SEI Investments Co (SEIC) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the SEI second-quarter 2016 earnings call.

(Operator Instructions)

The conference call is being recorded. I will now turn the meeting over to your host, Chairman and CEO, Al West. Please go ahead, sir.

Thank you and welcome, everyone. All of our segment leaders except Wayne Withrow, Leader of the Advisor segment, are on the call; as well as Dennis McGonigle, SEI's CFO; and Kathy Heilig, SEI's Controller.

I will start my recap by recapping the second quarter of 2016. I will then turn it over to Dennis to cover LSV and the investment and new business segment. After that each of the business segment leaders will comment on the results of their segments. Dennis will fill in for Wayne. Then, finally, Kathy Heilig will provide you with some important Companywide statistics.

As usual, we will field questions at the end of each report. So let me start with the second quarter of 2016. Second-quarter earnings decreased by 6% from a year ago. Diluted earnings per share for the second quarter of $0.49 represents a 4% decrease from the $0.51 reported for the second quarter of 2015.

We also reported a 2% increase in revenue from second quarter 2015 to second quarter of 2016. Plus, during the second quarter of 2016, SEI's non-cash asset balances under management increased by $5 billion while LSV assets were flat.

In addition during the second quarter 2016, we repurchased approximately 1.5 million shares of SEI stock at an average price of $48.57 per share. That translates to over $73 million in stock repurchases during the quarter. Finally, during the second quarter, we capitalized approximately $10.1 million of new technology development, of which approximately $8.5 million was for SEI wealth management development, and we amortized approximately $11.1 million of previously capitalized development.

Now turning to sales, our net new recurring revenue sales during the quarter were strong. Of the $29.1 million of net new sales events we generated $23.4 million are recurring revenues. Each of the segment heads will address their second quarter sales activity.

We're very excited about our recent wins of large clients and expansion of the markets we can now serve, all brought about by the investments we have made to date. But as we discussed in January, we need to increase our R&D spending through 2017. This need is primarily caused by growth. Growth evidenced by the large new clients in multiple markets.

All in all our R&D spending which, for sometime, has run at 8% of revenues, ran at 9% of revenues for the first and second quarter of 2016 and will grow to approximately 12% of revenues by the end of this year. It's will run at that range during the year 2017.

Post 2017, we will be in a position to drop the R&D rate back to 8% to 10% of revenues, the rate range we have historically targeted. The increases R&D investments, along with other anticipated expense increases, will increase our total expenses by 4% to 6% in each of the next two quarters, then we will increase at a lower more normal rate in 2017.

The investment in banking, our largest investment, is focused on preparing our solutions for Regions Bank and Wells Fargo bank and the markets they represent. They are marquee clients in both the large business as a service and large software as a service markets and meeting their needs will position us to win a lot more business in these large markets. Joe Ujobai will elaborate on the importance of these investments.

Now in the advisor business we are investing in the migration of their 7,000 clients to SWP. The have been successful in migrating a number of larger clients to SWP and are honing their ability to handle mass client migrations. Also, they are adding to the front end capabilities of SWP. Dennis, who is filling in for Wayne, will cover the advisor segment.

In the investment manager segment, we've had a number of large sales. One which occurred in the second quarter. These wins require large conversion projects causing us to spend ahead of the revenue we receive. Also, investments are being made into new solutions. Steve Meyer will cover these investments.

In the institutional investor segment, our investments are aimed at our continued entry into the [defying] contribution marketplace and expanding our worldwide footprint to deliver fiduciary management services. Paul Klauder will cover these investments.

We have big opportunities in all our businesses that make these investments the wise thing to do for long-term growth. As always, we will aggressively manage total Company expenses while we make the necessary investments.

And this concludes my remarks. So, I will now ask Dennis to give you an update on LSV, the investment in new business segment, and the advisory segment. I will then turn it over to the other business segments. Dennis?

Thanks, Al. Good afternoon, everyone. I will cover the second quarter results for the investments in new business segment, discuss the results for LSV asset management, and cover our investment advisor segment in Wayne's absence.

During the first quarter of 2016, the investments in new business segment continued its focus on the ultra high net worth investor segment, through our private wealth management group and the operational development and testing of web-based digital advice offering. During the quarter, the investments in new business segment incurred a loss of $3.8 million, which was flat to the first quarter of 2016. There's been no material change in this segment.

Regarding LSV, our earnings from LSV represent our approximate 39% ownership interest during the second quarter. LSV contributed $30.3 million in income to SEI during the quarter. This compares to a $29.2 million contribution for the first quarter 2016.

