Morgan Stanley (MS) Q1 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Eaton Vance First Quarter Fiscal Year 2012 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Dan Cataldo. Thank you Mr. Cataldo, you may begin.

Thanks [Ruth]. Welcome to the Eaton Vance first quarter fiscal 2012 earnings call and webcast. Here this morning are Tom Faust, Chairman and CEO; Bob Whelan, our CFO; and Laurie Hylton, our Chief Accounting Officer. Tom and Bob will comment on the quarter and then we will take your questions. The full earnings release and the charts we will refer to during the call are available at our website, eatonvance.com under the heading Press Releases. Today's presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our operations and business, including but not limited to those discussed in our SEC filings. These filings including our 2011 Annual Report and Form 10-K are available on our website or on request to the company at no charge. And now I'd now like to turn it over to Tom.

Good morning and thank you for joining us. Our first fiscal quarter began much to like fiscal 2011 ended, the significant market volatility contributing to investor uncertainty, and net client withdrawals. For the first quarter as a whole we saw net outflows of $1.1 billion, our second consecutive quarter of negative net flows after 22 consecutive quarters of positive organic growth. But since the time of the calendar year the market environment and our flow results have improved markedly. On the back of strong equity returns, we had $800 million of net inflows in the month of January and closed the fiscal quarter with $191.7 billion in managed assets, up 2% from the beginning of the quarter and unchanged from a year ago. Although we are still early in our second fiscal quarter and things can change based on flows in the quarter to-date in visible pipeline through the end of January we now expect to return to positive internal growth in the current quarter. The favorable performance of the equity markets so far in February also positions us well for the second quarter asset growth. We had a solid first quarter from an earnings perspective with $0.47 in adjusted earnings per diluted share. This compares to adjusted diluted EPS of $0.47 in the fourth quarter of 2011 and $0.45 in the year ago quarter. As a reminder our adjusted earnings differ from GAAP earnings by excluding changes in the redemption value of non-controlling interest and our majority on subsidiary that we're required to reflect in our GAAP earnings. Bob will discuss our financial results in more detail in a moment. As I comment on the first quarter, please refer the slides on our website for additional color. As I mentioned, we had $1.1 billion in net outflows for the…

Thank you and good morning. Our financial condition continues to be strong as reflected in our balance sheet, cash generating ability, credit ratings and consistency of financial results. We saw sequential improvement this quarter in our growth and net flows and ended the quarter at higher managed asset levels than the quarterly average. We continue to manage for profitable growth with a keen eye on the profitability of new assets raised and new products and a continuous focus on the cost of sales and expenses generally. As such we're looking at all spending categories and managing staff additions closely. As Tom mentioned we are well-positioned for growth going forward and at the staffing and infrastructure in place to support that growth. We are reporting adjusted earnings of $0.47 per diluted share for the first quarter of 2012 versus $0.45 in the first quarter of fiscal 2011 and $0.47 in this past fourth fiscal quarter. As a reminder, adjusted earnings per diluted share reflects the add-back of adjustments in connection with charges in the estimated redemption value of non-controlling interest in our various affiliates, as well as other items deemed to be non-operating. This quarter, our GAAP earnings included an $8.1 million charge reflecting the estimated growth in value of non-controlling interest in Parametric Portfolio Associates over the past year. Please refer to the two tables in the slide that details the history of this charge as well as the other components of non-controlling and other beneficial interest. In an effort to simplify our financial reporting and provide greater transparency into our earnings from operations, we have reclassified income earned in realized and unrealized gains and losses on investments in consolidated funds from the other revenue line item to below operating income. These two items are now included in the other…

Thank you. [Operator Instructions] Our first question comes from the line of Ken Worthington with JPMorgan Chase. Please proceed with your question. Kenneth B. Worthington – JPMorgan Chase & Co: Hi, good morning, or good afternoon. I wanted to just do some [calls] on the eUnits. I guess maybe how are you marketing the eUnits and do they require seed capital, how are they sold, is there a load associated with them, and then what are the fee rates associated with them and the expense ratio. So I guess that one question was like ten parts.

