Good morning. Welcome to the Earnings Call for Raymond James Financial's Fiscal Second Quarter of 2019. My name is Tiffany, and I will be your conference facilitator today. This call is being recorded and will be available on the company's website. Now, I will turn it over to Paul Shoukry, Treasurer and Head of Investor Relations at Raymond James Financial. Please go ahead.

Thank you, Tiffany. Good morning. And thank you all for joining us on the call this morning. After I read the following disclosure, I'll turn the call over to Paul Reilly, our Chairman and Chief Executive Officer; and Jeff Julien, our Chief Financial Officer. Following their prepared remarks, they will ask the operator to open the line for questions. Certain statements made during this call may constitute forward-looking statements. Forward-looking statements include, but are not limited to, information concerning future strategic objectives, business prospects, financial results, anticipated results and litigation and regulatory developments and general economic conditions. In addition to words such as believes, expect, plans, will, could and would as well as any other statements that necessarily depends on future events, are intended to identify forward-looking statements. Please note there can be no assurance that actual results will not differ materially from those expressed in those statements. We urge you to consider the risks described in our most recent Form 10-K and subsequent Form 10-Q, which are available on our website. During today's call, we'll also use certain non-GAAP financial measures to provide information pertinent to our management's view of ongoing business performance. A reconciliation of these measures to the most comparable GAAP measures may be found in the schedule accompanying our press release. So, with that, I'll turn the call over to Paul Reilly, Chairman and CEO, of Raymond James Financial. Paul?

Thanks, Paul, and good morning, everyone, and welcome. Thanks for joining us. I'm going to start as usual with a brief summary of the second -- of the fiscal second quarter of 2019 and then turn it over to Jeff, who'll provide some more details on the financials and some line items. And then I'll discuss outlook before turning it over for questions. So, following a challenging market during the December quarter, I am pleased with the solid performance in a number of key areas during the fiscal second quarter. These include quarterly net revenues of $1.86 billion, an increase of 3% over the prior year's second quarter, a decline of 4% compared to the preceding quarter. As we discussed on the last call and at our recent conferences, Asset Management and related administrative fees were the primary drivers of sequential decline in net revenues as the vast majority of these fees are billed based on the beginning of the period fee-based asset levels, which were down with the market in December quarter. This quarter also had fewer billable days than the December quarter, which negatively impacts both Asset Management fees and net interest income. But despite the fewer billable days this quarter and the seasonal expenses related to year-end mailings and reset in FICA taxes, we generated quarterly net earnings per share of $1.81, lifted by record Investment Banking revenues and higher net interest income, primarily at Raymond James Bank, which experienced improvement in its net income margin during the quarter, driving record quarterly net revenues and pretax income in the segment. We ended the period, importantly, with records for client assets under administration of $796 billion. Total Private Client Group financial advisors of 7,862 and record net loans at RJ Bank of $20.1 billion. Annualized total return on…

Thanks, Paul. I'll run down some of the line items and add a little color. On the revenue side, although total revenues were reasonably close to the consensus model, there were really -- it's the net effect of two pretty significant variations. One is in the Asset Management-related fees. The actual decline in that revenue line versus the December quarter was pretty much in line with the drop in the related fee-based assets. If you remember, if you look at the December release, you can see those various asset categories decline between 8% and 10% in December, given the 14% drop in the S&P that quarter. At least -- so it's not a surprise that, that revenue line item would be down 9% sequentially, but apparently that you -- the Street underestimated that a little bit. So that drop was a little more severe than the consensus model would show. Looking forward to Q3, again, billings, which we have already done in April here, were up a percentage similar to what you would see in terms of the growth in fee-based assets in the March quarter for that particular line item. Granted, a small portion of that line is based on average assets or end-of-period assets, but again, the vast majority, 90% type range are beginning-of-quarter billed. So, you can expect that I think for the June quarter. Brokerage revenues, PCG commissions and equity institutional, both declined. They continue to struggle as we shift more toward a fee-based model here in the Private Client Group. That was offset this particular quarter by a nice uptick in the Fixed Income institutional business, in the principal transactions, both in commissions and what used to be called trading profits, which are now encompassed in the principal transactions line. Looking forward, the higher equity…

