Lazard Ltd (LAZ) Q1 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to Lazard's First Quarter 2013 Earnings Conference Call. This call is being recorded. [Operator Instructions] At this time, I will turn the call 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 first quarter of 2013. Hosting the call today are Ken Jacobs, Lazard's Chairman and Chief Executive Officer; Matthieu Bucaille, Chief Financial Officer; and Alex Stern, Chief Operating Officer. A replay of this call will be available on our website beginning today after 10 a.m. 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 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, Matthieu and Alex will be happy to answer questions. I will now turn the call over to our Chairman and Chief Executive Officer, Ken Jacobs.

Good morning. Our first quarter results reflect the uneven pace of the M&A markets balanced by the strength of the equity markets. Asset Management achieved record first quarter operating revenue and assets under management. This performance was offset by a weak quarter in Financial Advisory. In Advisory, both M&A and restructuring were down at the same time. The first quarter's decline in large staff M&A closings reflected softness in transaction announcements last summer and fall. Lazard Middle Market revenue was impacted by the acceleration of transactions late last year in anticipation of tax law changes. Restructuring was down as a result of strong financing markets and U.S. corporate default rates near historic lows. Advisory fees are often lumpy on a quarterly basis. On trailing 12-month basis, our M&A revenue continues to outperform the market, and the publicly announced value of our new M&A transactions is up 40% from the first quarter 1 year ago. In Asset Management, we had record AUM at quarter end of $172 billion, up 3% sequentially from the fourth quarter and up 10% from last year's first quarter. Our average AUM which drives management fees was $171 billion, up 4% sequentially and up 14% from the prior year. In equities, we continue to see demand for our international emerging markets and local strategies. And in fixed income, we continue to see demand for our emerging market debt and global fixed income strategies. On the cost side, our cost-saving initiatives are mostly complete and we're beginning to see the benefits. We expect to realize additional cost savings beyond our original target which Alex will discuss in a moment. Now Matthieu will provide color on our business activity and financial results.

Thank you, Ken. Lazard's operating revenue declined 17% in the first quarter, reflecting a 39% decline in Financial Advisory, partially offset by a 14% increase in Asset Management. While M&A and Other Advisory revenue was down in the quarter, we continue to advise on the largest and most high-profile transactions, including Berkshire Hathaway and 3G Capital on the acquisition of Heinz, Anheuser-Busch InBev's acquisition of the remaining stake in Modelo. Qatar Holding in the Xstrata, Glencore merger, and the sale of D.E Master Blenders to A. Benckiser-led investor group. Our Sovereign Advisory business also continue to be active. In the recent months, we advised Piraeus Bank on its acquisition of the Greek banking operations of Bank of Cyprus, Cyprus Popular Bank and Hellenic Bank. Despite lower levels of restructuring activity, our world-leading restructuring group remains engaged in highly visible and complex restructuring and debt advisory assignments, including for Cengage Learning, Eastman Kodak and the Allied Pilots Association with respect to American Airlines. In Asset Management, management fees of $220 million were a first quarter record, 5% higher than the fourth quarter of 2012, primarily reflecting the increase in average AUM. Incentive fees were $9 million compared to $3 million a year earlier, reflecting improved performance in selected funds primarily in Europe. Our Asset Management business experienced $995 million of net outflows in the first quarter. Turning to expenses. In the first quarter, adjusted GAAP compensation and benefit expenses was 21% lower than 1 year ago. Our adjusted GAAP compensation ratio dropped to 60% in the first quarter compared to 62.7% in the first quarter of 2012 and 61.8% for the full year 2012. This partially reflected our cost-saving initiatives, as well as the end of amortization expense related to 2008 deferred compensation awards. The first quarter GAAP compensation ratio assumed, based on current market conditions, a full year awarded compensation ratio of 58.5%, which is within our target range. Regarding non-compensation expense, we had some improvements this quarter reflecting in part the early stages of our cost-saving initiatives. Non-compensation expense in the first quarter declined 5% from the prior year period. We expect to see further benefit of our cost-saving initiative in the second half of this year. Now capital management. We continue to deliver on our commitment to return cash to shareholders as Lazard remains its strong cash generator. We are increasing the quarterly dividend by 25% from $0.20 to $0.25 per share. In the first quarter, we returned $176 million in capital to shareholders. We remain committed to offsetting the potential dilution of year end compensation-related equity grant. In the first quarter, we repurchased 1.8 million shares of our Class A common stocks at an average price of $32.85 per share. Alex will now provide more detail on our cost-saving initiatives.

