WisdomTree, Inc. (WT) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the WisdomTree's Second Quarter Earnings Call. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to turn the conference over to WisdomTree.

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 these forward-looking terminologies such as believe, expect, anticipate and similar expressions suggesting future outcomes or events. Such forward-looking statements may 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 or 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 the risk factor section of 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's CEO, Jonathan Steinberg.

Thank you, Stu. Good morning, and welcome to WisdomTree's second quarter conference call. Fellow shareholders, the second quarter of 2012 was a challenging one from a macro perspective, but again, WisdomTree executed well across all functions. We ended the quarter with $15 billion in assets. We had $338 million of inflows. We did achieve record revenues of $20.4 million. Of real importance, we also achieved record pro forma net income of $3.1 million when you back out onetime proxy-related expenses. Our market share of inflows for the quarter was 1.6%. In light of the fact that domestic fixed income represented 90% of total industry inflows, we did very well where we have competing product. Lastly, our insurance carrier agreed to reimburse a significant majority of our litigation expense. Later on this call, Amit Muni, WisdomTree's CFO, will walk you through that plus all of our financials. On the next page, let's look at the factors driving our assets under management. We ended the first quarter with $15.7 billion in assets. We, as already mentioned, we took in $338 million in new money, but suffered $1 billion of negative market move and ended the second quarter with $15 billion in assets. On the right, you can see that world equity markets experienced market declines, especially outside of the United States. In the pie chart, below, you can see that 83% of WisdomTree's assets are in equities, and 55% of our assets are in equities outside of the U.S. Now let's take a closer look at industry inflows on the next page. The industry had $20.7 billion of inflows for the second quarter, which is a decline of 61% from the first quarter and a decline of 29% from the year-ago quarter. On the right-hand side, you can see that in addition…

Thank you, Jono, and good morning, everyone. I'd like to begin by first reviewing our overall financial results for the second quarter and half year. Despite the challenging market, our revenues reached a record $20.4 million in the second quarter, primarily due to higher average assets. Remember that we earn our revenues based on average assets under management during the quarter, not end-of-period assets. For the first half, revenues increased 27% to nearly $40 million. Expenses, excluding the costs related to our patent litigation, ETF shareholder proxy and initial exchange listing fees, increased 26% from the second quarter of last year and were essentially flat compared to the first quarter. On a year-to-date basis, pro forma expenses increased 16%. Pro forma operating income reached $3.1 million, which is a 69% increase from the first quarter and $5 million for the first half of the year. As we demonstrated last quarter, the operating leverage in our business model is beginning to emerge, strong revenue growth, controlled expense increases and margin expansion, which you can see on the next slide. Our gross margin, which is our total revenues less fund-related and third-party sharing expenses, increased to 67% in the second quarter. This is primarily due to the change in mix of our assets that are part of our joint venture with the Bank of New York, as well as reaching pricing benefits with our third-party service providers. Our pretax operating margin is also growing as we are gaining scale. Pretax operating margin was 15%, which is within the guidance we have given investors at $15 billion of average AUM. The higher margins are being driven by strong revenue growth which are on the next slide. Our ETF revenues reached a record $20 million in the second quarter. This was up from $16.5…

Thank you, Amit. In summary, I just want to remind investors of a few points. Our product strategy is key to our current and future success. We have never launched a me-too product. We have a highly differentiated set of ETFs, and our performance record is an asset that is growing in value. The ETF phenomenon is disruptive. The ETF industry is experiencing secular growth that will continue uninterrupted as investors get better educated on the benefits of ETFs. And lastly, the third quarter though it's early, is off to a promising start. With that, I end the presentation. I want to thank you for your interest and support in WisdomTree and let's now open this up to questions.

[Operator Instructions] Our first question comes from Marc Irizarry with Goldman Sachs.

Just in terms of the gross margin continues to march higher here, could you give a sense of just where sort of the upside could be here if we're in a continued market environment like we're in now? And if things actually improve, if you will, how should we think about where that gross margin could end up?

Sure. So there's 2 components in that, right? First is the, how much of our AUM is part of the joint venture. And as you can see in this sort of market environment, we're seeing much more stronger flows than on the equities, and that's been benefiting the gross margin expansion, along with just the higher assets that we have and reaching the pricing benefits that we have with our third-party service provider. So in sort of this market environment, I would expect to be closer to that 67% as you saw in the third quarter. On an incremental basis, on average, our incremental gross margins are about 70% on average. So we should continue to -- with higher assets, we should continue to see growth in that gross margin. As a reminder, the joint venture that we have with the Bank of New York ends in 2013, and we'll be renegotiating that arrangement, and that should also hopefully be a catalyst to expanded margins as well. So I would say, the 67% is -- that just definitely reflects in the third quarter, like, it's sort of a good number right now in this sort of market environment.

