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Edited Transcript of PZN earnings conference call or presentation 18-Apr-19 2:00pm GMT

Q1 2019 Pzena Investment Management Inc Earnings Call

New York Apr 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Pzena Investment Management Inc earnings conference call or presentation Thursday, April 18, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jessica R. Doran

Pzena Investment Management, Inc - CFO & Treasurer

* Richard Stanton Pzena

Pzena Investment Management, Inc - Chairman, CEO & Co-CIO

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Conference Call Participants

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* William V. Cuddy

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to the Pzena Investment Management announces first quarter 2019 earnings conference call. (Operator Instructions) Please also note that today's event is being recorded.

At this time, I'd like to turn the conference call over to Ms. Jessica Doran, Chief Financial Officer. Please go ahead.

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Jessica R. Doran, Pzena Investment Management, Inc - CFO & Treasurer [2]

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Thank you, operator. Good morning, and thank you for joining us on the Pzena Investment Management First Quarter 2019 Earnings Call. With me today is our Chief Executive Officer and Co-Chief Investment Officer, Rich Pzena. Our earnings press release contains the financial tables for the periods we will be discussing. If you do not have a copy, it can be obtained in the Investor Relations section on our website at www.pzena.com. Replays of this call will be available for the next 2 weeks on our website.

Before we start, I need to remind you that today's call may contain forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from today's comments.

Please note that we do not undertake to update such information to reflect the impact of circumstances or events going forward. In addition, please be advised that due to prohibitions on selective disclosures, we do not, as a matter of policy, disclose material that is not public information on our conference calls.

Now let me turn the call over to Rich who will discuss our current view of the investing environment.

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Richard Stanton Pzena, Pzena Investment Management, Inc - Chairman, CEO & Co-CIO [3]

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Thanks, Jessica. It has been just over 90 days since I last offered some thoughts about opportunity in the markets for a value investor. Last quarter, I said the anti-value bias dominating the markets for most of the past decade has led to passive strategies gathering all the net flows and growth strategies appearing to be the only logical approach in a world dominated by technology and disruptions. It seems to me to be something artificial about speaking to investors or clients for that matter every 3 months with an expectation that there are brand-new insights that have suddenly appeared to illuminate the cloudiness that is in investor's lot in life. However, here we are at the beginning of the second quarter of the year, and the statements I will make today are not that different from the ones I made just over 90 days ago.

The first quarter was one where growth strategies again helped sway over value. And yet again, our strategies performed reasonably well in that environment and earned solid returns. Filled with recent history as primary proof text, the chorus that deep value no longer works is getting louder again. We have heard these refrains before.

Prior to this cycle, it was during the internet boom-bust of the late 1990s. I mentioned this similarity to a client recently and they correctly observed that this time the growth stocks in question are earning money. True I said, but that makes it possible to estimate the fair value of these high-growth businesses and compare them with the valuations being offered to the more cyclical holdings that dominate our portfolio. And we find that the spread between deep value and high flying is at the second lightest point in the last 50 years.

Further, just as we found in the late '90s, the deep value stocks are not impaired by heavy financial leverage or other clear threats to their survival. Our portfolios are filled with industry leaders, with solid balance sheets, many with attractive growth prospects and representing a wide range of industries and geographies. In other words, it's a good time to be a value investor.

And fortunately, April is looking much better so far. Interestingly, while the markets have not yet embraced deep value as the winner, we generated positive net flows again this quarter across each of our distribution channels and now show positive net flows in 8 of the last 10 quarters.

Further, our pipeline of potential new business remains robust as consultants and prospects have indicated that several of our competitors are drifting away from their value approaches. As an example, one consultant recently described a major global competitor that is buying Netflix for their portfolio. We've seen this movie before and have learned that staying the course reaps significant dividends and we continue to do just that.

I'll now turn the call over to Jessica Doran, our Chief Financial Officer, who will provide this quarter's financial update.

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Jessica R. Doran, Pzena Investment Management, Inc - CFO & Treasurer [4]

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Thank you, Rich. Our earnings release discloses both GAAP and non-GAAP adjusted financial results. We did not make any non-GAAP adjustment to our results during the first quarters of 2019 or 2018, however, our comparative results for the fourth quarter of last year adjust for certain tax receivable agreement items.

We reported diluted earnings of $0.17 per share for the first quarter compared to non-GAAP diluted earnings of $0.16 per share last quarter and $0.20 per share for the first quarter of last year. Revenues were $37.4 million for the quarter and operating income was $16.2 million.

Our operating margin was 43.3% this quarter, decreasing from 52.1% last quarter and from 50.8% in the first quarter of last year.

