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spk02: Good morning and welcome to the Pazina Investment Management Inc. announces fourth quarter and full year 2020 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I'll now like to turn the conference over to Jessica Doran. Please go ahead.
spk00: Thank you, Operator. Good morning, and thank you for joining us on the Pazina Investment Management Fourth Quarter and Full Year 2020 Earnings Call. I am Jessica Doran, Chief Financial Officer. With me today is our Chief Executive Officer and Co-Chief Investment Officer, Rich Pazina. Our earnings press release contains the financial tables for the periods we will be discussing. If you do not have a copy, it can be obtained in the investor relations section on our website at www.pizina.com. Replays of this call will be available for the next two weeks on our website. Before we start, we need to remind you that today's call may contain forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from today's comments. Please note that we do not undertake to update such information to reflect the impact of circumstances or events going forward. In addition, please be advised that due to prohibitions on selective disclosures, we do not, as a matter of policy, disclose materials that is not public information on our conference calls. Now, let me turn the call over to Rich, who will discuss our current view of the investing environment.
spk01: Thanks, Jessica. Everyone asks me the same question these days, so it seems I should start my remarks by trying to address that question. Was the fourth quarter the start of the long-awaited value cycle, or was it just another head fake? The outcome was pretty fantastic for the value style, but so much more for deep value. Most of our strategies outperformed their benchmarks by 10 to 20 percentage points in one quarter. It was the highest alpha generating quarter in our 25-year history. The truth is, though, I really don't know the answer to that question. And having lived through several cycles, I know that I won't really know until it's all become history. Let's consider what we actually know so far. First, Value cycles and recessions are highly correlated. We have written extensively about this relationship, and the data is compelling. Value rallies generally start shortly after recessions start, because once the recession starts, investors start looking forward for signals of the further recovery. This relationship has held in the U.S. for nine of the last nine recessions, and the data outside the U.S. is similarly robust. Second, value stocks actually become momentum stocks when value cycles begin, as the recovery translates into strong earnings growth for these beaten-down stocks. Consider the choice investors are being offered today. Buy a portfolio of deep value stocks with two-year forward expected earnings growth rates by the consensus of 23% a year. and you can buy that for 11 times earnings, or buy a portfolio of the Russell 1000 growth stocks with two-year forward earnings expected growth of 17% a year, and that sells for 27 times earnings. The deep value stocks have sharp expected earnings growth as they rebound from recession lows, while the growth stocks are having difficulty growing at rates fast enough to keep up with their high flying multiples. And as investors embrace these truths, value stocks gain the momentum. Even though the fourth quarter resulted in the highest alpha generation in our 25-year history, the spreads between expensive and cheap stocks have barely moved. In the U.S., the spread reduction in the quarter was a small fraction of the previously abnormally widespread. And the story is similar everywhere in the world. And still I know As I'm speaking, there are many out there who are saying, no, that quarter was just an aberration. The future is tech. The future is disruption via tech. The future is carbon loss. The future is, well, you can go ahead and fill in the blank with any of the commonly repeated themes. But our research keeps us pointed at the long-term truth. Buying good businesses at low prices is a winning investment strategy. Let me share a few words about our business as we close to 2020. We finished with our fourth consecutive calendar year with positive net flows, and that makes it seven out of the past nine calendar years. I have to say on behalf of my partners and in honor of our clients, we are very proud of that record, coming in an environment that has been anti-active and anti-deep value. Our AUM closed the year at its all-time high of $43.3 billion, and we are encouraged about the pipeline as we look forward into 2021. I look forward to answering your questions.
