道富銀行 (STT) 2004 Q4 法說會逐字稿

Good day, everyone.

And welcome to the Investors Financial Services Corp. fourth-quarter and year-and earnings release conference call.

Today's conference is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to Joe DeCristofaro.

Please go ahead, sir.

Thank you for joining us on today's call.

We will be making a number of forward-looking statements, which are based on management's assumptions and predictions as of today.

The Company's actual results may differ materially from our current predictions due to any one of a number of factors.

Information regarding the factors that may affect our actual results is set forth in the MD&A section of our most recent 10-Q and 10-K filings, as amended with the SEC.

I recommend that anyone listening to this call review these reports carefully.

Because this call will be archived on our website, www.ibtco.com, I want to emphasize again for anyone listening at a later date that the statements made today are based on our assumptions as of today, January 25th, 2005.

These assumptions may change, but the recording of this call will not be updated.

Joining us on today's call are Kevin Sheehan, Chairman and Chief Executive Officer;

Mike Rogers, President; and John Spinney, Chief Financial Officer.

I'll now turn the call over to Kevin Sheehan.

Thanks, good afternoon.

I'll begin by reviewing some of the key points from our full-year results.

John Spinney will then provide you with a more detailed discussion of our financial results.

For the year ended December 31st, 2004, we again reported extremely impressive results.

The 39 percent increase to 209 (ph$) in 2004 diluted earnings per share from $1.50 in 2003 was at the high end of our recently increased guidance.

These results were driven by a 25 percent increase in our net operating revenue to 613 million and a 43 percent increase in our net operating income to 142 million.

Even more impressive of -- are our five-year compound annual growth rates in revenue, diluted earnings per share and net income.

These growth rates include our performances in both strong and weak market environments and illustrate the health of our business and the leverage in our model.

For the past five years, we have grown our diluted earnings per share to 42 percent keger (ph), our net income at a 46 percent keger, and our net operating revenue at a 29 percent keger.

As of December 31st, we processed approximately 1.43 trillion of assets for our clients, up 187 billion or 15 percent from September 30th, 2004 and up 373 billion or 35 percent from December 31st, 2003.

During the fourth quarter of 2004, we converted approximately 50 billion in new assets from new clients, including the first substantial conversion of the 47 billion in assets from our previously announced 160 billion new European client.

We expect to convert the rest of these assets during 2005.

The remaining 3 billion in new assets comes from other new clients, including The Boulder Funds and Cypresstree International (ph).

In addition to the 50 billion in assets we won from new clients, we also converted approximately 15 billion in new assets from existing clients, including Aegon, Eaton Vance, and Mass Mutual.

We also experienced market appreciation and client fund flows of 123 billion during the fourth quarter.

The current status of our new business pipeline remains medium.

We continue to maintain a positive outlook on our sales pipeline, as we are seeing strong levels of RFP activity and increased interest by our clients in our service offerings.

To summarize our results demonstrates the continued robust condition of our business.

This performance was driven by our ability to sell to new and existing clients and strong client fund flows.

I will turn the call over to John Spinney, and we'll review the quarter's financial results in more detail.

Thank you, and good afternoon.

As Kevin mentioned, for the year ended December 31st, 2004, net operating revenue rose 25 percent to 613 million, while our expenses grew only 16 percent.

As a result of this leverage in our model, we are able to grow net operating income by 43 percent to 142 million in diluted earnings per share by 39 percent to $2.09.

For the fourth quarter, net operating revenue increased 19 percent year-over-year, while our diluted operating earnings per share grew to $0.52, an 11 percent increase over our fourth-quarter 2003 diluted EPS of $.47.

I will discuss our full year and fourth-quarter 2004 results in more detail in a moment.

We generate revenues based on assets under administration, the number of transactions generated by our clients and net interest income.

These three revenue components create a natural hedge for our business model.

The breakdown of our revenue stream for 2004 was 52 percent asset-based, 17 percent transaction-based, and 31 percent net interest income-based.

The breakdown of our revenue stream for the fourth quarter of 2004 was similar at 53 percent asset-based, 16 percent transaction-based and 31 percent net interest income-based.

I will now discuss the significant income and expense components for our full-year 2004 results.

As we disclosed in our last call in November, key business trends remain positive.

Our total 2004 core asset servicing fees grew an impressive year-over-year rate of 24 percent due to three factors -- wins from new clients and existing clients; the ability of our clients to develop and sell product, which generates fund flows that have a direct positive impact on our business; and higher asset values compared to the year-ago period.

2004 ancillary service fees grew by 37 percent, driven primarily by strong increases in foreign exchange and cash management sweet peas (ph).