Great. Thanks, Jeff. So, let me touch on the segments quickly and then we'll open it up for questions. So in the Private Client Group segment, we entered the third quarter with assets in fee-based accounts up 12% on a sequential basis. And remember, these are billed substantially based on the beginning balances. So it's kind of the reverse of last quarter, when they were down. This quarter, they are up. Also, last quarter, we had 2 fewer days. This quarter, we have 1 more day than last quarter. So those will both be positive on the tailwind for us going in the quarter. Offsetting some of this benefit is the decline in cash balances, as Jeff just mentioned. So overall, we continue to experience very good financial adviser recruiting and retention, so we're really optimistic on this segment and we're excited. In the Capital Markets segment, while the timing of closings are always difficult in the M&A business, we -- the pipeline for M&A remains very strong. It would be hard to match last year -- the first 6 months' closings, but on the other hand, the activity levels for equity underwritings are increasing. Although it will still be difficult, I think, to match the first half, but we expect good results. Unfortunately, the Fixed Income side of the business, we had a really strong March and a reasonable April, but you could see it's slowing back down a little bit. So if rate volatility remains low, given a flat yield curve and low long-term rates, it will still be challenging for that division. The Asset Management segment entered third quarter with assets under management up 5% year-over-year and 9% sequentially. So again, this should help the billing. Increased utilization of fee-based accounts in the Private Client Group as…

[Operator Instructions] Your first question comes from the line of Steven Chubak from Wolfe Research.

So, I wanted to start off with a question on the operating margin outlook. You cited a number of sources of record revenue balances and just given the strong revenue tailwinds in the second half and the growth in higher margin NII, how should we think about the outlook for operating margin? Should we think that some expansion in '19 versus '18 is achievable, even with the absorption of some of the higher non-comps as part of your investment plans?

There's multiple layers to this, but revenue mix does impact the margin and the comp ratio. So it's great that our fee billings will start 12% higher, but we pay advisers on net revenue. And if interest rates, where we pay -- we don't pay anybody, it really almost flows 100% to the bottom line of net interest. It's obviously going to impact -- the revenue will be up, but it's going to impact, both the comp ratio will be higher and the margin will be lower, given the same mix of other activities. So the revenue mix has been driving some of that margin in this quarter. And if we think what happens, happens, our comp ratio should be up and the margin should be down slightly, but Jeff, I don't know if there's anything...?

Yes. I think that's right. I think, Steve, if we can keep the pretax margin in this 18% type range, that's a very acceptable long-term margin, in our opinion. The way we would like to see growth happen over time is to grow revenues, control expenses at about the same level. So we continue to see this 18% margin, but on an increasing revenue base going forward and then controlling the share count through the repurchases, which we've been doing. And that's sort of long term how we would see it, not so much through concentrating our business in such a way that we optimize the pretax margin. I mean remember, PCG is our core business. And if you look at the margin in the segment, it's actually the lowest margin of our businesses, but it feeds all the other businesses. So through attribution, it's an integral part of that 18% margin. But I wouldn't look for a lot of margin expansion personally. If that's -- that's not how we intend to grow earnings per share going forward. It's more growing revenues and holding the share count flat.

Got it. Being provided to where we are [indiscernible] I think expectations reflect margin contraction anyway, so it doesn't feel like the bar there is particularly high. But comments about keeping it stable at 18% is certainly quite encouraging. Just one question for me on the non-comps. Though it certainly -- I can appreciate the fact that you guys continue to invest in the business, it was nice to see also that the other expense line came in a bit better. Jeff, you indicated that the core number for that was somewhere sub $60 million this quarter. At the same time, also noted that $67 million may actually be indicative of a more normalized level. I'm just trying to unpack how we should be thinking about that line item going forward.

