with debt $1.7 billion of the $4.3 billion in auction-rate preferred leverage.

Four more Nuveen taxable closed-end funds expect to redeem an additional aggregate amount of $920 million of ARPS in September.

For the municipal leverage closed-end funds, we have announced that $1.5 billion of the $11.1 billion originally outstanding muni preferred shares issued by Nuveen's municipal closed-end funds have been or are in the process of being redeemed at par.

The municipal funds have used tender option bonds to refinance a total of approximately $1 billion of auction-rate preferred shares.

The remaining refinancing was completed with proceeds from the successful issuance of variable-rate demand preferred shares, a new form of preferred stock eligible for purchase by money market funds, by four Nuveen municipal closed-end funds. The completion of VRDP issuance represents a milestone in our efforts to refinance auction-rate preferred shares at par.

Refinancing the closed-end funds' auction-rate preferred shares remains a very high priority, and we are focused on developing solutions that will both reduce the relative cost of leverage for the funds over time and provide liquidity at par to the current auction-rate preferred shareholders.

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.

Just a couple of closing comments before we open up to your questions. Our overall results continue to be impacted by the very difficult market environment. Despite these market challenges, second-quarter net flow trends improved versus the prior quarter. We have continued to make progress against our long-term strategic priorities of building out our mutual fund and institutional business. And we have achieved significant success in new distribution platform opportunities for mutual funds and retail managed accounts.

In addition, and very importantly, investment performance in most of our strategies has been strong. All of these actions position us well to return to positive net flows.

Finally, in light of the recent market environment, we have also taken actions to identify expense reduction opportunities, including streamlining the organization where appropriate, reviewing all discretionary expenses, and employing a more paced approach to reinvesting.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Jeff Kirt of Oak Hill Advisors. Your line is open.

Jeff Kirt - Oak Hill Advisors

Hi. Just had a question, two questions. The first one is, the open market repurchases of shares in the closed-end funds, I assume that is going to have, the effect would be if the fund repurchased 10% of its shares, that fund's revenue would basically go down by 10%, because there would be 10% less shares outstanding paying fees?

Glenn Richter

Jeff, 10% of the equity shares, up to 10% of the equity shares, so it would reduce the assets by 10%.

Jeff Kirt - Oak Hill Advisors

Right, okay. And then secondly, can you just comment on comp and benefits expense? I may have missed this in your remarks. But it is up about 10% or it is up, I guess, 3% of revenue from like 30% or maybe 2.5% from about 31% to mid-33%, as a percent of revenue, which was a little bit surprising just given that, I guess, one, the markets are down versus the first half of last year, the first half of this year. Equities are down double-digits when last year they were up kind of mid-single digits.

And then secondly, it just doesn't seem, based on at least the volume of resumes that we see coming in here that it is a very competitive comp environment.

Glenn Richter

Well, yes, a very good question, Jeff. Part of it is that over the last couple years, we have been made some significant investments in headcount to bolster a range of areas in the firm, including investment teams, some of our legal and clients areas, operations IT, some of our efforts in building out our institutional mutual fund business. So, part of this is you are just seeing these are the base salaries from the additions over the last year, rolled into the run rate.

I would say, in addition if you look at last year, the compensation expense was a little lumpy. It was a little bit more back-end loaded than first-half loaded. So, in fact, we're actually at a run rate in terms of our compensation expense fairly consistent with where we were last year.

So, we do expect relative to our full-year plan is actually to have a meaningful reduction because of the softness of revenue and assets in our business around compensation. But what you really have seen is sort of the historical build of the base.

And looking at last year, you really probably have to look at the full year rate versus the quarter-to-quarter rate, because the expense level was higher in the back half of the year as we trued up accruals and did some other things.

Jeff Kirt - Oak Hill Advisors

Okay, thanks.

Operator

Thank you. Our next question is from [Ron Speaker] of [eQuest]. Your line is open.

Ron Speaker - eQuest

Yes, could you just speak to your total debt outstanding and any pay downs or buybacks that occurred in the last year? And then a follow-up question on municipals. What area do you see the most promising in municipals, and what type of resources are you putting in it?

Glenn Richter

On the debt, we have $3.6 billion of outstanding debt. We have really done no buybacks. And the only thing that we have due is $250 million in September of 2002 of our bonds. So, basically over the next two and a half years, just 250 -- no buybacks in the market.

Regarding munis, we have actually seen a -- it was a little bit slow in the first quarter or the second quarter activity picked up across several aspects of our muni business. A number of our state funds actually showed improvement. Our high-yield municipal open-end fund actually had a very strong second quarter as well. And some products in our wrap strategies as well as actually been taking on and picking up some momentum as well.

So, it's been fairly broad based in terms of the improvement in the second quarter trends versus where we were in the fourth quarter of last year and then the first quarter of this year.

Ron Speaker - eQuest

Thank you.

Operator

Thank you. Our next question is from [Paretash Sikia] of Wachovia. Your line is open.

Paretash Sikia - Wachovia

Hi, is it possible to provide any update on how July framed up?

Glenn Richter

Sure. We're actually just closing the month at this point. The market was down a little over $2 billion, so it was a challenging market. Although, early August, every day is a new day, but early August was showing some improvement from a market standpoint. And we had outflows of around $400 million in the month.

Mutual funds was strong. Retail wrap actually showed improvement in terms of outflows, so we continue to see that moderation of the outflows. And we had some out flows on the institutional side. Institutional has been a little lumpy this year. We have had month-to-month it has been -- sometimes we will have a couple million to $3 million out. Other times, we will have 300-plus, in terms of the institutional.

Paretash Sikia - Wachovia

Any sense of where AUMs ended up? Or should I just assume a $2.5 billion decline? Sorry, how should I think of AUMs?

Glenn Richter

We ended about a little over 149 at the end of July. As a reminder, the majority of our revenues are based on beginning of quarter AUMs, so the choppiness within the quarter, particularly from a market standpoint, doesn't affect revenues much because it's really the start of the quarter that most of our revenues are based on.

Paretash Sikia - Wachovia

Thank you. And just one more question. Compared to how the market sort of fared in Q2, Nuveen's decline in market depreciation was fairly [deminimis]. Is that completely attributable to the superior performance that was sort of broad-based in various strategies by the firm?

Glenn Richter

Well, I would say there's two components. One is mix of business. As a reminder, half of our business is fixed income, primarily munis; so we are a buffered from the fluctuations in the equity markets in that only half of our business.

And then, secondarily, your point is right, as performance was strong from a benchmark, so we did better from a performance standpoint as well.

Paretash Sikia - Wachovia

Thank you.

Operator

Thank you. (Operator Instructions) I am not showing any further questions at this time.

Glenn Richter

Thank you much. We appreciate it and we will talk to you next quarter.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day.

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