Assets at LSV were essentially flat for the quarter, LSV did experience net positive cash flow, which was offset by negative market valuations. Revenue at LSV for the quarter was approximately $95.8 [billion] of which approximately 1% was performance-fee related.

Before I move on to the advisor segment, we will be happy to take any questions you may have at this point.

(Operator Instructions)

Glenn Greene, Oppenheimer.

Hey Dennis. I will asked the questions because we obviously had the fourth-quarter confusion on the increased expenses. This relates to Al's comment of total expenses being up 4% to 6% in each of the next two quarters. Can we get very granular and specific on that? Are we talking 4% to 6% increase from the $250 million of expense this quarter or relative to, call it, the $242 million in the third quarter of last year? How do we reference that?

[Just as the] second quarter of 2016 expenses. So sequential to this quarter.

And then do we go up another 4% to 6% in the fourth quarter from that higher-level?

Yes, and then we'll be more normal as we go to next year.

So we are talking north of $260 million of expenses in the third quarter and north of $270 million in the fourth quarter?

Yes, roughly in that range.

Okay. Thank you.

You're welcome.

Robert Lee, KBW.

Maybe just following up to that, the comment about the increased R&D spend going up to 12%. Obviously that's incorporated in some of your expense guidance here, but maybe get a sense of how much you expect of that's going to be capitalized this year and into next year, versus flow through the P&L in the short-term.

Generally over the course of the past few years now we have been bringing down the percentage of capitalization across our technology development space. So I would say it will continue to be on the lower end of the range, probably in the 45% to 50% area.

So you saw capitalization tick-up first and second quarter. A little bit of that was (inaudible) pure related -- it didn't really tick up a whole lot. But it will tick-up over the next couple of quarters and into next year.

Okay, and I guess we will go through this in the individual segments, but is this going to be -- mainly continue to be dominant, I assume, in the private bank segment and then maybe a little bit spun over into -- the next segment you will talk about, Dennis, investment advisors?

It's definitely in private banking because of the technology related investments associated with the two large markets that Joe is attacking and he will spend more time on that. But also it is in the investment managers services segment. Because some of the expenses are really operational in nature as Steve builds out capacity to absorb (inaudible) some of the new business wins he has incurred. So, as I'd say, it is more impactful to those two segments, a little bit less though to advisor and certainly a little bit less though to institutional.

Great. Thank you.

Chris Donat, Sandler O'Neill.

Dennis, just wanted to ask one more on the expenses here. This is going to be more in the category of consulting and temporary professional stuff and then also some other technology? Like you said, it's going to go away or decrease after 2017, right? It's not --?

Right, so it's more in that consoling line item and in the personnel line item. So, on the technology side of the development side, it would be more in that consoling line item. Although we will have some pickup in direct personnel because we're trying to hire some talent there.

And in Steve's market it's probably more on personnel side, because he is adding employees to increase his capacity. And both of them will go further into it when they talk about their segments.

Okay.

Chris Shutler, William Blair.

On the expenses I just wanted to make sure that we have this all straight. So Q3 you are essentially saying 4% to 6% growth off of the $250 million so that would be $260 million to $265 million in Q3 and then 4% to 6% again in Q4 which would be $270 million to $281 million, is that correct?

Yes.

Okay. And then holding that same level, whatever the Q4 level is, holding that reasonably consistent over the course of 2017.

Correct.

Okay. And then just quickly on LSV, Dennis, can you just give us the net flow number specifically for the quarter.

They have positive cash flows of about $600 million.

Okay. Thank you.

Patrick O'Shaughnessy, Raymond James.

Question on LSV. So we saw revenues ticked up a little bit but the average AUM was up pretty substantially quarter over quarter and as we're calculating it the average fee dipped a little bit and it's been in decline the last few quarters. Are they seeing any material pricing pressure or is that pretty much just noise?

I would say generally the market in the investment management space is competitive from a pricing perspective. So they are not immune to overall trends in the industry.

I would say relative to their more recent quarterly performance, I would say it is noise. They do a good job of holding the line on their fees and I would say protective in the sales process of their fees. But, generally speaking the whole industry is under fee pressure.

And then to circle back on the expense question. The increase in expenses in the back half of this year that you are talking about, are those increases that you knew about as you were heading into this year? Or are those additional investments that really you became aware of the need for as the year progressed?

Two things. One, certainly the costs associated with the Wells Fargo event and our need to deliver as a result of software as a service solution. We have been talking about for in a year now, since we announced that event last year. So those costs associated with that activity are not new.

