Affiliated Managers Group Inc (AMG) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Affiliated Managers Group second quarter conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (CALLER INSTRUCTIONS) As a reminder, this conference is being recorded today, Wednesday, July 23, 2003. I would now like to turn the conference over to Mr. John McNamara of FRB Trevor Shandwick.

Thanks for joining Affiliated Managers Group this morning to discuss results for the second-quarter and first half of 2003. By now you should have received the earnings release, however, if anyone still needs a copy, please call my office at area code 212-445-8435 and we will fax you a copy immediately following the conference call. In this conference call, certain matters discussed will constitute forward-looking statements. Actual results could differ materially from those projected due to a number of factors including, but not limited to those referenced in the Company's Form 10-K and other periodic SEC filings. AMG will provide on it's website a replay of the call and a copy or announcement of this quarter's results as well as reconciliation of any non-GAAP financial projections to the most directly comparable financial measures. You can access this information at www.AMG.com.

With us on the line from AMG this morning to discuss the Company's results for the quarter are Bill Nutt, Chairman and Chief Executive Officer, Sean Healey, President and Chief Operating Officer, Darrell Crate, Executive Vice President and Chief Financial Officer, and Nate Dalton, Executive Vice President in charge of affiliate development. Bill Nutt will begin the call with an overview of AMG's results and highlights for the quarter and year-to-date. Mr. Healey will then provide additional details about AMG's operating results, and finally Mr. Crate will discuss AMG's financials. We will then open up the line for questions. And now I will turn the call over to Bill Nutt.

Thank you, John. Good morning, everyone and thank you for joining us on this call. We are pleased to report today our operating and financial results for this quarter when, in a period of improving equity markets, our cash earnings-per-share increased to $1.16. In past calls, we have discussed the extent to which the diversity of our affiliate investment styles and distribution channels has helped our earnings remain stable, even in very difficult equity markets. Now, having had the benefit of diversity in declining markets and with approximately 95 percent of our EBITDA generated by affiliates equity oriented products, AMG is particularly well-positioned to benefit from improving equity markets.

In addition to broadly benefiting from market appreciation and rising equity markets, we will also realize growth from increased client cash flows as investors reallocate back into equity products from various fixed income and money market instruments. While we recognized only modest earnings growth from client flows in this past quarter, we did see signs that this shift in flows is underway. And we believe both institutional and retail investors will increasingly return to equities in this quarter and throughout the remainder of this year.

As you would expect, given the tremendous market volatility of the past 18 months, M&A activity in the asset management industry has dropped significantly. When facing a difficult investment and operating environment, the principles of midsize firms understandably focused on their investment performance and client service. Now, with an improving market, many of these firms can again devote attention to their succession planning issues. Obviously the need by principles of midsize firms who are reaching retirement age to deal with these issues has not gone away.

As you know, our approach is to develop relationships over time, and we are actively calling on prospects even during the difficult equity environment of the past several years. Now we are in a very good position to capitalize on the relationships we have developed as firms seek to take these discussions to a more active level. These discussions inherently take time, and thus it is hard to predict the precise timing of new investments. Overall, however, we are confident of our ability to continue to add materially to our earnings growth through accretive new investments. With that, I will turn to Sean to discuss the operating results for the quarter in greater detail.

Good morning, Everyone. As Bill noted, our affiliates produced solid results in the second quarter as they all benefited from the improvements in the equity markets. With respect to client cash flows, as you saw in the release a favorable mix of flows to affiliates with higher margin products resulted in a small increase in annualized EBITDA contribution of approximately $200,000 despite net outflows from directly managed assets of 184 million per quarter. In general, affiliate performance mirrored many of the trends in the market and within the industry as both our valued and growth oriented affiliates produced solid investment performance during a period of broad improvement in the equity markets. Among our larger affiliates by EBITDA contribution, value oriented Third Avenue had an especially strong quarter, as did value oriented Skyline. Other top performers this quarter included growth oriented managers Frontier and Essex.

Taking a closer look at our affiliates performance within each of our principle distribution channels, starting with the institutional channels, our affiliates generated 54 million in net flows. In addition to the positive net flows into its Mutual Fund products, Friess associates produced strong institutional flows in the quarter. David Hamilton, Systematic, and Frontier all generated solid net flows as well. In general, our affiliates began to see an increase in both search activity and funding commitments in the latter half of the quarter, although much of this is not reflected in the second quarter flow numbers.

