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Edited Transcript of MN earnings conference call or presentation 31-Oct-19 12:00pm GMT

Q3 2019 Manning & Napier Inc Earnings Call

New York Nov 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Manning & Napier Inc earnings conference call or presentation Thursday, October 31, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Marc Orlans Mayer

Manning & Napier, Inc. - CEO & Director

* Nicole Marie-Kingsley Brunner

Manning & Napier, Inc. - CMO

* Paul J. Battaglia

Manning & Napier, Inc. - CFO

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Presentation

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Operator [1]

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Good morning. My name is Maria, and I will be your conference operator today. At this time, I would like to welcome everyone to the Manning & Napier Third Quarter 2019 Earnings Conference Call.

Our hosts for today's call are Nicole Kingsley Brunner, Chief Marketing Officer; Marc Mayer, Chief Executive Officer; and Paul Battaglia, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 11:00 a.m. Eastern today. The dial-in number is (404) 537-3406 and enter pin number 6686766.

(Operator Instructions)

It is now my pleasure to turn the floor over to Ms. Nicole Kingsley Brunner.

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Nicole Marie-Kingsley Brunner, Manning & Napier, Inc. - CMO [2]

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Thank you, Maria, and thank you, everyone, for joining us today to discuss Manning & Napier's Third Quarter 2019 Results. Before we begin, I would like to remind everyone that certain statements made during this call not based on historical facts, including any statements relating to 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 statement.

During this call, some comments may include reference 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 Chief Executive Officer, Mr. Marc Mayer. Marc?

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Marc Orlans Mayer, Manning & Napier, Inc. - CEO & Director [3]

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Thank you, Nicole. I'm going to begin, as we always do, with a review of our performance for clients. And we're pleased to report excellent results across almost the entirety of our suite of investment strategies. In a very strong year for both equities and fixed income, we have delivered outstanding absolute results for clients and have broadly outperformed.

Starting with our multi-asset class portfolios. Our balanced solutions posted positive absolute results and outperformed their respective benchmarks across all risk tolerances during the third quarter. The strong performance builds on what has been a good year as we focus our efforts on delivering the results clients need.

We believe our strategies -- our performance, thus far, in 2019 deserves attention. Embedded in our core investment strategy, since their inception almost 5 decades ago, is a robust risk management framework, designed to help us manage downside risk in adverse markets and avoid the excesses of speculative bull markets. Given the unprecedented postfinancial crisis market run as well as considering where, we believe, we are in the economic cycle, we have chosen to hold a more cautious view on risks throughout 2018 and '19, particularly for clients within our balanced solutions.

Despite this more defensive posture, evidenced in an underweight to equities and multi-asset class portfolios, we have been able to generate relative outperformance for the vast majority of our clients reflecting superior equity security selection. These results are a testament to the inherent flexibility of our research processes and the excellent execution of our research team as it seeks to add value in all equity markets while maintaining its risk management disciplines. The results in 2019 are particularly noteworthy in the context of the broad outperformance we delivered for clients in the difficult fourth quarter of 2018.

Each of our fundamental equity portfolios outperformed its respective benchmarks for the quarter. Within the U.S., our equity series delivered positive results for the period on an absolute basis. And for the full year, the fund has moved ahead of its benchmark by over 250 basis points and is up 23% as of the end of September.

Internationally, equity markets were down for the quarter but are up significantly for the full year. We are pleased with our relative results. And on a year-to-date basis, our overseas series ended the quarter ahead of its benchmark by over 450 basis points.

After a challenging start to 2019, our disciplined value strategies returned to favor in the third quarter. Both our Disciplined Value unrestricted and U.S. composites outperformed their respective benchmarks for the period, modestly closing their relative performance gaps year-to-date. These strategies continue to demonstrate a stellar intermediate to longer-term track record. Performance for the Disciplined Value series ranks in the top decile of its Morningstar peer group on both a 3- and 5-year basis.

Our Rainier International Small Cap team experienced a more difficult third quarter, trailing its benchmark by 346 basis points and returning negative absolute results. Despite the challenging quarter, the fund has delivered robust absolute results year-to-date and remains well ahead of its benchmark in 2019, outperforming by a strong 319 basis points. Performance remains equally impressive over longer time periods. And over the trailing 3 and 5 years, the Rainier International Discovery series is ahead of its benchmark by an annualized 160 and 325 basis points, respectively.

