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Pzena Investment Management Inc (PZN)
Q2 2019 Earnings Call
Jul 18, 2019, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning and welcome to the Pzena Investment Management Announces Second Quarter 2019 Conference Call. [Operator Instructions] I would now like to turn the conference over to Jessica Doran, Chief Financial Officer. Please go ahead.
Jessica R. Doran -- Chief Financial Officer and Treasurer
Thank you, operator. Good morning and thank you for joining us on the Pzena Investment Management second quarter 2019 earnings call. I am Jessica Doran, Chief Financial Officer. 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 period 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 two weeks on our website. Before we start, we 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 materials 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.
Richard S. Pzena -- Chairman, Chief Executive Officer and Co-Chief Investment Officer
Thanks, Jessica. I remember as a boy taking driving trips with my parents. The US is a big place. My parents would remind me and my siblings, and they had wanted us to experience the country. Invariably, as kids all over the world are prone to do, one of us would whine, are we there yet? Almost as automatically, our parents would respond hang in there, we're almost there. This childhood story strikes me as a perfect analogy to the conversations we have been in with clients and prospects over the past couple of quarters. The anti-value cycle has been the longest in history and the valuation spreads are widening. Looking at price to book, spreads between the cheapest and most expensive stocks are nearly at the extreme level set during the Internet bubble period and on a price-to-earnings basis, the dispersion between the cheapest and most expensive stocks today is the highest on record, with the most expensive 20% of stocks trading at more than 80x earnings. These nosebleed levels are nearly double with dotcom levels. Are we there yet?
Let's consider earnings recovery during this cycle, which will date back to 2008 versus the prior one, which we'll define as 1997 until 2007 to try and help answer that question. The high flyers in this cycle, heavily dominated by technology, have without question experienced strong earnings growth. Just as certainly though, at an average of 80x earnings, these companies are priced for perfection. Interestingly, the earnings recovery for the cheapest stocks have followed a nearly identical path in this cycle as they did in the last. During both cycles, approximately 70% of the stocks that were hardest hit had raised their profit levels to the average level of their peers within three years. In other words, earnings mean reversion has occurred again. The question remains though, while earnings levels have mostly recovered valuations have not. So is it different this time? We argue no. History may not repeat itself but it rhymes is a quote attributed to Mark Twain and indicates that he was likely a value investor at heart and a prescient observer of human behavior. Today, market participants swing monthly from expecting imminent global recession to the inevitability that robust economic activity will result in rapid rise in interest rates. As always, we keep our eyes on the opportunities embedded in the companies in our portfolio, and seek a combination of undervaluation, downside protection and a viable strategy for earnings recovery and growth.
Today, these companies are called General Electric, Rexel, AIG, Maersk, China Resources Power, Citigroup and Ford to name just a few. Each of these trading at near fire sale levels of just 8x times our estimate of normal earnings and each holds powerful market positions, solid earnings prospects, strong downside risk protection and management teams with rational strategies. So are we there yet? Maybe not quite but as my parents reminded me so long ago, hang in there. The evidence suggests we're almost there.
On the business side, we experienced a small net outflow this quarter of approximately $250 million. This is only the third quarter in the prior 11 with a negative net flow number; for the trailing 12-months, we had $1.4 billion in net inflows reflecting a 16.5% gross inflow figure. For the prior five years, we have averaged nearly 20% annual gross inflows. We attribute these positive business results to our clients' confidence that we will not waver from our valuation discipline. Further, as we have expressed over the past couple of years, we continue to be encouraged by our robust pipeline of potential new business opportunities and look ahead with optimism.
I'll now turn the call over to Jessica Doran, our Chief Financial Officer, who'll provide this quarter's financial update.
Jessica R. Doran -- Chief Financial Officer and Treasurer
Thank you, Rich. We reported diluted earnings of $0.18 per share for the second quarter, compared to diluted earnings of $0.17 per share last quarter and $0.20 per share for the second quarter of last year. Revenues were $37.8 million for the quarter and operating income was $17.6 million. Our operating margin was 46.4% this quarter, increasing from 43.3% last quarter and decreasing from 51.5% in the second quarter of last year.
Taking a closer look at our assets under management, we ended the quarter at $37.3 billion, up 0.5% from last quarter, which ended at $37.1 billion, and up 1.1% from the second quarter of last year, which ended at $36.9 billion. The increase in assets under management from the first quarter of this year was driven by market appreciation of $0.5 billion, partially offset by net outflows of $0.3 billion. The increase from the second quarter of last year reflects net inflows of $1.4 billion, partially offset by $0.9 billion in market depreciation.
