WisdomTree, Inc. (WT) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the WisdomTree Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I'll now turn the call 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 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 in the risk factors 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. Good morning, everybody, and welcome to WisdomTree's third quarter conference call. Fellow shareholders, this was another great quarter for WisdomTree. We continue to execute extremely well across all functions. Highlights include: Record revenues of $21.7 million, up 22% from the year-ago quarter; record GAAP net income of $4.5 million with a pretax margin of 21% in the third quarter demonstrating our overall efficiency and margin expansion potential; we had $1 billion of net inflows and we ended the quarter with $16.8 billion in assets, a new quarter-end high. In addition to this stellar operating results, we were productive on a number of other fronts. We completed our search for a Chief Operating Officer by hiring Greg Barton. I am pleased to be adding Greg to our already world-class team. On the product side, we launched one new fund in the quarter, China ex-Financials, as well as successfully repositioned another fund, which is now our new European Hedged Equity ETF. Also significantly, we successfully renegotiated our joint venture with our long-time partner Bank of New York, on our currency and certain fixed income ETFs. Importantly, the effects of this will begin flowing through our financial statements in the first quarter of next year, ahead of our original schedule. Later on this call, Amit Muni, WisdomTree's CFO, will walk you through the benefits of that initiative, plus the rest of our financial results. On the next page, let's look at the factors driving our assets under management. In light of our daily disclosure, much of what we discussed today is already known to those of you who follow us. So I will be brief with the data is "old news", but offers some insights around the numbers where useful. We ended the second quarter with $15 billion in assets. We…

Thank you, Jono, and good morning, everyone. I'd like to begin by first reviewing our overall financial results. This was an excellent quarter for WisdomTree. The revenues reached a record $21.7 million in the third quarter, primarily due to higher average assets under management. Our pro forma operating expenses, which exclude the cost related to our patent litigation, ETF shareholder proxy and initial exchange listing fees, declined slightly to $16.9 million. The third quarter is typically a lower expense quarter for us. Our pro forma operating income tripled from the third quarter of last year to $4.8 million, an increased 52% from the second quarter of this year. On a year-to-date basis, revenues increased 25% to $61 million, yet pro forma operating expenses increased only 12% and pro forma operating income was also more than tripled to $9.7 million. The attractiveness of the operating leverage in our business model is beginning to emerge, and this is demonstrated when you look at our margins on the next slide. Our gross margin, which is our total revenues less fund-related and third-party sharing expenses, increased to 68% in the third quarter compared to 61% in the third quarter of last year, and on a year-to-date basis, was 66% primarily due to change in mix of our assets that are part of our joint venture with the Bank of New York, as well as starting to reach pricing benefits with our third-party service providers. Our pretax operating margin also grew to 22% in the third quarter from 9% in the third quarter of last year, and was 16% on a year-to-date basis. Again, you can see the operating leverage in our business model as our AUM scales. The higher margins were being driven by strong revenue growth, which we can review on the next…

Thank you, Amit. WisdomTree launched our first ETFs in June of 2006. Over that time, a lot has happened to the asset management industry. The first chart is conventional wisdom. It shows that in the mutual fund structure over the last 6 years, bond inflows were more than $1.1 trillion, while equities had outflows of $350 billion, a difference -- a differential of $1.5 trillion. Most investors talk about what a fixed income world it has been, that's the conventional wisdom. On the right, the second chart tells a very different story. It examines the same equity and bond flows, but this time in the ETF structure. This is the new world. Here, equities took in $600 billion and fixed income took in $200 billion. Both had inflows, but the equity advantage was a positive $400 billion. You can't say it's been a fixed income world in ETFs. Now let's look at the new reality on the next page. No longer is it prudent for investors in public asset management firms to only look at inflows separated by structure. I say you must look at the combined bond and equity cumulative net inflows for both mutual funds and ETFs. We have talked about ETFs taking 50% of the inflows over the last 5 years on prior calls. This is the new reality. What will the next 5 years or 10 years bring. For perspective, in 2002, 10 years ago, WisdomTree had developed a fundamentally-weighted approach to equities and had made the decision to own our own indexes, now referred to as affiliated indexing. These decisions in 2002 were being driven by the belief that there was and would continue to be fee pressure in commoditized cap-weighted ETFs. That the only value add in ETFs were in the indexes themselves, and…

[Operator Instructions] The first question is from Marc Irizarry of Goldman Sachs.