Turning to fixed income. Our team continues to generate strong absolute results in what has been a remarkably strong year for fixed income, certainly relative to broad expectations at the beginning of the year. As interest rates fall, long-term performance becomes an increasing challenge for bondholders, which is why we believe our flexible team-based approach remains appealing to a wide array of investors.

As an example, our high-yield series has delivered strong absolute results and ranks in the top quintile of its Morningstar peer group on both a 3- and 5-year basis.

It is always challenging to forecast market environments in the future. Our research processes are highly flexible, dynamic, nonstyle specific, very focused on risk management and most importantly, time-tested over many cycles during almost 50 years. We are confident that our research will continue to deliver the required long-term outcomes for all types of clients over the range of potential markets in the future.

By way of example, our flagship long-term growth portfolio has a track record that goes back to January 1973. Over the past 46 years, this globally diversified, dynamically allocated multi-asset class portfolio has compounded at 9.4% per annum after fees. $100,000 invested in January 1973 is worth $6.6 million today.

I'd like to put some context around our strong recent performance. As mentioned last quarter, we are in the midst of rolling off some difficult periods. During the fourth quarter, specifically, our 3-year track records will be rolling off one of our most challenging quarters. And our 5-year track records are continuing to work through a difficult multiquarter stretch a number of years ago. Of course, our track record will be influenced by upcoming performance as well.

As Paul will discuss in more detail, we are closing a number of subscale or underperforming investment strategies and vehicles, which will have a de minimis impact on revenues. We are making associated reductions in our research staff.

While the investment results we have achieved for clients have been good, we recognize the need to improve results for shareholders. We continue to see net outflows in all our businesses in spite of our investment results, including the previously disclosed termination of our largest sub-advisory relationship during October. Although our operating margin is up from the second quarter of 2019 at 10%, it is simply too low.

We have been taking action on costs, and we'll continue to do so. But it is important to note, as we have in the past, that substantial spending to completely overhaul our IT infrastructure will continue to pressure margins through 2020 despite reductions in headcount and compensation expense.

Our balance sheet is a strength. With over $150 million in cash and short-term investments and no debt, it affords us the opportunity to complete these necessary enhancements.

We are confident that on the other side of the technology spend, we will have a modernized, future-proof infrastructure, enabling a nimbler, leaner, less complicated enterprise, a meaningful advance from the current state. As I've done on our past few calls, I'd like to provide an update on our firm-wide strategic initiatives.

Over the last quarter, we made significant strides to improve our organizational readiness. We believe these efforts will both help us realize efficiencies while positioning us better for future growth. As stated last quarter, we will build on our historic strengths as a wealth manager. In August, we established our Wealth Management leadership team comprised of Greg Woodard, Managing Director of Wealth Management, who is leading our team of advisers; Megan Henry, President of the Exeter Trust Company; Mark Macpherson, Managing Director of Wealth Management Strategy; and Dana Vosburgh, Managing Director of Advisory Services. This is a formidable team of seasoned Manning & Napier colleagues, and I am excited for the direction they are bringing to this important initiative.

Our Wealth Management business has always been at the heart of who Manning & Napier is as a firm. And we fully intend to revitalize our growth efforts in this area. We believe that the Wealth Management business is both attractive, given its good growth dynamics and less fee-sensitive characteristics and closely aligned with how we intend to evolve as a firm. The needs of future generations are different from those that came before. And we must expand our capabilities and improve our client experience in order to meet those changing demands.

As we enhance our Wealth Management offering to build a sustainable business for the future, we expect to leverage key historical strengths. Our investment track record is excellent, compelling and a key differentiator from peers. Our Advisory Services provide financial planning and trust and estate services to individuals and families as well as sophisticated strategies for endowments, foundations and retirement plans. Our lasting relationships with clients are a testament to the ongoing value we provide. We are in the midst of holding client seminars in our major markets for many hundreds of clients. A large number have been clients for decades, and the relationships often span generations as well as both business and personal interests for many families.