Foreign exchange revenues grew by 49 percent year-over-year due to new clients, increased activity in international markets for our existing clients, and volatility in the currency markets.

Cash management suite revenues grew 26 percent year-over-year, primarily as a result of higher domestic in foreign cash balances held by our clients.

Total operating expenses were up 16 percent year-over-year, compared to our 25 percent increase in net-operating revenue.

Turning to individual 2004 costs, compensation benefits expense was up 10 percent year-over-year, largely due to higher headcount in incentive accruals, as well as higher payroll taxes and benefit expenses consistent with our growth in headcount.

The increase in headcount of 365 employees to 2,778 at the end of 2004 was driven by the higher amount of new business we won during the year and the filling of open positions.

Technology and telecommunications increased 28 percent due to our continuing investments in technology and our new outsourcing arrangement with IBM Global Services, which is scaled to support our growth.

Transaction processing service costs increased 27 percent due to higher global asset values and transactions with our subcustodians.

I'll now discuss the significant income expense components for the fourth quarter in more detail.

Core asset servicing fees for the fourth quarter increased 18 percent year-over-year due to the same three factors I mentioned previously -- wins from new and existing clients, the ability of our clients to develop and sell their products, and higher asset values compared to the year-ago period.

The 21 percent increase in fourth-quarter ancillary services revenue was driven by strong increases in foreign exchange, cash management, and securities lending fees.

Cash management suite revenues grew 33 percent, primarily as a result of higher domestic and foreign cash balances held by our clients.

The 35 percent increase in securities lending fees resulted from generally improved spreads and higher volumes.

Foreign exchange revenues grew 15 percent due to new clients, increased activity in international markets, and volatility in currency markets.

For the fourth quarter, total operating expenses were 19 percent quarter-over-quarter, compared to a 19 percent increase in net operating revenue.

The growth in our cost structure during the fourth quarter was largely driven by new business we won during the second half of 2004, which required us to lead with headcount in technology.

Turning to individual fourth-quarter costs, compensation and benefits expense was up 18 percent quarter-over-quarter, largely due to higher headcount in incentive accruals, as well as higher payroll taxes and benefit expenses consistent with our headcount growth.

Technology and telecommunications increased 51 percent, primarily due to the transition to our new outsourcing arrangement with IBM Global Services.

The transaction processing services cost increased 18 percent due to higher global asset values and transactions with subcustodians.

Directly related to the growth of our processing business is the growth of our balance sheet, which on average basis grew by 2.1 billion or 24 percent from last year's fourth quarter to this year's fourth quarter, as a result of strong client funding.

Net-interest income was up 22 percent on a year-over-year basis, primarily due to balance sheet growth -- again, driven by healthy client funding.

We continue to maintain strong interest margin and spread during the fourth quarter.

The linked-quarter net-interest margin decreased by 6 basis points to 1.88 percent, while the linked quarter interest rate spread decreased by 10 basis points to 1.75 percent.

Our investment portfolios comprised of securities backed by the U.S. government and/or AAA-rated securities.

As of December 31st, we continue to run a closely match balance sheet with an asset duration of approximately 1.3 years and a liability duration of approximately 1 year.

The continued high amount of variable-rate securities in our portfolio has allowed us to maintain low-asset duration.

Turning to our earnings guidance for 2005, as we have done historically, we are reverting back to our targeted long-term diluted earnings-per-share growth rate of 25 percent at the outset of the year and will adjust our guidance as we progress through the year.

Our guidance includes an additional 175 basis point increase in the fed (ph) funds rate from today to 4 percent by the end of 2005.

We are also modeling a further flattening of the yield curve in 2005.

We remain comfortable with our long-term growth rate of 25 percent EPS.

I would now like to turn the -- open up the call to your questions.

Operator?

Thank you, the question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS).

Jon Arfstrom, RBC Capital Markets.

A question for you on the value edit numbers.

They look good in the fourth quarter, and I'm wondering if -- so far that environment is continued into the first quarter.

And then, I have a follow-up on that.

Yes, that's continued into the first-quarter, Jon.

And then, also, on Q1 and Q2, you had some fairly high comps.

You had the strong Q1 and Q2, a year ago, in some of your F-ex line, and I'm just curious how you feel about your ability to exceed that year-over-year?

I think what we see is -- we've seen assets in the international markets that we have custody for increase, substantially, the last part of this year and going into next year that will hopefully provide us with the volume.

We're still getting some volatility in the currencies.

So I feel pretty good about being able to meet what we did last year in the first two quarters here, provided the flows keep coming into these international products, as we saw last year.

And we're seeing it to the end of this year.

Okay.