Jono, I was wondering if you can just talk a little bit about a lot of the news around this "price war" that's been happening with Vanguard and iShares. What's been sort of the response from the channel, if you will, from the RIAs in particular, and from some of the wire houses in terms of your ability to sort of differentiate your proposition? Has anything changed there?

Thank you, Mark. Thank you for this question. So currently, we're not seeing any fee pressure. Aggressive pricing, as the presentation indicated, is not new. WisdomTree specifically was designed to address these exact market dynamics. 10 years ago, when we were building the business plan, domestic large-cap was 8 basis points at the low end. Today, it's as little as 4 basis point, so a 4-basis point change. This does not change WisdomTree's calculus in any way. I'm going to make a statement. I don't think any firm can more comfortably co-exist with Vanguard than WisdomTree. So that's sort of the backdrop. The positive is, first, Vanguard switching indexes, money is in motion. For the first time in a very long time, if ever, Vanguard has to explain themselves. Another real positive, indexes are being scrutinized. We think it's very positive for WisdomTree that people are looking under the hood at the underlying indexes, at the exposures that they're getting. A huge positive for us. Also a positive, the attention that aggressive pricing is getting from the media, from analysts, from the financial advisers, will help expand the ETF pie dramatically. I said in the presentation, for the first 9 months of the year, we're at $132 billion of inflows. So our record was about $178 billion. I would expect that we could do $180 billion to $200 billion of inflows this year and I wouldn't be surprised if we could do $250 billion in inflows next year. So I think it's all very, very positive. I think it's a legitimate question for the analysts to ask WisdomTree about the value proposition, or BlackRock about their value propositions and fee pressures. But I think the bigger story is, what does it mean for the traditional asset managers whose products get less and less competitive everyday? So I think it's all very, very positive at net-net of it all, and we're well-positioned for this trend.

The next question is from Jason Weyeneth of Sterne Agee. Jason Weyeneth - Sterne Agee & Leach Inc., Research Division: You talked about fixed income being a big growth driver for the industry. I mean, I guess, how do you think you guys are positioned to take advantage of that, particularly given the scenario where you don't have a lot of products currently, and when you think about the domestic fixed income area, it's probably not a prudent part of the market to dive into?

So we have a few bond funds, active bond funds, mostly or really, primarily foreign bond funds. We've chosen where we wanted to compete very specifically. Again, very aware of how certain cap-weighted fixed income categories have been commoditized. So we're very, very selective in what we launch. But between our relationship with Mellon and our new relationship with Western on emerging market corporate bonds, we should see more growth in fixed income and we see opportunities. Product development is always an area where we have to be very careful. We do want to tip our hands to our competitors, it's very competitive. But you will see more activity in fixed income over the coming year and years. We're very optimistic about it. Jason Weyeneth - Sterne Agee & Leach Inc., Research Division: And I got on a little bit late, so you might have discussed this. But for the funds that you recently closed, I guess, can you talk a little bit about what, maybe, you didn't get right? And then similarly, sort of how you decide when the right time is to close them?

So we announced, I don't know, a couple weeks or a week ago, that we're closing 3 very small funds that had been in the marketplace for quite some time. Two of them were currency funds, one was equity fund. So as an example, let me use the South African rand, as an example. The fund didn't attract much in terms of assets or trading volumes, and we looked at that space, sort of emerging market or commodity currencies -- emerging market currencies and commodity currencies, and the response that we got from the financial intermediary is that for the most part, they prefer our basket products. So we thought we would capture virtually all of the demand for that kind of exposure through the existing products that we had. So product management, closing funds is a normal part of our business, and we're just trying to be very efficient so that we can devote our resources, our people and energies to things that we think will be more receptive to the end customer. Jason, did I answer your question? Jason Weyeneth - Sterne Agee & Leach Inc., Research Division: Yes.

The next question is from Bill Katz of Citigroup.

This is Steve Fullerton filling in for Bill Katz. Can you guys provide an update on the patent infringement issue?

Sure, we have really no update to mention. We're still in the discovery and deposition phase. The guidance that we have given to investors, as far as expenses, still stands, so we really have no updates to report.

Okay. And then to the discussion you guys were having with emerging markets, the fee rate ticked up, you're having solid flows. So with the discussion on the commoditization pressure, what are you doing to differentiate yourselves there? Maybe this will talk to Slide 11. Do you have any numbers to how you're outperforming in that specific category?

Luciano, would you like to take this?