I would say certainly there's some newness in the work we're doing for that large platform as a service market, but it's principally the changing dynamics that are occurring in the front office technology space or application space, that not only our clients are looking for, but the market in general is looking for. And us making the decision and the commitment to invest more heavily in that front office space, and Joe can give you a little more color when he talks about what w mean by front office applications.

In the operational cost side, it's really a result of growth and absorption of growth and it's really a timing issue of expenses ahead of revenue matriculating when the clients go live. That's more, I'll tell you, having more of an impact on Steve's business in the -- over the next couple of quarters.

So while we're talking about expenses, we also do expect modest revenue growth through the third quarter and then I'd say a little bit stronger revenue growth in the fourth quarter as we matriculate the new revenue associated with this sales activity. Hopefully that answers it for you, Patrick.

That is helpful. Thank you.

We do have a follow-up question. Chris Shutler, William Blair.

I just want to follow up on this one more time. How much of this incremental expense in the back half is permanent versus temporary?

Off the top -- roughly I would say that the temporary side is larger because that's more on the development side versus the operational capacity increments. So it's definitely more on the temporary side, if you well. And that's where Al talked about the R&D -- overall R&D percentage will drop in a 3 percentage points to 4 percentage points year to year, as we get out of 2017. It's indicative of that.

Okay. Thanks.

We have no additional questions, please continue.

Okay. During the second quarter -- and I'll cover the advisor segment. During the second quarter of 2016, we posted good growth in our traditional business at the same time we continued significant progress towards a transformation of our business onto one supported by the SEI wealth platform and the growth opportunities it holds for us in the future.

Assets under management were $53.7 billion at June 30, a 2.4% increase for March 31. During the quarter, we had $770 million of positive net cash flow.

Revenues for the quarter were $81.9 million, this compares to $76.7 million for the first quarter a 6.8% increase. Contribution to this increase were a net positive cash flow, positive market returns, improved yields on money market funds, and a shift from lower revenue liquidity products to higher revenue equity portfolios. Expenses for the quarter were flat compared to the first quarter as expense management remained a focus of the unit.

On the new business front, we signed 128 new advisers, while somewhat lower than our recent quarterly totals, we view this as just a timing issue. Our signings for the first six months of this year approximate the signings from the first six months of last year and our pipeline of prospects remains very strong.

Moving on to the status of the SEI wealth platform. We completed another client migration at the end of April and now have about $10.5 billion in assets on the platforms. We plan to migrate another $5 billion in assets in September of this year and expect to accelerate the pace of migrations next year shooting to complete all of this by the end of 2018.

In summary, we continue to recruit new advisers and to gather net positive cash flow during the quarter. Our second-quarter client migration to the SEI wealth platform was a success and we expected additional migration at the end of this quarter. The transformation of our business onto one supported by the SEI wealth platform remains on track and we all remain optimistic about our future prospects.

I will now take any questions you may have on the advisor segment.

(Operator Instructions)

Chris Donat, Sandler O'Neill.

We've seen for the segment operating margins expand over the last three quarters. Are we seeing some expenses roll away that had been elevated ahead of the migration or is there something else going on, on the expense side?

One benefit we had in the early part of the year compared to say fourth quarter, and I would say later part of third quarter, is that sales compensation in the fourth quarter, as you remember, was somewhat elevated because of the really strong sales year we had last year and the acceleration of (inaudible) that some of our sales folks hit in their compensation plan. So that came back to, say, a more normal rate so far this year. That certainly has helped.

I think the comment in the comments I read about expense management applies in this segment, applies across the Company, frankly, but in this segment Wayne and his team continue to focus on spending where it is strategically necessary and cutting back in areas where it's not so strategically important. Even with the commentary we had just a few minutes ago on overall expenses, that will hold true really across the Company as we go forward.

Got it. Thanks.

You are welcome.

(Operator Instructions)

We have no additional questions, so please continue.

Thank you. I am now going to turn it over to Joe Ujobai to discuss our private banking segment. Joe?

Thanks, Al. I will start with the financial update on the second quarter for the private banking segment. Second-quarter revenue of $115 million was up $1.5 million from the first quarter. Operating profit of $12 million was up over $2 million in the first quarter. Net sales events for the quarter were $4.4 million of which $750,000 is recurring investment [processing] revenue and the remaining $3.7 million as professional services related to our investment processing business.

