WisdomTree, Inc. (WT) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the WisdomTree Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference WisdomTree. You may begin.

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 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 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, Stuart. Good morning, everybody and welcome to WisdomTree’s fourth quarter and year-end conference call for 2012. Fellow shareholders, 2012 was another record year. Our assets under management rose 50% to end the year at $18.3 billion. We had inflows in the fourth quarter of $1.1 billion and a record $4.7 billion of inflows to the year. We also had record revenues, $23.6 million in the fourth quarter, up 46% year-over-year and $84.8 million for the full year, up 30%. Pro forma net income more than tripled to $5.1 million in the fourth quarter and to $14.8 million for the full year. We also expanded our gross and pre-tax profit margins. Key metrics which display our corporate discipline. Amit Muni, WisdomTree CFO later on this call will walk you through our financial statements and update our expense guidance. We also ended our joint venture with Mellon Capital on very favorable terms. We launched two new ETFs, emerging market corporate bonds, and China ex-Financials. In addition to all of the above, we also completed two stock offerings in 2012, completed our search for a new COO and we successfully ended the patent litigation. As in prior years, it was the completeness of our execution across all business functions that define the year. It is simply a testament to the talent and dedication of the 70 person team that WisdomTree has been fortunate enough to assemble. 2013 is off to a fast start with almost $2 billion of inflows to date. We are having trouble updating our website this morning but our assets under management would be approximately $21 billion, an all-time record, which is up another 15% in just one month. Yesterday, we launched our second active bond fund with Western as sub-advisor, global corporate bonds or GLCB. WisdomTree is…

Thank you, Jono, and good morning, everyone. I would like to begin by first reviewing our overall financial results. This was another record quarter and year for WisdomTree. Revenues continue to grow reaching $23.6 million in the fourth quarter, up 46% from the fourth quarter of last year. Our pro forma operating expenses increased only 22% to $18.5 million, and pro forma operating income more than tripled from the fourth quarter of last year to $5.1 million. For the full year, revenues increased 30% to $84.8 million yet pro forma operating expenses increased only 14% to $70 million and pro forma operating income also more than tripled to $14.8 million. The operating leverage in our business model has also translated to attractive margin metrics which you can see on the next slide. Our gross margin increased to 68% in the fourth quarter compared to 62% in the fourth quarter of last year, and for the full year, was 66%. Gross margins were flat compared to the third quarter due to timing of tax-related payment for one of our funds. Our pretax operating margin also grew significantly to 22% in the fourth quarter from 6% in the fourth quarter of last year, and 18% for the full year. Pre-tax margins were also flat compared to the third quarter. Our expenses are typically less in the third quarter so the third quarter is seasonally high. The higher margins are being driven by strong revenue growth which we can review on the next slide. Our ETF revenues reached a record $23 million in the fourth quarter due to higher average assets under management, which you can see in the bottom of this slide. For the full year, ETF revenues increased to $84 million. You can see that this was a very strong equity…

Thank you very much, Amit. As I noted earlier, 2012 can be characterized as a busy year of impressive execution at the corporate level. We completed several important tasks, which place the company on even stronger footing today. And as proven by our growth in strong results, we never took our eye off the business. Our house is in order and 2013 looks to be a promising year. I would like to end by discussing the new slide, which shows the top asset gathering complexes across all ETFs and mutual fund firms over the last two years. WisdomTree ranked 26th in asset gathering in 2011 and 22nd in 2012. As I look at this list of names, I ask what would it take for WisdomTree to become a top 20 or even a top 10 asset gatherer? The answer is, one, continued growth of the ETFs at the expense of mutual funds, that’s a given; stronger and more favorable sentiment towards equities, I am hopeful; three, continued demand for dividend-based strategies. I think the resolution to taxes on dividends at the end of the year makes this highly likely. Fourth, continued strength in emerging markets, given. And five, further innovation and adoption of active bonds, I am very optimistic. And as I see it, WisdomTree is extremely well-positioned for the future. We are very well positioned relative to the other firms on this list. Our goals for the coming year are to continue executing at these very high levels and to maintain high relative growth. We have a strong mainstream defensible product set, with an enviable long-term performance record. We have a great brand, a superior business model, and a truly talented operating team. It should all translate into an exciting 2013. This ends the planned portion of today’s call. I thank you for your interest and support. And now, let’s open it up to questions.

