Lazard Ltd (LAZ) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to Lazard's Third Quarter 2013 Earnings Conference Call. This conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Judi Frost Mackey, Lazard's Director of Global Communications. Please go ahead.

Good morning, and thank you for joining our conference call to review Lazard's results for the third quarter and first 9 months of 2013. Hosting the call today are Ken Jacobs, Lazard's Chairman and Chief Executive Officer; and Matthieu Bucaille, Chief Financial Officer. A replay of this call will be available on our website, lazard.com, beginning today after 10:00 a.m. Eastern Time. Today's call may contain forward-looking statements. These statements are based on our current expectations for future events and are subject to known and unknown risks, uncertainties and assumptions. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from those expressed or implied by the forward-looking statements. These factors include, but are not limited to, those discussed in Lazard's filing with the Securities and Exchange Commission, including our Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Lazard assumes no responsibility for the accuracy or completeness of any of these forward-looking statements. Investors should not rely upon forward-looking statements as predictions of future events. Lazard is under no duty to update any of these forward-looking statements after the date on which they are made. Today's discussion may include certain non-GAAP financial measures. A description of these non-GAAP financial measures and their reconciliation to the comparable GAAP measures are contained in our earnings release, which has been issued this morning. For today's call, we will focus on highlights of our performance. The details of our earnings can be found in our press release issued this morning and in our investor presentation of supplemental information, both of which are posted on our website at lazard.com. Following their remarks, Ken and Matthieu will be happy to answer your questions. I will now turn the call over to our Chairman and Chief Executive Officer, Ken Jacobs.

Good morning. Lazard performed well in the third quarter. Operating revenue rose 10% on a broad mix of business and adjusted net income rose 75%, reflecting the operating leverage in our business model. In Financial Advisory, the breadth and depth of our global franchise was evident as we continued to increase our share of the advisory fee pool despite a challenging M&A market. We are advising clients in some of the most significant and complex transactions around the world. In M&A, we are advising on 7 of the 20 largest global transactions announced this year. Recent announcements include Amgen on its acquisition of Onyx Pharmaceuticals; Health Management Associates' sale to Community Health Systems; and Vivendi on its exclusive talks with Emirates Telecommunications to sell its interest in Maroc Telecom. In Restructuring, we're winning significant mandates despite the generally low level of corporate restructuring activity. In the third quarter, Lazard was selected to advise the Brazilian Petroleum Company, OGX, on its capital structure and Detroit's Committee of Retirees on their Chapter 9 proceeding. In Capital Advisory and Sovereign Advisory we continue to be active advising corporations and governments, respectively, on balance sheet matters, capital raising and privatizations. In Asset Management, we're benefiting from a global franchise that's diversified by investment strategy, region and client type. The business set records for third quarter and 9-month operating revenue. It had net inflows of $1.7 billion for the quarter. Quarter end AUM hit a record high of $176 billion, and management fees were the highest they've been for any quarter. Despite high volatility in emerging stock and bond markets, we had net inflows in both our emerging market equity and emerging market fixed income platforms. While this was only 1 quarter, it illustrates our solid position in this area. We have a long track record, a pattern of strong performance and an institutional investor base that is increasing its allocation to these asset classes. In equities overall, we continued to see demand for international, emerging markets and local equity strategies. In fixed income, we are seeing demand for emerging market debt and global fixed income strategies. We continue to expand our investment platforms and our global distribution network. We recently opened a new Lazard Asset Management office in Singapore, with investment managers and marketing staff adding to our local presence in Asia. Our results for the quarter and for the 9 months reflect the breadth and depth of the Lazard franchise in both the Financial Advisory and Asset Management businesses. Despite challenging conditions, Lazard's operating revenue after 3 quarters is near a record level. Our net income is up 40% for the first 9 months. We continue to generate strong cash flow, we're enhancing our profitability and increasing our operating leverage, and we continue to invest for growth. Matthieu will provide further details on our financial results.