For example, we had several significant new mandates fund already in the first few weeks of July. In the High Net Worth channel, while flows in the investment counseling area remains stable, we experienced outflows in the broker sold area and overall net flows in this channel were -425 million. While most of the outflows were concentrated in one product, in general, as Bill suggested, individual investors have been slow to reallocate to equities from fixed-income investments. Although there are now signs that this trend is changing, and net flows into equity products are picking up, it did clearly impact our affiliates in this quarter.

With respect to the mutual fund channel, we had net inflows of 192 million. Most affiliates had positive flows including Third Avenue, Skyline, Friess and Managers. Tweedy, Browne, was the exception with slightly negative flows. Again we anticipate that mutual fund flows to equities will increase in the second half of the year. And with over 80 percent of our EBITDA in the mutual fund channel generated by funds that are rated four or five stars by Morningstar, we are confident that we will see more of our shares of these flows going forward.

Turning briefly to our affiliate development activities during the quarter, our initiatives in the broker sold channel continued to show progress. Our separate account distribution platform, Portfolio Services Group, added another sponsor to the growing list of brokerage firms offering our multi-affiliate product. PSG is now also distributing single manager separate account products for two more affiliates, Renaissance and Systematic, bringing the total number of participating affiliates to five.

In addition, the rollout of our back office operations platform, Advantage Outsourcing Solutions, is proceeding well as AOS signed up two client during the quarter, including one affiliate. AOS is also in discussions with additional affiliates and third party asset managers to provide similar services. With that, I will turn it over to Darryl for a discussion of our financials.

Thanks, Sean. Good morning, everyone. As you saw in the release, we reported cash EPS of $1.16 for the second-quarter, one penny above First Calls consensus estimate. While we benefited from the gains in the equity markets this quarter, the variation in billing methods among our affiliates meant that this quarter's earnings did not fully capture the benefit of market growth. We will realize this full benefit for the second quarter's growth in assets under management in the second half of the year.

We reported GAAP earnings-per-share for the quarter of 64 cents. EBITDA was 34.7 million for the quarter. Quarter to quarter, our margin of EBITDA contribution to end of period assets under management declined from 22 basis points in the first quarter to 20.5 basis points in the second-quarter, primarily as a result of the 9 billion dollar increase in our assets under management during this quarter. We believe a margin of about 21.2 basis points is appropriate for the remainder of the year as we realize the full quarter benefit of these assets.

Holding company expenses were $5 million for the quarter. As I indicated last quarter, we anticipate that holding company expenses for the year will be just under $20 million. With regard to taxes, we accrued a rate of 40 percent through the second quarter. As we forecasted, this rate has increased to 41 percent in the third quarter and will remain at that level for the fourth quarter as well. Looking ahead to 2004, our effective tax rate will vary between 40 and 41 percent, depending upon the relative growth of our affiliates. Our cash tax rate was 7.3 percent for the quarter, a decrease of 2.2 percent from the first quarter as growth in our operating income was more than offset by a full quarter's benefit of the tax shield provided by the floating-rate convertible securities we issued at the beginning of the year.

Total deferred taxes were 7.5 million in the second-quarter, of which 5.9 million related to intangibles. While we expect none of these deferred taxes to reverse, we only add back the 5.9 million related to intangibles to cash earnings, that these will not reverse but for impairment or sale. However I would like to note that the additional $1.5 million was cash received by A&J. Amortization for the quarter was 4 million dollars. Depreciation for the quarter was 1.6 million, of which 1.1 million was attributable to affiliate depreciation. As you recall, affiliate depreciation is a non-cash charge we include in cash net income as replenishment of these depreciated assets is paid by affiliates and not AMG shareholders.

Interest expense was 6 million for the second-quarter and we expect it to remain at this level for the rest of the year. Now, turning to the balance sheet, as of the end of the second-quarter, we had a $250 million available under our credit facility and cash on our balance sheet of 200 million available capacity. Stockholders equity is 572 million. While we are not providing specific guidance on individual analysts estimates, we would like to provide guidance on earnings for the remainder of the year. If market were to remain flat from today to the end of the year, we would expect earnings to be in the range of $4.70 to $4.75 for 2003.

