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Pzena Investment Management Inc (NYSE:PZN)
Q4 2019 Earnings Call
Feb 5, 2020, 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 reports results for the Fourth Quarter and Full Year 2019 Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

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 fourth quarter and full year 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 and Co-Chief Investment Officer

Thanks, Jessica. I'm frequently asked, what do you think will be the trigger for growth strategies to finally relent and for value to take the lead? I have to admit, I really have no idea, but I do know that history and arithmetic say it will. I also don't know why March 10, 2000 turned out to be the moment, the internet bubble popped, simply was. I'm also often asked, why has value been such a poor strategy for the past decade? And to this question, my answer is entirely different. I believe the premise of the question is simply incorrect. Factors such as low price to earnings and low price to book may have had a difficult period, but value as a philosophy, as practiced by Pzena, has in fact had a pretty good 10-year around.

I think if I'd asked clients a decade ago on the heels of the global financial crisis, would you be satisfied with a compounded annual return of 9% to 11% for the coming decade, we would have had overwhelming acceptance. Now, after that is what occurred in our global and US strategies, clients were asking what's gone wrong? And our answer is nothing. Companies in our portfolios are delivering on our expectations. It's growth stocks and the market more broadly, however, that have had a truly spectacular decade, the proper question I think, is, will that phenomenon continue for the next decade? I find the premise hard to imagine.

Cycles are fascinating phenomena. We observe them through an historical lens, and definitely explain their frequency and duration based on the facts and circumstances after the fact. But to predict the turning points, to predict the timing of the next cycle, that's the stuff of fairy tales. What I am comfortable saying is that the opportunity set for a deep value investor like us, is roughly the same as it was 10 years ago. In fact, the universe of deep value stocks has consistently offered opportunities below 10 times earnings for the past 70 years, as they do today.

Meanwhile, the market darlings, the most expensive segment of stocks, using the US Universe to illustrate, has seen their PE multiple consistently expand over the last several decades, and now stand at or near all-time highs. Value investing as we practice it at Pzena Investment Management, is the process of studying businesses whose stocks have collapsed, gathering enough data to make a reasoned judgment about whether the history of the business and industry remains a useful guide for estimating future earnings and for investing, when the range of outcomes skews solidly in our favor.

We said at one of those moments, where a small number of market darlings have driven market returns to record levels and caused an enormous dispersion between value and growth strategies. And yet, we judge that with an opportunity set that looks as good or better than it did a decade ago, the odds of our deep value approach succeeding in the next 10 years seems like a much better place to be, and to bet that the winners of the past decade continue to defy analysis.

On the business side, we ended our fourth consecutive year with net inflows, and we closed 2019 with our assets under management at an all-time high of $41.2 billion. Inflows during the fourth quarter were driven by both new relationships and flows from our strong sub-advisory partnerships. And we continue to be encouraged by our robust pipeline of potential new business.

At the end of this year, we issued a new form of equity award to a number of the firm's key contributors. We strongly believe that broad equity ownership is an important part of our success. We also believe that the key leaders in the firm should have a sizable stake in the outcome, along with our founders. Accordingly, we made a one-time grant of what we call Class B1 shares to a handful of our future leaders. These shares are designed for employees to participate directly in the firm's dividend stream, and in the appreciation of the stock from the date of the grant.

So if an employee left the firm today, the units would have no value. The value accrues from increases in the firm's earnings and share price appreciation beyond where it is today. These one-time grants are designed as a substitute for future salary increases by the senior team and tie their remuneration more directly to the firm's results.

Furthermore, we are using these grants more broadly with the rest of our team as part of normal compensation and expect to continue to issue this form of equity as a part of the ongoing compensation program as we have been doing for years. The portion of the grants that were part of our normal compensation strategy, were not included in the non-recurring expense item that we specifically identified in our press release.

We think this is an efficient and equitable way to incent hard work, where the benefit happens only if we improve the results for all of our shareholders. We awarded these shares to those employees that have worked tirelessly to focus on results for our clients, and hopefully for growth to our business and our earnings.

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. Our earnings release discloses both GAAP and as adjusted financial results. Our results for this quarter are adjusted to exclude $22.7 million, a non-recurring compensation and benefit expenses. The vast majority of the expense is related to the issuance of certain unit based and other awards to a number of the firm's key contributors during the fourth quarter as Rich mentioned.

We also had some costs related to certain employee departures. Our results for the fourth quarter of last year are adjusted for certain tax receivable agreement items. For now I will focus on the as adjusted information. We reported as adjusted diluted earnings of $0.20 per share for the fourth quarter compared to diluted earnings of $0.19 per share last quarter and as adjusted diluted earnings of $0.16 per share for the fourth quarter of last year.

Revenues were $38.4 million for the quarter and as adjusted operating income was $17.5 million. Our as adjusted operating margin was 45.5% this quarter, decreasing from 46.3% last quarter, and from 51 -- excuse me, 52.1% in the fourth quarter of last year. We reported as adjusted diluted earnings of $0.73 per share for the full year of 2019 compared to diluted earnings of $0.77 per share for the full year of 2018. Revenues were $150.7 million for the year and as adjusted operating income was $68.4 million. Our as adjusted operating margin was 45.4% for the full year of 2019, decreasing from 51.3% for the full year of 2018.