Okay, what I’ll say is, addressing the first deal we did in January, though it would be a template that we would expect to follow in future deals. So, the eUnits were offered in approximately a month-long offering period. I mentioned that these are, from a regulatory standpoint structured as closed-end investment company. Then they are marketed not unlike a closed-end fund, also like a structured note would be offered. We had offering period of probably three to four weeks. We offer them both with and without a sales charge. For commissionable accounts there is a 2% sales charge and for fee-based accounts the investor has the ability to invest at net asset value. So you can either, depending on what type of client it is, it's a 2% load or no-load. And remember, that's for a two-year term offering. If we did it with a different term, perhaps the pricing would be different. So it's a 2% or 0% depending on whether it's load or no-load client. One of the things that is significant about that is that the structure potentially gives us the ability to market to fee-based accounts in a way that structured notes are not. I'm not an expert on structured notes, but I understand that the commission is effectively built into the product in a way that you can't apply it to some clients and not apply to others. So it’s a dual pricing, so that it can appeal to both potential markets with a particular focus on opening up an opportunity for fee-based business that hasn't before been participating in structured notes. I guess the other part of the question as I remember it is the fee, what's in this potentially for Eaton Vance. The fund or the trust has a structure of 75…

Thank you.

Our next question comes from the line of Roger Freeman from Barclays Capital. Please proceed with your question. Mr. Freeman, you’re now on the line. Roger Freeman – Barclays Capital: Hi, can you hear me?

Yes.

That’s not working. I’ll process with you on speaker. I just wanted to ask, in terms of the Macro fund reopening, clearly there seems to be some additional traction coming through. Can you just talk maybe anecdotally at least what kind of reception you're getting from the third-party distributors [warehouse] just in terms of them marketing that product again because I think you've talked last quarter about sort of the challenges in kind of getting that backlog in the radar screen?

Yeah, certainly both the commentary and the flow numbers, the guess we're making significant progress and getting that back up and front of financial advisors. The timing is, this was a blow out product in really throughout 2010 until we closed it in October. We saw some continuing positive flows through, I’d say the end of 2010, end of the calendar year, and that's started to turn negative during the course of 2011, since that we had a big base of investors and literally no new flows. So it was not surprising that we turned down. When we reopened it in October, it took us a while I’d say to get the word out, to get back [front] of mind with financial advisors. And again not surprisingly its taken up a little time, but we've seen a pretty good built, we're not blaming it to back to where we were the heyday of 2010, but we've seen a good built month-by-month in global macro flows. January was substantially better than December, February is looking better than January. Returns year-to-date have been I think in the range of 3%, 2.5% to 3%, 2.55% as of yesterday for the [GMR] Class A I believe, which was better. The strategy lost a little bit, I think we were down about 30 basis points or so in terms of total return for 2011. But returns backed positive with investors increasingly embracing asset rate return that this thing is certainly among the biggest and most visible asset rate return products in the retail advisory channel. We're certainly optimistic that if and the other four asset return products we have will be pretty good contributors for us over the balance of the fiscal year. Roger Freeman – Barclays Capital: Okay, thanks. And then on the value product, you mentioned you're very focused obviously on the returns improving. Last quarter, I think you talked about some staff changes you had made. What else are you doing? How much of this gets resolved by less, [quarterly] to market that we're seeing now?