Thank you, Ken. Lazard's 10% operating revenue gain in the third quarter reflects a 6% increase in Financial Advisory and a 13% increase in Asset Management over the same period last year. Quarterly M&A and Other Advisory operating revenue increased 3% from a year ago despite a generally weak market for M&A, demonstrating the global breadth of our Advisory business, including Sovereign and Capital Advisory. This quarter, we had a number of M&A closings in Europe, showing the benefit of our strong presence in the region, even in a difficult environment. Restructuring operating revenue increased 23% from a year ago, primarily reflecting the closings of several large assignments, including Eastman Kodak. Lazard maintains its leadership position in global announced restructurings. In Asset Management, record third quarter operating revenue increased 13% from a year ago, driven by a 9% increase in average AUM and a slight change in the mix of our AUM. On a sequential basis, management fees were up 5% from the second quarter on a 2% increase in average AUM. The $13 billion sequential increase in our AUM was primarily a result of market appreciation, as well as $1.7 billion of net inflow in the quarter. As Ken mentioned, the net inflows were driven by emerging market equity and emerging markets fixed income, as well as our multiregional equity platform. These inflows were partially offset by moderate net outflows in our global equity platform. Turning to expenses. We are seeing the result of our cost-saving initiatives. In the third quarter, adjusted GAAP compensation expense increased 5% from a year ago, even as operating revenue increased 10%. And for the first 9 months, adjusted GAAP compensation expense decreased 3% from the 2012 period, even as operating revenue increased 1%. On an adjusted GAAP compensation -- our adjusted GAAP compensation ratio remained at 60% in the third quarter. This compared to 62.7% a year ago and 61.8% for the full year 2012. The third quarter adjusted GAAP compensation ratio assumes, based on third quarter market conditions, a full year awarded compensation ratio of 58.5%, down from 59.4% for the full year of 2012. Adjusted non-compensation expense increased just 1% despite the 10% increase in operating revenue. This reflects cost-saving, offset in part by expenses from increased business activity. Finally, regarding capital management, year-to-date, we have returned $294 million of capital to shareholders, primarily through dividends and share repurchases. As of September 30, we have reached our annual objective of offsetting potential dilution from our 2012 year end equity grants. We continue to believe we are on track toward a 2013 operating margin of approximately 21% or 22%, creating a path toward achieving our 25% operating margin target in 2014 full [ph] at 2012 activity levels.

Thank you, Matthieu. We continue to be cautiously optimistic about the environment and confident in our model. We're starting to sense some optimism regarding the global economy from boardrooms and business leaders, ultimately an encouraging sign for M&A activity. Global equity markets have been recovering, causing a surge in IPOs and privatizations, corporations and governments are seeking independent advice on capital structure and capital raising, and Lazard is positioned to serve all of them. In Asset Management, the long-term trends that make this a great business are intact. Our clients continue to look for investment solutions on a global basis, and we have significant capacity for organic growth. Both our businesses are well-positioned for revenue growth as the real economy recovers. In Financial Advisory, we're the leading global independent advisor with multiple sources of revenue. We have a world-class Asset Management business with strong performance and growth. Our discipline on costs is creating operating leverage as demonstrated by our results this quarter. We continue to return capital to shareholders, more than $1.2 billion since the start of 2011. And we're creating value for our clients, our shareholders and our employees. Let's open the call to questions. Thank you.

[Operator Instructions] It appears our first question comes from Alex Blostein with Goldman Sachs.

To just start off, I guess, the obligatory question on the environment. Ken, you suggested that, maybe the outlook is getting a little bit better, but I was hoping you could focus specifically on Europe given how important that region is for you guys. Clearly, the macro picture there is starting to get a little bit better, but I was hoping you could say anything more specific on the deal-making environment, and if you're seeing any early signs of hope in Europe.

Okay, look, Europe -- the drivers of activity in Europe are really not much different than they are in the United States, or for that matter, anywhere else in the world. The M&A environment tends to be driven by 3 factors: valuation, financing and confidence. In Europe, the financing conditions have improved. You see a very active IPO market, and you see a very active financing market for -- certainly, for the larger credits. And the valuations, while they've gotten a little richer, are still if you start to believe that the environment is going to be stable or even see some growth, are probably still okay. And the key thing is the global -- is the macroeconomic environment. And there, there are 2 probably positive developments. One is the fact that the tail risk in Europe is much diminished. At least the markets have really moved on with regard to tail risk. And in terms of the macroeconomic environment itself, you're starting to see stabilization in the southern part of Europe. You're even starting to see some growth creep back in. It's not significant enough to say it's sustainable. But it has -- it is a better environment than it was a year ago. And for the first 6, 9 months of the year, for the most part, this growth beat people's expectations during that period of time. So, if that's the case and you start to see a sustained stabilization of the macroeconomic environment with some improvement in trading conditions, confidence should start to improve. And as confidence starts to improve, you're going to likely see more activity.