Taking a closer look at our assets under management, we ended the quarter at an all-time high of $41.2 billion, up 15.1% from last quarter, which ended at $35.8 billion and up 23.4% from the fourth quarter of last year, which ended at $33.4 billion. The increase in assets under management from the third quarter of this year was driven by market appreciation of $4 billion and by net inflows of $1.4 billion. The increase from the fourth quarter of last year was driven by $7.1 billion in market appreciation and net inflows of $0.8 billion.

At December 31, 2019, our assets under management consisted of $16.4 billion in separately managed accounts, $22.4 billion in sub-advised accounts and $2.4 billion in our Pzena funds. Compared to last quarter, assets under management across all channels increased, with separately managed account assets, reflecting $1.7 billion in market appreciation and $1 billion in net inflows.

Sub-advised account assets reflecting $2.1 billion in market appreciation and $0.5 billion in net inflows and Pzena funds reflecting $0.2 billion in market appreciation, partially offset by $0.1 billion in net outflows. Average assets under management for the fourth quarter of 2019 were $38.1 billion, up 5.8% from last quarter and up 5.5% from the fourth quarter of last year. Revenues increased 3.5% from last quarter, and 5.5% from the fourth quarter of last year. The increase from last quarter and the year-ago period reflects an increase in average assets under management, partially offset by a decrease in performance fees recognized.

During the quarter, we did not recognize any performance fees, compared to $0.3 million recognized in each of the third quarter of this year and fourth quarter of last year. In addition, the increase in revenue for the quarter is partially offset by 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 fees, the investment strategy underperforms its relevant benchmark or allow for a performance fee if the strategy outperforms its benchmark.

During the fourth quarter of 2019, the third quarter of 2019 and the fourth quarter of 2018, we recognized a $0.8 million, a $0.5 million, and a $0.2 million reduction in base fees respectively. These fees are calculated quarterly and compare relative performance over a three-year measurement period. To the extent, the three-year performance records of these accounts fluctuate relative to their relevant benchmark, the amount of base fees recognized may vary.

Our weighted average fee rate was 40.4 basis points for the quarter, compared to 41.2 basis points last quarter, and 40.4 basis points for the fourth quarter of last year. Asset mix and the impact of swings and performance fees and fulcrum fees are all contributors to changes in our overall weighted average fee rates. Our weighted average fee rate for separately managed accounts was 54.1 basis points for the quarter, compared to 54.3 basis points last quarter, and 54.1 basis points for the fourth quarter of last year. The decrease from the last quarter was driven by shift in assets toward strategies that typically carry lower fee rates.

Our weighted average fee rates for sub-advised accounts was 27.3 basis points for the quarter, compared to 29.2 basis points last quarter and 28.9 basis points for the fourth quarter of last year. The decrease from last quarter and the fourth quarter of 2018 is driven by the impact of the fulcrum fees and decrease in performance fees. Additionally, the decrease reflects an increase in assets in larger client relationships that typically carry lower fee rates.

Our weighted average fee rates for Pzena funds was 69 basis points for the quarter, increasing from 68 basis points last quarter and from 64.8 basis points for the fourth quarter of last year. The increase from the last quarter and the fourth quarter of last year reflects the shift in assets to strategies and products that typically carry higher fee rates. Looking at operating expenses, our as adjusted compensation and benefits expense was $16.1 million for the quarter, compared to $16 million last quarter, and increasing from $13.9 million for the fourth quarter of last year. The increase from the fourth quarter of 2018 reflects increases in headcount and compensation.

G&A expenses were $4.8 million for the fourth quarter of 2019, compared to $3.9 million last quarter and $3.5 million for the fourth quarter of last year. The increase from last quarter and the year-ago period reflects increases in professional fees and data and systems expenses. The increase from the fourth quarter of last year also reflects an increase in occupancy costs.

Other income was $3.2 million for the quarter, driven primarily by the performance of our investments. As adjusted effective rates for our unincorporated and other business taxes of 3.3% this quarter, compared to a negative 5.1% last quarter, and 4.8% in the fourth quarter of last year. The negative effective tax rate last quarter reflects the benefit associated with the reversal of uncertain tax position liabilities and interest 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 as adjusted effective tax rate for our corporate income taxes, ex-UBT and other business taxes was 27.6% this quarter, compared to 24.4% last quarter and 26.3% for the fourth quarter of last year. We expect this rate excluding any adjustments to our deferred tax asset to be between 23% and 25% on an ongoing basis.

The allocation to the non-public members of our operating company was approximately 74.6% of the operating company's net income for the fourth quarter of 2019, compared to 74.5% last quarter, and 75.3% for the fourth 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 114,000 shares of Class A common stock and Class B units for $0.9 million. At December 31, there was approximately $18.8 million remaining in the repurchase program. At quarter end, our financial position remains strong, with $52.5 million in cash and cash equivalents as well as $29.1 million in short-term investments. We declared a $0.46 per share year end dividend last night.

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

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions].

[Operator Closing Remarks]

Duration: 18 minutes

Call participants:

Jessica R. Doran -- Chief Financial Officer and Treasurer

Richard S. Pzena -- Chairman, Chief Executive Officer and Co-Chief Investment Officer

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