Yeah, that's always the challenge in these things. You don't want to fix things that are not broken, but you do have to fix the things that are broken. As you referenced, we have made some changes in our analyst staff. We've really analyzed the problems with market rate performance quite thoroughly and come to the conclusion that, I think quite clear from the numbers, which is really two things, one is that over the last three years we’ve had a significant style headwind, large cap has underperformed, mid cap and small value has underperformed core and gross, high quality has underperformed, low quality and high beta, all of those things. Large cap value, high quality are the (inaudible) of our strategy and we don't intend to change those. So that's one of the issues we face. But the other one equally clearly is that we’ve had some poor stock picking in certain sectors and we’ve tried to address that by adding resources to our analyst team and in a few cases as you mentioned we’ve made some changes there. I think we’re in a pretty good spot where it's a hard thing to analyze. You run an investment portfolio for long-term results, it's hard to tell from those results in the short term whether you’re addressing the underlying problems. The challenge we have is mostly the fact that our three-year numbers are in the bottom best sell of the peer group. That reflects the coming out of the market bottom just about three-years ago we were relatively conservatively positioned and underperformed pretty significantly in the early stages of the market rally and have not been able to recover that ground. The one-year numbers, the one-year performance numbers this is for our A shares as of yesterday, in the 69 percentile all of our peer group, not parable but also not where we want to be and also not good enough to turnaround the longer-term, the three-year numbers. The five and the 10-year numbers still continue to be competitive. The challenges we face here particularly is that our peak year for raising, years for raising assets were 2007, 2008, 2009 and those of us that came on then, they heard about the period when we performed spectacularly well versus our peer group, unfortunately I didn’t experience that. So, we're doing all the handholding with client. Ours is a steady consistent style. We have a very developed ingrained philosophy about the kinds of companies we’re looking for. As your questions suggested that this has been a pretty lousy market environment for those types of stock generally, but we're working hard doing everything we can to buy better stock picking, overcome the dollar headwinds that we’ve been facing. Roger Freeman – Barclays Capital: All right. Thanks a lot.

Our next question comes from the line of Michael Kim from Sandler O'Neill. Please proceed with your question James Howley – Sandler O'Neill & Partners, L.P.: Hi, good morning, this is actually Jim Howley filling in for Michael. I just want to circle back quickly to new products. Obviously you guys talked about the [ENS], but if you can give just a more broad overview, and then more specifically if you have any update on the pipeline for incremental closed-ends outside of the U.S.?

Not a lot is happening at Eaton Vance regarding closed-end bonds. We continue to monitor the market, as you may know if you follow the market closely. Issuance in the closed-end market is down fairly significantly. The range of strategies that have proven successful over the last couple of years has been pretty limited. There have been several funds invested in master limited partnerships that have had pretty good raise ups, but other than that the fixed assets have been few and far between. Our view is that the closed-end fund market needs some structural innovation. The pricing structure of, everyone pays an embedded 4.5% upfront sales charge is a, I would say a significant and a growing impediment to investor interest for a pretty broad range of investors, so fee based accounts, high network investors, institutional investors. Clearly, paying that level of the front-end sale charge is not something that they would readily do. The other structural issue obviously relates to the persistency of discounts in the secondary market. As I mentioned, eUnits, though not a traditional closed-end fund, does have some elements that we are hopeful can be applied to more traditional closed-end funds, specifically the ability to offer it on a reduced load basis and specifically to include mechanisms that may help address and mitigate the development of discounts.

So closed-end funds were a big part of the growth story at Eaton Vance from 2003 to 2007 for each of those five years. We led the market in new issuance. But we haven't had lot to show forth since then. I think we’ve done two offerings in total since 2007, raising roughly $400 million. So it is an important part of our history. We are close to that marketplace. When the time is right, and when the product is right have demonstrated an ability to be successful in both raising assets and managing the assets effectively. But unfortunately, we haven't seen those opportunities over the last couple of years, and frankly we don't have a lot of much pipeline focused on closed-end funds at the moment, but are certainly eager to work with distribution partners to look at ways that we might enhance the structure of the product to make it more broadly appealing. James Howley – Sandler O'Neill & Partners, L.P.: Okay, great. And then just in terms of seeding investing, should we kind of expect the [exemptions] to seed investment this year and if that is the case, how would you think about using that capital going forward, and more broadly how would you think about deploying excess capital? And if could just give the average AUM number again?