Taking a closer look at our assets under management, we ended the quarter at $37.1 billion, up 11.1% from last quarter, which ended at $33.4 billion and down 1.6% from the first quarter of last year, which ended at $37.7 billion. The increase in assets under management from the fourth quarter of this year was driven by market depreciation of $3.2 billion and net inflows of $0.5 billion. The decrease from the first quarter of last year reflects $2.3 billion in market depreciation, partially offset by net inflows of $1.7 billion.

At March 31, 2019, our assets under management consisted of $13.8 billion in separately managed accounts, $21 billion in sub-advised accounts and $2.3 billion in our Pzena Funds. Compared to last quarter, assets under management across all channels increased with separately managed accounts reflecting $1.1 billion in market depreciation and $0.1 billion in net inflows, sub-advised account assets reflecting $1.9 billion in market depreciation and $0.3 billion in net inflows and assets in Pzena Funds being $0.2 billion in market depreciation and $0.1 billion in net inflows.

Average assets under management for the first quarter of 2019 remained unchanged from last quarter at $36.1 billion but were down 7% from the first quarter of last year. Revenues increased 2.8% from last quarter and decreased 4.7% from the first quarter of last year. The increase from last quarter reflects an increase in weighted average fee rate and the decrease from the first quarter of last year primarily reflects a decrease in average assets under management.

During the quarter, we recognized $0.4 million of performance fees on our sub-advised accounts. Our weighted average fee rate was 41.4 basis points for the quarter compared to 40.4 basis points last quarter and 40.5 basis points for the first quarter of last year. Asset mix continues to be the most significant factor in our overall weighted average fee rate, although swings in performance fees and fulcrum fees also contribute.

Our weighted average fee rate for separately managed accounts was 55 basis points for the quarter compared to 54.1 basis points last quarter and 53.4 basis points for the first quarter of last year. The increase from the fourth and first quarters of 2018 reflects an increase in assets in non-U. S. strategies that generally carry higher fee rates.

Our weighted average fee rate for sub-advised account was 29.5 basis points for the quarter compared to 28.9 basis points last quarter and 30 basis points for the first quarter of last year. The increase from last quarter reflects an increase in assets in non-U. S. strategies that generally carry higher fee rates, while the decrease from the first quarter of 2018 reflects a decrease in performance fees recognized during the quarter, partially offset by the increase in assets in non-U. S. strategies.

In addition, the weighted average fee rate for the quarter reflects the reduction in base fees of certain accounts related to fulcrum fee arrangements of 1 client relationship. These fee arrangements require a reduction in the base fee if the investment strategy underperforms its relevant benchmark or allows for a performance fee if the strategy outperforms its benchmark.

During the first quarter of 2019 and fourth quarter of 2018, we recognized a $0.3 million and a $0.2 million reduction in base fees, respectively, related to 1 client account.

The reduction in base fees was not recognized during the first quarter of 2018. These fees are calculated quarterly and compare relative performance over a 3-year measurement period. To the extent the 3-year performance record of this account fluctuates relative to its relevant benchmark, the amount of base fees recognized may vary.

Our weighted average fee rate for Pzena Funds was 67.9 basis points for the quarter, increasing from 64.4 basis points last quarter and from 59.9 basis points for the first quarter of last year. The increase from the fourth and first quarters of 2018 reflects the decrease in fund expense cap reimbursements recognized during the first quarter of 2019. These fund expense cap reimbursements are presented net against revenue.

The remainder of the increase from the fourth and first quarters of 2018 reflects an increase in assets in products that generally carry higher fee rates.

Looking at operating expenses. Our compensation and benefits expense was $17.2 million for the quarter, increasing from $13.9 million last quarter and from $16.2 million for the first quarter of last year. First quarter 2019 and 2018 compensation rates include expenses associated with tax payments and our employee profit sharing and savings plan, which generally do not recur during the year. The remainder of the increase from last quarter and the first quarter of last year reflects an increase in compensation rate.

G&A expenses were $4 million for the first quarter of 2019 compared to $3.5 million last quarter and $3.2 million for the first quarter of last year. Fluctuations were primarily driven by changes in the level of professional fees recognized during the period. The increase from the first quarter of last year also reflects an increase in data and systems expenses.

Non-GAAP other income was $1.7 million for the quarter, driven primarily by the performance of our investments. The effective rate for our unincorporated and other business taxes was 3.9% this quarter compared to 4.8% last quarter and 3.7% in the first quarter of last year. We expect the effective rate associated with unincorporated and other business taxes of our operating company to be between 3% and 5% on an ongoing basis.