Great, thanks. Mark Irizarry of Goldman Sachs. Jon, in terms of, lot of debate around the equities, equity flows and what we are seeing, seasonality versus sort of secular and structural, can you just speak to sort of what you guys, you know, where you guys are coming out on that, what impact if any that’s having on the business?

It’s very new, you are talking literally about just one month. There tends to be sort of 401-k strength in the early part of the quarter. So, I would say it seemed seasonal. Certainly, ETFs have nothing to prove. We are sort of the dominant play for equity. So, really the burden is on the mutual fund industry. I am not sure I see any trends. I mean, it’s certainly too early to make any conclusions.

Okay. And then just on some of the guidance and strategic growth initiatives, can you talk about the philosophy for launching funds, number of launches, and then if you can comment on your latest for launch – I am curious how the (inaudible) how that works.

I will talk philosophically. So, when we discuss fund launches, we are always trying to do something that’s first-to-market or something innovative, a differentiated approach that we are adding choice to the market. We have never launched a ‘me too’ proxy. We will continue to do that. The guidance that we have given is three to five new funds a year. For the last two years, we were on the low end of that. This year, you should expect to be at the high end of that range. So, five or six funds would be not to be surprising.

As far as the fee structure on the new fund, we don’t disclose the fee that we pay to our sub-advisors, but ETFs are generally lower fee products and they have to work within that fee structure.

And as you can tell, we have obviously been very disciplined in our all of our business arrangement and what continue to be.

Gotcha. And then when you think about the sort of the number of ETFs versus the depth of the market there you are launching in, like how can you help us understand when you launch something like the new global bond, the ETF, what you think the uptake would be, and then, how to sort of the – when you think about the five, are you launching more in niches or are these all deep markets that you are thinking about out there?

It’s very hard to open up a new asset class. So, Global Corporate Bonds is it’s a really new asset class, but it’s the first actively managed execution. So, that happens to be a deep market. What I would just say is new funds are positive. Obviously, you try to be an active gatherer in the year that you launch them, but it’s really more than just a year that you will launch them. So, last year, we launched emerging market corporate bonds, and it took maybe 105 million in the first year. But it’s not about the first year. What is it going to do in the second, third or fourth and fifth years? We really don’t launch anything that we don’t think has the ability to be a $1 billion fund.

Okay. And then, Amit, just on the gross margin guidance, I guess 70% to 75% is the range, how should we think about the way that ramps up closer to 75% versus 70%, and I appreciate any color on just sort of the overall operating leverage that you expect to see in 2013 if the current state of growth of the business continues?

Sure. So, as far as gross margins, so we gave that range of 70% to 75%, that’s really all going to depend on mix of assets, where we see the flows coming on. On an average basis, the incremental gross margins are about 80%. Some of our funds, larger funds will have incremental margins close into the higher end of the 80%. So, it really all will depend on where we see those flows coming in. As far as the longer-term margins, we have improved the guidance that we have given before, and now we believe that 35 billion, we will get to that 40% operating margin. And, you know, Mark, I think you have to remember, we are a young company, we are in a fast-growing industry and we are in growth mode. And we are focusing on growing that top line revenue, continuing that long-term goal of becoming a top five ETF player. We will always carefully manage those investments with our bottom line results, but you can see today we are offering leverage in the business, and these are all the early days. I think directionally we are going to continue to head towards that 40% margin. And remember that as we stated before, it is the goal of this management team that we will operate and target this business to be at the highest end of all the operating margin range of traditional asset managers.

Okay. Great, thanks.

Thank you. Our next question comes from Bill Katz of Citi, your line is now open.