spk00: Thank you, Rich. To review our financial results for the period, I'll share some of our quarterly result details. We periodically present both GAAP and as adjusted financial results. We did not adjust results for the fourth quarter or full year of 2020. However, our results for the fourth quarter and full year of 2019 were adjusted to exclude $22.7 million in non-recurring compensation and benefits expenses. For the purpose of this discussion, I will reference the 2019 as adjusted information. We reported diluted earnings of 22 cents per share for the fourth quarter compared to 16 cents last quarter and as adjusted diluted earnings of 20 cents per share for the fourth quarter of last year. Revenues were $39.9 million for the quarter and operating income was $18.2 million. Our operating margin was 45.7% this quarter compared to 44.1% last quarter and the as-adjusted operating margin of 45.5% in the fourth quarter of last year. We reported diluted earnings of 52 cents per share for the full year of 2020, compared to as-adjusted diluted earnings of 73 cents per share for the full year of 2019. Revenues were $138.6 million for the year, and operating income was $55.3 million. This compares to revenue of $150.7 million and as adjusted operating income of $68.4 million for the full year of 2019. Our operating margin was 39.9% for the full year of 2020, decreasing from the as adjusted operating margin of 45.4% for the full year of 2019. Taking a closer look at our quarterly results, We ended the quarter with assets under management, as Rich mentioned, of $43.3 billion, up 30% from last quarter, which ended at $33.3 billion, and up 5.1% from the fourth quarter of last year, which ended at $41.2 billion. The increase in assets under management from last quarter was driven by market appreciation, including the impact of foreign exchange. of $10.3 billion, partially offset by net outflows of $0.3 billion. The increase from the fourth quarter of last year reflects $1.6 billion in market appreciation, including the impact of foreign exchange, and net inflows of $0.5 billion. At December 31, 2020, our asset center management consisted of $17.3 billion in separately managed accounts, $23.3 billion in subadvised accounts, and $2.7 billion in Arpazina funds. Compared to last quarter, separately managed account assets increased, reflecting $4.1 billion in market appreciation and foreign exchange impact, partially offset by $0.1 billion in net outflows. Subadvised account assets increased reflecting $5.5 billion in market appreciation and foreign exchange impact, partially offset by net outflows of $0.2 billion. And assets and casino funds increased due to $0.7 billion in market appreciation and foreign exchange impact. Average assets under management for the fourth quarter of 2020 were $37.7 billion, an increase of 13.9% from last quarter. and a decrease of 1% from the fourth quarter of last year. Revenues increased 17.7% from last quarter and increased 3.9% from the fourth quarter of last year. The fluctuation in revenue primarily reflects the variance in average assets under management over the period, as well as performance fees and fulcrum fees recognized during the period. During the quarter, we recognized $1.1 million in performance fees compared to no performance fees being recognized during last quarter or in the fourth quarter of last year. The fourth quarter also reflects the reduction in base fees of certain accounts related to the fulcrum fee arrangements of one client relationship. These fee arrangements require a reduction in the base fee if the investment strategy underperforms its relevant benchmarks. or allow for a performance fee if the strategy outperforms its benchmark. During the fourth and third quarters of 2020, we recognized a $1 million reduction in base fees related to these accounts compared to a $8.8 million reduction in base fees during the fourth quarter of 2019. These fees are calculated quarterly and compare relative performance over a three-year measurement period. To the extent the three-year performance record of these accounts fluctuate relative to their relevant benchmarks, the amount of base fees recognized may vary. Our weighted average fee rate was 42.3 basis points for the quarter compared to 41 basis points last quarter and 40.4 basis points for the fourth quarter of last year. Asset mix and the impact of swings in performance fees and fulcrum fees are all contributors to changes in our overall weighted average fee rate. Looking at operating expenses, our compensation and benefits expense was $18 million for the quarter, increasing from $15.8 million last quarter and from the as-adjusted amount of $16.2 million for the fourth quarter of last year. The increase from last quarter is driven by an increase in the bonus accrual and in the market performance of strategies tied to our deferred compensation obligations. The increase from the fourth quarter of 2019 reflects increases in compensation. DNA expenses were $3.7 million for the fourth quarter of 2020 compared to $3.2 million last quarter and $4.8 million for the fourth quarter of last year. The increase from last quarter primarily reflects an increase in professional fees and data and systems expense. And the decrease from the fourth quarter of last year primarily reflects a reduction in travel costs and professional fees. Other income was $6.1 million for the quarter driven primarily by the performance of our investments. The effective rate for our unincorporated and other business taxes was 2.9 percent this quarter compared to negative 6.8 percent last quarter and 3.3 percent in the fourth quarter of last year. The negative effective tax rate last quarter reflects the benefit associated with the reversal of uncertain tax position liabilities and interest due to the expiration of the statute of limitations. We expect the effective rate associated with the unincorporated and other business taxes of our operating company to be between 3% and 5% on an ongoing basis. Our effective tax rate for our corporate income taxes, ex-UBT and other business taxes, was 24.5% this quarter compared to our effective tax rate of 26.5% last quarter and our as-adjusted tax rate of 27.6% for the fourth quarter of last year. The fluctuation in these effective rates reflects certain permanently non-deductible expenses. We expect this rate, excluding these items, to be between 24% and 26% on an ongoing basis. The allocation to the non-public members of our operating company was approximately 77.3% of the operating company's net income for the fourth quarter of 2020, compared to 78% last quarter and 74.6% in the fourth quarter of last year. The variance in these percentages is the result of changes in our ownership interest in the operating company. During the quarter, through our stock buyback program, we repurchased and retired approximately 31.9,000 shares of Class A common stock and Class B units for $0.2 million. At December 31st, there was approximately $10.5 million remaining in the repurchase program. At quarter end, our financial position remains strong with $65.5 million in cash and cash equivalents, as well as $7.3 million in short-term investments. We declared a $0.25 per share year-end dividend last night. Thank you for joining us. We'd now be happy to take any questions.