Recurring sales events in this quarter include two new clients in the UK and indicates we have restarted new business sales there in conjunction was solid client net cash flow's to the platform. SWP sales activity remains robust in both the US and the UK and has been fueled by the recent sales success and progress towards delivering our large-scale operating models.

Recurring sales were negatively impacted by the loss of two, smaller (inaudible) 3,000 clients. Modest client losses have been tied to merger and acquisition activity and extremely competitive pricing at some of our smallest legacy clients.

Over the past year, we have successfully recontracted all UK SWP clients and have begun to recontract the early SWP adopters in the US. Our total signed, but not installed backlog, for the SEI wealth platform is $45 million in net new recurring revenue. We expect half to install by the end of 2017 and the remaining to install in later years.

As always we are focused on expense management and over the last several quarters we have kept spending within a tight range. As Al discussed, increased investment has been triggered by sales to very large firms and to help us grow our business in some of these large and growing market segments. We are investing in our software as a service, or as you would have known in the past ASP operating model.

As the very largest wealth managers look to replace legacy technology, to drive growth and scale this model meets the needs of a substantial market opportunity. Wells Fargo will be the first large-scale, US wealth management firm to adopt this model. In the model we provide technology and infrastructure services and our clients typically run their own operations.

We are targeting our largest ASP clients and other very large wealth managers in the US and globally. To install Wells Fargo and access this market opportunity, we are primarily investing in development to further scale core investment processing and streamline integration to the platform. We're also investing in enhanced risk solutions related to disaster recovery and data security.

We're also investing in our business processing as a service, or as you would have known formally have known formally VSP operating model. As other wealth managers consider technology consolidation, combined with back office outsourcing, this is another larger, and growing, market opportunity. Regions bank will be the largest US wealth management firm to utilize this model.

In the model the platform will be consumed in a fully integrated capacity including wealth advisory services and client experience, securities processing and back-office operations. We're targeting our BSP clients, some ASP clients, and other large wealth managers in the US and around the world.

To install Regions bank in an excess of this market we are primarily investing in enhancing our comprehensive, integrated, front office solution. This includes end client websites, mobile apps, and other tools to drive advisor productivity and investment management efficiency gains.

In the UK, in addition to signing the two new clients, net cash flow from current clients to SWP was approximately $1.6 billion for the quarter. Assets and administration are now approximately $38 billion. Our asset management distribution business had a challenging quarter given market and currency volatility.

Assets under management were relatively flat at $18.4 billion, they have a growing, diversified pipeline new distributors and expect to see growth over time. In summary, we have much work to do, but we are making good progress as we enhance the solution to grow the business.

Are there any questions?

(Operator Instructions)

Robert Lee, KBW.

Hi, Joe. Quick question. Curious on -- the flows are pretty good in the quarter, but I'm curious if you have any color around how it was immediately leading up to and then maybe post all of the trauma and in the UK around Brexit. How do you feel that's going to impact the wealth managers you have as clients?

I think so far, Brexit, I mean, certainly, we've had currency decline and though that impacts our financials. I'm really proud of, frankly, the way the platform operated because we did see some uptick in volatility and trading the first couple of days afterwards. The team in London, the operation team, the platform, all did very, very well and we were very happy about the situation and nor did we expect that was going to happen but we did have a solid plan in place.

I think what we're seeing from our clients, there's definitely some asset allocation -- a re-allocation of assets. Certainly, UK real estate, most firms have tried to get their clients out of UK real estate and some of those funds have closed for retentions. Again, lots of them have been a great job in administering that.

So we have seen some asset allocation. We're seeing people actually stay invested in the market and then a -- I think from a prospect perspective, there's certainly in the large advisor space and the private client space, I think we're so far, so good. We're not seeing decisions being slowed down.

It's still pretty early, also. I think the question would be, how do the larger banks respond once they singularly shake out. There's obviously a fewer much to determine what's really going to happen.

So, so far, so good. But we'll see with the larger opportunities what's going to happen I think when they feel more comfortable with the true outcome.

Okay. And then maybe going back to the expense question, as it flows through your segment, given the guidance about total Company expenses going up the 4% to 6% route, since that will be concentrated in your business as well as Steve's. Are we looking, just to make sure I understand -- with this from a modeling perspective correctly, are we looking like an something like a 10% sequential increase in expenses in your specific segment given how you report?

We're not disclosing that. I think what we did is we tried to give some information around -- from a broker's perspective. But -- as Al said, we're going to ramp up and then it will flatten out a bit and then we think it will trail off at the end.

Okay. Thank you.

As Al and others said, it's going to impact me the most.