Hi, this is actually Steve Fullerton filling in for Bill Katz. Quick question, with the fee rate ticking up recently in the recent releases, I know some may be due to DXJ, where directionally should we look at the fee rate looking out ’13, ’14 and ’15?

On our website, we give you the aggregate bps that we collect. We make no guidance on that. The money will flow where the money will flow, and so our domestic equities are lower fee, our emerging markets are higher fee and it just the mix will determine it.

Okay. And can you just update as to the amount of the NOL and just to confirm, that is after-tax, correct?

Yes, so we are updating that number now, given it’s the end of the year. Last year, it was at $48 million and that’s the after-tax amount. In our 10-k, we will update you with what the current number is. But right now, it’s at $48 million.

Okay. One more quick one, just looking at the transient [ph] alternative bucket, is there any outlook on what you guys are looking to do with those funds?

We have a few alternatives, it’s an area that because of all of the regulatory-exempted release that we have, it’s something that we are focused on. We want to grow the existing funds, and you will see some selective launches in that space overtime, but we are bullish on alternatives in the ETF format.

Okay. Great, thanks a lot guys.

Thank you. Our next question comes from Mike Grondahl of Piper Jaffray. Your line is now open.

Yes, thanks for taking my question, guys. The first one, could you talk a little bit about your marketing strategy for GLCB, just so we can kind of understand, when you roll out a fund, how you kind of – the different avenues that you market into?

Thanks Mike. It’s consistent across every fund. Certain teams are easier from a marketing standpoint, but all of our sales material obviously is organized. We have a very engaged database and client base that we are always communicating to. And we are supporting it with some selective advertising, both online and sometimes in print and sometimes on TV, but you have to take it fund by fund. So, I wouldn’t make a generalization. We get behind certain funds when we see an easier, cleaner marketing strategy against that fund.

Okay. And then, maybe just one more as a follow-up, the Japan fund, DXJ has had an amazing couple of months. As a fund like that, really picks up that kind of steam, do you kind of shift gears and say, ‘hey, now it’s time to market this one.’ It’s hot or how do you react to a situation like that?

So, I think our execution on DXJ was very strong. We launched the fund originally in the initial 20 funds in June of 2006. We shifted the fund to hedge out or mitigate the currency exposure, and then we actually adjusted the underlying basket of equities to tilt towards exporters. So, we became a truly differentiated fund. In December, we saw that there was political movement that would be extraordinarily constructive, and we started from a research side very aggressively updating our clients as well as the media to the shift within Japan and how well it positioned DXJ for those exchanges. And then, as you saw that it had a very strong end of year. Now, towards marketing, we get to sort of quiet as you get into the holidays regardless and we always come back in January. So, in January, if you probably notice that we also started to promote the fund on television and continue our online and print push and so that we try to just max it out, so that the world was aware of this unique exposure in the world of ETFs, and that now takes on a life of its own.

Gotcha, helpful. Thanks guys.

Thank you.

Thank you. Our next question comes from Adam Beatty of Bank of America Merrill Lynch. Your line is now up.

Thank you and good morning. Just a follow-up question on the strategic initiatives. Appreciate your comments on the new product launches, which I think are still crucial to the firm. Now, in terms of the other items there, marketing and sales support, maybe if you could just give some detail around, if there are channels that you are focusing on or other objectives that you have for that spend?

So, like in a couple of components, we are not going to get into specifics, you know, dollar value versus each one, I would say it’s just continuing to do what we do today, which is continuing to push the brand, continuing to support our existing products and new products, continuing to add resources, technology resources and life to our sales staff, continuing to add bodies to help grow that top line revenue. There are maybe some small initiatives in there to look at broadening some of the distribution channel that we may have, but a lot of it is just really continuing to do what we do today, which are accelerating the rate of how we support that effort. Luciano, would you like to add any color?

Yes, I would just say that we are going to continue to add sales people both on the outside as well as on the inside across the RA, wirehouse, institutional channels. We already had hires this year on our capital markets team and on our outside wirehouse team. So, we are definitely leaning into this year, and we want to make sure we have a full capability to take advantage of what we see out there in the marketplace.

