Lazard Ltd (LAZ) Q3 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to Lazard's Third Quarter and First 9 Months of 2017 Earnings Conference Call. This call is being recorded. At this time all participants are in a listen-only-mode. Following the remarks, we will conduct a questions-and-answer session. Instructions will be provided at that time. [Operator Instructions] At this time, I would now like to turn the conference over to Judi Frost Mackey, Lazard's Head of Global Communications. Please go ahead.

Good morning, and thank you. Good morning, and thank you for joining our conference call to review Lazard's results for the third quarter and first 9 months of 2017. Hosting the call today are Kenneth Jacobs, Lazard's Chairman and Chief Executive Officer; and Evan Russo, Chief Financial Officer. A replay of this call will be available on the Lazard website beginning today by 10 a.m. Eastern Daylight Time. Today's call may contain forward-looking statements. These statements are based on our current expectations about 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 filings with the SEC, 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 also 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, both of which are posted on our website. Following their remarks, Ken and Evan 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 achieved record operating revenue in the third quarter, surpassing last year's record level. Our strong quarter contributed to a record first 9 months of the year and a record 12-month period. Over the last 4 quarters, we've achieved almost $2.7 billion in operating revenue, up 18% over the previous LTM period. Our performance reflects the strength of our franchise, the quality of our work for our clients and benefits from investments we have made in our business over the past decade. In Strategic Advisory, we continue to advise on many of the largest, most complex transactions around the world. These include 3 of the 10 largest global M&A announcements in the third quarter as well as 3 of the 10 largest in the first 9 months. The diversity of our advisory services has supported our revenue growth with high levels of activity in our Restructuring, Capital Advisory, Capital Raising, Sovereign and Shareholder Advisory practices. Our Asset Management business continues to achieve excellent results with all-time record operating revenue in the third quarter, record assets under management and net inflows for the third quarter and first 9 months. We continue to benefit from our focus on differentiated strategies in asset classes where active management makes a difference and our primarily institutional client base, which is focused on the long-term strategic allocation of capital. I would now like to welcome Evan Russo to this morning's call. He became Chief Financial Officer on October 1. Evan will provide color on our financial results and capital management. Then I will comment on our outlook. Evan?

Thanks, Ken. It's a pleasure to be here. Lazard's third quarter and 9-month results reflect the stability of our franchise and our continued high level of performance. Operating revenue of $627 million was a third quarter record for the firm, 3% higher than last year's record level. For the first 9 months, operating revenue was also at a record level, 19% higher than a year ago. And as Ken mentioned, our last 12-month operating revenue reached a record high, approaching $2.7 billion. That is our fifth consecutive quarter of LTM revenue growth. Revenue gains in the third quarter were driven primarily by strong Asset Management results, with operating revenue up 19% year-over-year. Management fees increased 18% from the last year's third quarter and increased 8% sequentially from the second quarter of this year. During the third quarter, average AUM reached a record level of $234 billion, an increase of $12 billion or 5% from the second quarter. The sequential increase was driven primarily by market appreciation, foreign exchange movement and modest net inflows of $15 million. Growth inflows remained strong across our investment platforms. And for the first 9 months of the year, we have achieved net inflows of $3 billion. Our average management fee has held steady this year at around 51 basis points. As of October 20, AUM was approximately $240 billion, driven by market appreciation of about $3.8 billion, offset by net outflows of about $800 million and negative foreign exchange movement of about $760 million. In Financial Advisory, third quarter operating revenue decreased 11% from last year's period. Revenue for the first 9 months of 2017 was 17% higher than last year. Our number of publicly disclosed completed M&A transactions for the first 9 months was 5% higher than last year. These included 4 of the 10 largest European M&A transactions that closed in 2017 and 3 of the 10 largest in the U.S. For global M&A announcements in the first 9 months, we gained market share on transactions valued over $5 billion. In North America, we achieved a 10% increase in total volume compared to a 10% decline in the overall market. Our Restructuring business remains active as we are seeing an increase in consumer and retail assignments in addition to the energy sector. Lazard was ranked number 1 in the league tables for completed restructuring assignments in the first 9 months. Our Shareholder Advisory business continues to grow in the United States and in Europe as we advise on significant assignments relating to corporate activism and shareholder engagement. And our Sovereign and Capital Advisory services remain active, advising governments and corporations across a range of geographies on financing strategy and capital raising. Looking ahead across all of our businesses. Asset Management entered the fourth quarter in a strong position, with AUM about $33 billion higher than 1 year ago. In Financial Advisory, as we have said earlier, last year's record fourth quarter revenue could make comparisons a bit more challenging. However, our Advisory results this quarter were strong and we have momentum in the fourth quarter and going into next year. Turning to expenses. We continue to invest in our business through promotions of our outstanding performers, ongoing selective hiring and the seeding of new investment strategies. We are achieving organic growth through the extension of our investment platforms and the expansion of our advisory services. We continue to consider inorganic growth opportunities, including team lift outs and acquisitions. In the third quarter, we continued to accrue compensation at a 56.5% adjusted compensation ratio. Our adjusted non-compensation ratio for the third quarter was 17.6% compared to 17.2% in the third quarter of last year, reflecting higher marketing and activity levels. The non-comp ratio for the first 9 months was 16.9% compared to 19.2% for the same period last year. As we discussed last quarter, our adjusted non-compensation expense again excludes certain charges, primarily reflecting the implementation of a new global enterprise resource planning system. We expect the total cost of the project to be approximately $25 million, most of which will take place in 2017 with the remainder in 2018. Our effective tax rate in the third quarter as adjusted was 24.6%. We continue to expect a full year tax rate in the mid to high 20s range for 2017. Our business continues to generate strong cash flow to support share repurchases and dividends. For the first 9 months of 2017, we returned $612 million to shareholders, primarily through share repurchases and dividends. Year-to-date, as of today, we have spent $260 million buying back shares. Our total outstanding share repurchase authorization is now approximately $300 million, following yesterday's additional authorization by our Board of Directors. Ken will now conclude our remarks.