Thank you.

Patrick O'Shaughnessy, Raymond James.

Just a quick one on the assets under management distribution business, what was the net cash flow this quarter?

It was about flat.

Okay. Great. Thank you.

One of the things that is very different than our, say, advisory business in the US is that the clients are generally -- are largely non-US and so you'll be seeing some more volatility in those markets and some of that are higher net worth and those clients can stay on the sideline a bit.

Okay. Thank you. And then I guess circling back to expenses, so as we think about the evolution of the SEI Wealth Platform over the last decade-plus, there's been a lot of investment spending for a number of years and I think from a lot of investors' perspective, it felt like you had the infrastructure in place. Now you're starting to plan some of the big contracts, and so I think it comes as a little bit of a surprise there's another round of investment spend.

So can you just walk us through -- I know you already have a little bit on the prepared comments but can you just walk us through a little bit more about why there has to be another ramp at this point in time?

I think there's three things we're spending money on, as I said. One is some development to scale this thing to some fairly substantial numbers and also deliver in ASP, what we call software-to-service environment, versus at VSP, where we do the operations. So there is some investment as we recognize the only reason that there would be some investment to change the operating model.

And we are working in close partnership with Wells Fargo, as building client in that space, and we're -- and that's a decent-sized investment to do that and to drive some very, very substantial scale, frankly, that will grow SWP, again, as we grow SWP even larger than with our TRUST 3000 business.

The second area, where we have created some largely enhanced or advanced services, particularly around recovery and around, say, security. So we have an enhanced the solution there. We are charging premium prices for those solutions, but that's an investment in infrastructure that is required to service these very, very large national or global organizations.

Then the third area which I mentioned before was this, what we call the front end. We've built from the back to the front so we believe when we -- and we still believe when we started this that in order to be able to provide enhanced advisor we needed to build a very modern and robust backend because the way banks and their clients use this platform, it was a lot more access, a more desire to plug data, and to turn that data into information.

So we started from the back and we, more recently, have begun to develop the front-end side and we know we're doing that certainly in partnership with some of our clients and with some of our largest prospects. But I think that was a natural evolution. So these are -- we think these are three very important investments for us to grow this business and to certainly sell this at a premium to either our legacy solution or to competitors.

Got it. That's very helpful color. Thank you.

Tom McCrohan, CLSA.

Hi, with the incremental investments, Joe, can you give us a little sensitivity around the pricing going forward? And how a dollar revenue on, say, TRUST 3000? What you might expect to get a new platform, given these changes that you're making.

I think we've -- so I think again, we have lots of letters now to -- hope we have a border set of levers to grow revenue relative on the SWP platform relative to TRUST 3000, where TRUST 3000 was largely a business brick model that was account-based. We're re-building financials that we believe will help advisors in private banking, grow their business, things like portfolio or proposal generation tools, very robust end client websites.

So we make -- we grow our business certainly as those clients grow their business based on the AUA part of the business model. There are things, as I've mentioned, some of these advanced infrastructure things that we can now charge a premium for where we going to actually even charge for in the past, we were really part of the TRUST 3000 bundle.

But there's opportunities there and then in the core of TRUST giving what we built from efficiency around processing, we were able to charge a premium so that TRUST 3000 to SWP core. So those are three more examples of where we have either new revenue levers or we have an opportunity to charge a premium based on a more robust solution.

Can I -- thank you. And then in terms of the different type of clients that you're going after. There's a perception out there that the Wells client, which is a great client to have. It's a pretty complex client as opposed like a Regions, which may be arguably, a little less complex.

So a lot of these changes seem to be directed for everybody, but arguably, supporting a really complex client like a Wells Fargo. Can you just give us a sense -- or how many more Wells Fargo-size prospects do you have in your pipeline so people can get comfortable you're not just building this just for one client that you can't replicate with other prospects?

We have a lot of very large clients already on TRUST 2000 so those clients should be very important prospects of ours. I don't want to name, but I think you all know that we have a big business at the high end here in the US and those clients would all be -- are all very prospects for us.

There are also some firms that either probably their legacy systems and manage that technology themselves and so there are large firms that may be because we did not have the strongest global capabilities pre-SWP that maybe have -- does some of their own things or have funded businesses on other technologies.

So that's really the top -- if you look in the US, it's probably tuck-in -- a hand -- certainly, a decent amount of the top 20 banks and then there's certainly s other types of wealth managers. Historically, we haven't called on outside of banks that are very big and that, that software-as-a-service solution would be an ideal operating model for them. So it's clearly not -- Wells is a great lead client for us. But it's clearly for the market, it isn't for one client.