It's hard to pick a number on that one. There's a lot of -- I hate to overuse the word lumpy, but there's a lot of costs, particularly on the legal side, that can come in or go out of that any particular quarter. But again, it's somewhere in the -- if we can keep it somewhere in the $60 million to $65 million range for that line, now that we've taken professional fees out and established a separate line item, we can keep the other expense in that $60 million to $65 million range, I think that's indicative of some ongoing legal costs. And in this business, we're never going to be without some litigation from clients or other sources. But in terms of all the other items that fall into that particular category, that would be an acceptable long-term run rate at our current level of operations.

And just one final one for me on Private Client Asset Management fee yield. Clearly, well-positioned to benefit from higher AUM levels in Private Client as we approach the back half. But the calculated fee yield continues to contract, albeit at a fairly modest pace. I was hoping you could speak to what's driving that fee dynamic and how we should think about the trajectory for the fee yield going forward?

The only shift that you could really see is there's more of a movement to fee-based accounts. So we're not seeing big pressure at all on advisers, what advisers are charging clients. So those have held in pretty well. So I know there's been a lot of commentary about compression there, we don't see the compression on the fees advisers are charging. There's normal compression on any Asset Management fee or in our industry, but in terms of the adviser fees have held up very, very well. So I think it's more of a mix than any fee compression.

It's mix and average size of account, as over time in our client base, average account size has grown and larger accounts typically can come in at a slightly better fee.

Your next question comes from the line of Bill Katz from Citi.

This is Kendall Marthaler, actually, on for Bill Katz. So I know you guys talked a little bit about the client cash since April, but I was wondering if you could give more of an update on pace of that relative to the last few months and how we should think about the economic trade-off between the elevated retail engagement and the lower cash balances.

We've been spending a lot of time on this over the last 4 to 5 months with our sales force. It's gotten to where the rate that people earn on what we call sweep balances compared to what they can earn in what we'll call positional cash, such as an investment in the money market fund. The differential is large enough now that advisers and clients are actually bifurcating their cash into what we'll call operating cash and what we'll call investment cash. And so what we're seeing is, it used to be all just amorphously one into the sweep balance, so now what we're seeing is additional runoff, if you want to use that word, of cash balances into what we'll call positional type of investments. The pace of that, at some point in time, it will hit what we'll call stasis, where the investment cash is in its investment vehicle, and what's left in the sweep program will be the operational cash. I don't know at what point we hit that inflection point. We continue to recruit new advisers and our client assets continue to grow. So there's an incoming flow from that process. But at this point in time, at least through today, we continue to see a net runoff of some of that cash. And again, what percent of assets it ends up being is a little hard to predict now at this point in time. So we'll just have to wait and see.

Okay, great. And just a quick follow-up, kind of going back to the previous question. So as PCG client AUA shifts more towards the fee-based, how do you see that impacting just the overall margin for Ray Jay?

Historically, on average, fee-based revenues as a percentage of assets have been a little bit higher for us than commission-based revenues as a percent of the related assets. But there's a lot of assumptions and all that go into making a statement as broad as that. I don't think it will have a material negative impact, and if anything, it could have a slightly positive impact. The good news about it is it creates a very predictable stream of revenues and it makes us a little bit more model-able company, if that's a word, going forward. And I know that people in your seat appreciate that. And our advisers have been kind of encouraged over the years to use professional management and other sources of fee-based revenues to eliminate some of the old conflicts that arose with commission-based accounts, and that was obviously accelerated with DOL and some of these other potential regulatory changes, and maybe will again, depending what regulatory changes come out and other things that may be on the docket. But at this point in time, I think we still see a continuous shift, plus we recruit advisers that have a practice that is largely focused on fee-based, because it fits with our model better. So I think profitability-wise, it will be our best long-term economic history shows it's a slight positive.

Your next question comes from the line of Chris Harris with Wells Fargo.