Yes, we of course, post our monthly performance on our website. And so, in emerging markets, we've had some of our strongest relative performance, relative to the cap-weighted indexes. Our broadest fund, DEM, covers emerging markets equities. That's a $4.5 million fund since inception that's outperformed the comparable cap-weighted index by more than 6 percentage points annualized. So that's a very large number. It's also outperformed, I think, something like 99% of all of the actively managed open end mutual funds according to MorningStar. So we source that and report that data on our website. Certainly, we think, emerging market equity is probably the space where we have the greatest competitive advantages because we are the most differentiated. Our indexes typically start out with higher dividend yield since comparable cap-weighted and there's a 5-year track record now on certain of these funds and people can draw longer-term conclusions.

The next question is from Matt Kelley of Morgan Stanley.

This is Tom Whitehead filling in for Matt. Just wanted to ask a question on what you guys see as the potential for future exempted relief grants from the SEC. Could you comment on what they're looking for from applicants, the progress and the timing of it all?

We -- so, this is Jono. We have very broad relief so we haven't been looking for new relief. But what we've heard is that the SEC has become very restrictive in granting new relief. There's varying degrees of relief, so there's traditional sort of third-party licensing of an index. That's sort of the easiest thing to receive, but it still takes time from the SEC. Active is harder. They put a ban, it seems, on the use of derivatives, something that we have the ability to do. So the SEC has been really quite the stumbling block for firms to get into the business. And we don't -- it doesn't seem that it's getting any easier at the moment. But that can always change. So we are not building our expectations that the SEC will remain a roadblock from future competitors forever, but at the moment, it definitely, for those that are in the business, it is a huge competitive advantage.

All right. All right. I guess, more -- you commented on the active and derivatives side. Anything, specifically, affiliated index. I believe that's another layer of complexity beyond your plain vanilla ETF. And any commentary there?

The only thing that I would say is it always made a lot of business sense for WisdomTree. I always thought that this would be a way to, one, control the investing experience better, but also would be a better business model, not having the licensing fee. So if -- for the WisdomTree, it's really played out as a best-case scenario, exactly how we anticipated. I would imagine that this will become an area of future efforts for other firms. But again, I think that the SEC is just moving slowly in general with regard to ETFs.

The next question is from Mike Grondahl of Piper Jaffray.

Can you talk a little bit about what sales channels you're emphasizing today and which ones are kind of outperforming and which ones are maybe underperforming?

Well, this is Luciano speaking. We continue to have the same effort in the sales channel that we've had since October 2008. It's primarily the RIA channel has been leading us in inflows. The wire house channel including the regional broker dealers and the institutional channels is where we're spending most of our time. Year to date, I think we've seen improvements in the wire house channel in terms of both getting on to some additional platforms, getting on into ETF models. We've seen very strong flows there. But the RIA channel continues to perform at a very high level. So we're very fortunate to have inroads into both of those channels. And that's where we're going to continue the lion's share of our focus.

And then maybe just comment on the institutional channel. How do you think that's progressing?

I think it's progressing well. There, it's a little bit different in the sense that some institutions are -- have just been getting their hands around trading and using ETFs over the last few years. And there, I'm talking more about pension, foundations endowments. We also have been getting help with some of the consulting firms that are starting to incorporate WisdomTree ETFs into some of their recommendations. And so, I think there's definitely potential for growth on the institutional channel going forward, as well.

The next question is from Adam Beatty of Bank of America.

First, just a question on sales and business development and the expenses there. I appreciate what Amit said about sort of balancing growth mode with being careful around margins. Looks like the 9-month sort of year-to-date is down a little bit year-over-year. And I know the company's changed a lot in the intervening period. Just maybe some comments on -- I wouldn't really expect you guys to be taking your foot off the gas at this point. Maybe some comments about business development efforts going forward?

Well, Adam, as I mentioned in my remarks, we're in growth mode and we're carefully managing, investing back in the business when the right opportunities present themselves with continued improvement in our bottom line results. You can see, from our sales and business development, that particular expense line item for the last 9 months, we spent a lot of money last year in some product development-related activities. We had a little bit of slowdown in new product launches this year and the amount that we've been spending are particularly related to just R&D on new products. But it doesn't -- it was just related to certain products that we were looking at, at the time. But again, our focus is to continue to innovate, continue to broaden our product offering, and we should continue to see continued spending in the sales and product development-related line items.

Hey, Adam, this is Jono. I just wanted to add, when you look at the last few years, we've -- the industry has averaged only about $118 billion of inflows. So we've been appropriately conservative in this sort of a very lackluster investing market. You're starting to see a little bit of a pick up this year, we think, and it bodes well for future, maybe, for 2013. Things are a little slow just ahead of the election, but once you get clarity, just settling the future, I think that 2013 maybe a time where you'll see just greater inflows. And if it's appropriate, we'll be more aggressive, but you don't want to get ahead of it. So we feel very good with the way we've been anticipating the flows and the business model.