spk02: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we'll pause momentarily to assemble our roster. Our first question today will come from Sam Sheldon with Punch and Associates. Please go ahead.
spk04: Good morning, Rich and Jessica. Rich, you spoke about the strong investment performance in the fourth quarter with plenty of opportunities in the deep value corner of the market. Can you flesh out these opportunities a little bit more? I guess, what sectors are you spending the most time researching and investing in today?
spk01: Yeah, I mean, for the most part, our portfolios are pretty well stable and not changing very dramatically. Remember, a lot of this performance in the fourth quarter came from the fact that these same stocks all had been killed in the previous 12 months leading into the pandemic and through the pandemic. So our exposure continues to be skewed towards financial services energy, consumer cyclicals, and industrial cyclicals, with fairly light exposures in consumer staples, real estate, and mostly end-electric utilities. Okay.
spk04: How would you characterize the current environment for value manager searches, and has there been any noticeable changes to RFP activity with values broadened? performance in your record alpha in the fourth quarter?
spk01: I would say there's a big increase, very, very noticeable in the, I'll call it pre-search activity phase. So, for example, we did a webcast to potential clients and prospects and existing clients in a week or two ago and those are getting five to 10 times the volume of attendees than we had been getting for the past few years. Um, so while I would tell you that our pipeline is fine and it's stable, um, and fine is, and I don't mean to sound bad by the word fine. Um, there's there, the, the, the search activity, um, continues to be kind of around the pace that it's been at. Maybe a little uptick is all I can say. But the pre-search activity volume is pretty strong.
spk04: Got it. Okay. Can you give us an update?
spk01: I'm sorry. I was just going to add to that that if you look at prior cycles, it takes – probably a good year for you to get into the positive side of the value cycle before you see strong movements in cash flows. At least that's been the observation I would make from history. So we'll see if that's the same this time. And obviously we're very early in this.
spk04: Sure. That makes sense. Okay. Maybe you could update us specifically on the sub advisory business. I guess what is the sentiment there, and is there any large relationships up for renewal on the horizon?
spk01: You know, as you may be aware, the sub-advisory businesses are always up for renewal. We generally have an initial term, and then it's just reviewable at will by our partners. So I would tell you that the cycle of renewing is not something that we are concerned about. There's been some increase in activity in sub-advisory from the standpoint that, I mean, it's hard to characterize it as trends, but I would tell you we had some very positive rebalancing that happened during the pandemic. And now we had a big account win during the year where we established a very new sub-advisory relationship. And we're involved in discussions about incremental sub-advisory relationships going forward. So I would say renewal isn't the issue. The issue for us is will any of these existing relationships start allocating more towards us as the value cycle, as they recognize their lack of or too low of a level of exposure to value. So that, I think, will happen. Some of the conversations are going on. And then there's the looking for new sub-advisory relationships. I think you know that we like this business a lot, and the partners that we've had in sub-advisory have tended to be very, very long lives, and mostly because we do what we say we're going to do. And from everything I can tell, the relationships continue to be strong. So I think there's upside going forward, but I hope that gives you a play for it.
