WisdomTree, Inc. (WT) Q1 2012 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to WisdomTree's First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to WisdomTree. Please go ahead.

Thank you. Good morning. Before we begin, I would like to reference our legal disclaimer available in today's presentation. This presentation may contain forward-looking statements within the meaning of the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of forward-looking terminology such as believe, expect, anticipate and similar expressions suggesting future outcomes or events. Such forward-looking statements reflect our current expectations regarding future events and operating performance and speak only as of the date of this presentation. Such forward-looking statements are based on a number of assumptions, which may prove to be incorrect. Forward-looking statements involve significant risks and uncertainties, should not be read as guarantees of future performance and results, and will not necessarily be accurate indications of whether or not, or the times at or by which, such performance or results will be achieved. A number of risks and other factors could cause actual results to differ materially from the results discussed in forward-looking statements including, but not limited to, the risks set forth in this presentation and in the Risk Factors section in the company's annual report on Form 10-K for the fiscal year ended December 31, 2011. Now it is my pleasure to turn the call over to WisdomTree CEO, Jonathan Steinberg.

Thank you. Good morning, and welcome to WisdomTree's first quarter conference call. Fellow shareholders, the first quarter of 2012 was simply our best quarter ever. We ended the quarter with record inflows of $2.3 billion, with record assets of $15.7 billion and record revenues of $19.2 million. We continue to execute well across all functions as demonstrated by our first quarter results. In addition, our market share of inflows was 4.4%. $1.1 million of net income was achieved by driving our revenues higher and managing our expenses appropriately. Later on this call, Amit Muni, our CFO, will walk you through our financials in greater detail. In addition, we launched the fourth most successful new ETF in the first quarter, emerging market corporate bonds. Lastly, we completed our secondary offering, which further establishes WisdomTree as the only public pure play in the ETF space. The offering has allowed us to significantly broaden our institutional shareholder base, which was one of our goals for the offering. On the next page, let's look at our quarterly inflows by category. First, as stated earlier, first quarter inflows came in at $2.3 billion, that is $600 million, or 35% higher, than our next best quarter, which was the second quarter of 2011. On the right-hand side, you can see the composition of flows. We experienced very strong inflows into our equity ETFs. We took in $1.4 billion in emerging market equities, almost $600 million in U.S. equities and over $300 million in international equities. The vast majority of our equity flows were in our dividend-based strategies. Let's look at how our flows affected our assets on the next page. We ended the first quarter with $15.7 billion in assets, which is up 29% sequentially and up 39% year-over-year. On the right-hand side of the page,…

Thank you, Jono, and good morning, everyone. I'd like to begin by first reviewing our overall financial results. The record net inflows we experienced in the quarter, together with positive market movement, helped us to achieve a record quarter. Total revenues in the first quarter are $19.2 million, which is up 32% from the first quarter of last year and 19% from the fourth quarter. Our total expenses on a GAAP basis were $18.1 million in the first quarter, which was up 26% from the year-ago quarter and 18% sequentially. On an adjusted basis, excluding the cost related to our patent litigation, ETF shareholder proxy and initial exchange listing fees, our pro forma operating expenses were $17.4 million, which was up 14% from the first quarter of last year and 24% on the fourth quarter. Our GAAP net income was $1.1 million and our pro forma operating net income was up 78% to a record $1.9 million. You can see the attractiveness of the platform in our business model. Compared to the fourth quarter, revenues are up 19%, operating expenses up only 14% and our operating net income is up 78%. I'll go through the main drivers of our revenues and expenses in a few moments, but I first wanted to review our key margin metrics on the next slide, which also reflects the attractiveness of the business model. Our gross margin, which is our total revenues less fund related and third party sharing expenses was 63% in the first quarter. That is up from the fourth quarter due to the change in mix of our assets and lower expenses for our joint venture with the Bank of New York Mellon for our currency and fixed-income ETFs. As we continue to gain scale and grow our assets, I would expect…

Thank you, Amit. I will be brief. It was another very strong quarter for the ETF industry. WisdomTree remains well positioned within the fast-growing ETF marketplace as the only pure play public company. Again, we reported record revenues, record assets and record inflows. I want to thank you for your interest and support in WisdomTree, and it is now my pleasure to open this call up to questions.

[Operator Instructions] Our first question comes from Mike Grondahl of Piper Jaffray.

Just a question. Jonathan, you mentioned the acceleration from iShares in kind of PIMCO. And you guys had won real successful fund. Do you worry at all that you need a little bit more quantity out there in terms of new funds? Or how do you kind of gauge that?