And then, Jono, can you talk about the trade-off between market share gains and sort of just being on the leaderboard of market share, if you will, versus the margin in the business and how product launches play into that. And maybe, I don't know if you have a long-term margin target, like, if you think about the levels of AUM again, where should -- how should we just be tracking if you think about the operating margin versus the market share gains?

Before I do your -- the first part of the question, Amit, why don't you answer the longer term margin part?

Right. So the -- on the pretax margins, the guidance we have given investors is that how does our margins, our pretax operating margins, scale. At about $40 billion in assets under management based on the sort of current mix we have today, we believe our operating margin will be closer to 40%. So again, another way of thinking about it is, a T. Rowe Price, a BlackRock, the leaders in operating margins in the traditional asset management group, we can reach those same pretax operating margins that they do at a significantly -- at a fraction of the assets that they have. And that's really the power of the ETF model and our business model.

So, Mark, let me just talk about -- your question, I think, really deals with the number of new fund launches, the marketing spend, the headcount. And we have, over the last couple of years, taken a very conservative approach to all of those elements in light of what we felt were very constrained, muted investor interest, not just in WisdomTree, but inflows in the aggregate, in traditional mutual funds and ETFs are very muted. And so in that light, we've been very, very conservative. We are always looking at the question about, are we finding the right balance between growth and investment. And we're looking at, as the potential catalyst for changing our stance in the upcoming election. It might be a catalyst for greater inflows for investors, greater participation to equities versus fixed income. And so we're -- we have our decision tree and we're -- we could step it up if we wanted to, but I think particularly using hindsight, we've been appropriately conservative. We have given guidance that we're going to launch 3 to 5 funds a year in this environment. We did not launch a new fund in the second quarter. I expect to have launched a new fund in the third quarter, and may probably get it in the fourth. So we'll probably do 3 funds plus 1 repurposed fund this year. So I think that answers your question.

Yes, definitely. And then there's been some discussion about changes in regulations for SEC lending. Can you just remind us, I mean, is that impactful for you? I guess it's just a bigger question in terms of your European business or building a business outside the U.S., which I think maybe you put on a laundry list of priorities at some point. Does the issue with SEC lending revenues, is that pertinent to you or the way you think about the strategy building internationally?

Not at all. We don't earn any revenues from SEC lending. That benefits goes right to the shareholders of the WisdomTree funds. So we don't get any benefit of that. So there wouldn't -- that doesn't really affect us. And as far as how we think about internationally, again, that benefit would fall to any shareholders that we would launch internationally as well. So it wouldn't affect our business.

Our next question comes from Mike Grondahl with Piper Jaffray.

Jonathan, could you kindly just update us on the competitive environment, kind of what you're seeing there? And then have you given any thought to maybe launching more than 3 to 5 funds a year? I mean, as you guys have gotten a little bit bigger in terms of number of funds in AUM, I mean, is there any strategy to kind of leverage that side a little bit and just create a few more alternatives, if you will, or funds for your existing customers who are in there that are looking for different options?

So first the, sort of, the general environment, in certain segments, it's very, very competitive. I think investors are very aware of the price competition that's taking place on cap-weighted equities between Vanguard, iShares and State Street. There has been a lot of new funds launched year-to-date and last year and a decreasing amount of assets, on average, going into new funds. The market is having trouble absorbing all of the new funds. Just as a reminder, there are about 1,500 ETFs launched in the United States and 25% or 30% of them have $10 million or less in assets. So again, in this muted investor participation-type market, we've taken this very conservative approach to new fund launches. And we are willing, under -- in a different scenario, a different market sentiment, to be more aggressive, but what we don't want to do is get ahead of it, increase significantly our expenses and falter in some way. One of the things that we want to continue to try -- market movement is market movement, nobody can predict that. But we want to continue to, whatever ability we can control, show improving margins quarter-to-quarter.

Okay. And then maybe just as a follow-up, just seeing all the flow into those domestic fixed income funds, have you thought at all about throwing a fund at that category? Is there anything you can do there? Or are you pretty much happy with your mix to date?