On the 2 acquisitions you just closed, how should we be thinking about the financial impact of those deals? And if you happen to have a revenue number for us, that will be helpful.

Well, Silver Lane is an M&A firm, so trying to determine how those revenues fall is as difficult as trying to determine how our own M&A falls, but it certainly will help augment our M&A revenue stream going forward. It's not an overly material part, as Paul mentioned, neither one of these are transformational acquisitions. And on the ClariVest side, they've been consolidated into our numbers all along. And then the portion we didn't own came out through minority interest. So given the size of minority interest over the last several years, since 2012, when we purchased our initial 45% stake, I mean you could see that what will no longer be coming out. Again, that -- and that won't be a huge transformational number.

Got it, okay. That's helpful. I guess a follow-up question I had was on PCG recruiting. You know, you guys continue to have great success there. Just wondering if there's been any kind of change with respect to where you guys are seeing interest among advisers. And then maybe if you can elaborate a little bit more on how the pipeline looks, whether it's better or worse or about the same as to how things were maybe 12 or 24 months ago.

So I'd say the interest still remains high. Pipeline is strong. We started off with a slower quarter at the first quarter. Part of that was due just to also a reported net number, we had a lot of retirements. We have some retirements this quarter, but we're lower than last year, our pace of recruiting so far on average, but the pipeline is very good, very strong. And I would say similar to 12 months ago, maybe a little bit less, but not a lot. So given that we're behind on the first 6 months, I would expect us to be under last year's all-time record, but still a very strong recruiting pace.

Your next question comes from the line of Jim Mitchell from Buckingham Research.

Maybe just talking a little bit about recruiting expenses, how do we think, if we're looking at FA headcount growth and recruiting off a record year, I think you had 3 record years in a row, this year is a little bit starting to, I guess, the second derivative is starting to slow. Do we -- would we expect recruiting expenses to also slow in terms of the growth? Or is it not really that impactful because the bigger numbers, amortization, that takes time? Just help me think through the recruiting expense dynamic from this year and next if we're kind of at these levels.

Yes, so first of all, last year's record was a record above 2009. So we didn't have 3 years in a row. 2009 was our all-time record and then we beat it for last year. So although recruiting is still very strong, it's just not as good as last year's all-time record, so -- and certainly, if recruiting is slower, the expense is lower, both ACAT fees when we transfer client assets in, and outside recruiting fees, if we have to pay them. So those costs, those transfer costs, certainly hit the P&L when people move over. So our goal is not to have it slow down. But if it's slower, the expenses will be lower.

And the amortization of all the transition assistance related to that does have an impact on the comp ratio.

Great. Well, I'm just trying to get a sense, does this help the margin if these expenses flatten out and the revenues continue to come on? It seems like it will naturally help the margin.

It helps the margin over time. It doesn't in the year or maybe the 2 years following the year you recruit the person. But once they have their business substantially over and have started using our other platforms, the bank, the Asset Management platforms, et cetera, and it radiates throughout the rest of the firm, they become incrementally profitable within a couple of years.

Okay, thanks for that. And then maybe just a question on just on the progress on the West Coast. I know that's been an area of focus. It seems like you've had very good success on the East Coast, just any help in thinking about the progress in the West Coast would be great.

Yes, the progress is we continue to recruit. The pace is higher, but we've got a long way to go, because we're just starting, really, in that market being aggressively recruiting. So we're having more and more success, but we've got a lot of territory and opportunity there. So we continue to be very focused on it. We've increased our support out West. And so we still view it as a big opportunity for us.

Do you think it needs sort of kind of like an Alex. Brown type deal to help jump start it, or do you feel you can still penetrate pretty well without that?

We have a number of independent -- we have many independent employee offices out there now. Almost all of our affiliation options are represented in the West. So if there was something out there that made sense, we -- I don't know what it would be.

If you know of one, please call us, Jim.

But we're long term, and I think our pace is picking up, the number of advisers on a percentage basis, the growth is good, but again, it's a small base, so we're continuing to work at it.