At June 30, 2019, our assets under management consisted of $13.9 billion in separately managed accounts, $21.1 billion in sub-advised accounts, and $2.3 billion in our Pzena Funds. Compared to last quarter, assets under management and separately managed accounts and sub-advised accounts increased with separately managed account assets reflecting $0.2 billion in market appreciation, partially offset by $1 billion [Phonetic] in net outflows and sub-advised account assets, reflecting $0.3 billion in market appreciation, partially offset by $0.2 in net outflows.
Assets in Pzena Funds remained unchanged with $0.1 billion in growth inflows, offset by $0.1 billion in growth outflows. Average assets under management for the second quarter of 2019 were $37.1 billion, up 2.8% from last quarter and down 1.6% from the second quarter of last year. Revenues increased 1.2% from last quarter and decreased 1.3% from the second quarter of last year. The increase from last quarter reflects an increase in average assets under management, partially offset by a decrease in the weighted average fee rate.
The decrease from the second quarter of last year primarily reflects a decrease in average assets under management.
During the quarter, we recognized $0.3 million of performance fees on our sub-advised account. Our weighted average fee rate was 40.8 basis points for the quarter compared to 41.4 basis points last quarter and 40.7 basis points for the second quarter of last year. Asset mix continues to be the most significant factor in our overall weighted average fee rate, although swings and performance fees and fulcrum fees also contribute. Our weighted average fee rate for separately managed account was 54.5 basis points for the quarter compared to 55 basis points last quarter and 53.5 basis points for the second quarter of last year. The decrease from last quarter was driven by large client relationships that generally carry lower fee rate, partially offset by an increase in assets in non-US strategies that generally carry higher fee rates. The increase from the second quarter of last year reflects the increase in assets in non-US strategy. Our weighted average fee rate for sub-advised accounts was 28.7 basis points for the quarter compared to 29.5 basis points last quarter and 30.3 basis points for the second quarter of last year. The decrease from last quarter and the second quarter of last year reflects a decrease in performance fees recognized during the quarter, partially offset by an increase in assets in non-US strategies. In addition, the weighted average fee rates for the quarter reflects the reduction in the base fees of certain accounts related to the fulcrum fee arrangements of one client relationship. These fee arrangements require a reduction in the base fee if the investment strategy under performs its relevant benchmarks or allow for a performance fee if the strategy outperforms its benchmark.
During the first and second quarters of 2019, we recognized a $0.3 million and a $0.5 million reduction in base fees respectively related to one client account. A reduction in base fees was not recognized during the second quarter of 2018. These fees are calculated quarterly and compare relative performance over a three year measurement period. To the extent the three-year performance record of this account fluctuates relative to the relevant benchmark, the amount of base fees recognized may vary. Our weighted average fee rate for Pzena Funds was 69.4 basis points for the quarter, increasing from 67.9 basis points last quarter and from 62.4 basis points for the second quarter of last year. The increase from last quarter and the second quarter last year reflects the decrease in fund expense cap reimbursements recognized during the quarter, which are presented net against revenue. The remainder of the increase reflects an increase in assets in products that generally carry higher fee rate.
Looking at operating expenses, our compensation and benefits expense was $16 million for the quarter decreasing from $17.2 million last quarter and increasing from $15.2 million for the second quarter of last year. First quarter 2019 compensation expenses include expenses associated with tax payments and our employee profit sharing and savings plan, which generally did not recur during the year. The increase from the second quarter of last year reflects an increase in compensation rate. G&A expenses were $4.3 million for the second quarter of 2019 compared to $4 million last quarter and $3.4 million for the second quarter of last year. The increase from last quarter reflects an increase in business activities, while the increase in the second quarter of last year reflects an increase in professional fees and data and systems expenses. Other income was $0.5 million for the quarter, driven primarily by the performance of our investments. The effective rate for unincorporated and other business taxes was 4.3% this quarter compared to 3.9% last quarter and 4.3% in the second quarter of last year. We expect the effective rate associated with the 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 23.8% this quarter compared to 30.6% last quarter and 27.8% for the second quarter of last year. The fluctuation in these effective rates reflect tax benefits and expenses from employee share unit issuances and vesting. 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 74.5% of the operating company's net income for the second quarter of 2019 compared to 74.1% last quarter and 74.4% for the second quarter of last year. The variance in these percentages is the result of changes in our ownership interest in the operating company. At quarter end, our financial position remains strong with $33.8 million in cash and cash equivalents, as well as $15.9 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.
Questions and Answers:
Operator
[Operator Instructions] There are no questions at this time. [Operator Closing Remarks]
Duration: 16 minutes
Call participants:
Jessica R. Doran -- Chief Financial Officer and Treasurer
Richard S. Pzena -- Chairman, Chief Executive Officer and Co-Chief Investment Officer