Okay, thanks. Appreciate the color. And then maybe a follow-up on the NOL. My recollection is that at a certain point, you are going to have to recognize that asset and that’s going to lead to some GAAP accounting event. Maybe give us an update on that and my understanding is that’s based on sort of a level of earnings beyond trace amounts. Is that a quarter-by-quarter evaluation in your accounts or more of an annual thing?

Sure. So, we have a NOL today on the U.S. GAAP. We will take that NOL in when we believe it is more likely to, not that we will be profitable for the foreseeable future and be able to use those NOLs. Our auditors tell us that they generally like to see at least one to two years of solid operating earnings before we get over that more likely than that threshold from a GAAP perspective. So, right now what we are doing is we are taking it in every quarter, but at some point, we will have whatever the balances remain, when we get over that threshold, we will take it all into our income statement from a GAAP perspective. But remember, from a cash perspective, we still don’t have the cash flow going out and have to pay those taxes. It will just be a book entry.

Right, understood. And so, I guess 2012 would probably count as a year of solid operating income under that, right?

Yes, again. We have been told it takes like one to two years. So, I don’t see that happening in the short term that we take in.

Right, got it. Okay, thanks very much. And then, turning more towards product development philosophy you have, obviously the DXJ has done very well, and you just launched Global Fund. In terms of the trade-off between a fund that’s kind of global, go anywhere versus maybe regional fund that can obviously benefit from hot market at a given time, what’s your philosophy around that?

You got to take each idea as its own case. Looking at the existing offerings in the marketplace, a regional idea can be extraordinarily large as an opportunity, global obviously it’s going to be large, but you just can’t look at it in a vacuum. So, everything again, it just must add choice to the market to be differentiated. I mean we try to line up new funds with market sentiment, but that happens to be very challenging, because of the sort of the laborious process it takes to actually launch the funds. So, timing it to the moment is not the easiest thing, and we are not really, we are trying, but I wouldn’t put much hope there. So, again, we just look for the bit in each opportunity, we take it one by one.

Got it, thanks very much guys. Much appreciated, that’s all I had today.

Thank you.

(Operator Instructions) Our next question comes from Mac Sykes of Gabelli and Company. Your line is now open.

Good morning gentlemen, congratulations on the results and certainly the efforts this year. I jumped on the call a little bit late, but and maybe you did explain this, Jon, but I wanted to get, it was interesting to get more of your thoughts. I mean, you have seen a sharp acceleration certainly in the industry in the fall in this year, but maybe you could give us some more specifics on what you are seeing in the industry now versus maybe a year ago and any new launches that you expect to continue this year?

I think the industry on merit continues to take market share against other structures. And what we do find is that particularly that we always meet skeptics, since it’s just good as it’s going to be. But I think historically, certainly in my, let’s say, seven or eight years of the industry, the ETF industry itself has always been underestimated. So, on merit, full transparency, greater liquidity, greater tax efficiency, no minimums, no gating, no lock-ups, only one share class, no incentive fees, is the best of class, and on merit, we are educating all of the intermediaries and the retail investors at every level including the media and it’s just we are picking up steam and I don’t think this train is ever going to slow down. I think it’s only accelerating and I don’t see how it’s going to stop. So, we are seeing the trends. You know, the thing that we suffer like all asset managers, we just suffer from market sentiment. But there was a lot that was taken, a lot was done with respect to the fiscal cliff at the end of the year that was just constructive for investing in general and there is a tremendous amount of money on the sideline. So, net-net, I am very optimistic.

Terrific. And I think Western received its own exemptive relief last year. Will that impact your relationship with them going forward or in terms of marketing, or maybe competition for products?

I am sorry. Could you just repeat the question?

I think Western Asset received its own exemptive relief. I was just curious if that might impact your relationship with them in terms of marketing or competition with products going forward.