Thank you, Evan. I will provide some perspective on our outlook, and then we'll open up the call to questions. Overall, the global macroeconomic outlook for the near to midterm remains positive. The U.S. economy is healthy, and Europe's recovery is gaining momentum. Emerging market economies continued to improve. Global M&A activity remains at slightly lower levels compared to the past few years, particularly for very large transactions. This is, in part, due to continued uncertainty regarding U.S. policy. However, the overall environment remains favorable for M&A. In the longer term, we see growth opportunities on our Advisory business around the world, and we are in an excellent competitive position to increase our share of the market. In Asset Management, we are well positioned for continued growth. We are building from a record base of AUM. We have a broadly diversified set of investment strategies serving a global primarily institutional client base, and our quantitative strategies are competing effectively against demand for lower fee products. To conclude, some takeaways. We achieved record operating revenue for the third quarter, first 9 months of the year and last 12 months. Asset Management achieved record fees and AUM with net inflows for the quarter and first 9 months. Gross flows were a record $33.7 billion for the first 9 months, up more than 10% versus last year against the backdrop of declining gross flows for active managers. Financial Advisory continues to be a leader across our practices globally, achieving record LTM and 9-month operating revenue. Both our businesses have momentum going into 2018. We are achieving organic growth and continue to consider inorganic growth opportunities. We are maintaining our cost discipline, and cash flow remains strong with capacity to support both dividend growth and increased share repurchases. We remain focused on serving our clients well while we manage the firm for profitable growth and shareholder value over the long run. Let's open the call to questions.

[Operator Instructions] We'll take our first question from Brennan Hawken with UBS.

Hey, good morning. Thanks for taking the question. I just wanted to get in a bit more on the restructuring outlook. It seems like while we've seen restructuring revenues slow down, I think you had highlighted that there is some indications that mandates [ph] may be building. Could you maybe just give us some greater color on that where you see good opportunities from here? And how we should think about the opportunity for you all?

Sure. Well, look, the overall economic environment is pretty favorable. So you wouldn't expect a strong restructuring environment. But when you start to look at certain industries, you see some stress. Well, obviously, a lot of the activity over the last couple of years was driven by the oil and gas environment -- the oil and gas sector. Over the last several months or so, we've seen stress in the retail sector, and we expect that will probably continue for some time. And then there may be some stress that kind of fades out of that sector into real estate at some point as a result of some of the consolidation and some of the restructuring that takes place in the retail sector. So I'm not sure we're going to see the levels that we saw at the peak of the oil and gas restructurings, but there continues to be a steady level of activity.

Sure. And given your franchise and your footprint and strength in Europe, are you also seeing any opportunities, particularly in certain parts of Europe, like Italy or what have you, where you can have some asset sales, some bank-driven activity and the like?