Thank you, Matthieu. The cost-saving initiatives we announced 6 months ago are proceeding as planned. As stated, our goal is to achieve $125 million in annual savings from Lazard's cost base, with the full impact realized in 2014. Our cost-savings initiatives are intended to improve the firm's profitability with minimal impact on revenue growth. The initiatives remained focused on: streamlining our corporate structure and consolidating support functions; reducing investments and staff in low -- in areas of low return so we can devote more resources to areas with greater long-term potential; and renegotiating or exiting certain third-party contracts. Most of the cost-saving initiatives have been completed. And during the implementation process, we identified additional cost savings. We expect all the remaining implementation to be finished by the end of the second quarter of 2013. In the first quarter of 2013, associated implementation expenses were approximately $26 million. Combined with last year's fourth quarter charge, implementation expenses related to the initiatives now total $129 million. We currently expect the second quarter implementation expenses will not exceed the level of first quarter 2013 expenses. And we anticipate that the ratio of the additional cost savings to expenses will be approximately 1:1, which is the ratio for the initiatives currently underway. We are confident that our cost-saving initiatives will provide Lazard the greater operating leverage as well as increased flexibility to invest in areas of growth. We continue to believe our initiatives put us on track to achieving an operating margin of approximately 21% or 22% in 2013, assuming 2012 activity levels. This should create a path to achieving our target of a 25% operating margin in 2014, also at 2012 activity levels. Ken will now conclude our remarks.

Thank you, Alex. A few words on our outlook. In the U.S., the macroeconomic environment continues to improve. In Europe, markets are stable, but the macroeconomic environment is still challenging. Emerging markets are country specific, but the overall trend is positive. In our Advisory business, we remain cautious as the pace of M&A announcements has been uneven in the first part of this year. We see encouraging signs for U.S. and cross-border activity. Our announced transactions year-to-date are up from last year. Our market share announced transactions has improved. In Advisory, our first quarter results temper our view about the first half of this year. The second half of the year historically is stronger than the first half. In Asset Management, even after the market volatility of recent weeks, equity markets have trended higher in the first 4 months compared to last year. We are performing well in asset classes of interest to institutional investors. Average AUM in the first quarter was 14% higher than the prior year, and we have significant capacity for organic growth. We continue to incubate new investment strategies across our platforms. As a result of our cost discipline, we have the flexibility to continue hiring new senior level people, both in Financial Advisory and Asset Management, as opportunities arise. To summarize, 4 takeaways on the quarter: Asset Management, strong performance; Financial Advisory, soft quarter, but good trend on announcements; cost discipline, our cost-savings initiatives are showing results and provide us with increased operating leverage and flexibility; dividends increase demonstrates Lazard's ability to generate cash and our commitment to return capital to shareholders. We remain confident that with the breadth and depth of our platform, strength of global network and our financial discipline, Lazard is well positioned. We're serving our clients with a more and better integrated resources, we're creating value for shareholders of whom Lazard employees are the largest single group and we have substantial operating leverage as the environment improves. Let's open the call to questions.

[Operator Instructions] We go first to Howard Chen with Crédit Suisse. Howard Chen - Crédit Suisse AG, Research Division: Ken, just beginning on the Financial Advisory outlook. Realizing deal announcements are inherently lumpy, and you had a good bit of activity pulled forward into 2012. But I guess the broader question is just with all the good drivers we've been talking about for quite some time, what do you think is holding up the industry from more deal, new deal formation?