spk04: Sure, that's helpful. Maybe you could walk us through your philosophy around the special year-end dividend and buybacks and how that philosophy might have changed over time.
spk01: The philosophy really hasn't changed at all. We've tried to use... to pay out between 60% and 70% of our earnings as a dividend, and then kind of reserved the rest for stock buyback. And this year is no different than that. Obviously, we had a down year, and as you know, we pay our dividend since the beginning vagaries of the market are very difficult to predict. We've operated for over a decade, that's probably right, for over a decade with a modest quarterly dividend followed by a year-end dividend that's pretty much just a calculation based on historical profitability, which was down last year because, as you know, we went through a big dip even though our assets under management ended the year. at their high. We were at, at the bottom, it was substantially lower. So our revenues were lower this year and our earnings were lower and that's what led to the dividend. But philosophically, that's no different. We've tended to try to be smart about timing the stock repurchases by buying when there's softness in our share price. And for the most part, we've accomplished that. We've, we've, acquired shares at reasonably attractive prices over time. We hope to continue doing that. And we hope to deploy the excess cash that we have to buy back stock. We do it in a fashion that is cognizant of the volume of our trading activity. So you can't turn it on and off in rapid fashion. strokes, as you might imagine. But given those constraints, we want to take advantage of softness and try to redeploy as much of our capital as possible to offset dilution that comes from our share issuances under our employee compensation programs.
spk04: Okay. Maybe last for me, your cash and investment balance continues to grow. could you update us on capital allocation priorities and maybe what your growth initiatives are that you have in place at the business today?
spk01: Yeah, you have to remember about the seasonality of our cash. I mean, our cash is sort of at its high at the end of the year. And then there are substantial cash requirements in the first quarter because we pay our bonuses and we pay our our year end distribution. So mostly we manage to the minimum cash balance, which occurs in March or April every year. And we try to have a modest cushion. So when you see where we are at the low, where there's not, you wouldn't think of there being a whole lot of excess cash. So the cash that we have on our balance sheet is mostly temporary. And so it's mostly focused on short-term investments that are not risky. The only money that we put at risk, some of it is seeding new products and strategies, and that we will continue to do. And some of it is to fund our employees' deferred compensation program, which allows our employees to allocate their deferred comp to our own investment strategies, and then we take those funds and actually invest it in those investment strategies. So it has some impact on our quarterly earnings performance. It had a favorable one this quarter. But the strategy continues to be primarily to to increase the distribution of our existing products, to incubate new products that we think might have interest in the future. And that's pretty much what we're doing.
spk04: Thank you for taking my questions.
spk01: Of course.
spk02: Our next question will come from Tom Brownell with Rocket Point Advisors. Please go ahead. Tom, you might be muted on your end.
spk03: Hi, good morning. I apologize. You are correct. I was muted. And just to be clear, it's Tom Brownell with Rock Point Advisors. Rocket Point might sound better and actually might be a great name for us at some point, but for the time being, we're just Rock Point Advisors. We'll take Rocket Point. Thanks for taking the question. If I could ask you to circle back to the sales and marketing initiatives, so this might be slightly repetitive, but encouraged by your comment that you were encouraged by your pipeline, and I was curious to hear you say that it usually takes about a year for the interest in value mandates to sort of gain traction. I'd be curious to know what you think of this being the start date in this cycle of when that might have started. Secondly, interested to hear about the participation in your webcast. I guess my question is, is that primarily coming from the consultant space or are those actual members in the investment management community that are participating in those webcasts? And depending on the answer to that question, what are you hearing today? from the consultant space in terms of interest in deep value strategies. And then lastly, can you just comment quickly on whether there's any change in the sort of geographically where the interest might be coming from and whether you're seeing greater and or less interest in deep value strategies domestically or is that coming from abroad? As I think I'm aware, you have built out some of your sales and marketing efforts internationally. So thanks.