This range does not include additional earnings from performance fees or accretion from investments in new affiliates. Of course these estimates are based on current expectations about our affiliate growth rates, mix and affiliate contribution, and the absence of substantial changes in the equity market. Now we would be happy to answer any questions.

Thank you, sir. (CALLER INSTRUCTIONS) Mark Constant of Lehman Brothers.

A couple of things I wanted to clarify. It looked like the Lion balance came down about 4 or 5 million. Did you purchase more of that this quarter?

Yes, at the beginning of the quarter there was a $4 or $5 million of Lions that we were able to attractively repurchase.

And thinking about that the stock now having recovered at least the bulk of its irrational decline, the likelihood of that being put to you is obviously lesser next spring, and if we're sitting in a situation next spring with that put date either having passed already or the convert being significantly on the money, how much you think differently about your net deposition, and is there something else you might do in terms of paying down that or another convertible instrument?

I think with the Lions in particular there were some opportunities in the market that we were able to take advantage of and that is what guided us to the Lions. But as always, we're husbanding our cash and making sure we have maximum capacity to continue to execute our strategy.

But with the idea of the floating-rate revolver effectively being to refund that prefund that rather and still leave the revolver unused, would you consider yourself overly liquid if that weren't put?

As you can imagine, if the interest rates where they are now, having those Lions outstanding at 50 basis points is clearly attractive and the cash that we keep on the balance sheet is -- we're earning rates that are higher than the 50 basis points. But of course, and I think as Bill and Sean mentioned, as we look at our new investment prospects, we feel very good about how that is developing. And of course my job as the CFO is to make sure that as we come out of this period, which has been challenging the last couple of years for the equity market is that we are very liquid and we are in a position to seize all the new investment opportunities that present themselves.

So we should really look for investments and repurchases as opposed to convert buyback?

That is where the money is best spent.

And on the cash subject, one last thing, it looked like the decline in the net debt was about 25, $26 million of free cash flow -- actually came down about 34 million, 223 million or so. Is that working capital more cash at the holding company this quarter? Is this quarter more or less indicative of the go forward in the last quarter?

I think this is a typical quarter. You see the cash earnings of just about 26 million. Of course, we have a couple million dollars more for some other non-cash items that are out there, so about 27, $28 million is the cash that we will have out of this quarter going forward, adding to total balances.

Okay, and I assume the increase in net interest expense this quarter was really just the effect of having the flutter for the four quarters, right?

Yes, exactly.

Henry McVey of Morgan Stanley.

Just a couple questions. One, could you just on the high net worth you said there were some one timers, but the year-to-date outflows are 825, so can you just characterize in a little more detail what is going on there? Second was, you used to talk more about managers funds in the context of the overall firm. We have not heard much about that; I'm interested in your views there. And then third, just share repurchases and performance fees, what were the totals for the quarter if there were?

The High Net channel, as you know, includes investment counseling, which is ultra High Net Worth and is exhibited as you would expect. Stability throughout the declining market period. Quarter over quarter you may have something happening, but in general that has been a very stable and continues to be a very stable element of the High Net Worth business that we have. The other part of High Net Worth is for the so-called affluent investor through the broker sold channel, and that business exhibits historically more volatility. In good periods, it can generate a lot of new assets quickly and you saw Rorer (ph) for example, exhibit terrific growth in 99, 2000, and even a bit beyond.

In periods where one style or one class, meaning equity products, continue to be relatively out of favor, you can see volatility the other way, which we have seen. The outflows are at a level which, for the Rorer product, which has more than 7 billion in the product, they are at a level which is nobody loves it, but their long term performance is fine. And this quarter over quarter kind of issues which, as we suggested in the introductory remarks, we think are beginning to change, both individually in that channel for Rorer, and then on an overall basis as investors continue to reallocate from fixed income back into equities. We have seen in the industry, and then with certain affiliates as well, less of that or more delay in the reallocation back to equities than we would have anticipated. Even in the institutional channel, so that is what is going on there. And we think that going forward to the extent equity markets continue to be stable or improve, that you'll see flows in that channel in both areas of that channel return to positive position. The managers funds --

Can I just clarify one thing? You said in your comments it was largely related to one fund this quarter. Was that the same thing last quarter? I am just trying to identify trends so we can follow it.