Got you, that's very helpful. And then, on the Asset Management business, I'm not sure if Ashish is on the line as well, but clearly big improvement in flows for you guys this quarter. I was wondering if you could speak to the pipeline. And then specifically, since global thematic still seems to be such a big overhang, is it possible to identify a certain amount of assets that you guys still think might be at risk to help us kind of dissect what the more natural organic growth is versus some of the riskier products?

Okay, quite a few questions built into that. Let me start with the pipeline. RFP activity for the first 9 months has been strong, continues to be strong for us. Gross flows for the quarter -- for the year so far have also been quite strong. Net flows for the quarter were positive. In the emerging market franchise, we saw both positive net inflows, and we also saw AUM growth as a result of markets improvements. In the thematics business, we had some outflow still but reduced from the first half of the year, offset by improvements in the overall AUM from market performance in that business. And then, as far as the thematics business going forward, a lot of the decision-making around this strategy is going to probably happen in the end of the fourth quarter, the first part of next year. And while this is a strategy which is based on long-term performance, and the 5-year and 10-year numbers are still pretty good, we've obviously had some difficulties in the shorter term, so we're keeping an eye on it.

Our next question comes from Howard Chen with Crédit Suisse. Howard Chen - Crédit Suisse AG, Research Division: Ken, I was wondering if you could comment to what extent the U.S. government shutdown, potential default and this continued movement in benchmark interest rates has impacted new business formation and potentially delay or change the completion of deals, if at all?

Okay, on the asset side, it probably doesn't have all that much of an impact. The markets were pretty strong during this whole period of time. There was a couple of days where they fell off, but generally speaking, the rally post the shutdown got us back to where we were, probably plus some in some places. So overall on asset, there probably is not much of an impact. On the advisory side of the business, it didn't impact the third quarter results because most of everything there is pretty much baked before the shutdown happened. The question is whether or not those 3 or 4 weeks of distraction either delayed things or put things on the shelf or whatever, and we won't really feel that until the -- until subsequent quarters. In reality, this was a little bit of a setback for confidence. A lot of it depends on how people view what's going to happen in January and February. Current consensus is we're not likely to go through the same events we went through last month. Howard Chen - Crédit Suisse AG, Research Division: Great, and Matthieu, you touched a bit on this on your prepared remarks but can you elaborate on what drove the revenue yield pickup in Asset Management, and how sustainable do you think that is?

Right, this is probably 2 things. One is in our institutional business, when we described our inflows and outflows, you remember that we've said that in inflows, we've been strong in emerging market and multiregional platforms, which tend to have high yields. On the outflow, you remember that what we've pointed out to is the global thematic, and also the local equity. And the local equities have higher yields. So net-net, on the institutional business, the reason for the pickup is the change in the shift -- the change in the mix of our AUM as a result of those flows. There is also a little bit of an impact created from our wealth management business in Europe. Howard Chen - Crédit Suisse AG, Research Division: Okay. And then my final question, Ken, you and the team have laid out the near- and long-term goals of what you hope to achieve in terms of the operating margin and compensation, both on a GAAP and an awarded basis. But I was just hoping you could comment, heading into compensation season over the next few months, just what's different or not different about this year for the firm and the competitive landscape versus what you all and how are you approaching that potentially differently than 10 years past?

We're laser-focused on achieving our targets, and we're going to go into year end with that in mind.

Our next question comes from Brennan Hawken with UBS.

So, a follow-up on the Asset Management questions there. Emerging market net AUM was up really, really nicely. Can you give some color around how much of that was due to flows versus market tailwinds?

It's principally flows.