Average AUM for the quarter was 188.2. James Howley – Sandler O'Neill & Partners, L.P.: Okay, the same as last quarter.

Yes.

The seed capital, I think at this point we're not expecting significant changes. We’ll have some products we're going to put to, see capital into, others we'll be pulling out of. I would expect probably modest net growth in these capital commitments. So it's, that may change if we have some strategies. We’ve got a lot of money sitting in the bank. How much? James Howley – Sandler O'Neill & Partners, L.P.: $475 million.

$475 million sitting in the bank, earning not very much if we can find better uses for that, either in seed capital investments or share repurchases or other capital funding opportunities, we’re open to do that. That money is not sitting there because we think the returns that we’re earning from the bank are attractive. That money is sitting there waiting for an opportunity to be applied in a better way. So we’re open to acquisitions. We’ve talked in the past about acquisitions as being an element of our growth strategy. We did significant acquisitions in 2001, 2003, 2008 and are certainly open to that possibility in 2012 as well. But we think about capital uses, we pay dividends, we repurchase stock, we invest in seed capital and we opportunistically pursue acquisitions. Those are kind of the uses of capital that we have. We’re fortunate to be in a cash generating business and we view our ability to invest that cash strategically as a very important, very significant asset for Eaton Vance. James Howley – Sandler O'Neill & Partners, L.P.: Okay, great. Thanks for taking my question.

Our next question comes from the line of Dan Fannon from Jefferies & Company. Please proceed with your question. Daniel Fannon – Jefferies & Company, Inc.: Thank you. I guess I want to talk a little more about the return to positive organic growth as you think about this quarter. I mean is this a function of just kind of building on what was going on in January? And maybe give some context around the gross sales versus redemption’s in terms of the trend there?

Two reasons for optimism that the second quarter will be a positive. One is, as I mentioned, forward results to-date over the first three plus weeks of the quarter has been positive. And secondly we have a pretty good pipeline of primarily institutional business that we fully expect to fund during the current quarter. We’ve got visible outflows, we’ve got visible inflows but the balance for the remainder of the quarter looks to be north of $1 billion to the [good]. So things look pretty good. The challenges we face are mostly related to our share value, where we do expect that there will be some level of continued outflows, we hope at a measured pace and we hope that we can turn that around as the performer improves. I mentioned the muni ladders as a new product that is starting to build momentum. We had over $100 million in inflows in the first quarter branded products though gross inflows and net inflows are essentially the same, building momentum there. And just to remind you what that opportunity is, traditionally many financial advisors met their clients to actually [income] these by assembling and, I guess you’d say overseeing portfolios of muni bonds, the ladders, we use the term ladder to note the fact that different maturities and we'll turn it over that portfolio periodically given the, the rising concerns about credit in the municipal space given increase in transparency of cost and to be trading costs in the bond world including muni’s there is increased appetite on the part of financial advisors and their clients. So, I hope to a more managed solution and the tabs group has developed a, what we think of highly competitive product in terms of the features and in terms of its pricing that we're…

Yeah, I think that's obviously had generations in compensation over the last couple of quarters. We think that's a pretty good number. We also mentioned that we have ending assets about $4 billion higher than the average for the quarter. So if you take that $4 billion that's puts about $20 million on revenue for the full-year $5 billion for the quarter. So if you think about the margin where it is right now, those two items are loan obviously we’ll help a little bit. Expense management we’ve talked a little bit about that on the call, we’re focused on it, we're focused on comparable growth that constant it's pretty ingrained, purity advance so that's when we look at new products where focused on the economics of that any funds we launched obviously where, it's focused on the effective fee rate and then on the extent side the cost of sales is obviously important just what we pay to put assets on the book, so managing the incentive that we pay off, our field force, managing our relationships with the intermediaries and getting the most value out of our sales support is important. And then obviously we’ve had a major revamp in terms of marketing, and those three components would play into it. So managing that is important going forward, and that’s what we’re focused on. If you can think about the big extent, that when you take a step back it’s really compensation. Last year for the full year, compensation was $375 million of the $822 million or 45%. So managing compensation keeping [as the] staff only where necessary is important. But we feel like we’re fully built our – looking on the horizon, there aren’t major initiatives that we’ve had in the past in terms of building out…

Okay. Let me just make one more comment on your, while we’re talking models, remember that the second quarter does have a fewer number of days. This year is a leap year so it’s only two fewer days but that's a factor into a number of the income statement line items which I know a lot of you are familiar with. Daniel Fannon – Jefferies & Company, Inc.: Great. Thanks for taking my questions.