Very good question. Thanks, Mike. Well first, I reference the increase in activity for iShares, not for PIMCO. PIMCO also launched only one fund like WisdomTree. I can only speculate what iShares is doing, which adds -- the firm that has roughly 50% to the assets and $3.7 trillion in assets in -- overall, having a very large tail of small funds is not really a burden for them. So they have a different business line. I think that they are making it much more difficult for additional firms to come into the industry by sucking up seed, taking up shelf space and being third and fourth to market in many categories. That really just is not a productive strategy for WisdomTree and it doesn't seem to us that it is holding back our growth. So it's something that we discussed -- what we have targeted 3 to 5 new funds a year, and I think we're very comfortable with that -- with that strategy.

Got you, that's helpful. And then secondly, what are you hearing from your customers? Are they -- are they wanting more funds from you guys or wider kind of selection or are they happy with what you have?

This is Luciano. I think they're happy with what we have. Part of the challenge for us is familiarizing them with funds we already have in the market. And so, we are -- if we ever get word that there's a fund that they really want that doesn't exist, we certainly take a look at creating that. But for the most part, our challenge is showing them how our funds work within the investment themes that they're already seeking. And I think that's what where we're getting the traction. I think people are understanding how the WisdomTree funds are different from the other funds in the marketplace and how the funds we have that are clearly differentiated and really are the only option in the marketplace; I think those funds are also starting to get more attention from our customers.

Our next question comes from Bill Katz of Citigroup.

This is actually Steve Fullerton on the call for Bill. I just want to get an idea, with you guys outlining how well you've done in equity. Is that going to guide you guys to do more new product offerings in equity or is that not the way your guys' process would work when thinking about new products?

This is Jono. First, we have a very broad equity lineup as it is. So we're very well situated in the equity space. But we have filed what's public for one equity fund, China ex-Financials and also another bond fund, Brazilian bond. So we're selectively launching and we're not -- it's not -- these trends of inflows, they can change very quickly. So we're just continuing to try to diversify the business model, fill out any holes that we have, but again, be very selective and focused in what we do launch.

Okay, great. And then just one follow-up as well. With AUM climbing, just thinking about margins and thinking about expenses, what should we expect from comp moving forward? And when thinking about margins and your guys' goals, what line should we be looking for on the expense line?

This is Amit. Obviously, we will continue to gain leverage particularly in our fund related cost as our assets continue to grow. But I'll just reiterate, those longer-term margin targets that we've talked about at the $15 billion of average asset levels we should be in the 10% range once we get closer to the $20 billion in average assets, we could get closer to that 20% margin range. So you'll see a little bit of movement here and there in some -- certain line items. Overall, our expenses are going to continue to decline as a percentage of our revenues as we continue to gain scale.

Our next question comes from Cynthia Mayer of Bank of America Merrill Lynch.

Can you talk a little about the subadvisory agreement you have with Western? I see you launched the EM Corporate Bond ETF, but do you envision doing others together this year? What's the timing and what's the financial arrangement?

I'll take the financial arrangement part. We have not disclosed what the arrangement is. It's confidential. But obviously, it has to be within the fee structure of an ETF. So it's not generally that different from our other subadvisor relationship that we have today.

And when we initially struck the agreement with them, it was anticipated that we would continue to build out fixed income on the credit side with them. So that's really our intentions that there happen to be some opportunities that we see on the credit side of fixed income and they would be our expected subadvisor.

So does that mean you'll be doing anymore this year you think?

Yes, we do expect to be doing some more this year, yes.

Okay. And in terms of the performance, it looks like the percentage of funds outperforming, the benchmarks fallen from something like 76% to 62% this quarter. What deteriorated and what kind of impact does that have on flows? Is it similar dynamic to mutual funds or do ETF buyers really pay less attention to relative performance?

Well, what happened in the quarter, risk was on, he had a very strong equity market in Q1 led by tax, so dividend paying stocks overall underperformed the market. So that contributed to some of the relative changes in the performance numbers. But don't forget that was after a very strong year in 2011, where the dividend payers outperformed materially. So I would say that performance is always important, but there's other reasons why people are buying our funds, particularly on the equity side. Sometimes they're buying them for income, sometimes they're buying them because they hedge up the currency exposure in a certain region. Sometimes they're buying them because they're the only option in terms of getting a particular asset class exposure. So these numbers fluctuate, but over time, these are still very competitive numbers when you're talking about 71% of the 12.8 billion invested in our 34 equity ETFs, wherein funds that have outperformed their capitalization weighted or competitive benchmarks through that date from their respected inceptions. So I would stack that performance record up against any active mutual fund manager, and I think it's something we can certainly be proud of.