Got it. That's great context. And just maybe a follow up on sort of the pace of product launches. I guess, I've always thought, in terms of maybe 3 to 5 per year, do you expect to return to that pace next year, what's the outlook there?

We've said 3 to 5. We've done 2 new funds and a re-purposed fund this year. We treat the re-purposed fund as a new fund launch. We feel that we've done, really, 3 new funds this year. And I think that pace is a good number for next year as well. So 3 to 5 is sort of what we were targeting.

The next question is from Mac Sykes of Gabelli & Company. Macrae Sykes - Gabelli & Company, Inc.: Congratulations on the restructuring with the BNY. This may be difficult to quantify, but I was just curious as to how much new business is due to ETF reallocations to WisdomTree versus reallocations away from traditional mutual fund products. And I guess I'm asking you because iShares is going to be beginning that new re-branding campaign, and I just wanted to see if you might be a derivative of that.

Well, there isn't perfect visibility into the data, but I can just speak anecdotally in terms of what we see. And I think there's 3 major trends. On the wire house side, we continue to see advisers moving from transactional or brokerage-related business to a more fee-based business. And that works so ETFs work very well within the fee-based business. So I think that's one of the key drivers. A second driver is that there are money managers out there, particularly on the RIA side, who are now using ETFs in their models. Instead of buying individual stocks, they create their portfolio with ETFs. And so as they grow, it creates demand for exchange traded funds and WisdomTree participates in that, so we benefit. And I think the third major trend is just in a low return environment, I think people are more conscious of fees and taxes and that lends itself to people taking a look at the exchange traded funds instead of traditional actively managed mutual funds. So I would say those are the 3 big drivers that I see driving additional flows into ETFs and I see every reason that those trends will continue.

Mac, this is Jono. Just -- when Luke spoke about really, in the wire house channel that the financial advisers moving from the active mutual fund businesses, WisdomTree's sort of rules-based active ETF approach is very well suited as a transition for new advisers that come into ETF. So we get to compete with Vanguard on one end and the traditional active mutual funds on the other end. It's a very, very big space, but we're a very good transition for those new advisers that, I think, are coming in large numbers now and I think in the future. Macrae Sykes - Gabelli & Company, Inc.: Great. And just I noticed that currency ETFs have been trending down a little bit. Maybe you could go over the outlook for that and what are the drivers that flows into that product?

It's really just dollar. It's just sentiment. These are on the other side of the dollar. The dollar's been very strong in recent years and no trend continues forever, so they'll have their debt.

The next question is from Todd Wachsman of Morgan Stanley.

I have 2 different questions on completely different subjects. The first is, with the election coming up and the looming fiscal cliff and with the likelihood of higher taxes next year, do you think that the S3 filing that occurred the other day was largely due to that. In other words, if it looks like taxes are going to really sky rocket next year, might the secondary occur this year so they don't get slammed another, say, 8% or 9% or 10% in taxes. So I was wondering if you could give any guidance on the secondary, that was my first question. My second question was regarding 401(k)s. Really, just what progress are you making there and do you think it makes sense to effectively bundle some ETFs within an open ended fund structure just for 401(k)s that do not allow ETFs in their platform?

Todd, this is Amit, I'll take the first question. So, yes. Last Friday, we did file a shelf registration statement and these -- this shelf only concerns shares being filled by Michael Steinhardt and RRE Ventures. Management is not selling any shares and the company is not selling any shares. I really can't comment beyond that regarding timing or anything else. I can just refer you back to the registration statement.

Okay. All right. Well, it was just interesting because obviously, if they -- if it occurs this year, they'll save a lot of money on taxes. But -- and then about the 401(k), that was my next question.

Yes, on the 401(k) side, we are starting to see some increased activity and it is related to getting our ETFs into other structures. So right now, the most success we've had is in seeing RIA firms and money managers that are on 401(k) platforms and have a distribution capability there incorporate WisdomTree ETFs into their models. So to the extent that they can get an ETF model within 401(k) channel or create another structure that includes ETFs within it and get into the 401(k) channel as well as even the other channels. I think that's the way you'll see growth from WisdomTree. And there, I would just say that there's large custodians out there that are looking at making ETF-enabled options available. And I think in the next year, you'll probably hear some news about that and hopefully, that's the driver for ETFs within 401(k).