No. I mean, listen, one of the -- when you talk about -- we're not a start-up any longer. We're 6 years old. So we are building out our product set. But you have to -- you can't do everything, you have to prioritize. No one knew, in hindsight, how strong domestic fixed income would be in flows and, quite frankly, how long this trend of inflow strength would continue. We are looking at and have made a lot of efforts in our fixed income offerings over the last couple of years. In the first quarter, we launched our first dollar-denominated emerging market bond fund, EMCB, with Western, so we're expanding into credit. So we are looking to do more. We think there's a very big opportunity in fixed income. What's interesting about this, the inflows in fixed income -- in mutual funds, it's mostly all active, and in ETF fixed income inflows, it's almost all index based. We're one of the leaders with PIMCO in active fixed income. We think there is a big opportunity for WisdomTree in either rules-based asset fixed income or structured active fixed income like we've done with our sovereign debt funds, as well as just pure active with Western. So we are looking for more opportunities. I don't want to you to think that we're ever satisfied. But I will say, don't expect that WisdomTree will have an offering in every category over time. It's probably -- it's not necessary, an ETF investor looks at the ETF world as a giant menu and you don't have to get all of your executions from one provider. And what we won't do is launch a me-too product and then have to compete solely on price.

Our next question is from Steve Fullerton with Citigroup.

Just noting the decrease in the fee rate, in the week ended 720 to 53 basis points, can you guys go into the dynamics there? And is this something we should look at as we go into 3Q?

The fee decline really is just a factor of change in mix of our assets. That will be the only thing that really drives sort of the changes that you see in our fee structure. If we see more flows going into our higher priced funds, the fees, the overall fee rate will go up. If we see it coming into more of a -- on the U.S. side, our lower priced funds, it'll drive the overall average lower. So it's really just a function of market sentiment and where their flows are going.

And just to add on that, we're not trying to manage it. Investors will put their money where the money goes. So to our credit, I hope you feel at least we're showing you what that number is on our website on a daily basis, so you're not surprised.

Great. And then -- so I noticed some of the headcount additions. Where are those focused and what's kind of your guys outlook as far as distribution?

So as far as -- so where we've been adding headcount is predominantly in our sales function. A little bit in sort of our back ops operation, but it's predominantly been in our sales function. And you can see over time, if you go back and look at our history, we've been incrementally adding to our headcount. You don't see massive changes in our headcount. And on a going-forward basis, I think that trend will continue, right? We're not going to get ahead of ourselves. We're going to carefully and incrementally add to our headcount predominantly to help grow that top line revenue. So it'll just be a small increase on a going-forward basis.

And just, again, in terms of our outlook, we have a very much a sort of a decision-tree approach to how we will build out our infrastructure. And I think really internally, we're looking to see how the election plays out, which I think will give a clear choice to investors on how the economy will grow and how investors will -- how aggressive investors will be about putting new money to work. So we're watching this election very carefully to see if we should step stuff up.

Our next question is coming from Jason Weyeneth with Sterne Agee. Jason Weyeneth - Sterne Agee & Leach Inc., Research Division: I just had a question. When you think about the pool of assets that sits in cap-weighted funds and the strategies that you offer your fund, I guess what percentage of that pool do you think is longer-term-focused investors versus those that are using ETFs more as trading vehicles? I guess I'm trying to get a sense of how much growth you can drive by market share gains in the current fund lineup as opposed to being too focused on launching new funds.

This is Luciano Siracusano. I think the way we look at it, by and large, our clients really are more long-term investors. We're not really targeting the trading community. I think when the long-term investors build out their asset allocation, they're looking for ETFs that give them broad asset coverage of an asset class. And that's really where WisdomTree, I think, has the most upside. But a good example would be emerging market equity this year. We've done very well on attracting emerging market equity inflows in broad asset classes. And the percentage of our capture of that category year-to-date in terms of net inflows is much higher than our overall average firm wide across the complex. So I would say certainly for U.S. equity, for equity income, for emerging market equity and emerging market fixed income, those are big asset classes that we have the potential to take in significant percentage and flows in absolute numbers in the years ahead. And that's been guiding our product development thinking. And frankly, it's been guiding where we've been focusing on the existing funds in terms of our sales, marketing and research efforts.

And just to add on to that, so yes, we are competing with cap-weighted equities within the ETF format, but we're also competing with active equity mutual funds for those new dollars. WisdomTree approach allows us to compete both at the Vanguard on one end and all of the leading active mutual funds on the other end.

Our next question comes from Mac Sykes with Gabelli & Company. Macrae Sykes - Gabelli & Company, Inc.: One quick question and one follow-up. Are you locked in to Western for future cobranded income funds, or could you use other firms?