Well, it's just -- look, a couple of things. First, to get back to the 3 things that we look at: financing, valuation and sentiment, and let's of sort separate markets. U.S. are generally everywhere. Financing is -- rates are as low as they've been in our lifetimes, availability high. It's a good sign. On the valuations, they've creeped up, but still relative to organic growth, not bad. And on sentiment, again, this is more geographic. I think in the U.S., it's improved. In Europe, because of the macroeconomic environment, it's still pretty uncertain. And in the developing world, market-by-market will be different but generally speaking, sentiment is improving. That said, we're in a world that's just different from what it's been precrisis. And there's sort of an uneven -- and there's clearly a little bit of a detachment of the M&A markets from the equity markets. But that said, I think our view is, as I've said, in the U.S., as the U.S. economy continues to improve, in all likelihood, the M&A markets should start to follow more closely sort of more traditional patterns. And the European markets are likely to lag for a while because of the challenge macro economically. And I think the flows from the emerging markets, they look okay at the moment. Howard Chen - Crédit Suisse AG, Research Division: Great. And shifting gears, I was hoping we could just drill into the Asset Management flow picture a bit. With all the moving parts, can you help us delineate where you fall out on the desire by your clients to own more equities today versus 1 year ago? The incubation of some of the new products that you mentioned and maybe some of the unique dynamics around the Global Thematics product in particular?

Sure, okay. So let's start with our client base. Our client base is primarily institutional. Obviously, we have some impact -- some retail exposure because of the financial institution platforms. But institutional markets tends to be slower in, slower out. And so it will lag the participation of the retail investor as markets go up, and it is probably more stable as markets go down. And I think that's kind of what we're seeing. It's improving. Our fee activity has started off strong. It was a little weaker for a couple of weeks and seems to be picking up again, which is real good for us. In terms of our product mix, I don't think -- I think we're about as well positioned as we could be, given the demands of our client base. Global emerging markets, emerging market debt, these are all areas where there seems to be high interest on the part of our core client base. In terms of Thematics, I'd say that -- we pointed out in the fourth quarter that there had been an illness of one of the senior members of our team. We have a deep team under that. We expected some outflows. We're probably doing a little bit better on that than we would have guessed for the first quarter. But this is something that will continue over the next several months or so. We're moderating, working as hard as we can. Howard Chen - Crédit Suisse AG, Research Division: Okay, great. And then finally, Alex, I think, I heard you note some incremental identified expense savings. I was wondering if you could dig in a little bit deeper as to what the nature of those are. And is the plan to ultimately take up the $125 million program and the 25% operating margin goal or are you reinvesting that or is it just too early to kind of give an ultimate plan?

Sure. As we progress to the process of implementing the cost initiatives, we identified a potential additional $10 million to $20 million of savings versus the announced $125 million objective. They're primarily in the same areas we've talked before, streamlining our corporate the structure and consolidating support functions, reducing investments in staff and areas of low return and renegotiating or exiting certain third-party contracts, so consistent with what we've done in the past. With respect to margins, we're still very focused on the 21%, 22% for '13 and the 25% for '14. This provides us a little bit more flexibility in the event of a tougher environment and also provides an opportunity for us to invest further in the business

We'll move next to Alex Blostein with Goldman Sachs.

Just picking up on the last question. I was hoping you guys could help us understand a little bit your near-term margin targets. And the way I'm trying to, I guess, address the question is, given the fact that markets are up as much as they are and probably a little bit more than you guys had anticipated in your kind of baseline scenario, especially hearing you on the 2012 kind of run rate revenue numbers, is the 21% to 22% -- does that stay stale because you have a little bit of a softer outlook for the other -- the Advisory piece of the business? Because it feels like just from the market, the Asset Management should do a little bit better and it is a higher margin business for you guys. So Ken, how to manage then, I guess, the moving pieces there?

Okay, so let me start with this and maybe Alex could fill in on it. Look, we're focused on the 25% margin target as we did for 2014. And the 21%, 22% for '13. It's too early in the year for us to change our outlook on revenues. So this is -- we're working hard towards these targets.