Yes. The managers funds is doing just great. It is a business that obviously, given the difficult markets, it was relatively difficult both to continue to show strong internal growth in the existing business, that is a manager of managers business, as well as in the business which involves serving as a platform for institutionally-oriented affiliates to roll out their own mutual funds, which we call the Managers AMG Funds family. Flows have been positive, consistently again in this quarter. Performance has been great, and we are pleased with how that firm is doing. The pace of new mutual funds, new affiliate mutual funds has slowed, but that is because we have an A put (ph) 5 or 6 already set up and that is probably where we will be for a little while. And more of the affiliate development activity has been in penetrating the broker sold channel, which, while we just said it has been through a difficult period, we see that channel as being an enormous channel, one that, as I said, can drive tremendous growth in period's where flows are headed in the right direction. And we want to be and we are, both with the affiliates like Rorer that are already strongly in that channel as well as through PSG, other affiliates getting into the channel. We think we're well-positioned and leveraged for increases in the equity flows.

Did total assets (indiscernible) managers funds at this point?

Under 4 billion, just under 4 billion. And in regard to performance fees and stock repurchases, performance fees had very little contribution this quarter, a little over $100,000 of EBITDA was from performance fees. And likewise, stock repurchases did not dominate the quarter. We made a few purchases at the beginning of Q2, but after repurchasing about $35 million of stock with the offering, we thought it best to preserve our capacity.

Just looking at the over cash flow actually, we actually had issuance of equity securities 4.7, is that right?

Yes, and at the end of the quarter we repurchased some of the points from three affiliates as part of the normal point transition process.

Bill Katz with Putnam Lovell.

I'm still wondering if you could talk a little bit about your target leverage ratio little bit? Of the $200 million of cash and cash equivalents, do we need to deduct anything for the holding companies perspective from liquidity, or was that a net number? The second question on the target ratio, sort of pointed to a 1.5 to 2.5 times ratio, but recently indicated you would be willing to go north of that if the right deal came along. So I was wondering if you could talk to that and maybe as a follow-on, maybe quantify your statement that you're seeing more deal chatter. What type of institutions? Are these more sizable transactions and maybe by product or by size? That would be helpful, thanks.

That is a great question and you have got it just right with regard to capital structure which is our target ratios is 1.5 to 2.5 times cash flow, but that said, and recently we had meetings with the rating agencies and other folks and it would seem that even going up towards three times wouldn't be inappropriate for the right deals, if it were to come along. And given the business and the cash generating power, that is just right. And with regard to the 200 million we have outstanding, there is probably about 30 to $40 million of that is cash that is at the affiliates that they have not distributed to their partners. So the rest of it could certainly be used for making new investments or repurchasing stock or buying down debt. And Bill, I guess I would say with regard to the pipeline, particularly in the two quarters just past, the first quarter of this year and the fourth quarter of last year, really since our investment in Third Avenue investments in the fall of last year, we have been active in calling upon prospects, but I think it is fair to say in these difficult markets, they have focused most upon retention of their investment performance record, their style, expanding that, and also client service, not on particularly for those who are succession planning oriented, not on the necessity to do that. With the improvement in the equity environment, they are much more willing to have those discussions go forward, and by that I mean to share not only their investment performance numbers, but their financial performance numbers, their client lists and all of those things that are necessary for us to do the due diligence to decide whether we would wish to proceed. That has become much more active in the second-quarter and continuing into this quarter. And there are as well some divestiture activities, things that were not completed in the first or second quarter that continue to remain active, so we feel quite good about the quality of the pipeline.

Just a follow-up on that, in recent meetings we had you suggested you prefer to go solo on the wealth transfer or succession issue rather than divestiture. If you were to lay some odds out over the next couple orders where you might see an affiliation would be more, the former will be more of a pickup of a divestiture elsewhere?

Bill, we are indifferent between the form of the investment, so if we gave you that impression, then I would say we should correct it now. We focus on the quality of the firm, quality of the management partners, their prospects for growth going forward, the stability and diversity of their business mix, and we see terrific firms in both categories. By far the most common opportunity to invest in a very attractive midsize firm is in the succession-oriented investments in independent firms. There are just far fewer high-quality sufficiently entrepreneurial subsidiaries which are available in divestiture investments. So you'll see more of a focus going forward in our calling effort clearly has more of a focus on the succession-oriented transactions, but there are still some really good ones in the other category and we are, as Bill said, we are actively looking at both.