To clarify, Legg Mason, the parent company received exempted relief. As I understand, the subsidiaries do have a lot of independence but our relationship with Western is not exclusive, I expect that Western will launch funds under the Legg Mason brand, but I think that they will continue to launch funds with us as well. It’s still early, so we will see how it all plays out, but it feels like we have a strong and growing relationship with Western.

My last question, on the DXJ flows, congratulations, but can you talk a little bit about the diversification of those flows? Is it being driven by specific channel or region, just any sort of color on how that’s coming together?

This is Luciano. It’s been very broad based. We are seeing tremendous interest across all the channels. There has literally been thousands of trades in DXJ in January. One of the things that’s going on is that a lot of asset managers have been under waged pan equities for some time. So, as interest comes back into Japan, folks who are looking for the Japanese exposure but they are also looking to hedge the impact of the yen. This is a long term trend or even a secular trend that could last a few years. This is actually a tactical beta way to get exposure to get that investment thing. Right now, for all kinds of purposes it’s the only ETF in town that gives people this exposure. So, this is a fund that’s trading 1 million, 2 million shares a day and it’s taking on a life of its own. So, I would say the interest is very broad-based and Japan is a very large important market in terms of global equity markets.

Just a little more color. When we launched our funds and DXJ was one of our original funds in June of 2006, the leading fund in Japan at that time had $9 billion in assets. So, today that fund 7 years later it may be a little less than $6 billion. We are $2.5 billion, so it shows you that ETFs as an industry have grown immensely in those 7 years, but Japan has actually shrunk. There is a tremendous amount of upside I think to the category as Luc indicated.

Great, thank you very much.

Thank you. Our next question comes from Matt Kelley of Morgan Stanley, your line is now open.

Good morning guys, thanks for taking my questions. I just wanted to ask a little bit more detailed question on the penetration or the uptick you are seeing by channel currently? Are there any, where are you seeing the incremental buyer more, is it in the resale brokerage, or RAs, or institutions getting more involved? Where are you seeing the incremental buyer for your product?

This is Luciano again. It’s really across the board. I mean, last year was a very strong year for the wirehouse channel for WisdomTree. We got to a point where the wirehouse team in aggregate was contributing pretty much as comparable to what the RA team contributed. So, I would say on a relative basis last year we saw gains on the wirehouse channel. But in aggregate, we are seeing increased interest across all three channels. We are seeing more firms with at least $1 million dollars in WisdomTree funds, more branches with at least $1 million. The number of clients we have is increasing, the number of large clients we are having is increasing. So, I would say it’s just a gradual gaining of traction across the board. As these funds take on longer histories and become larger they open themselves up to larger interest, including derivatives that are trading around the fund. So, with volume we get volume. A lot of these funds are at all-time highs in shares outstanding and a lot of the activity in the channels are as highest as they have ever been.

Okay. And then, maybe this one is for Amit. In terms of the margin guidance again, I know everybody has asked the same thing here, but just taking the different way, you did between 21.5% and 22% for the quarter, a little over $17 billion AUM. Your guidance at $35 billion, or 40%, I have been thinking what Jono was saying about the product launch is being on the upper end this year. Is it fair to assume, as you hit the end of those product launches, you may get more acceleration at that point towards your margin target than you would through the first half of this year?

I wouldn’t focus so much on the shorter term. But given that longer term guidance which we have taken down now to $35 billion in assets to get to that 40% operating margin. That’s what I said. We are in growth mode, we want to invest in the business. You may get a little bit noise quarter-over-quarter, but directionally we are headed that way. A lot of it is going to depend upon markets, I mean, how fast these funds take in money versus others. But directionally, we are headed towards that margin. And remember, I have talked to you about the gross margins, 70% to 75%, the incremental margins on that are on average 80%. Some of our larger funds are closer to the higher 80%, so we start to see higher flows into those larger funds that’s going to improve those margins. We don’t look at it on a fund by fund basis but more of just entire family.