And then, on the expenses how -- are all of your new business expenses from the fourth quarter in the run rate, or will you see some incremental expenses in the first quarter from the new business that you added late in the year?

They are already in the fourth-quarter run rate, as we look into next year.

I think the only expenses going up -- going into the first quarter would be typical comp expenses, payroll taxes reload as annual comp increases go into effect.

Those will be the major -- and incentive accruals begin again.

So other than that, I would expect most expenses to be at their current run rate or less, with the exception of depreciation expense that will go up slightly.

And then, in terms of the 100 billion (ph) that comes out later in the year -- do you need to add significant amount of incremental expenses to handle that, or is this embedded in what you have added already.

There will be some incremental headcount, as the rest of the staff (ph) has come on.

But as far as the technology cost and other transition costs, those are already embedded in the run rate.

Joel Gomberg, William Blair.

Thanks.

The technology expense line item, you mentioned IBM.

Are you going to be able to get some efficiencies out of that going forward?

Or is this the run rate as well?

Joel, that run rate will come down.

As I mentioned, on the previous call, in entering into this agreement with IBM, there were certain transition costs, which were born in the second -- I mean, third and fourth quarter of '04.

So our run rate will go down in the first quarter.

And then, the whole premise behind entering into an outsourcing arrangement like this is to get the leverage out of the model that IBM brings to the table.

So we will be able to grow based off that current run rate.

And that was the key -- is that the growth was built into the existing run rate.

So as we grow, we are not going to need to add incremental expense there.

And then, John, it looks like you had a big jump in the headcount during the fourth quarter.

Are you taking on some people from this new European client?

Is that part of it?

Yeah, as we said in the last call as well, we were adding headcount going into the beginning of the fourth quarter here -- to handle both that and the Aegon business.

So, both of those were being staffed up.

We also filled open positions towards the end of the third quarter into the fourth quarter.

And that is what caused the sequential increase in headcount.

But we are not taking over any incremental people from the client, Joel.

(Indiscernible) It's not a list of -- and then, you had a pick-up in your deposits at year end.

Is that something that is seasonal, and we expect to go back down?

And then, we have clearly seen some flattening of the yield curve here this last quarter.

So maybe you could talk a little bit about your expectations on the margin -- some contraction here in the first quarter, as we move along if the deposits run down.

I think I would probably look at it more on an average basis and year-over-year on the deposits front.

Regardless of what we've got right at 12/31 is grown tremendously.

And that afforded us the ability to grow the balance sheet by $2 billion this year.

And as our assets continued to grow that we administer, more deposit flow will come off of that as a result.

So I feel pretty comfortable that deposit flows will continue to move in line with asset growth.

And whatever we've got at year-end, it could have been a year-end principal and interest payments that we got over year-end.

So I'd more focus on the average balance increasing.

And then with respect to the yield curve, we do have a flattening of the yield curve baked into our guidance for next year and expect dead (ph) funds to achieve 4 percent by the end of December.

That's baked into our guidance.

Does that answer your question?

Yes, thank you.

Carla Cooper, Robert Baird.

I wondered first if the amount that you expect to convert from -- the amounts that you have not yet converted from the European client -- does that total roughly 100 billion yet to convert from that client?

It's not in the total number of assets process we gave you.

You have to convert --

You have to convert.

Right, okay.

You have to convert.

Because I think you said that client -- you expected; ultimately, to get about 160 billion in two different conches (ph)?

And so, I'm just trying to make sure I'm doing all of the math.

You got 47 this quarter, and that is in the number that you reported.

And then, there should be roughly another 100, 110?

Yes.

Okay.

And then, the second thing I wanted to just clarify is -- when you talk about your 25 percent EPS growth expectations, what kind of assumption does that bake in for, I guess, both the market and then also fund flows from your client?

Typically, as we've always done, Carla, we revert back to that 25 percent.

There is no market appreciation built into achieving the 25 percent.

If we get it, that's great.

And from the fund flows perspective, we only bake in 6 percent.

As we talked about at the end of the third quarter, most of the growth in assets we had this year was from good, strong client fund flows.

We saw in the fourth quarter, the S&P was up on a link basis about 90 percent.

Our asset growth was somewhere in the neighborhood of 15 percent.

We are still getting strong fund flows to the tune of 6 percent just in the fourth quarter.

So I feel from a budgeting and forecasting perspective right now, we are going down the right path.

And then, I had a question about investment advisory in the fourth quarter.

It looked to me like that was down a bit, both sequentially and year-over-year.

And I wondered if you could just comment on that?

Yes, the Mayor Max funds, which are a family of -- a family of mutual funds, excuse me, that we advise and we utilize subadvisers to work with us on those funds.