Terrific. And then, when we think about the drop in noncomp and then clearly, there was a component of that, that was due to seasonality and maybe lower activity levels, but just when we're trying to deconstruct that versus the impact from the cost-cutting program, can you give us some color on that front?

So if you're talking sequentially, yes, there is, in the third quarter, a seasonal low versus the second quarter, which drives the decrease in the third quarter versus the second quarter. If you look third quarter this year versus third quarter of last year, so 2 same quarter, then you see that it went up only 1% whereas revenue went up 10%. This is really the result of, number one, some impact of our cost-saving initiatives but there is also, in particular in our Asset Management, increased business activity, which has led to increased non-compensation costs in the line fund outsourcing and other expenses associated with that acquirement which has offset some of those benefits.

That's helpful, thank you. And then last one for me. We haven't really seen the price of the high-cost debt that you guys have that's maturing in 2015 come down. I understand that you may not want to signal here too quickly, but is there a level that you guys are watching for in order to consider biting the bullet and maybe restructuring some of that debt?

This is always on our mind. We are consistently -- constantly evaluating the different paths we have to deal with this. And the challenge is making sure that we see real economic value created by whatever move we take here. And we're examining it all the time. And obviously, it becomes more real as we get closer to the '15's maturing.

Our next question comes from Devin Ryan with JMP Securities.

Just given some of the positive commentary on the Restructuring business or at least what we interpreted as positive commentary, particularly relative to what's been a really slow backdrop, I'm just trying to put some context around that. I mean, has that activity actually been improving for you guys in that business? Or are we kind of just at a more stable place in the cycle for that business, where we'd expect activity to be around where it's been over the past year?

Our view is probably activity levels are probably where you expect -- where they've been for the past year is a good indicator. Liquidity conditions are so strong right now that the restructuring environment is probably pretty stable at the moment and not likely to improve that much. The one area where there's probably some opportunity is in some of the developing markets. As an example, we just took on a large assignment in Brazil, which is a result of perhaps, some of the outgrowth of the changing markets over the last few months for the developing world.

Okay, got it. And then just with respect to recruiting, can you just speak a bit to your view of the recruiting environment today and maybe, some area that you may be more focused on, whether it be by geography or sector where you see the potential to add some people in the coming year?

This year, we've been pretty active on the Asset Management side, particularly on the sales and marketing functions. That's been an area where we've invested some money this year. And on the advisory side, a couple of places where we saw some opportunities to strengthen our business, one in particular was Germany. And then we've kind of filled in a couple of other places. What we're really doing right now is taking a careful eye on the cost-savings plan that we had. We've always said we're going to reinvest some of that, but we're going to modulate it so that we can make sure that we hit our results. And also to make sure that we're in line with the environment we're in. The environment itself for hiring is still pretty good, compensation is not out of control on Wall Street at all at the moment relative to previous periods of time. And so there remain good opportunities there. But we also have a good franchise that is pretty well built out. We have a lot of operating leverage in Europe at the moment. And also to a little lesser extent in the U.S. because the markets a little better in the U.S, but still there's a lot of operating leverage in both parts -- in both of our key markets. And we have a good presence in the emerging market, that was -- has been developed over a long period of time. And part of what we've done in this restructuring is concentrate our efforts on the places where we think the fee pull is most attractive.

Our next question comes from Jim Mitchell with Buckingham Research.

Just a follow-up question on your debt coming due in '15, is there any reason why you wouldn't want to pay that down with cash right now? Cash levels are a little bit low, lower than what the total amount outstanding is. So I guess, just trying to get a sense of would you -- is it fair to assume that, that may -- the interaction between capital return and building cash to pay that down, it seems to me that -- versus issuing more debt to pay it down or refinance, it would make more sense to raise cash. Is that fair, or what kind of dynamics are you thinking through?

Look, we have a -- half our debt roughly speaking is due in '15, half our debt is roughly speaking due in '17. If we were to take all our cash flow to pay down debt, we're not going to pay down both tranches. We're probably going to have debt at some point even after '17. And so one of the questions is, is which is the better tranche to pay down and which is the better tranche to start to work off or keep extant. And some of that comes back to how attractive the financing environment is today versus how attractive the financing environment might be in 2 or 3 years from now. I think we all have to keep in mind, we have historically low rates today and spreads are pretty tight. And so, it's a relatively attractive environment to refinance. But for us, it's a balance between the attractiveness of the refinancing, our view on rates, the world's view on rates and what kind of premium we have pay to refinance the debt or pay it down.