Our next question comes from the line of great section about from Craig Siegenthaler from Credit Suisse. Please proceed with your question. Craig Siegenthaler – Credit Suisse: Hi guys, its Craig Siegenthalen from Credit Suisse.

Got it. Craig Siegenthaler – Credit Suisse: First, just starting on the positive net flow commentary that you provided for the second quarter, can you talk about which two assets classes are the largest drivers of sequential improvement when you think about this guidance if there is any areas we should think about which will significantly improve on a quarter-over-quarter?

I may give you more than two, one will be emerging market equities and the other would be muni’s occurred with the asset rate of returns. A fourth would be what I’ll call leverage credit including bank loans and high yields. Those would be the ones that I would walk to. Anything else Dan or Bob that you would…?

No, I think those are, in terms of existing products, that’s where we’re seeing the most momentum right now. Craig Siegenthaler – Credit Suisse:

You’re saying about the non-controlling interest value adjustment? Craig Siegenthaler – Credit Suisse: Yeah, if I look at your presentation on slide 16, and I look at non-controlling interests value adjustment, yeah 2Q 2011, 2.9.

Craig, that's related to Parametric Risk Advisors, the Q2 2011 adjustment. And that’s based on the annual revaluation of the minority interests of Parametric Risk Advisors. When we did evaluation last year we actually owned I believe 49% of the company, we now own 60% of the company. So in terms of the amount that we’re valuing it will be of minority interest. It’ll actually be a smaller percentage amount. Now as their business grows, that could cause the adjustment to go up. And their business has been growing, they stop (Inaudible) the eUnits product and they’ve had some pretty good success in some of the other auction products. So that's what to think in the Q2 Mark. Craig Siegenthaler – Credit Suisse: And Dan, that was 49% to 69% or is that 49% to 60%, I missed that number?

It's actually 50% to 60% is our ownership now. Craig Siegenthaler – Credit Suisse: Got it. Guys, thanks for taking the questions.

You're welcome.

Our next question comes from the line of Cynthia Mayer from Bank of America. Please proceed with your question. Cynthia Mayer – Bank of America/Merrill Lynch: Hi, good morning. Looking at the flows, it looks like the high network flows improved quite a bit and so did the retail managed accounts. So I'm wondering how much of that is seasonal, how much of that was in January and anything particular driving those? Thanks.

On the high network side of the business, we had a couple of nice wins. One was a Parametric Risk Advisors options products and the other was a Parametric tax-managed core overlay product. I don't think there's anything that's fairly seasonal about that, but there were two significant wins that comes up the business.

I guess the other thing I would point to is that the retail managed account business we have is increasingly dominated by the muni’s and particularly our tab muni’s strategies and to the extent that muni performance has been improved and many flaws have been improved, that's a big enough factor within that [RMA] category to help the drive the improvement in the category as a whole.

And actually interestingly enough in the managed account business in this past quarter we had a sizable large cap value win. So you had help from both muni’s and that large cap value and on the retail managed account side of the business. Cynthia Mayer – Bank of America/Merrill Lynch: Great. Well maybe since you bring it up, could you give us the asset breakdown in those channels just roughly I mean how much of that is muni’s is now in retail managed account? Maybe how much is equity versus non-equity?