During the fourth quarter, with the rate increases and the weighted-average life of that portfolio, it did lag a little bit in performance.

And as a result, we waived fees during the fourth quarter.

We expect that to continue a little bit into the first quarter, most likely, until the yield in the portfolio catches up with more of a market yield, which is not uncommon in this marketplace.

Okay.

And then, last thing, is just that your fund flows from your client have continued to outpace the market pretty substantially.

And I wonder if you could amplify maybe why you think that is?

Just you're aligned with the right clients, who are doing a great job driving their product?

Or is there something else that's feeding into that success?

I think it's just exactly what you said -- we are aligned with clients that know how to develop products, distribute products.

That's one of the basic underpinnings of the firm since day one -- was to align ourselves with those types of clients.

You saw that with -- we've got a very -- couple of good international fund managers that have really done well for themselves and garnered a lot of assets that have been driven to our platform.

You the ETS grow extremely -- strongly this year, that benefited us.

Eaton Vance (ph) has done a great job of developing some new products over the last 12 months that have really driven assets to their platform.

And you know, performance drives asset flows, I think, the clients that we have have done a very good job of managing money.

And as a result, -- have gotten the returns and the asset flows great.

I think the last point I'll make is on the European front.

Dublin -- the assets in Dublin are up probably about 70 percent this year.

We have had tremendous flows in that office off of some pretty sizable clients.

We continue to see that business grow in terms of income perspective, about a hundred percent over last year.

So we're getting some good movement out of Europe as well.

(OPERATOR INSTRUCTIONS).

Trisha Meave, Variant Research.

Just a small question -- looking at the pipeline -- just trying to get a sense of whether we're seeing large clients, small clients?

What's the mix here in the pipeline?

What is the sales cycle that you're seeing?

I think the pipeline still has all different sizes of clients -- large outsourcing, medium-sized outsourcing client, and small clients, whether they are CDOs, CLOs, partnerships, thing of that nature.

So the pipeline, I think, is robust across itself.

And I think what we have seen in '04 is a lot more sales close in '04.

We've talked about the sphitzer (ph) phenomenon getting some headwind in '03 and into '04.

We're starting to see a lot more movement from our prospects on looking at outsourcing and by a lot of the things we dealt with in '03 and '04.

And we feel pretty bullish about the pipeline right now in terms of what we see in there and what is coming down the pipe for us.

Great.

You talked about your client penetration in 2005.

How much of that is already baked in into your 25 percent growth rate?

I'm sorry, say that again, Trish?

In looking at your client, it says two clients -- how much of the 25 percent is incorporating in further client penetration or additional business wins with them?

There is nothing baked in there in terms of additional growth.

That's growth that will get you new sales or cross cells.

But is -- in the achieving the '05 number is anything we've sold in '04 that had a fraction of a year will now be in the '05 run rate for the full year and help us achieve the 25-percent growth.

Brandi Shaw, Beekman Capital Management.

Hi, guys, great quarter.

I was kind of wondering if you could just touch base real quick and just refresh whether or not the accounting changes are going to have any significant effect in '05 or any at all?

And just -- if we have any expectations for stock option expensing or anything along those lines?

Yes, Brandi, on the stock-option expensing first -- we have come out publicly and talked about that being somewhere in the neighborhood of $0.05 to $0.06 once it is opted on July 1st of '05.

And that is baked into the 25-percent earnings guidance.

And then, secondly, on the change in accounting on fast (ph) 91 that we talked about on the November 15th call, I expect that to have very little impact going forward.

Okay, that is what I thought.

On the $0.05 to $0.06, are you guys going to take that all in the third quarter?

It will be spread through both the third and fourth quarter, as the previous grants get amortized off and any other grants that are made in those two quarters come on.

(OPERATOR INSTRUCTIONS).

Stuart Quint, Gartmore Global.

Congratulations on the quarter.

Just one quick question -- one of your big competitors was talking about additional expense from regulatory and compliance issues.

And I'm curious about your thoughts on that, if any?

I think that one of the biggest expenses we've had was Sarbanes-Oxley.

That was born in our expense run rate for '04 and is in our estimates for '05.

All other -- I think, regulatory expenses are built into our forecast for next year.

I don't see there being a tremendous amount of expense increase from that area.

That does conclude our Q&A session.

I'll turn the conference back over to Kevin Sheehan for additional or closing remarks.

Thank you.

In closing, thank you for your interest in Investors Financial.

Given our new business, closings during the fourth quarter and increasing demand for our services, we look forward to a strong fiscal 2005.

That ends our call.

That does conclude today's conference.

We thank you for your participation.

You may now disconnect.