Okay. Because I'd love to see more of the fundamentally-weighted WisdomTree ETFs within 401(k) plans, especially from outside providers that don't currently have that capability.

We agree. We would like to see that as well. And the last -- the last thing on 401(k) was in the third quarter that transparency of fees emerged. So for the first time ever, when you got your statement you actually had some fee disclosure. So that should prove to be a very constructive catalyst for future ETF adoption within 401(k) plans.

The next question is from Howard Rosencrans of Value Advisory.

I'm a little surprised in the context of -- so it sounds like a very significant change in your BNY deal that you're not raising your guidance for your long-term pretax operating margins. Remind us, if you would, what was the 40% pretax margin target previously predicated on in terms of the gross margin, if you would?

So the previous growth -- we had not given longer-term gross margin targets. We had given guidance that we expected to be anywhere between 65% and 68%. Now that we have renegotiated the joint venture with the Bank of New York, we've taken that short-term target up between 70% to 75% and at $40 billion in assets, we expect, at the current mix we have today, we expect that gross margins would be closer to 80% gross margins.

So there's a lot more points there that you now have to get back to still be at the same $40 billion, so.

Again, I'll -- I guess, I'll say 3 things. First, as I already stated was when we gave that guidance, that we expect 40% of pretax margins at $40 billion of assets under management, we had already assumed some level of gross margin improvement in there. The second thing is, again, remember, what I stated is that WisdomTree is in growth mode. Our goal is to become one of the top 5 ETF sponsors and we're going to do that by continuing to invest back in the business when the right opportunities present themselves. But again, carefully managing our cost based so that we improve -- show improvement in our bottom line operating results. And the third is if you look at our results today, you can see the attractiveness of the operating leverage we have in our business model. Specifically, if you look at the ETF structure in our business model, we believe we can run our business. And that really is the mindset of this management team. We're going to run this business to be -- operate, once we get the scale at the highest pretax operating margins of any traditional asset managers.

The next question is from Olly Ludwig of IndexUniverse.

I wanted to know if you guys could -- you've been talking about these gross margins and your benchmarking 80% gross margin with the $40 billion asset level at the current mix. I'm wondering, if notwithstanding the sort of perilous macroenvironment we're living through, if you might -- can you give us a little visibility as far as when that $40 billion might be reached. And in the nearer term record income, record revenues for the quarter that had just ended, is it likely -- are you keep -- are you likely to keep ratching it up and keep setting records along the way? Or are you reluctant to go out on a limb given the various variables of uncertainty that you guys have isolated this morning?

So, we don't give any guidance on sort of timing because the large part of our results and when we'll reach asset levels depends upon the markets. And so, we can't project what the markets will do. But again, if you look at the operating leverage of our business, with continued asset growth, we should continue to see improvement in our bottom line results, continued improvement in gross margins. And that's just the beauty of the asset management business. And that's what we're demonstrating. Once you reach scale, there are true attractive margins that our business can reach. And again, because of the ETF structure and particularly, our business model, we believe that we can run our business at the highest margins of any traditional asset manager once we get the scale.

And Olly, just one last thing that Amit touched on earlier in the presentation. Because of our transparency, you know that we're running, in the fourth quarter, $1 billion of higher average assets than the last quarter. So we're -- again, we are off to a good start in the very short-term.

Are you guys surprised on the upside generally, all things being equal? Or is it kind of like what you guys have been planning for?

Olly, we really have -- we're not surprised on the upside, we're not surprised on the downside. I think we have -- we came into this business with very realistic expectations and it's really panning out the way we expected.

[Operator Instructions] The next question is from Marc Irizarry of Goldman Sachs.

Great. It's just a long quick follow-up on the operating margin where it can go from here. Just, Amit, if you look at, I guess, the next near-term plan, if you will, in terms of comp, how should we think about headcount, where you're investing in the business and sort of what kind of leverage you can expect over comp if sort of the current run rate of the business continues?

Sure. So, we'll give a little more clarity on sort of expense guidance in comp in particular on our next call when we look -- when we talk about our year-end results, we'll give a little bit more guidance. As we publicly -- as far as headcount growth from here, it's really incremental growth from here. We don't want to get ahead of ourselves. We want to continue to invest back in the business. Continue to expand our sales force. Continue to -- we need to add back into our back-office operations. But it's really incremental growth from here, going forward. So I think we'll give a little bit more guidance on our next call as far as our expense run rates and the like.

There are no further questions at this time.

And I just want to thank all of you for your continued support and interest in WisdomTree and we'll speak to you at the end of the year. Thank you.

Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.