We're not locked in. We have flexibility in what we're doing. Macrae Sykes - Gabelli & Company, Inc.: Okay. And then are you seeing any changes with the regulatory authorities in terms of the approval process, any of the dynamics that may go into that for ETF, acceleration, certain narrowing of requirements? Any color on what you're seeing there would be great.

I would say that, if anything, it's getting more difficult. The length of time for new sponsors to enter the market has been maybe extended, not decreased. So the regulatory environment has been quite a challenge. But since we already have such broad regulatory approval, it's probably an advantage for us. But you can't guess how long this tone with the SEC will last, but it has been going on for quite some time.

Our next question is from Adam Beatty with Bank of America Merrill Lynch.

First quick question topside on market share, you make your share flows at 1.6%. Do you have your share of AUM? I think it's probably a little bit less than that.

Our percentage of AUM market share is about 1.3%.

Right. So you're still gaining share basically?

Absolutely. Even this quarter was a growth, gaining market share. And certainly, year-to-date is gaining market share.

Got it. And just one question on flows, I noticed that U.S. equity category actually turned to outflows in the quarter, which certainly is not unusual within the industry. But previously, you guys had a pretty remarkable record of having inflows. I just wanted to get any color or your thoughts on that.

It was minor -- really, not much color other than it is what it is. It just wasn't a robust quarter for equities in general. I wouldn't read much more into it than that.

Okay. I mean, some of your -- the way that you do some of your rules-based U.S. equity seems like it might have underperformed a more momentum-driven market in 1Q. Do you think that had any effect?

Well, last year, the dividend funds generally outperformed cap-weighted. In the first quarter, there was a rotation in the sectors, so the more aggressive sectors outperformed in Q1, including technology. So the dividend funds did lag in Q1, but they also took in very strong inflows in Q1. In Q2, they actually outperformed because the market was in a sell-off mode. So sometimes there's a little bit of lag, but I think generally what happened was people took profits after a very strong first quarter and they redeployed it into U.S. fixed income.

Got it. That's very helpful color. Just maybe 1 or 2 for Amit. In terms of the margin -- and I appreciate the guidance around the $40 billion AUM level, and you mentioned sort of that being a distinctive aspect of the business model. I mean, there are active managers with the $40 billion or less in AUM who have margins up around 40% as well. I was wondering if there's something a little bit incremental to that in terms of having a better incremental margin at the $40 billion level or something that makes your business model more distinctive.

If you think about our cost structure, right, we don't have any of the key man cost of risk of having a store portfolio manager. Our funds are predominantly rules based. Think about the infrastructure that's needed for an ETF sponsor. We're built off of the backbone of the exchange industry. We don't have any of the technology infrastructure to worry about protecting customer data, customer service infrastructure. So the types of training that we do are different. So just the key aspects of an ETF sponsor is very different than that of an active manager, and that looks what we believe is one of the key differentiators that helps us drive that margin growth.

So sorry, go ahead.

Just to add, I mean, if you're asking is a 40% pretax margin the ultimate, the number we gave you was for $40 billion, so but I guess, internally, we discussed what size AUM number do we have to put forward where we start? If we were to talk about $100 billion, do you think it would be higher than $40 billion? Yes, we do. But, I mean, to talk about $100 billion in assets when we only have $15 billion seems a little bit far ahead of ourselves.

Got it. That's exactly where I was going. And then finally maybe for Amit again, in terms of the insurance payout, it seems like some of that -- this quarter was a little bit in arrears. Do you expect sort of a, more of a pay-as-you-go kind of repayment from the insurance company going forward?

Yes, exactly. That's what you saw. So we had recent agreement this -- in the second quarter, so what you saw was sort of the catch-up for everything that -- all of the -- we had about $1.5 million cumulatively in reimbursable costs that we could apply to that for insurance less than deductible. So now going forward, it will be a sort of pay-as-you-go.

And the deductible, is that for the life of the litigation or is there a periodic deductible?

It's for the life of the litigation.

Our next question is from Dan Weiskopf with Forefront.

My question is in regard to your -- actually 2 questions. My question is with regard to your website. I actually go back to the website at least once a week, sometimes more often. For competitive reasons, I'm not sure you'd want to do this, but there was some talk about breaking down the flows when you report them by category, whether it's EM currency, U.S. equities, international. Are you still thinking about doing that?

Dan, yes we are still thinking about it. Right now, we're in the process of sort of revamping our website. We're transitioning. One of the things -- benefits that we get of listing on NASDAQ is that they do offer things to do on an IR website. So we're sort of prioritizing that with all the other enhancements that we're doing with our website. So unfortunately, it's taking a little bit longer than I would like, but that's essential goal, to get that done.