So actually haven't broken down by company. Eaton Vance is $13.4 billion of the total, and it looks like municipal are about $7.5 billion of that. The balance would be equities. The remainder of the assets really would be largely in equities through Atlanta or Parametric. Of course Parametrics business is partially overlay as well. Cynthia Mayer – Bank of America/Merrill Lynch: Okay. Great and let's see, maybe I'm reading between the lines too much, but it sounded like you might be making a change to sales force compensation. It sounded like you said it was important to manage that. Is that a change you're making, and how should we think about the impact of that on comp? Would that be something that would shift as the comps to revenues ratio or be a set function or…

No, don't read into that, that there is a change. We typically adjust the sales force compensation or put in new compensation programs at the beginning of the calendar year, and we've done that. But there haven't been significant changes. The primary driver of sales force compensation year-over-year will be sales success. Any contribution one way or the other from changes in how we pay people is, I would say pretty incidental relative to the total level of sales success year-over-year. Cynthia Mayer – Bank of America/Merrill Lynch: Okay. So we should just continue to think about the gross sales as the driver?

Yes, that's right.

Yeah. Mix is also important, but total sales, mix of sales as opposed to changes in compensation for any particular type of business. Cynthia Mayer – Bank of America/Merrill Lynch: Any particular products you're exercising now in terms of the mix?

Well, most of the things we've highlighted, I think you could consider to focus products. Certainly our compensation tends to be higher on a range of newer strategies that we're trying to get up to some critical mass. So newer strategies, things that we've made as focused products areas over the last couple of years, those tend to be higher levels of compensation, more established franchises, for example like bank loans that tend to have relatively rapid ins and outs tend to be lower compensation and other things, and that's part of retail. Cynthia Mayer – Bank of America/Merrill Lynch: All right, great. Thank you.

Our last question comes from the line of Bill Katz from Citigroup. Please proceed with your question. William R. Katz – Citigroup Inc.: Okay, just a couple of qualifiers in my (inaudible) question. You mentioned 75 basis points as a gross fee on the eUnits. What's the net fees in that?

Well, 75 basis points is the expense ratio of the fund, so we bear all of the cost out of that. I don't know what that number is for the initial offering. It's either negative or small after we eat all of the expenses. So in a big offering, it can be pretty meaningful relative to that 75 basis points. In a small offering like we just did its round to zero. William R. Katz – Citigroup Inc.: And then on the $1 billion pipeline you have the institutional (inaudible) good. Is that embedded in your commentary of bank loans, emerging markets, et cetera?

Correct, Yeah. William R. Katz – Citigroup Inc.: Okay, so a bigger question is, if you look at your business today, it's about flat year-on-year, a recognized market impact if you well. Your margins are down about 150 basis points or less. On a go-forward basis, just given the dynamics between these large cap funds struggling with the [versions] in these newer, faster growth initiatives, how would you think about your overall margin, flat up or down the next 12 months?

Reported margin right? William R. Katz – Citigroup Inc.: Operating margin, right.

We’ve talked about a range historically on a GAAP basis between 30 and 35 and on the adjusted between 35 and 40. And right now we're in the lower end of that. That's not to suggest we can go higher. I think there's some items as I mentioned earlier, in the earlier question where we’re going to get some relief on comp. Our assets are at higher starting levels and we don't have any major build out. So moving back towards the range where we've been, back to that 35 on a GAAP where we were in the last couple of quarters and back to, I think we’re at 39 on adjusted I don't think is a stretch.

The way I think about it Bill is that we and our competitors have significant pressures on margins that are ongoing, both pressures on fees, pressures to reduce fees, pressures to introduce new products at lower price points and existing products, certainly a range of cost pressures, both internal mostly compensation-related as well as external, which is the rising cost of distribution. William R. Katz – Citigroup Inc.: Okay. Thanks to taking my questions.

Thanks, Bill.

There are no further questions at this time. I would like to turn the call back over to Mr. Cataldo for closing comments.

Thank you for joining us this morning, and we look forward to speaking with you at May on the close of our second fiscal quarter. Goodbye.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.