I think we're getting to the point in Europe where you're going to start to see interest rates perhaps moving up a little bit over the course of the next year or so. I think there may be some consolidation amongst some of the financial institutions in Europe, which hasn't been particularly active -- where there hasn't been much activity over recent years. And I think in the course of that, yes, you may be right, there may be some opportunity for some kind of further restructuring here. But I expect, again, we're not -- in an improving macroeconomic environment, you generally don't expect a strong restructuring environment. But at the same time, we're seeing massive disruption across a range of industries, both in the United States and globally. And whenever you see that kind of disruption, you can see restructuring in those industries.

Okay, okay. Thank you. And then last one from me. Can you provide an indication about how you think MiFID might impact your Asset Management business? And what we should expect here as we roll into the January 3 deadline for that regulation?

We think MiFID's going to have -- is not going to have a material impact on our Asset Management business at all as we see it right now.

Okay, that's certainly clear. Sorry.

Yes, trying to keep it simple.

Our next question comes from Conor Fitzgerald with Goldman Sachs.

Hi, good morning. I just wanted to talk a little bit more about some of the inorganic growth opportunities you're seeing that you mention in your prepared remarks. How has that -- opportunities had evolved over the last 12 months? And would you say it's an environment kind of more ripe for inorganic growth at this point of the cycle?

Look, I think on the asset side -- at the Asset Management side of the business, we've always had a careful look at the overall environment. The stress caused by the move to passives, also the consolidation of the hedge fund industry, creates a lot of opportunities for continued lift outs, small, inorganic type of acquisitions for us, probably more today than we've seen in the past. And so I think it's something we're going to look carefully at. There's just a lot of change going on in the Asset Management industry right now. I think we have a strong platform. And there may be some opportunities that comes through this change, which could be attractive to us, and so we're keeping a very careful eye on that.

And are you more focused on ways to expand your product set? Or more cost-synergy type acquisitions?

I think it's product set. I think on the Asset Management side of the business, you are always attracted to opportunities which give you more areas to compete in with good performance. It's very difficult to take on a business with bad performance and turn it around. So I think the first criteria for us is finding something that adds capability in areas where we don't have it, geography in areas where we may be missing something and talent where we might not have it. And if cost follows, that would be great, but I don't think you lead with costs in this environment.

That's helpful. And then just in terms of thinking about the compensation ratio for this year, given how high the bar was for 4Q Advisory revenue last year, it looks like Asset Management's going to have better revenue growth this year than the M&A part of your business. How should we think about that impacting your full year compensation ratio accrual?

So look, we generally accrue through the third quarter at the same rate at which we end the last year until we have a very clear sense of how the fourth quarter comes out. And as you've seen in the past, when we have these in fourth quarters, we've had adjustments that reflect the actual results. And I think that's -- you can expect the same here. I think a lot depends on what happens in the fourth quarter when we have real visibility on the outcome of the business.

But is it fair to think about the compensation ratio this year, just given somewhat of the divergent trends being more of a sum of the parts type of compensation ratio?

I hate to predict what's going to happen in the fourth quarter between the 2 businesses. The Advisory business, through the first 9 months of this year, has had a very strong performance. Asset Management has also had a very strong performance. So let's wait and see what happens in the fourth quarter.

I appreciate the color. Thank you.

Yeah.

Our next question comes from Ann Dai with KBW. It appears that person may have stepped away. [Operator Instructions] Our next question comes from Devin Ryan with JMP Securities.

Thanks. Good morning, Ken and welcome, Evan.

Morning.

I guess, first question here on Managing Director kind of headcount trends. You've had really nice growth since end of 2015, I think, and some of that's maybe been under the radar a bit. And I know that kind of ramping production's never smooth, but you have to carry the upfront cost of all the additions and the revenues can take some time. So I just wanted to maybe get a sense of how some of the newer MDs that have come on to the platform are producing maybe relative to what you think their potential is, and maybe how that factors into your business outlook for 2018. Meaning, could you see kind of an acceleration or is it just because you have more people that are kind of hitting their stride at the same time?

Yes. I must say, I think about it a little bit more of franchises hitting their stride. Lazard is very much a team sport, if you think about it on the advisory side. You get clients not because one person is successful, but because the firm, that person is able to leverage their capabilities to the firm in driving the client relationship. So what we think about is franchises, and we think about the opportunity that, with regard to total addressable market, people and places where we're making investments. And so, therefore, to just give you some color on that, yes, we've -- over the last several years, we have chosen places to, as I think we said in '09 and '13, we left some options on the table in '09 to see how they played out. At the end of '13, we made our bets on where we thought the opportunity set would be for the next several years or so. And I think we've really seen the fruits of those kind of decisions. The places where we've made bets recently have been in places like Japan, China. We've recently expanded into Canada. We've integrated our business in Latin America. The people -- and then also we've made a significant investment in the United States in Chicago, as an example. The people, as you'll see from - some of the - on the investor deck, kind of the people on those markets are very significant. And what we're very excited about the fact is that we're now scaled in almost everywhere we've made one of those investments. And by scale, I mean the capacity to have multiple partners with real teams, which are among the largest dedicated teams in those particular markets. So you have real scale in those markets, and that's when we see the rewards. And so we're pretty excited about the investments we've made in those particular markets over the last few years or so in the Advisory side. And we expect the pay off on that, really, just -- we've already seen some, but we expect much more to start rolling in over the next few years or so.