Your next question comes from the line of Alex Blostein from Goldman Sachs.

Jeff, back to your point around the margin, I guess when you talk about 18% being an acceptable margin I guess over time and well, clearly interest rate dynamics and markets will fluctuate and I get the fact that it's obviously going to impact margin in the quarter, but bigger picture, why is there a structural reason that your model can't have margin expansion over time?

Only because our mix of businesses, and this is back to me talking again. I don't think interest spreads are necessarily sustainable at these levels, particularly if the Fed is done with the rate hikes and there will be -- I think there will be continued pressure on client deposit rates for us to maintain any kind of acceptable level of client cash balances. So I think that will -- if we see some spread contraction there, even though we're growing the overall revenue base with the PCG business, and 18% is not just acceptable, that's excellent. I'd love to stay at 18% for the rest of our careers. But given our mix of businesses and that dynamic with interest rates that I foresee going forward at some point in time, I may be right. I haven't been yet for the last 3 or 4 years, but at some point, it may happen. That's why I'd be surprised if there's much room for margin expansion in the near term.

That's a challenge, when you have, whatever the number is, 65%, 2/3 of your revenues in compensation expense and you add 18% margin, and you've got less than 15% to operate the whole rest of your business, expenses, real estate, people, support. So you can always eke out a little, but there's not a lot of room in there. In our Private Client Group business, our second-biggest corporate expense is real estate. So you add that and put the people in and the people costs, those are hard to beat -- those are hard to move in the short term. You can move them in the short term, but there's a lot of consequences, on service levels and everything else if you do that. You can change payouts, but then there's consequences also. And we pay competitively, not at the highest, but we think we pay fairly and we're able to keep people because of the support, so it makes it tough to move that number a lot.

That's helpful. And then second question around just the current dynamic. So obviously, you guys talked about cash balances coming down in April. Any sense of where these stand today and then more specifically, looks like the bulk of the client cash outflows took place from third-party banks over the course of the quarter. Is that the dynamic you guys expect to continue, where kind of Ray Jay Bank balances remain fairly stable?

Again, it's continued through today. But at some point in time, we think it will level off. We don't know where that is and we're looking at doing some things that will help stem the tide on it that don't involve just purely raising rates to try to keep deposits here. So I don't know where that's going to bottom. It's continued to flow out a little bit every day. Not every day, but a little bit on average every day since the end of the quarter. But again, at some point, we'll reach that level at which people are going to move this investment cash to another location have done so and the money that's there is money awaiting investment.

I think your comment about it, what you see flow out of third-party, we feed the bank first. So you're going to see the delta really in that cash.

Yes, it's going to be in account and service fees. That will be the line impacted, as Raymond James Bank is, we accommodate its growth. It's the first one in the waterfall stack.

Right, so cash is kind of fungible. Got it. All right, one more, guys, for you, just on Fixed Income trading. Obviously, a quarter of improvement for the first time in a while. I understand that the backdrop sounds like got a little bit softer, but to what degree is the recovery in the muni market is helping you guys and if there's any sort of sustainability in that business? How should we think about that impacting your overall Fixed Income franchise within Cap Markets?

Yes, again, I think it's really more rate expectation. We do have a big part of that business is muni-oriented. But I think, again, the volatility is going to drive that more than anything else and to get a continued movement, or rate expectations. So you see in March 2 things. That volatility went up, but also, people's mind shift changed about investing long as the Fed announced they were considering slowing down and not giving rate. So there were a lot of people that went long that have been holding off going long, a lot of clients, and that certainly increased the appetite and certainly the volume for us. On the other hand, I mean not just on the revenue side, on the profit side, we have adjusted sales force and have taken cost actions there, where even at a downscaled business from a revenue standpoint, we are profitable. So I think a lot of firms are experiencing that we are, but not certainly the margins that we enjoyed a few years ago, but we do have it scaled for profitability and yet have kept the main heart of our group. So that if there is a market increase, we'll be able to take advantage of it.