And arguably, I'm not sure you'd want to do it for competitive reasons as well, but everybody knows the flow so maybe it's not a big deal. The second question I had -- you're doing a lot, I think that's great. Is there any further progress in bringing on somebody to support you, Jono? Bruce...

I guess you're referring to the COO search. And so the COO search, thank you for this question, is well under way. We've met numerous, many outside candidates, as well as evaluating some internal candidates. And I'm highly confident that by the next phone call, this will be resolved, that we'll have made the announcement of the new COO.

Our next question is from Howard Rosencrans with Value Advisory.

Can you give me some color on what the associated launch costs are on a per-fund basis and a little more color on your enhanced marketing effort? And the latch onto that associated with the new funds would be, previously, when you've launched funds, you've had some good success sort of out of the gate in having an institutional presence where there's like 100, or like $40 million $50 million, $60 million, $70 million, that sort of get kicked off out of the gate in the first few days. Are you willing to launch funds if you don't have that in place?

You take the first part.

I'll take the first part, Howard. So it costs us about $175,000 to launch a domestic fund, anywhere from $225,000 to $275,000 to launch an international ETF depending if it's the developed world or emerging markets, and maybe a little bit higher than that if we're doing something that's alternative.

And those numbers don't include marketing costs. They're really, at the moment, similar to some of the other questions about spend. There's no plan for a more aggressive spend until we evaluate how the election goes. But in terms of launching, yes, we would launch a fund with less money than that. Much -- I think the norm is around $5 million in seed. So as an example, if you go back to January of last year, we launched managed futures with $5 million in seed. So we're willing to -- and so -- I'll leave it at that, but obviously, you're trying to round up as much interest prelaunch as possible.

Okay. I'm just -- I'm a little confused by your election comments. Is there a preferable outcome you have or you just want to wait -- I'm not sure what visibility or the world's going to get better when -- I'm just -- I'm a little confused as to what you're implying about the election one way or the other.

I believe that you're getting a real choice on the economy between the 2 candidates. And so I think that there will be market reaction depending upon who wins, so I'll just leave it at that.

Our next question is from Todd Wachsman with Morgan Stanley.

Just a couple of questions, the first one regarding 401(k)s. What progress are you making within the 401(k) framework to really market your ETFs there and progress more into the wire house channel as I know you're starting to do in the RIA channel? The second question, basically, is a question I asked before. When might you consider a common stock dividend?

This is Luciano. Let me address the first part of it. So on the 401(k) side, we have made progress in the last 6 months getting onto additional record-keeping platforms. We had originally had an agreement with the census. We've since expanded that to several others. And we've been able to basically create an end-to-end solution now including an ETF-enabled custodian that gives RIAs and other consultants in the business a way to get ETFs into their retirement plan businesses and in some cases, in a way that doesn't require them to convert their record keeper. So we are making progress there. We're starting to see increased interest, particularly with the disclosure that came out this July in terms of fee disclosure to more transparency now that's being put into effect. And that's going to have an impact on the industry, particularly by the end of this quarter. So we would hope to see flows accelerate. On the wire house side, we have the best 6-month period we've ever had on the wire house side in terms of net inflows. There were more than $1.2 billion of our total net inflows to date have come in the wire house side, and that reflects the investment we've made on that side, not just in people, but also in terms of the relationships at the home offices, getting onto platforms. And we're starting to see some terrific traction in that part of the business. And I certainly give credit to James Denitto, who's our National Sales Manager, on the wire house side and to Joe Windish, who handles our home key office relationships there.

In terms of a dividend policy or a cash policy, we only relatively recently turned cash flow positive. We have about $35 million net cash today. We know that at some point, we would have trouble investing cash or cash flow into the business. But today, we're still not ready to commit to a dividend strategy, but we are looking at it, and obviously, we'll give guidance as things develop. But I don't want to, again, get ahead of ourselves. So the cash at the moment is a benefit, it gives us cushion, it gives us security and some optionality, both for an international expansion and maybe small acquisitions. So we're building our cash at the moment.

And one last question just regarding product, would you consider getting into the municipal space? You see any value there?

The U.S. fixed income is a tough space to enter because the fees are so low and because most of the major asset classes have already been covered. We're always going to be taking a look at what we can do on the active side. And certainly, if there's a way to do active municipal, I think that's something we could explore.

And we are exploring, but again, just as Luke said, it is crowded and difficult, but it does help that we now have the expanded sort of adviser relationship with Western.

[Operator Instructions] I'm showing no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day.