Our intermediary and institutional businesses, with the majority of the latter being with Taft-Hartley clients, are making important strides in refining their focus under the leadership of Aaron McGreevy. We have a long history of providing third-party financial advisers with comprehensive investment solutions with our multiasset class strategies. We have a very large installed base of multiasset class and single-asset class portfolios with external advisers, and we will refocus to grow this cohort while working to develop new adviser relationships in a tightly focused manner.

Further, we are now leveraging the differentiated efforts of our Advisory Services group to help third-party advisers with our insights.

We also have a large number of Taft-Hartley relationships, many of very long duration. We are focused on the key Taft-Hartley consultants with whom we have clients in common, working to advance opportunities where we can while defending the base of business.

During the quarter, we realigned certain stewardship functions to improve the nimbleness of our organization and reallocate resources towards our digital technology transformation. Scott Morabito has been named Managing Director of Operations. He is a crucial change agent in the evolution of our infrastructure. Together with our Chief Technology Officer, Chris Briley, we continue to work closely with an industry-leading consultant on overhauling our technology approach.

The review portion of this initiative has been completed, and we are in the process of formulating detailed next steps with specific business partners in order to put this plan into action. Over time, we expect our technology transformation to realize significant cost efficiencies as well as create a substantially better client experience.

Before turning the call over to Paul, I'd like to reinforce that continued pressure on our financials should be expected through 2020 as we reinvest in critical areas of need. The 3 key areas of focus, our research processes, sales initiatives and technology and operations transformation are vital to rebuilding the long-term health and strength of our business.

With that, I will turn the call over to Paul for more details on our financials. Paul?

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Paul J. Battaglia, Manning & Napier, Inc. - CFO [4]

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Thanks, Marc. Good morning, everyone, and thank you for joining us today. Before addressing our third quarter results, I want to address a few items of note.

As part of our review of subscale and underperforming products, we made the following changes during the quarter. In August, we completed the sale of Perspective Partners to Bill Manning, recognizing a gain of approximately $3 million in our nonoperating results as previously disclosed.

Separately, we provided notice to Mutual Fund shareholders of our intention to close 3 of our Mutual Fund offerings, International Series, equity income and Income Series. The majority of the assets in these funds represent allocations from our separately managed accounts, and therefore, we do not expect a material impact to AUM or revenue resulting from these fund closures. When combined, these changes provide approximately $6.5 million of run rate expense relief without any material impact to revenue starting in 2020.

And with regard to the sub-advisory relationship termination that Marc mentioned earlier, this was a $1 billion relationship that represented approximately $3.3 million of annualized revenue and was the only such relationship at its size within our book.

Finally, our press release makes reference to our non-GAAP measure, economic income. For period starting in January 1, 2019, economic income will now exclude from pretax income, certain items related to advancing our strategy. These may include severance-related costs, certain consulting and other professional service fees related to our key strategic initiatives, costs related to the potential termination of existing contracts and any gain or loss associated with the sale of a business.

For the third quarter, economic income will exclude the aforementioned gain on the sale of Perspective Partners as well as certain severance and consulting charges. With that in mind, I'll now address our third quarter 2019 financial results, starting with assets under management.

AUM decreased from $21.3 billion as of June 30, 2019, to $20.5 billion on September 30. This 4% decrease was the result of $1 billion in net client outflows, partially offset by $300 million in market appreciation. When compared to September 30, 2018, AUM is decreased by $2.6 billion or 11%. While we are pleased by the competitive performance across most of our strategies year-to-date, we remain in a net outflow position. Inflows remain slower than we like, as we continue to implement our updated distribution strategies. The majority of the net outflows came from our blended asset strategies and specifically, from our retirement target in Pro-Blend funding collectives.

Our annualized separate account retention rate through September 30 is approximately 90%. However, as I just discussed, the retention rate will decrease in the fourth quarter when the $1 billion cancellation is completed.

As of September 30, our overall business mix remains generally unchanged from prior periods, with just under half of our AUM being serviced by our Wealth Management team, approximately 22% from Taft-Hartley clients and the remainder represented by our other intermediated and institutional relationships.

Turning to our third quarter P&L. We reported revenue of $34.2 million for the quarter, down slightly from last quarter, with overall revenue margins holding steady at 65 basis points. After a few quarters of reductions in revenue margins resulting from our mutual fund fee restructuring, we now believe that we have settled into our expected go-forward run rate in the mid-60 basis point range. However, as I've mentioned in the past, our revenue margin is largely influenced by our overall business mix. And I expect that we may see a slight uptick in our revenue margin next year once the lower fee sub-advisory account redemption, that I mentioned earlier, is completed.