spk01: Okay, well, hopefully I'll hit all these. If I didn't, you'll remind me. You know, most people are dating the start of the value cycle to October 1st. You can be cuter than that if you want, and we can date it back to the actual bottom of the market in March of last year. But I would say that from March 23rd, which would have been our bottom, October 1st, there was a little bit of – we kept up with the market. We were a little ahead. I wouldn't call that a dramatic value cycle. So the fourth quarter is a dramatic value cycle, or at least a dramatic value performance. We hope it turns into a cycle. So I think October 1st would be my guess of where that starting point would be. The increase in interest is actually in a number of areas, but the one webcast I was specifically referring to had a lot of financial intermediaries on. These are people that are advising clients. They're not consultants in the institutional consulting community, but they were on as well. But the big bulk were on intermediaries. These are brokers that are probably answering their own clients' questions about value and are trying to be educated on that. We do see consultants and institutions looking more closely. We see it in conversations. I'm going to use that same word I used before, pre-search activity. conference calls the consultants are we're doing educational conference calls for broad swaths of consultants who are engaged in the same kind of questions with their clients about should I change my investment allocation given how well growth has done and given maybe that this is the beginning and So I'm going to say it's kind of across the board. And you're right to say that most of the people that we're talking to are intermediaries rather than the ultimate investment decision makers. But my sense is that this is getting communicated onward, and there's enough of those direct investors that it's encouraging. They're also asking, or existing clients are asking for more engagement with their boards and committees than we've had lately. So all of those things are the things that give me – made the statement that pre-search activity is getting pretty interesting. Now, where is it coming from? It's everywhere. I don't think that there's a geographic bias. I probably can look at data and see if that's the case, but this is my gut instinct from the conversations I've had over the last few months that it's pretty much across the board. Great, thank you. Did I get every one of your questions? You nailed it. Thank you.
spk02: Again, if you'd like to ask a question, it is star then one, star then one to ask a question. There being no further questions at this time, I would like to turn it back to Jessica Dorn, who has an emailed question.
spk00: Thank you, Operator. I will read a question from an investor that we received via email this morning. This is a question for Rich, who is Operator trying to get back on the line right now, so if you could keep an eye out for that. As I read the question, we'll just give Rich a moment to get on and respond. So the question that came in is as follows. The markets are very worrying lately. From observing large-scale runaway valuations like Tesla, Bitcoin, and GameStop, It makes me think of stories that I read from the late 20s and dot-com bubble. While I understand it's impossible to predict when or what might happen, I'm wondering your assessment of the greater risks that might affect Pazina's assets under management, i.e., in your view, is there large-scale debt finance speculation or other risks that could cause significant and permanent capital loss in the markets? further, how do you assess the potential impact of these risks on the assets you manage? And what are your clients' hesitations on how Pazina's assets are positioned to weather the coming years?
spk01: Okay, thanks. I apologize that I got disconnected for a quick second. But You know, I'll use the word the craziness in the market has very little impact on us because we just don't have any exposure to any of these kinds of companies. And we don't have exposure to the high-flying growth stocks that are, you know, traditional things that people have invested in. And certainly the items that have caused the market to – to have these giant dislocations where you stare in amazement that you could have of the size and magnitude that you've had. We're not in those. I wish I could tell you that we own some in the advance and we benefited from that. What happens is when the market wild like this and volatility gets introduced to the marketplace it actually creates opportunity for us and by having a very very disciplined approach to thinking about valuation and to assessing valuation we can exploit when the market goes crazy in one way or another by buying things that get punitively priced and lightening up if and when we have something that would run Now, does this cause our clients to worry about their investment overall in equities? I'm sure it does. Do I think that it's likely to have much impact on us? I really don't. Because one thing that we've succeeded at over 25 years of being in business is making sure that our clients understand exactly what it is that we do. So there aren't They understand, and we've been repetitive over and over and over. Because most of our clients, particularly the two... Where do you want to put your money? Which aspect of equities do you want to put your money in? And given that as this kind of stable, steady operator executing the same strategy year over year, I think we instill some of the that would exempt us from this kind of fear that it would impact our business. And the only thing I can point to is what happened during because we were having a lot of these same discussions at the end of 1999 and early 2000. We would stare at amazement. I can't believe this is going on in the marketplace. And when it unwound, we actually had the five best years of flows into our business and good investment performance because the stocks that we owned attracted capital as people withdrew capital in companies with market values many, many, many times the size of ours. And people just buy and sell at the wrong time, and we try to take advantage of that. And I know it was a red question, and I don't know if I addressed it well enough, but hopefully you can hear my sentiment.
spk02: This will conclude our question and answer session. And at this point, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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