Then my last question, and I'll jump back in the queue. The timing for implementing Wells; has that changed at all?

No, it has not changed at all. We're -- we continue to meet all the milestones. We are working closely together with them and that hasn't changed.

Thank you.

(Operator Instructions)

Chris Shutler, William Blair.

Hi, Joe. So on the spending, is the fundamental issue that there are new items or functionality that you find yourself needing to build or is it that you simply underestimate the amount of expense?

We opted to probe the platform and as we call it, business processing as a service so the initial clients, the initial letter of 20, or 30 clients were all delivered in that way. A lot of this spending is tied to delivering it in the more ASP-like service. We knew that, that would require additional investments and I think we've made some good decisions that we've moved forward to get that done. I think on the front end, we just -- we were -- we hadn't gotten to that yet so we got closer to it and now we're really focusing on that.

We're finding a lot of interest in integrated front-end so a lot of these prospects and clients have gone out and bought a lot of different software or have tried to build their own advisor-tied tools on the front end and because they're not very well integrated, there's a lot of swivel chairing. And we've, I think, had designed and are in the process of building -- again, with in this case, it was Regions as the lead client, a very unique and integrative front-end that we think has a pretty strong competitive advantage for us.

A lot of our clients have (multiple speakers) tried to pull that altogether and keep it up-to-date and we think it's -- we're the only ones who can really provide that integrative solution.

Okay. Thanks.

We have no additional questions at this time.

Thank you, Joe. Our next segment is a institutional investor segment and I'm going to turn it over to Paul Kaluder to discuss this segment. Paul?

Thanks, Al. Good afternoon, everyone. I'm going to discuss the financial results for the second quarter of 2016.

Second-quarter revenue was $74.7 million, increased 3% compared to the first quarter of 2016. Capital market performance and net new client funding of $725 million during the quarter positively impacted revenue for the second quarter of 2016 compared to the first quarter. Quarter-end asset balances of $78.6 billion, reflecting $2.6 billion increase compared to the first quarter.

The unfunded client backlog at quarter end was $900 million. Second quarter 2016 operating profits of $38.1 million increased 2% compared to the first quarter. Second quarter 2016 margins were 51.1%, less than a 1% decrease from the first quarter.

Client signings for the second quarter 2016 were $900 million, including a new large market defined contribution investment client. We anticipate making continued investments in executing our strategy to grow our DC business and expand our global footprint in the incremental markets that will embrace fiduciary management, OCIO or standalone investment strategies.

We are pleased with the continued growth of our fiduciary management OCIO business across our focused market segments and we continue to see an increased appetite for delegation by institutional investors.

Thank you very much and I'm happy to entertain any questions you may have.

(Operator Instructions)

Robert Lee, KBW.

Thanks. I guess, I just want to make -- clarify the $725 million, that was net client fundings, right?

Correct, Robert.

Okay. As you've enter -- or build out the DC capability and enter that market, your margins in this business have held up -- been pretty steady, bounced around the 51% level. So is there any reason to expect at least in the short-term, some pick-up in spend here just to prepare for getting larger and that new business segment?

I think we'll see just a little bit of incremental spend around thought leadership and public relations, probably a couple of key resources and then just the execution. Going to market, and making sure we're getting the number of appointments that are necessary in order to drive a pipeline so we can be successful the same way we've been successful in the defined benefit area of the marketplace.

Okay. That's all I had. Thank you. Thank you.

We have no additional questions.

Thank you, Paul. Our final segment today is investment managers. I'm going to turn it over to Steve Meyer to discuss this segment.

Thanks, Al. Good afternoon, everyone. For the second quarter of 2016, revenues for the segment totaled $70.9 million, which was $1 million, or 1.5% higher as compared to our revenue in the first quarter 2016. This quarter, our reported increase in revenue was primarily due to new client fundings. Revenue growth was somewhat muted this quarter due to negative revenue event including with some client liquidations and redemptions.

Industrywide, we saw alternative managers experience record outflows and liquidations this past quarter. Our quarterly profit for the segment of $24 million was approximately $600,000, or 2.6% lower than the first quarter of 2016. This decrease in profit quarter over quarter was driven by an increase in our expenses, primarily due to implementation costs associated with our new client as well as an increase in sales compensation.

As I've mentioned previously, we continue to invest in and increase our infrastructure ahead of large new business activities to support such growth. As Al mentioned, we expect that looking forward, our expenses will uptick modestly in the next few quarters as we implement previous sold business and bring on additional new business.