And I apologize, I joined the call a tad late. You may have covered this. On the institutional channel, what are the products that seemingly are picking up speed? Is it on the growth side, is it the value side? And is there any way to sort of quantify the pipeline coming into the quarter?

I would say in the quarter we continued to see flows in value and have begun to see good flows in growth, so that is the way I would characterize the change during the quarter. In terms of the pipeline going into the next quarter, we feel very good about it. Sean did mention there are a couple hundred million of mandates that actually funded in the past couple of weeks of this quarter, and that is not including committed unfunded mandates, which we also see a number, so I feel very good about institutional flows going into this quarter.

Michael Freudenstein with J.P. Morgan Securities.

I'm just wondering if you could comment on the competitive landscape for acquisitions. Obviously the overall M&A market in the money management world is heating up a bit and I realize that not all of those have gone would necessarily be in your sweet spot, but maybe comment a bit on the competitive landscape for acquisitions and affiliates?

I think it is fair to say, Mike, and I will start this and maybe Sean will add, we feel very good about our position right now. There are fewer, frankly, buyers for asset management firms today than there were let's say 1.5 or two years ago. Frankly also the performance of our affiliates during the difficult equity markets of the last 2.5 years did come out very well both in terms of their investment performance, in terms of their client retention, in terms of the people part of their business, so we feel they are a great reference for our structure and everyone understood how well it worked in rising markets, but I think a pleasant surprise is how well it has worked in declining markets as well. Some of the best firms have seen that, so we feel pretty good about that. In fact, the inbound calling is a consequence of that is a part of why the pipeline is so good at this point. So from a competitive standpoint, we feel restructure is probably one of the best references that we can have.

I think the only thing to add to that is that while we certainly do expect, as you suggest, more overall activity in the industry, remember the niche that we focus on is a pretty big niche and a very attractive niche, are these high-quality midsize firms. And in that part of the market we feel extremely confident about our competitive position, far fewer competitors either are still around or are focused on investing in this part of the universe. So that element I think should be borne in mind. We are not looking at large public companies. We're looking at very high-quality mid-sized boutiques.

And just as a follow-up to an earlier question, with respect to lift outs versus your more traditional affiliate-type acquisitions, how should we get comfortable? Where we to see an acquisition that is to say less traditional than what you have typically done? Tell us how we can get comfortable if you have had experience with that and what sort of different challenges might that kind of affiliates present to you versus the more traditional type?

Over the period of the last decade now that we have been doing these kinds of investments, three of our investments have been lift outs. First Quadrant, for example, was a wholly-owned subsidiary of Halogens (ph) insurance company which was in turn a wholly-owned subsidiary of Xerox. Skyline was a division of Mezzero (ph) so those are two examples. Those two firms having done quite well. Our experience has been long-standing then in doing these types of transactions. The difficulty is generally before the transaction closes, and that is that you are dealing essentially with a melding of three interests, that of the selling entity, which is not going to be involved going forward, a management team, which generally has produced the investment results, driven the business, but doesn't have any equity, and happily our structure works very well because in many instances they are getting equity for the first time, in AMG. And what we have to be sure is that the motivation, the principles of this division or subsidiary remain just as strong or indeed that we can incant them to do even better in our structure, and that has clearly been the case with the two that I mentioned, Skyline in Chicago and First Quadrant in Pasadena.

Mark Lane of William Blair & Co.

First question, can you just remind us how the billing works, how much you bill in advance? As for the mutual funds, is daily asset under management, what percentage of assets are billed in advance?

A little more than one-quarter of the business is based on average assets. About 40 percent, maybe a little bit more is based on arrears. And then remaining what is approximately one-third is based on beginning of period.

Beginning of quarter?

Yes.

And then in the first half, in terms of repurchases from existing affiliates, you have stated that maximum use of cash would be say 20 to $25 million normal flow. How much was spent in the first half relative to what was potentially portable?