Fair enough. And then maybe just on Sovereign Advisory, that's been pretty strong, obviously, of late. How do we think about that going forward? Is it more of a kind of like a restructuring cycle, whereas as fiscal -- as global economy improves, fiscal -- the fiscal shape of governments get better that, that would wane? Or do you feel that, that's -- you're not punching above the weight here and that, that can continue to grow? How do we think about that?

Look, that business is interesting. We started off as a business associated with the developing world, and then over the cycle in 2010 and '11, as a result of the turmoil in Europe, it moved a bit towards Europe. As Europe stabilizes, there are going to be other parts of the world that are going to be a little less stable, and I think we can continue to see activity there. It's a business with a lot of runway still, in our view.

Okay, I mean, how do we -- is it fair to assume it was a reasonably good driver this quarter? Or I mean, how do we size that? If you can give us any kind of color, that would be great.

It's kind of hard to break it out but I'd say it's consistent with where it's been for some time. And again, this business -- it has multi facets. On one hand, you advise the government, and then it turns into advising on a financial system or banks and it can turn into corporate assignments. It's got a -- it's turning into a life cycle business for us. Many, many years ago, it was simply advising on a debt restructuring for a troubled country or countries. Today, it has a broader application to our emerging market platform.

Our next question comes from Mike Needham with KBW. Michael Needham - Keefe, Bruyette, & Woods, Inc., Research Division: I just have a question on the buyback. Just curious, are you guys being more opportunistic just where the share price has been trading this year? Or was it more of just really a function of buying back stock to offset dilution from comp?

It's a little bit of both. We clearly have offset the dilution associated with comp, and then we're going to be opportunistic about the remaining buying. Obviously the share price has moved up pretty significantly this year, so we have to be thoughtful as to what's the best application in terms of cash flow here. Michael Needham - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. And I mean, I guess from what we're seeing, just sort of number of announced deals globally and volumes really don't look all that strong for M&A. But it seems like at least this quarter, the industry is really beating expectations. Do you guys think sentiment has gotten a bit too negative on volumes more generally, kind of based on the opportunities you guys are seeing in your pipeline?

Look, the M&A environment is really -- as I said before, it's really going to be driven by the real factors that drive M&A. So it's going to be valuation, it's going to be financing -- availability of financing, and confidence, which is really a function of the real macroeconomic environment. And that's been sort of the missing element here. And our view is as the macroeconomic, and if people really start to have confidence in the improvement in the macroeconomic environment, then confidence overall will improve and that should be a driver of the M&A cycle. And that's been the piece that's been missing since the crisis.

[Operator Instructions] Our next question comes from Patrick O'Shaughnessy with Raymond James. Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division: My first question is on Lazard Capital Markets. Obviously, that was spun off from your entity several years ago. But there's still I think, some kind of very modest business relationship between the 2 of you. With them apparently struggling and looking for strategic options, can you talk about the financial and/or the brand risk that you guys are facing from that?

Okay, on the financial side of things, it'll -- it should have minimal impact on us. The lion's share of our activities on the capital side is in the advisory business globally, which really has very little to do with LCM. On the brand, look, Lazard's been around for a long time. It's a durable brand. LCM is not a part of Lazard. It's noise right now, and we expect we'll be past this at some point soon. Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division: All right, appreciate that. And then last one from me, real quickly on your share count. Your diluted share count was up quarter-over-quarter by about I think, 1.5%. Can you talk about what played a role there because, given that you had share repurchases, I would have expected it to be down sequentially?

It's the wonders of treasury method accounting. Matthieu, may --

Right, right. This is -- all of it is the increase in the average share price between the second and the third quarter led to an increase in our weighted number of shares for EPS calculation. And that's really just the impact on the treasury share method. I think we've discussed this in the past.

And it appears we have no further questions in the queue at this time. This now concludes the Lazard conference call.