Manning & Napier's (MN) on Q4 2016 Results - Earnings Call Transcript

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Manning & Napier, Inc. (NYSE:MN) Q4 2016 Earnings Conference Call February 9, 2017 5:00 PM ET

Executives

Richard Yates - Chief Legal Officer & Secretary

Beth Galusha - Principal Financial Officer

Paul Battaglia - VP, Finance

Analysts

Robert Lee - KBW

Will Cuddy - JPMorgan

Operator

Good evening. My name is Stephanie and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Manning & Napier Fourth Quarter and Fiscal Year 2016 Earnings Teleconference. Our host for today's call are Richard Yates, Chief Legal Officer; Beth Galusha, Principal Financial Officer; and Paul Battaglia, Vice President of Finance.

Today's call is being recorded and will be available for replay beginning at 8:00 PM Eastern Standard Time tonight. The dial-in number is 404-537-3406 and enter pin number 51514312. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions]. It is now my pleasure to turn the floor over to Mr. Richard Yates.

Richard Yates

Thank you, Stephanie and thank you everyone for joining us today to discuss Manning & Napier's fourth quarter 2016 results. Before we begin, I would like to remind everyone that certain statements made during this call are not based on historical facts, including statements relating 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, allow me to introduce our Principal Financial Officer, Beth Galusha. Beth?

Beth Galusha

Thank you, Richard. Good evening and thank you all for joining us. For today's call, I am going to provide a brief review of our business in 2016 and an outlook of our priorities for 2017. Paul will then provide you with details on flows and financials and we will then open up the call for questions.

We came into 2016 focusing on investment team execution and client service to slow asset outflows. With respect to the former, our largest investment products, we're able to overcome the challenging environment for active managers and produce competitive relative and absolute returns through the third quarter. However, our performance advantage was eroded in the fourth quarter with strong post-election rallies in financials, energy and other areas underrepresented in our portfolios.

For the year, the equity series finished in the top quartile of its large growth peer group but lags the S&P 500 while the prevalent funds ended the year in the bottom quartile of their peer group. World opportunities, overseas and international series gave up some ground in the fourth quarter, but all held up better relative to benchmark and peers for the year.

While our performance advantage built in the year built early in the year did not withstand the rotation experienced in the fourth quarter, we have seen a meaningful reversal of those fourth quarter trends in January and finished the month having made up the relative returns lost post-election.

More importantly, we believe that our investment teams are executing our strategies and disciplines well. Our disciplines tell us we're later cycle in a long bull market in the U.S., when risk management becomes more important to achieving investor objective. Our history has included lagging late in bull market, but more than making up for it by providing solid downside protection and sustain bear market to deliver competitive returns across bull market cycles.

Our most attractive track records are real estate series, disciplined value, international series and unconstrained bond. In addition, our ETF allocation portfolio including the Global Tactical Allocation portfolio or what we refer to as GTAP and GOAL Funds have regained traction over the past year. Our direct and intermediary sales teams have continued to push these products through due diligence processes, but flows in these products have not yet offset the outflows experienced by the larger products.

More broadly, while firm outflows slowed from 2015 to 2016, client flows continue to be a headwind for Manning & Napier and many active managers. Despite this, we believe that we have the product diversification, distribution capabilities and high-touch service model to return to positive flows.

Looking ahead to 2017, we will continue our focus on servicing clients in our long-tenured equity products and where our short to intermediate term track records remain challenged. This servicing effort includes various communications on the merits of active risk management, particularly after an extended bull market and the case for our current positioning in light of the environment.

Use of GTAP, GOAL, disciplined value and strategic income as defensive strategies offering lower fee, better recent performance alternatives to our traditional strategies and where necessary a review of fees to maintain relationships. Despite these efforts, we do expect asset flows to remain challenged due to fourth quarter performance and continuing trends towards passive management. In particular, we have received a cancellation notice from our largest client with approximately $2.4 billion expected to flow out of our multi-asset class funds at the end of the first quarter.

From a new business standpoint and as a follow-up from our last call, we're excited about the new partnership that we expect will contribute between $1 billion and $1.5 billion of multi-asset class inflows over the course of 2017 and 2018. This new relationship was driven by the depth of our life cycle product lineup, our digital marketing approach and our value-added services. Specifically, our risk-based and target date mutual funds will be the underlying investments of a $2.5 billion AUM insurance-based retirement and savings program, serving a wide range of individual investors.

While this new relationship has the potential to be an important source of growth cash flows over the coming quarters, the timing is uncertain due to the need for individual client conversions. As we look ahead, we will be focusing our sales efforts on products with competitive short and long term track records such as our unconstrained bond, disciplined value, global quality equity, real estate, strategic income and Rainier International small-cap strategies. In addition, giving the continuing trend to index-based investments, we expect our actively managed ETF allocation portfolios GTAP and GOAL to receive improved traction.