Okay. And then, I guess, on the Asset Management. Can you guys help us understand a little more -- more granularity on net versus gross flows? And you mentioned there could be potentially more redemptions from some of the issues you had earlier. Do you know, I guess, the size of total redemptions that we should still anticipate and how should we balance that against the -- against somewhat of an improving RFP activity that you guys mentioned?

Sure. I mean, we had, as you'll see the queue, we had a strong quarter on gross flows, very strong quarter on gross flows, which was offset by the incremental outflows associated with the Thematics business and one other -- one of the local businesses, which, I think, we've talked about in the fourth quarter. And I think that kind of activity probably continues. The fact is, as I said earlier, the flows out of Thematics, we're probably a little bit -- they were probably a little bit less than we expected for the first quarter, but it's going to be something that we're going to be dealing with for the rest of the year. The team we have is quite good in there. Really, it's a deep team, and I think we're going to manage this pretty well.

Our next question comes from Brennan Hawken with UBS.

So just a quick clarifying question on the incremental saves that you guys identified. It think you said 10 to 20 on top of the 125. And you said a 1 for 1, and you already have $129 million of charges. Does that mean that we should think about 10 to 20 in onetime charges around restructuring next quarter?

Roughly. We always said that we expect implementation cost to be consistent with what we've already realized, and that's been about the 1:1 ratio. So approximately, that's correct.

Cool. Okay. Just wanted to make sure on that. And then following up, I guess, on the outflows in Thematic. Is the fact that it's come in a bit lighter than you guys anticipated, is -- does that adjust your view of overall outflow based on discussions that you guys have had with consultants and clients? Or is it just a delay of the flow and maybe it's going to disperse this sort of nagging outflow might just be persistent for a little bit longer?

I'd say both. Okay, so it's been a little bit better, perhaps, because lion share of consultants are still neutral to positive on the product. That said, this is just something which we're working hard. And it's a great team, and they're spending all the time with clients and educating them and -- but this isn't something that's going to go away tomorrow.

Sure. That helps. Is there a way to think about or quantify the expected investments that you guys plan to make? Should we think about it as maybe like, the investments might offset the additional gravy of the 10 to 20 that we hit on before? Can you help us think about how the puts and takes for that might work?

Okay. Because the additional savings give us a little bit more -- few more levers to reach our targets. And so in part what we're doing here is, number one, we're -- we are opportunistic about hirings. That is, if we seek someone great, it should really add value to the franchise on the advisory side that we see additional resources that help us drive the Asset Management business. We now have the ability to execute on that without necessarily impinging upon margins. Because as you know, we expense the stuff to reward it as we do it. So that's number one. But that said, it also gives us a little bit more flexibility if the environment's tougher or we have a tougher time to hit our targets. So we're going to really modulate between the 2. And this hiring environment, and particularly on the advisory side is, is not a onetime event. This year is better than last year, but it's probably going to continue for the next few years or so.

Great, that helps. And then the last one for me, is it possible -- I mean, it seemed like in 2012, given the pending tax changes, that our folks are worried about. We had a good deal of a pull-forward in mid markets. So my guess is that that's going to create a headwind for '13 because we probably pulled a bit into the last year. Is it possible to quantify what that -- what you guys think that might have been and how we should think about how that might affect the advisory line all things equal?

Okay, so we've never broken out the middle market business because it's how we share revenues credit. All the stuff internally is rather complex, because a lot of it is team tackling at the firm. But the way I kind of characterize it, and I pointed this out in the fourth quarter call, it was clearly an acceleration of deal activity in the fourth quarter for the middle market business. The sell-side business, people are very sensitive to the tax law changes taking place. And so it's not terribly surprising to see a weak first quarter for us here. And this is a time where pipeline's getting rebuilt. I don't think we're going to see the level of activity this year in the middle market business that we saw last year. But it should be -- it still should be okay, but it will be down from last year.

Okay. But it's not really something that you're comfortable kind of, I guess, quantifying for us?

