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Pzena Investment Management Inc (PZN)
Q3 2019 Earnings Call
Oct 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 Third Quarter 2019 Earnings Conference Call. [Operator Instructions]
I would now like to turn the conference over to Jessica Doran. Please go ahead.
Jessica R. Doran -- Chief Financial Officer & Treasurer
Thank you, operator. Good morning and thank you for joining us on the Pzena Investment Management third 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 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.
Richard S. Pzena -- Chairman, Chief Executive Officer & Co-Chief Investment Officer
Thanks Jessica. The classic value investment approach remains unchanged by recent events. Recall that our strategy is to buy businesses that are selling at low prices relative to their long-term sustainable earnings power. The availability of a business at a low price is nearly always due to uncertainty of our future earnings prospects.
We believe that through intensive research and patience, we can earn superior returns over the long-term. Today's uncertainty surrounds the outlook for global economic activity, and stocks exposed to that uncertainty have become extremely cheap. Unfortunately our portfolio has not been exposed to the small subset of the largest cap stocks, which have appreciated strongly as a result of their presumed isolation from global economic risk. The result is that the opportunity set open to us has increased dramatically.
We wrote these words in July of 1998, while the cycle did not turn immediately after we wrote these words. The turn that came was extraordinary for true value investors. These words are a remainder of the frustrating reality that at times must be borne by value investors. But, while the frustration has now lasted longer than in any other value cycle in measured history, the opportunity embedded in our portfolios appears to us to be equally extraordinary. Consider a couple of our large holdings as examples.
First is UBS. UBS is tarred with the Moniker bank, and yet they really are not a bank. They are a leading global wealth manager with a deep and stable client base, a growing business with high net worth and ultra high net worth clients that is growing faster than global GDP. Further, 15% of their business is in Asia, the fastest growing region of the world, growing at our 10% per year. Their capital position is 5 times what it was prior to the financial crisis.
Over the past five years, UBS' earnings have grown by 32%. They have generated a shareholder return from dividends of 21% and yet their valuation has collapsed, driving the total return negative over the five-year period.
Compare these facts with market darling Nestle, over the same past five years, Nestle's earnings have shrunk by 1.5%. Their shareholders have only earned 16% from dividends and yet the total return to shareholder is over 70% over that five-year period. How can that make sense? Even more startling is the free cash flow yield for UBS in a negative environment. If we apply the same loan loss conditions to UBS today, that existed at the worst point of the great recession and the global financial crisis, UBS still would have a free cash flow yield of 8%. Compare that to a German 10-year bond of negative 40 basis points, hard to understand.
We also own Volkswagen stock in our portfolios. VW is the largest automaker in the world with brands expanding the consumer demand spectrum. They enjoy leading market share in China and Europe, and their cash position gives them a margin of safety that blights the current recession fears. Our analysts says that VW's strong market can be summed up in just three words, leaner, cleaner and greener. Leaner, if cutback on unproductive R&D spending, they are planning to use common parts across platforms under the VW family of brands.
Cleaner, they have paid for their past sense, paying out $25 billion for their diesel gate fiasco. They are improving their competitive reputation and expect to be at breakeven in the Americas in 2020, up from down at $1.5 billion. And greener, they are already offering electric vehicle versions of their premium brands, while pricing is high enough to enable the profitable distribution of electric cars and this is giving them the opportunity to leverage their premium, their brands to reach scale in this important segment. And we get this all at a price that it is just over 6 times consensus estimates of next years earnings.
In short, these are the environments that Tri-Asset owner sold, and these are the environments that bring excitement to value investors. We share the frustration that the waiting time for reward, this cycle has been extreme, but that has led to these kinds of opportunities that we believe will make the way worthwhile.
On the business side, we experienced a net outflow this quarter of approximately $800 million. Almost all of these outflows stemmed from our sub-advisory channel, where we attribute -- which we attribute to the reality of a skittish retail end-client. Our sub-advisory partnerships remained strong.
I will now turn the call over to Jessica Doran, our Chief Financial Officer, who will provide this quarter's financial update.
Jessica R. Doran -- Chief Financial Officer & Treasurer
Thank you, Rich. We reported diluted earnings of $0.19 per share for the third quarter compared to diluted earnings of $0.18 per share last quarter and $0.22 per share for the third quarter last year. Revenues were $37.1 million for the quarter and operating income was $17.1 million. Our operating margin was 46.3% this quarter relatively flat from 46.4% last quarter and decreasing from 50.9% in the third quarter of last year.
Taking a closer look at our assets under management, we ended the quarter at $35.8 billion, down 4% from last quarter, which ended at $37.3 billion and down 8% from the third quarter of last year, which ended at $38.9 billion. The decrease in assets under management from the second quarter of this year was driven by market depreciation of $0.7 billion and by net outflows of $0.8 billion. The decrease from the third quarter of last year was driven by $2.6 billion in market depreciation and net outflows of $0.5 billion.
At September 30, 2019, our assets under management consisted of $13.7 billion in separately managed accounts, $19.8 billion in sub-advised accounts and $2.3 billion in our Pzena fund. Compared to last quarter, assets under management and separately managed accounts and sub-advised accounts decreased with separately managed account assets reflecting $0.3 billion in market depreciation, partially offset by $0.1 billion in net inflows and sub-advised account assets reflecting $0.3 billion in market depreciation and $0.8 billion in net outflows.
Assets in Pzena Funds remained unchanged with $0.1 billion in net inflows, offset by $0.1 billion in market depreciation. Average assets under management for the third quarter of 2019 were $36 billion, down 3% from last quarter and down 6% from the third quarter of last year.