Before wrapping up my remarks, I'll touch base on a few more items. First, as mentioned on previous calls, our digital marketing strategy continues to help us identify new prospects through targeted content marketing. In early January, we published our semi-annual investment outlook and have seen an unprecedented response. This restores has been valuable in servicing our existing clients as well as attracting new leads during a challenging performance environment, including the previously mentioned new business relationship. And finally, we continue to prioritize initiatives that support deep relationships with our clients; relationships that include numerous touchpoints that allow us to provide solutions to help clients achieve their goals.

We're actively promoting and see strong interest in our various solutions-oriented services, consultative fixed income offerings, family wealth management and endowment and foundation services. Additionally, we continue to pursue initiatives that involve using innovative technologies as a tool to help solve client problems.

Thank you. And now, I'll turn the call over to Paul Battaglia. Paul?

Paul Battaglia

Thank you, Beth. Thank you 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. I'll start by addressing a few financial highlights. We finished the year with assets under management of $31.7 billion. As an update, tomorrow morning, we'll release our preliminary AUM for January, where you will see that our AUM is increased to approximately $32 billion.

Net client outflows in the quarter were approximately $2 billion and were $8.1 billion for the year. Revenue for the quarter was $59.1 million and was $249 million for the year. And we reported fourth quarter economic net income per adjusted share of $0.16, in line with the $0.16 per adjusted share in the third quarter and $0.68 per adjusted share for the year ended December 31.

Turning to AUM and net client cash flows. AUM decreased by $3.1 billion during the quarter as a result of net client outflows of $2 billion and another $1.1 billion of market depreciation. When compared to December 31, 2015, AUM is decreased by $3.8 billion or 11%. The $2 billion in net client outflows were about evenly split between separately managed accounts in mutual funds and collective trust. By portfolio, nearly half of the net client outflows were attributable to our multi-asset class products, with another $600 million in net client outflows from our U.S. equity strategies and the remainder from our non-U.S. equity strategies.

Our blended asset portfolios contributed approximately $670 million of our $1.1 billion of gross inflows for the quarter. This includes nearly $450 million of gross inflows into our life cycle and retirement target products that are prominent in the defined contribution space. However, we expect that our blended asset inflows will decrease as we move through 2017, with the impact of the account cancellation previously mentioned being partially offset by the additional flows resulting from our new partnership. Gross client outflows were $3.1 billion for the quarter, a slight improvement from the $3.4 billion we reported last quarter. A rolling 12-month separate account retention rate stands at 85%.

Moving to our fourth quarter financials, we reported revenue of $59.1 million for the quarter, down 7% from revenue of $63.3 million reported last quarter. Overall, revenue margins remained consistent with last quarter at 71 basis points of assets.

Operating expenses were $37.3 million in the quarter, a decrease of $4.3 million since last quarter. Compensation and related costs for the quarter were $17.6 million or 30% of revenue, down from 39% of revenue last quarter. The decrease is primarily attributable to decreasing AUM and market depreciation during the period and the corresponding impact on variable incentives. Distribution, servicing and custody expenses have decreased by approximately $1 million since the last quarter to $7.9 million in the fourth quarter of 2016 and continues to be approximately 24 basis points of average funding collective trust assets.

Other operating expenses were $11.8 million in the quarter, up from $8.2 million last quarter. This increase is directly attributable to the net impact of the non-cash write-down of certain intangible assets and our contingent consideration associated with the Rainier acquisition. When excluding the impact of these charges, ongoing other operating expenses have remained consistent with prior periods.

Non-operating income was $400,000 in the quarter and included income associated with amounts payable under the TRA receivable agreement, partially offset by investment losses in our seeded products. As a result, we reported pretax income for the quarter of $22.1million, a 3% increase over last quarter. Economic net income for the quarter was $12.8 million or $0.16 per adjusted share. Economic net income includes an effective tax rate for the quarter of 42% which is reflective of the tax receivable agreement income I just mentioned. Looking ahead however, we anticipate that 2017 effective tax rate to be 38%.

With that, I'll summarize our full-year results. Revenues were $249 million, a decrease of 22% compared to last year's revenue of $318 million. Our revenue margin for the year was 72 basis points compared to 75 basis points for 2015. The change in our revenue margin was a result of overall changes in our business mix during the year.

Operating expenses decreased by 16% or approximately $30 million to $159.7 million in 2016. The decrease was about evenly split between compensation-related costs and distribution servicing and custody fees. In both cases, the change was primarily attributable to lower AUM levels and relative performance challenges throughout the year.

Our employee count as of December 31 stood at 468, down slightly from 474 in 2015. This resulted in 2016 pretax income of $90.8 million, down 25% from $121.6 million in 2015. Our economic income margin was 35.8% for the 12 months ended December 31 compared to 40.4% last year. Equity ownership remained generally unchanged during the quarter with approximately $81 million adjusted shares outstanding as of December 31.