And also, I gave you sort of guidance for 2013, but it’s not going to slow down, I don’t think in 2014. I think that over the next 24 months WisdomTree will be more aggressive in new products than we were over the prior 24 months. Because what we have also done, we have closed funds, we have repurposed funds, so the existing product suite it is immensely efficient right now. And then we took care of all these corporate issues in 2012. So, you will just see a more aggressive tone in general in 2013, I think and ’14.

Okay. That’s helpful. And then final one from me, just on thoughts on product launches outside of Europe. How attractive is that? How is it penetrate? How could you potentially do that? Thanks, guys.

I am not sure I understood the question. Please, before you get off, you said outside of Europe?

Sorry, if I did, I apologize. I meant, outside the US, thoughts for Europe, potential Asia longer term. Where do you think there is, is the most attractive to enter the market outside the US?

Sure. ETFs are not just a US phenomenon, it’s a global phenomenon. What we have done is a couple of things. One is, we actually have listed about 10 or 12 of our ETFs in Mexico and we have a relationship with the Compass Group that are selling those funds in Latin America to the institutional channel there. We have also set up a usage structure in doubling, and what that will allow us to do is launch ETFs in Europe and Asia, if the right opportunities presented themselves. It’s a low cost to keep that going but it gives us the option to do something. Right now, we are just sort of seeing it, if the right opportunity comes up for us to really turn that on. I would say probably – I don’t want to say Europe, but probably leaning more towards Asia, I would imagine if we are going to do something overseas.

We still evaluate it quarter-by-quarter and because we are making so much progress quarter-by-quarter, maybe our tolerance for investment might change over time, but at the moment we are still very very much focused on the US market share.

Great, thanks guys.

Thank you. Our next question comes from Todd Wachsman of Morgan Stanley, your line is now open.

Hi, good morning, gentlemen and congratulations on just an outstanding quarter and year. A couple of questions. First I would like you to talk a little bit about your progress in the 401(k) space and really trying to get the ETFs within that space? Secondly, with regard to the Japan area, might it make sense to do something with the yen DFJ, just a thought? And lastly, the advertisements for DXJ which we always see on CNBC, I don’t know if you guys know this but it’s gone completely viral on YouTube, it so far seen like 137,000 views for that, which I thought was impressive. Anyway, so that was basically my question with regard to 401(k) and 401(k) market share growth, maybe potentially hedging yen and the Japan small cap.

Hi, well, thank you for the questions, Todd, this is Luciano. With respect to 401(k), 401(k) represents about 1% of our ETF assets, so we are seeing some good progress there. We may good progress in 2012 in terms of expanding the number of 401(k) record keepers and 401(k) ETF enabled custodians of that kind of work together and kind of an end-to-end solution, but then allows other folks who were interested in getting into the 401(k) market using ETFs within that system to expand their business. So, we are talking to other money management firms out there that use ETFs as part of their models, helping educate them about how to get greater transaction, utilizing this broader 401(k) system. So, I would expect continued progress in that channel. But again, it’s a very small percentage of our overall assets today. With respect to hedging out other currencies, you know, in other parts of the world that’s something we are always evaluating, always interested in feedback from clients, particularly in areas of the world that could benefit from a weakening currency that was being hedged by our ability to use forwards (inaudible) products that we will certainly consider that around the world where it makes sense. With respect to social media, that’s been a big initiative of the marketing department over the last year and we are starting to see some really interesting, as you mentioned, viral repercussions to it. We are blogging on a regular basis and we are also getting our content out into broader social media forums, including from your own attestations YouTube and we are certainly encouraged that the DXJ TV ads are seeing that after within the free media.

Thank you. I think that’s really just incredible, keep up the good work. I look forward to see what you guys come up with next.

Thank you very much. We appreciate your support.

Thank you.

And our next question comes from Dan Weiskopf of Forefront, your line is now open.

Actually, thanks very much guys, my questions have been asked.

Alright Dan, thank you. Are there any more questions? Well, with that I think we just want to thank you again for all of your support and interest in WisdomTree and we look forward to speaking to you in a few months. 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.