Third-party asset balances at the end of the second quarter of 2016 were $419.1 billion, approximately $18.6 billion or 4.6% higher as compared to asset balances at the end of the first quarter 2016. The increase in assets was primarily due to net new client fundings of $13.2 billion combined with market appreciation of $5.4 billion.

And turning to market activity, during the second quarter of 2016, we had a record sales quarter. Net new business sales events totaled $17.1 million in annualized revenue.

These events were comprised of new name business and expansion of existing business with current plans across all of our segments. These events included a competitive win of a large US-based global investment management firm who will be outsourcing their entire alternative business to us as well as a competitive win of a global manager's platform expansion into Europe.

While market volatility, Brexit, and other factors have provided a headwind for investment managers, we still see good opportunity for growth. We see ongoing demand for our core outsourcing solutions as well as our regulatory and compliance solutions.

The investment management industry is evolving and changing rapidly; innovation is key for continued growth in this market. We continue to invest in our solutions and increase our technology and data services to be at the forefront of the emerging needs of the industry. This goes well for future growth.

I will now turn it over for any questions you may have.

Thank you.

(Operator Instructions)

Chris Donat, Sandler O'Neill.

Hey Steve. Just -- I'm trying to reconcile something. I thought you said you had record redemptions but then also record sales quarter. Could you give us a sense of what that trends are that are at cross purposes there?

Well, if you're talking about the liquidations or redemptions, that's obviously within specific clients from managers funds where they're seeing investors either move to other products or redeem.

We are still seeing though a demand among these managers, even one that are out there large, medium, small that do have pressure on their business. They're also looking to add, given it's a new market, add infrastructure and they love to partner with someone else for that. So I think it is a tough market swap providing a headwind to one side, or providing still an opportunity for us to grow and capitalize on the needs of these managers.

Okay. Thanks.

Sure.

Robert Lee, KBW.

Hi. Hey, Steve. How are you?

Good, how are you, Rob?

Good, thanks. I mean, maybe just to follow-up to that just to make sure I understood it because the numbers go by pretty quickly. So the annualized new business sales were $17 million in the quarter?

$17.1 million net revenue.

Right. And then net cash flows were $13 billion? Or was that the negative?

$13.2 billion net.

Okay. And then what's the pipeline that's, I guess if you include that 2017 and then what's the pipeline of one business that hasn't converted yet? I think it was like $35 million at the end of last quarter so where does stand today?

Okay. So that's not pipeline; that is backlog. Backlog at the end of Q2 is $46 million, which would include a majority of the deals we sold in Q2.

And generally, you expect that funds over a year-and-a-half period?

Yes, I think, we say 12 to 14 months. I think we're expecting for a large portion of what we sold in Q2 that will happen in a shorter timeframe but I say looking out over the next 12 months.

Okay. And then maybe last question just to -- on the -- I guess, theme of the day on expenses, some uptick expected. And my sense was from prior comments that, that's in your segment, at least some of that will be fairly more -- I don't know, maybe more temporary in nature? It will pick up Q3, Q4 and then either stabilize or then maybe fade away a little bit or how should we think of that?

Yes, I think you're going to expect a modest uptick in expenses, I think in the range that Al gave in the beginning. I think there's two really portions of that expense uptick. One, which is the larger, is obviously with winning the large deals within this quarter and previous quarters the uptick of expense, especially around operations and people.

I think we're going to see that go up a little in Q3 and Q4. Again, per the range outlook, and then, we'll -- I think we will see that level off. But the good news is this is all and as Dennis said, a part of growth and what we should start to see is then the revenue come in that will help offset this expense and help margin.

Great.

Tom McCrohan, CLSA.

Hi, Steve, just a quick question. What percent of revenues in your segment are derived from what most would consider traditional hedge funds?

So I would answer it saying, alternative versus traditional. I'd say it's about 55/45 -- so 55% versus 45% traditional, loan only products.

Thanks, that's all I had.

Robert Lee, KBW.

Thanks. So just had one quick follow-up, Steve. If I think of -- and maybe this isn't necessarily how you think of revenue but I guess one way we think of it is obviously looking AUA and the AUM and thinking of a fee rate. If I think of that over the last couple of years, there has been a downward trend as the mix changes. So is there any reason to think that, that's -- isn't going to continue just as you saw it on more of the large clients or is it-- should we think that maybe there's some stabilization that we should expect?