Not at this point.

Next we take questions from Joel Jeffrey from KBW. Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division: Just want to follow-up on the cost savings again. I apologize if you, guys, touched on this earlier. I know you guys gave us the ratio of the expenses to cost savings, but in terms of the impact that had -- the cost savings had on the first quarter, was that consistent there? Was it about a $26 million cost saves that you got out of...

No. No, you can't look at that because the implementation cost happened ahead of realizing the savings. So no, what we're comfortable saying is that we're -- on the original $125 million, 2/3 of that should show up in '13 and the full impact in '14. Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, great.

A little color I'll give you on that though is the cost savings -- as you know, the -- whatever you put down for your compensation ratio for the first quarter is kind of a guess and guesstimate on what it's going to be for the year, both on and awarded basis, which we have accrued at 58.5 right now, on a GAAP at 60. And so I think I could say that the cost-saving initiatives have given us confidence that we're going to get to this kind of ratios and be within our target ranges for the year. And then second of all, clearly on our non-comp side, we're beginning to see some of the benefits. Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, great. And Ken, I appreciate the color you gave us in terms of the geographies that you could see some increased activities in. But are there any verticals that you guys are specifically focused on that you think might be the most opportunistic within the...

So far, this year, the consumer has done very well for us. I mean, the 3G deal, and then the coffee deal in Europe, that's a good example. And there seems to be, I wouldn't quite call it, big strategic deals in the area, but there's a lot of sponsor interest or smart financial investor interest around that sector. I think the healthcare services area probably picks up this year. I mean, this is a lot of the -- now that health care reform is pretty much accepted by all, it's a fait accompli, I think people are now going to start aggressively positioning themselves for more activity there. There seems to be some pickup in discussions in the TNT sector, particularly on the telecom and media side of stuff. Oil and gas seems a little softer than it has been. I think, again, the big banks and the systemically important institutions have a very difficult time doing deals now but you're seeing some smaller, medium-sized stuff start to happen. There's not a single trend here, but those are some important ones, I think. Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division: Great. And then just lastly, can you just remind us, how much remaining do you have on your repurchase authorization?

We have about $125 million, I think.

[Operator Instructions] We move next to Michael Wong with Morningstar.

Just curious about your marketing and business development expenses. Is the low level even relative to quarters over the last several years purely a seasonal effect, a result of less business to go after or is that an effect of your cost-savings plan?

It's a couple of things. I mean, first, last -- first quarter last year included a deal-related expense, which isn't here this quarter. And then, I think the rest is pretty much the cost-containment measures.

Okay. And would you say there's a different hiring dynamic now between your Americas and European business?

I think you're saying -- a little bit, but not a lot. In other words, we're just -- the only thing we're focused on is if we're going to hire someone, they have to be really accretive to the franchise. I'd say that we're a little, I think, we're in pretty good shape everywhere in terms of people. The area that I think we're going to prepare ourselves for is around the cross-border activity a bit, so.

Okay. And just given that global economy seems to be in a 2-steps-forward, and 1- or 2-steps back paradigm, what do you think of corporate executives that have sat on the sidelines for years, building up a cash forward and have access to financing finally designed to -- finally decide to return more capital to shareholders as you've done or just pull the trigger on the acquisitions to...

First, the man who can answer that question, and after the last 3 or 4 years deserves a big bonus here.

I'd say that, again, it's -- I think, we all probably underestimate how much shock there is to the system and how sensitive people are to smaller shops now in terms of sentiment. But that said, if you get a sustained improvement in U.S. economy, which looks like it's taking place, then you should probably start to get a more consistent level of deal activity in the United States. And then, you're going to need some significant healing in Europe before you see that, but the multinationals in Europe probably start to act over time like the multinationals do in the U.S. And the developing markets, again, it's country-specific, but there are certain countries where you got some pretty aggressive companies and forward-thinking companies. I mean, Brazil is a great example of that.

Ladies and gentlemen, that concludes today's conference. We thank everyone for joining us.

Thank you.