I think the characterization when I said 25 or a bit more percent of cash flow, that is a conservative estimate, and it is based upon what folks could contractually put back to us. And again, thinking about that number in this quarter, we have repurchased about $4 million of -- we've repurchased about $4 million of equity and another $1.5 million in the first quarter.

What was eligible?

I would say probably $12 million. They were running at about half if not less.

Nate, what were flows into the MAP product in the second quarter?

We haven't been breaking out the flows by specific products in PSG, but broadly to characterize PSG as a whole, and remember we also added our third MAP sponsor and the biggest one being Prudential during this quarter. PSG is up to about 200 million as a group.

And that includes the MAP product?

That includes the MAP product and also the single manager products, of which there were two coming into the quarter and -- well (indiscernible) three coming into the quarter and signed up an additional two during the quarter.

And the $200 million is all AMG affiliates?

Yes.

(CALLER INSTRUCTIONS) Sean Maher of Morgan Stanley.

Two quick questions. One, in your discussions with asset managers, are they bringing up costs and regulation that in the asset management industry as one of the reasons they might want to look to sell the Company. And then second, are you get any traction in your managed account technology platform that you have at Rorer? Has that gained any sponsors or do you have any RFPs?

Sure. Let me start with the cost of the regulation and others and Nate can speak to the AOS question. Broadly speaking, no. Margin pressure and even margin pressure from some of the newer regulatory issues that are hitting both separate account channel and, as you have seen, a great deal of Sarbanes-Oxley rules are now being applied in mutual funds area and there's more regulation there and more cost. But broadly speaking, no. That is certainly not the reason. Most of the firms in which we invest are comparatively high margin, smaller boutique type firms, and they outsource this. One of the things that we have done recently is to provide for our affiliates compliance function if they wish to do so. But that is not a motivation for doing the transaction. It is really succession planning, being certain that they are providing to the next generation the same kind of economic and governance opportunities that the founder owners had. So that is driving it, not margin pressure.

Well, just again a little bit of background. AOS is a platform which we are leveraging what we built at one of our affiliates, Rorer, and it is being marketed to other asset management firms, affiliates and not affiliates. So it is a platform that will be used by other asset management firms to outsource their back office. And principally in this kind of rap or broker sold area, are (indiscernible) attractive to firms in those channels. Launch beginning the quarter. Had an excellent quarter. As I think Bill mentioned or Sean mentioned earlier, signed up first two clients, one an affiliate, one an unaffiliated firm. In terms of levels of interest and levels of conversations with affiliates, it is very high and this is something where a number of them could migrate parts of their back offices to this. In terms of interest from outside firms, also very high. And that is a somewhat different proposition. That is where we would be offering the service and creating additional margin for Rorer and for RMG. So broadly (indiscernible) has been fantastic.

And how you go about -- do you have a sales force that is going to nonaffiliated companies to explain the benefits of the platform or, or how are they just hearing about it through word-of-mouth?

Yes, right now it has been the vast majority has been inbound indications of interest from other firms. We have obviously done a more complete job selling internally to other affiliates than we have outside, and we have not gone outside and hired a big sales force or anything like that. Most of the interest from outside has literally come from word-of-mouth and we've gotten relatively good press coverage within the industry and whatnot, that is all been inbound, but tremendous level of receptivity.

Is there anyone else in the market with a similar product selling it to third parties?

With the sales head-on I would of course say no, I don't think there is. And part of it is I don't think anyone else has come at this from the perspective of the asset management firm. I do think there are other firms in the market or organizations selling various components of it, and most of them are coming at it from other perspectives. Again, I just want to be clear, this is something that we really had this asset at an affiliate, Rorer. We are just leveraging it and found that we can leverage this for their benefit and ours. It is not something where we are planning to go out nor have we go out and spent a bunch of money building a platform or hiring a market for us or anything like that.

Gentleman, there are no further questions at this time. Please continue.

Thank you once again for joining us this morning. In sum, we are pleased with our affiliates performance during this quarter. In looking ahead, our broad participation in equity oriented investments leaves us very well positioned for continued growth. Thank you very much.

Thank you. Ladies and gentlemen, this concludes today's Affiliated Managers Group second-quarter conference call. If you would like to listen to a replay of today's conference, please dial 800-405-2236 or 303-590-3000 followed by access number 544707. We thank you for participating. You may now disconnect.

(CONFERENCE CALL CONCLUDED)