In conclusion, we're encouraged by the conversations we're having both with existing clients and prospects related to our value-added service capabilities and product offerings in the current market as well as by the returns we delivered during January. That said, the challenge that Manning & Napier and other active managers face are real. While the balance sheet remains healthy and debt free with over $100 million of cash and investments to help support the business, we continue to work with the Board on our dividend policy in light of the current operating results.

As we look ahead, we expect to review product pricing across our complex to ensure our products are competitive for distribution, while at the same time, being thoughtful about managing compensation and discretionary expenses. We're confident in our ability to manage our profitable business at the current asset levels and remain committed to having the resources in place to help clients achieve their financial goals while positioning the firm for future growth.

That concludes my formal remarks. I'll now turn the call back over to the operator and we look forward to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Robert Lee with KBW.

Robert Lee

And I apologize if you have mentioned this on the call, I kind of jumped in a little late, but the compensation, was there a true-up or true-down, however you want to call it, in the quarter relative to the prior quarters so that [indiscernible] full-year that will be a better kind of run rate?

Paul Battaglia

Hi, Rob, this is Paul and I can take that. Not so much of true-up as it is just. In the past, we've talked about the timing lag that happens on the analyst compensation specifically. We pay on a semi-annual cycle and we generally pay on trailing 12, 24 and 36-month period. So, as of September 30, we have an accrual on the books based on kind of what has happened through the first nine months of the year with some assumption around what's going to happen in the fourth quarter. So, when returns get somewhat detached from -- or volatile during the quarter, that results in a true-up that's what you saw in the quarter.

So, on a run rate basis, I think we've been talking about compensation in the mid-30% range as a ratio of revenue and that's probably the right run rate to think about. What you're seeing in the fourth quarter is really a result of the performance environment that we had in the period.

Robert Lee

Great. And then maybe as a follow-up on understanding the legacy performance challenges but if or when you start having performance base better for an extended period of time, could you maybe highlight specific distribution channels where you think you have the most potential to more quickly leverage improvements in performance?

Paul Battaglia

This is Paul again. I think that we feel strongly that both our direct distribution team and our intermediary team are really well positioned in terms of a resource standpoint to be able to capitalize when the market's right. We've got a differentiated product set and we've got a captive sales force which is somewhat unique to firms of our size.

So, we think that we've got some products in the short term, [Technical Difficulty] strategies, some income-generating strategies that we think can be attractive in the current environment and Beth mentioned those during her remarks. And we hope to see a continued turnaround in our traditional products in those track records and being an active manager, we can try to make up ground quickly on that. And both sales forces can utilize full suite of products and we generally, as you know, have products available both in separate account and fund form, so we can get to clients in a variety of different ways.

Operator

[Operator Instructions]. Your next question is from Ken Worthington with JPMorgan.

Will Cuddy

This is Will filling in for Ken. Thank you for taking the time for our questions. So first, we've seen a couple of companies in the small and mid-cap space merger similarly-sized peers to build scale and expand distribution. I know Rainier is relatively recent, but how are you thinking currently about opportunities for M&A to increase scale and expand distribution?

Richard Yates

Hi, Will, Richard Yates. I'll take that. I think specifically we're looking at the Rainier product suite has a five star, five year track record coming up on the international small-cap strategy which is available across product channels fund to collective and separate accounts. So, that's our primary focus in terms of recently-acquired products. And I think we're always on the look and would be open to discussions around potential distribution-related partnerships with counterparties leveraging either our distribution and their products or our products and their distribution depending on what makes sense going forward.

Will Cuddy

Okay. Thank you. So, in the release you mentioned termination of the revolving credit agreement. Could you give us some color on why you terminate the revolving credit agreement? Are there other plans for something else to replace it?

Beth Galusha

Yes, Will, this is Beth, I will answer that question. Given our cash position, we have over $120 million of cash and short term investments. We believe we have sufficient capital to support our planned initiatives without the additional flexibility of the credit facility which we had not drawn on since we established it back in 2014.

Operator

Your last question comes from the line of Robert Lee with KBW.

Robert Lee

I guess I've two quick follow-up questions. First one really just geography on modeling, the $2.4 billion of client redemption, is that out of the mutual funds or is that a separate account clients?

Paul Battaglia

It's in the collective trust. So, I think it's funding collective products from a reporting perspective.

Robert Lee

Okay. And maybe just following up on the question around -- you mentioned in the prepared remarks about working with the Board, thinking about dividend policy, so, do you think about it generally? I mean, some of your peers think of it in terms of the total cash flow they generate and have been willing to kind of maintain their dividend even if on a kind of earnings basis they're covering it, but could you maybe flesh out a little bit kind of your philosophy around managing distribution? Would you want to distribute 100% or use cash supplemented for a period of time or do you feel more comfortable with the more moderate payout ratio?

Beth Galusha

I'll take that question. This is Beth. Given our current operating environment, it is our dividend policy is the responsibility of our Board of Directors and we expect the Board will review the sustainability of our current dividend at its next quarterly meeting.

Operator

Thank you. This does conclude today's conference call. Please disconnect your lines at this time and have a wonderful day.

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