Revenues decreased 2.1% from last quarter and decreased 6.4% from the third quarter of last year. The decrease from last quarter reflects the decrease in average assets under management, partially offset by an increase in weighted average fee rate. The decrease from the third quarter of last year primarily reflects a decrease in average assets under management.
During the quarter, we recognized $0.3 million in performance fees on our sub-advised accounts. Our weighted average fee rate was 41.2 basis points for the quarter compared to 40.8 basis points last quarter and 41.3 basis points for the third quarter of last year. Asset mix continues to be the most significant factor in our overall weighted fee rate, although swings in performance fees and fulcrum fees also contribute.
Our weighted average fee rate for separately managed account was 54.3 basis points for the quarter compared to 54.5 basis point last quarter and 54.7 basis points for the third quarter of last year. The decrease from last quarter and the third quarter of last year was driven by a shift in asset toward strategies that typically carry lower fee rates.
Our weighted average fee rate for sub-advised accounts was 29.2 basis points for the quarter, compared to 28.7 basis points last quarter and 30.2 basis points for the third quarter of last year. The increase from last quarter reflects an increase in assets -- in strategies that typically carry higher fee rates. The decrease from the third quarter of last year reflects a decrease in performance fees recognized this quarter.
In addition, the weighted average fee rates for the quarter reflects the reduction in 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 performance its relative benchmark or allows for a performance fees if the strategy outperforms its benchmark.
During each of the second and third quarters of 2019, we recognized a $0.5 million reduction in base fees related to one client account. A reduction in base fees was not recognized during the third quarter of last year. These fees are calculated quarterly and compare relative performance over a three-year measurement period. To the extent that three-year performance record of this account fluctuates relative to relevant benchmark, the amount of base fees recognized may vary.
Our weighted average fee rate for Pzena funds was 68 basis points for the quarter decreasing from 69.4 basis points last quarter and increasing from 66.8 basis points for the third quarter of last year. The decrease from last quarter reflects the shift in assets to strategies that typically carry lower fee rates, while the increase from the third quarter of last year reflects the shift in assets toward strategies that typically carry higher fee rates.
Looking at our operating expenses. Our compensation and benefits expense was $16 million for the quarter, remaining flat from last quarter and decreasing from $16.1 million for the third quarter of last year. D&A expenses were $3.9 million for the third quarter of 2019 compared to $4.3 million last quarter and $3.3 million for the third quarter of last year. The decrease from last quarter reflects the decrease in professional fees, while the increase from the third quarter of last year reflects an increase in professional fees and occupancy cost.
Other income was less than $0.1 million for the quarter, driven primarily by the performance of our investments. The effective rate for our unincorporated and other business taxes was negative 5.1% this quarter, compared to a positive 4.3% last quarter and 2.1% in the third quarter of last year. The negative effective rate reflects the benefit associated with the reversal of uncertain tax position and liabilities and interests due to the expiration of the statute of limitations. 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 24.4% this quarter, compared to 23.8% last quarter and 16.9% for the third quarter of last year. The fluctuation in these effective rates primarily reflect a benefit recognized in the third quarter of 2018 associated with a one-time adjustment to the deferred tax asset. We expect this rate to be between 23% and 25% on an ongoing basis.
The allocation to the non-public members of our operating company was approximately 74.5% of the operating company's net income for the third quarter of 2019, flat from 74.5% last quarter and 75% for the third 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 $35.7 million in cash and cash equivalents as well as $29 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] Our first call -- question comes from Mac Sykes of Gabelli. Mac, please proceed.
Mac Sykes -- Gabelli -- Analyst
Good morning, Rich.
Richard S. Pzena -- Chairman, Chief Executive Officer & Co-Chief Investment Officer
Good morning.
Mac Sykes -- Gabelli -- Analyst
Thanks for the interesting parallel from '98. Interesting. I just have one question. It's of op kind of the comments you made in the past, but I wanted to know maybe you could just comment on the competitive landscape for value investing mandates? And at a time when allocator interests may be shifting positively? And what that means for your platform? Thanks.
Richard S. Pzena -- Chairman, Chief Executive Officer & Co-Chief Investment Officer
Sure. I mean one of the -- I'll say the good things about sticking to a discipline and having the world know that all you do is value investing is when they think about reallocating to value. We generally tend to be on the list. It doesn't mean that we'd win, but because the list shrinks in these kinds of periods, our pipeline winds up looking pretty good. So, when we look at the future, there's -- there is some fairly large opportunities that are on the horizon that we're competing for, I have to use that word, because we don't know that we're going to win them. But, it's pretty interesting to see how significant the interest level has become. And now when we go and travel to talk to existing clients and prospects, really, the only topic of conversation is, are we are we about to turn the value cycle? That is true whether they are prospects, whether they are existing clients, it's really not of a concern about what happened in the last 12 months, because it hasn't been good, what's happened in the last 12 months, so its, are we near the end? And of course we don't know the answer to that question. But, all I can say is the conversation is being had with a lot more frequency than it has over the past few years.
Mac Sykes -- Gabelli -- Analyst
Great, thank you.
Operator
[Operator Closing Remarks]
Duration: 19 minutes
Call participants:
Jessica R. Doran -- Chief Financial Officer & Treasurer
Richard S. Pzena -- Chairman, Chief Executive Officer & Co-Chief Investment Officer
Mac Sykes -- Gabelli -- Analyst