Okay, great. Maybe one more just in terms of the margins. In terms of the asset-based expenses, including payments to advisors, are there any breakpoints we should know about? I know that BNY Mellon payments go down, but are there any others where assets increased so there'd be breakpoints at some point for instance to Jeremy Siegel?

No, our biggest fund, the Bank of New York is our biggest vendor that we have that operates the funds. And those are the ones that have the breakpoint fees that based on asset levels. Professor's Siegel's arrangement is just a compensation arrangement that we have with them. It's not based on assets or anything.

Oh, it's not based on assets?

Not at all. The variable component that you see associated with him is stock equity awards that we had given him in the past. And that is a variable stock-based compensation because that will move in line with our stock price. That's the only -- that's tied to our stock price not tied to AUM levels.

Okay. Maybe one last one, which is you mentioned the 2 ETFs you filed for and they're both emerging markets. Do you expect you'll do any more U.S. equity ETFs and how do you differentiate yourself in that market, which seems more crowded?

Beyond what we have publicly filed for, product development is one of the few areas where we have to be careful about our transparency. So really, we don't want to comment beyond what we have publicly filed.

Our next question comes from Mac Sykes of Gabelli & Company.

It's Mac Sykes. First, you have my deepest sympathies to the Lavine [ph] family. I know he's a very good guy.

Thank you.

I understand that Legg Mason has filed for its own exemptive relief. Would that impact or any approval there back to your work with Western going forward?

I'm not sure. We seem to have a very strong relationship with Western. I'm sure Western was aware of Legg Mason's initiatives. But we seemed like we're in a very good place with our Western relationship.

And then just more broadly, on the subject of exemptive relief. Have you seen any signals, as the regulatory authorities had suggest the process is getting any faster or slower, any different? Just any color on that would be great.

It remains very challenging process to launch new funds and we have not seen any improvement in the speed with which it takes to launch funds.

Our next question comes from Todd Wachsman of Morgan Stanley.

Two basic questions. First, we're very big fans of the whole dividend family of ETFs, specifically the dividend ex-Financials ETF. My first question is, what are your considering in the dividend ex-Financials space? My second question is, what -- and this is a corporate question, what level would your assets under management in total have to get to where you might start paying a common stock dividend?

In terms of the dividends ex-Financials, we have 2 U.S. dividends ex-Financials and international ex-Financials that we're very excited about both of those. We have filed for China ex-Financials. We think that is a very attractive way to approach the Chinese equity market. It will be a very differentiated fund. That's one of our next funds and we have publicly filed for that. In terms of a dividend, it certainly, at some point, the business will have scaled to a degree where it will be hard to reinvest the money in the core business and you'll have opportunities to pay dividends or buyback stock. But at the moment, I don't know where -- what that number is. It's a little bit early for us to start contemplating that as we just recently turned profitable.

Okay and one last question. I've seen a lot of demand for dividend paying items. There's an asset class royalty trust. There's been a lot of issuance there. Will you guys consider putting an ETF in that space that might own something like -- I don't want to get into specific securities, but when you see a lot of issuance of some of the royalty trust that drill for natural resources in the ground.

Sure. This is Luciano again. We've taken a look at the royalty trust, the match limit of partnerships over time and it's always a complicated asset class to work with because of the tax reporting that's involved. There have been other products that have come to market. And once you've seen the horse leave the barn and other products to scale and taking billions of assets and have million of trading volume, it always makes it difficult to be the #2 player in that space. So at this point, we haven't filed for anything. It's not to close the door forever. Product development team takes a look at all good ideas, but at this point, we think people are pretty happy with the kind of dividend streams they're collecting from the common stocks to the traditional 1099 structures.

Our next question comes from Mike Grondahl of Piper Jaffray.

Just a follow-up, Jonathan, maybe for you. Any surprises so far in 2012 or opportunities that you hadn't thought about maybe at the beginning of the year?

In terms of from the beginning of the year, not really. I mean, we really seem to have a strong sense of how the industry is playing out. Really very few surprises over the last few years actually. So no, no surprises really.

At this time, I'm not showing any further questions. I'd like to turn the call back over to management for any further remarks.

I have no further remarks. I just want to thank all of you for your time and attention. And we look forward to speaking with you next quarter. Thanks.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.