Yes, okay, that's great color. Maybe one here just on kind of the cash and equivalents. You look at that up 50% nearly year-over-year, that's about $3 a share of delta. And I know you alluded to inorganic opportunities potentially being out there. But how should we think about cash needs today and maybe capacity for special dividend as well?

Sure. So look, I mean, we've been very clear about the fact that we -- it doesn't take much capital to grow our business. And my view on inorganic activities is that it's not difficult to finance in this environment if you have to do significant. And the smaller things really are not that significant and you can do that off a balance sheet or you can do it through the way you set up the compensation schemes in - or through the P&L essentially, and therefore, the normal compensation route that we have So the way I kind of look at the cash is we have to, obviously, leave some cash around because we're accruing compensation over the course of the year. The more you go into the year, the more you accrue in terms of compensation. And so that cash balance will build. This year is a particularly strong year for a cash build because we've had a spectacular 9 months so far. And so you'd expect the cash to build. And what we have said consistently is, yes, we're an aggressive buyer of shares, and we have been to-date this year. But we wait to see what happens in the end of the fourth quarter and then we make our capital allocation decision then. And I think people could expect us to be as responsible about the decision as we have in the past.

Okay, okay. And then just last one here. Yes, we're getting a bit more detail around what a pack -- excuse me, a tax package could look like. Obviously, I think there's still a lot of uncertainty there. But just, I'd love an update around -- thoughts around potential C corp conversion. Any updates, I'm thinking, there? And whether there's kind of a rate as you guys are maybe looking at some of the things being put out there that might kind of be the tipping point of where it makes sense?

Look, as I said previously, if we're at the rate the President's talking about or even the rate that is a compromise between where the President is talking and the rate and the statutory rate where it is today, that could be pretty attractive to us. The devil is in the detail about how territorial tax works out and a lot of the other stuff that goes into how one will go about repatriating earnings from abroad, tax credits and things like that. But look, we're a fan of tax reform. And if it takes place, that could create some very attractive opportunities for us.

Sure, okay. Great. Thanks a lot Ken. Thanks, Evan.

Our next question comes from Steven Chubak with Nomura Instinet.

Hi, good morning. This is actually Sharon Leung filling in for Steven. So first, on the Asset Management side, I guess what's your outlook for EM products in anticipation of the Fed balance sheet unwind and higher rates? Just noting that EM strategy still appears to be under-owned in a secular context?

Yes. Well, look, I mean there's no surprises about the Fed's strategy right now. There might be a surprise in terms of the new head of the Federal Reserve. But everybody's anticipating the unwind. Everybody's anticipating over time some increase in rates. So there's no surprises here for the market. And so I think it's -- I think what we're seeing in the emerging market performance today is kind of already kind of baked in. I mean, it's -- that news is discounted. I suppose where there's a risk is if you get some surprise in terms of the new Chairman of the Fed, a change in policy, something coming out of Europe that's unexpected. But at the moment, everything we're hearing out of the Fed and everything we're hearing out of Europe is pretty anticipated and pretty much priced into the markets we expect.

All right. And then just another one on Asset Management. Management fees in the quarter were pretty strong with a very high fee rate. Can you just give us a sense of what drove that? And do you think its sustainable moving forward?

Sure. Look, I mean, our fees have held pretty consistent and have been pretty consistent over the last several years or so. It reflects, I think, the mix of products that we have, which have, generally speaking, been able to differentiate themselves from a lot of the index products that are out there, the passive products that are out there. We've been through a mix, I think, of foresight and some serendipity, able to come up with new products that address a lot of the needs in the market. We have a few strategies in particular, which are not necessarily high fee strategies, but are very complementary to the products we have, such as Quant, that have created - that have significant demand right now. And our kind of core products, emerging markets, global, infrastructure, are all doing well right now and have capacity.

All right. Thanks for the color. That’s it from me. Thanks.

This now concludes the Lazard conference call.