Well, I think, I would expect that it stabilized. I think some of the things you've seen have been product mix over the years. Do they go into larger fee, higher fee, more complex products or more lower fee products?

I'll use this quarter as an example. The $13 billion point some in the uptick in assets, if you look at that, a lot of the inflow we got, two things happened. One, a lot of it was in some of our lower fee products that we service. And a lot of it came towards the end of the quarter so we didn't get a full quarter's worth it.

So I think that muted the results a little bit. But I think across board, we mentioned that shell pricing is, it is a competitive market out there. Pricing is getting more in the focus of managers, but we've really been able to augment that and not really reduce our pricing, so to speak out the market because of the premium solution we offer.

Great. Thanks for taking my follow-up.

Sure. Thanks, Rob.

We have no additional questions. Please continue.

Thank you, Steve. I would now like to ask Kathy Heilig to give you a few Companywide statistics. Kathy?

Thanks, Al. Good afternoon, everyone. I have some additional corporate information regarding this quarter. Second quarter 2016 cash flow from operations was $81.4 million, or $0.49 per share. Year-to-date cash flow from operations is $159.4 million.

Second quarter free cash flow, $66.9 million, or $0.41 per share and the year-to-date free cash flow, $130.9 million. The capital expenditures for the seconds quarter excluding capitalized software were $4.4 million but we expect the remaining 2016 capital expenditures to be an additional $25 million. The tax rate, the annual tax rate is projected to be close to what it is now, around 35%.

We would like to remind you that many of our comments are forward-looking statements, and are based upon assumptions that involve risks and that the financial information presented on the release and on the calls are unaudited. Future revenues and income could differ from expected results. We have no obligation to publicly update or correct any statements herein as a result of future developments. Be sure to refer to periodic SEC filings for a description of various risks and uncertainties that could affect our future financial results.

Now please feel free to ask any other questions that you may have.

(Operator Instructions)

Glenn Greene, Oppenheimer.

Hey Dennis, I just want to go back to the expenses. Sorry, but one way to think about it -- or at least how I'm thinking about it, and I want you to clarify or correct me. On an annual basis, we're figuring FY17, so generally, people are modeling, call it, $1.5 billion of revenue. I'm not asking for guidance on the revenue. That's less relevant.

But the 3% Delta on the R&D would equate to roughly $45 million of incremental expenses, which works out to about $0.20, a little less than that, but that's how I'm thinking about it. And then you're suggesting post-2017, you get back to that 9% or so R&D range, so that $45 million, while all else equal, moderates into 2018. Is it the way to think about it?

I can't get through all that math in my head that quickly, but I'm assuming you're netting out capitalization?

I wasn't.

Okay, so that would be one element that you would have to factor in as well.

So you're -- the 3% increase in R&D includes capitalized spending? How much is going to hit the P&L then, I guess --

That's gross. So -- and a question was asked earlier in the call about about what percentage are we capitalizing of the incremental spend and it's roughly in that 45%, 50% range.

Okay, so all else equal, if my math on the $0.20 were right, we're talking about half of that will hit the P&L, which seems to be like something like $0.10 and then that even moderates into 2018.

Yes.

Okay. Thank you.

Chris Shutler, William Blair.

Hey Dennis, I'm going to a follow-up on that last one. Just -- I think that I'm more clear now that you answered that question, but I just want to confirm in 2017, if I'm doing the math, so we -- so you're saying actually for Q3, the 4% to 6% increase, that was -- that's total expenses, right? So that's the $250 million of expense in Q2 times 1.04, times 1.06.

Same thing going into Q4 over Q3, 4% to 6% increase. That gets you to $270 million to $280 million, and then you're -- off of that, if we hold that rate flat, that would equal about $1.1 billion of total expenses next year; is that too high? It sounds like what you just said, that, that is too high but I want to better understand.

If you look at -- I'm just going to that real quick in my head.

Sure. No, it's important. Take your time. (laughter)

Thank you. So I think it is about $1.1 billion, roughly off the math. In total expenses, that, that may be -- maybe a little bit -- that doesn't have to do with the range, for sure, but on the downside. But just off the math, it's probably in that range.

Okay. Thank you.

We have no additional questions.

Well, thank you, again. So ladies and gentlemen, we feel that 2016 is off to a good sales start and the implementation of our large client wins are going well. Looking ahead, we will keep our focus on developing and implementing the solutions needed for capturing an enormous opportunities that we see in all of our markets.

Now thank you for joining us today and have a good afternoon.

Thank you. Ladies and gentlemen, this will conclude our teleconference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.