Our effective tax rate for our corporate income taxes, ex-UBT and other business taxes, was 30.6% this quarter compared to our non-GAAP effective tax rate of 26.3% last quarter and 29.4% for the first quarter of last year. The fluctuation in these effective rates reflect tax benefits and expenses from employee share and unit issuances and vesting and a onetime adjustment to our deferred tax assets and liabilities. We expect this rate, excluding these items, to be between 23% and 25% on an ongoing basis.

The allocation to the nonpublic members of our operating company was approximately 74.1% of the operating company's net income for the first quarter of 2019 compared to 74.8% last quarter and 73.9% for the first quarter of last year. The variance in these percentages is the result of changes in our ownership interest in the operating company.

During the quarter, through our stock buyback program, we repurchased and retired approximately 629,000 shares of Class A common stock and Class B units for $5.3 million. At March 31, there was approximately $21.3 million remaining in our repurchase program. At quarter end, our financial position remains strong with $14.7 million in cash and cash equivalents as well as $15.6 million in short-term investments. We declared a $0.03 per share quarterly dividend last night.

Thank you for joining us. We'd now be happy to take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today comes from Ken Worthington from JPMorgan.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [2]

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It's Will Cuddy filling in for Ken. Rich, thank you for the commentary on deep value. When you look at your different sectors, what areas do you think have the most attractive investment profiles at this time?

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Richard Stanton Pzena, Pzena Investment Management, Inc - Chairman, CEO & Co-CIO [3]

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There's a number of sectors. First, and this -- we've been saying this probably for 10 years, so maybe it sounds old, it's financial services. The big banking franchises continue to produce spectacular returns and are not fairly value in the marketplace so we've maintained a large exposure there. But I can say that's true in some of the big asset management franchises as well as in some of the insurance company franchises. So financial services is a big component.

Second, I would say are more cyclical sectors. In energy, we're particularly focused in oilfield services, way more so than in oil. And that's been a shift over the last couple of years as we believe that the industry is not spending enough in aggregate to support the demand that we see globally and feel like there's big upside here and keep going on and on. There is industrial cyclicals and consumer cyclicals. They all tend to have a cyclical orientation. But that -- and it's not surprising, given the market fears about an economic downturn. Interestingly, when you look at historical performance records of these kinds of sectors, they tend to bottom somewhere between 12 and 18 months prior to recessions because that's when the fear gets the highest. And we clearly saw that capitulation in the fourth quarter of last year and really continued somewhat into the first quarter. And now that seems to be reversing a little bit but that's where we're exposed.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [4]

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Great. So another good quarter for flows. And I know you've been investing in financial intermediary distribution, can you maybe elaborate on where the source of the flows are coming from?

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Richard Stanton Pzena, Pzena Investment Management, Inc - Chairman, CEO & Co-CIO [5]

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Pretty much across the board, actually. So I'd still say there was more of a bias into the non-U. S. strategies into global and emerging markets. But across the distribution channel, it's been pretty uniform. So we've seen it in traditional defined benefit plans that are more government oriented than they are corporate oriented. It's very geographically diverse, but in sub-advisory, there were no new relationships, but the existing relationships on average had positive flows because we're affiliated with partners that -- where there are businesses, particularly in the professionally managed, centrally managed model portfolio structure, are gaining share. And then our own funds, which have started to reach critical mass and critical track records of 5 years are seeing positive flow. So it's a -- it's pretty encouraging.

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William V. Cuddy, JP Morgan Chase & Co, Research Division - Analyst [6]

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Great. And then on expenses, thanks for the perspective on G&A, how should we be thinking about the growth of G&A from here?

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Richard Stanton Pzena, Pzena Investment Management, Inc - Chairman, CEO & Co-CIO [7]

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We're making some pretty big investments in our data infrastructure to really position us for more -- for better supporting an increasingly complex Pzena Fund operation. So when we look at our Pzena Funds, it's not just the 40 Act funds that we have in the United States, but it's also usage funds that are outside the United States, they're in multiple countries with requirements for multiple language data reporting. And we're in the process of automating a very manual process and that will take us the next year, probably, to be fully implemented. And so there's some costly investments in IT infrastructure that are -- and consultants that are underway right now. So I would expect the growth rate would moderate in the future. But the level of these expenses will probably stay where they are. I don't expect them to go back down again.

And then on the compensation side, we actually are continuing to invest in a gradual, methodical way in distribution. And our -- actually, our number of employees in distribution now exceeds, I think, probably for the first time in our history, the number of people that we have on the investment side. And we see that growing indefinitely as long as they are productive in producing net flows. And so far, that's been the case.

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Operator [8]

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(Operator Instructions) And ladies and gentlemen, in showing no additional questions, we'll end today's conference call. We do thank you for joining today's presentation. You may now disconnect your lines.