Moving to expenses. Operating expenses were $30.7 million in the quarter, a decrease of $1.1 million compared to last quarter and a $5.3 million decrease compared to the third quarter of 2018.

Compensation and related costs decreased by approximately $700,000 or 3% in the quarter due to a decrease in headcount. Our compensation and related costs as a percentage of revenue remained elevated at 57% but has decreased by 2% when compared to last quarter.

Distribution, servicing and custody expenses decreased by 2% during the quarter, generally in line with the 3% decrease in average funding collective trust assets and continue to represent approximately 19 basis points of average funding collective assets.

Other operating expenses were $8.3 million in the quarter, a $350,000 decrease from last quarter. We reported nonoperating income of $3.3 million during the quarter, $2.9 million of which was related to the onetime gain from the sale of Perspective Partners.

Pretax income for the quarter was $6.7 million, while economic income was $5.2 million. Economic net income for the quarter was $3.7 million or $0.05 per adjusted share.

With that, I'll summarize our year-to-date results. We reported revenue of $103.2 million, down 17% from $123 million last year, with overall revenue margins of 66 basis points. Operating expenses were $96.1 million, a decrease of $9.7 million or 9% from the 9 months ended September 30, 2018 as decreases in distribution expenses and compensation were partially offset by increases in other operating costs.

Compensation and related costs of $61.1 million have decreased by $7.5 million when compared to last year and represent 59% of year-to-date revenue in 2019. The majority of the decrease is due to a decrease in the overall size of our workforce, down from 377 at this time last year to 318 as of September 30. Distribution, servicing and custody expenses have decreased by 29% this year as a result of decreases in average fees and our Mutual Fund fee restructuring efforts. And the 8% increase -- year-over-year increase in other operating costs are primarily driven by our technology enhancement initiative with over $1.5 million of incremental expense during the year resulting from this as well as by the fact that our 2018 results included an expense reduction stemming from the sale of the Rainier U.S. funds last year. As a result, our pretax income through September 30, 2019, was $13.4 million with economic income of $13.2 million and economic net income of $9.4 million or $0.12 per adjusted share.

Looking at equity ownership, the adjusted share count decreased slightly from 79.1 million shares outstanding at June 30 to 79 million shares outstanding on September 30. And as Marc mentioned earlier, our balance sheet remained strong as we maintain a debt-free capital structure with cash and investments of approximately $153 million. During the quarter, we declared a $0.02 per share dividend to our Class A shareholders, consistent with the previous quarter.

Before opening up the call for any questions, I want to provide a few more updates as we look ahead to 2020. As I said in my opening remarks, we have achieved approximately $6.5 million in run rate cost savings stemming from the changes during the quarter, including approximately $5.5 million of compensation expense and $1 million of other operating costs. These savings will be fully reflected in our P&L starting in the first quarter of 2020, after the Mutual Funds, I mentioned earlier, are officially closed.

Looking ahead to 2020, I expect we'll commit as much as $10 million to $12 million of cash to our technology infrastructure upgrade. While a portion of this will be capitalized and amortized over future periods, it is fair to assume an increase in our other operating expenses will result.

In closing, I want to reinforce the comments that Marc made earlier on the call. Our vision is to better serve and grow our Wealth Management business using our proprietary investment strategies that can also be sold through third-party intermediaries and to institutions. Over the last several months, we have taken necessary steps towards executing this strategy, all while striving to achieve near-term expense savings. Our commitment to our clients and to our business remain strong, as illustrated by the returns achieved by our investment team and by our separate account retention rate in the midst of the changes this year. Our employees have shown great resolve in recent years to serve our clients well in spite of the headwinds we have faced, and we look forward to their continued contribution.

As Marc mentioned, we are dedicated to growing our business for the future, and that growth will be facilitated by investment in our people and in the technology required to support them. This effort will continue to put pressure on earnings in the immediate term, but we remain committed to achieving a better future state for our clients, our employees and our people -- and our shareholders.

That concludes my formal remarks. I'll turn the call back over to the operator, and we'll take any questions. Operator?

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Operator [5]

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(Operator Instructions)

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