Your next question comes from the line of Devin Ryan from JMP Securities.

I hopped on a minute late here, but I don't think you touched on this. Just on M&A opportunities, I know you guys have interest in doing deals that can augment organic growth. But the question is, is there really anything out there in wealth management today? Are there any targets, meaning specific companies that you're in touch with, that might be a good fit, but really, I guess the timing will need to be right for them and the price needs to be right for you. But I'm just curious, really, if there is anything out there. And then would you actually look at something in the independent adviser side or is there strong preference in employee adviser models?

So there are certainly a handful of companies we think are strategically and culturally good fits. They're just not for sale, so we stay in touch with them. And if the point comes that they're interested, both whether they're independent or employed or both, we are ready, willing and able. There are also a lot of things we're looking at outside the Private Client Group. There's probably more opportunities in M&A and Asset Management in terms of certainly a number companies than there are in the Private Client Group side, as that group has just gotten much smaller. It's much more consolidated. So it's not the numbers, same number of firms, certainly, that there has been historically. So I think of the 60 companies that took us public, I think 8 names are still alive, including Alex. Brown, which we kept alive. So there's just fewer opportunities. So we're in touch, we're in dialogue and we have a corporate development department that's active. And again, it just has to line up.

That's helpful. And just one on the ClariVest, the kind of the full acquisition. I know it's a relatively small transaction, but can you just remind us how moving the ownership to 100% from 45% is going to impact the P&L? And then just whether that's contemplated in the expense commentary you laid out?

It'll impact our pretax income by a couple million dollars a quarter. And that's the extent of that. So that's the amount that was flowing through NCI related to the part we didn't own. But that's -- and the revenues and the expenses were already in our numbers, because it's been consolidated because of our control. We're not a majority ownership, but our control on the board and other things over some of the operations, where we've been consolidating, but the revenue and expense numbers won't -- you won't see any change. You'll just see lower NCI.

And your final question comes from the line of Craig Siegenthaler with Credit Suisse.

On the Private Client Group fees that you really aren't seeing any fee pressure, can you share with us your internal estimate for the PCG advisory fee rate in the quarter and how this compares to historicals? Because we're back into a large decline sequentially and on a year-over-year basis, and the driver really is just mix shift. Can you help us better understand what you mean by mix shift there?

We didn't hear the first part of your question. You came in late, can you just...

I can repeat it, if that's okay.

Yes, please do.

All right. So earlier in the call, you responded to a question on Private Client Group fees. And I just wanted to understand what your fee rate is in the quarter for PCG advisory fees, and how that compares to historicals, just because we're back into a decline there. And then I think you said to a response to another question, that the driver really was mix shift. I just wanted to better understand what you guys meant by mix shift.

It's hard to say. You can pick one big average rate, and you can just take the revenue line off the PCG financial and divide it by the assets and that's probably what you're doing to see this decline. But it has to do with which types of programs they're in. We have a whole range of different types of fee-based programs, it depends. The mix really has to do more with are they heading more toward Fixed Income versus equity, which do have some impact on some of the programs, particularly in the managed programs. And then as I mentioned earlier, both the average account size makes a big difference as well, as we've seen the average account size of our accounts within the managed programs increase over time, which again, usually engender a smaller fee as you go up the scale. We're not seeing, and we're not seeing within any particular program or within any of our particular objectives or within our management programs -- our managed programs, we're not necessarily seeing a whole lot of fee pressure and decline. It's been a slow dribble for several years, but it's not been the pressure that it has been in years past.

And then just as my follow-up, I heard your response to Alex's question on third-party bank deposits. But can you help us on the account and service fee line? What is the outlook for this line in the next couple of quarters?

Yes. So, I said in the very beginning of my comments, in that line item, we're going to see, at least so far, we've seen continued decline in the assets that are in those third-party banks. I think our spread could hold up. It's just a matter of whether the balance decline stops, reverses or continues. If we froze everything today, it would be slightly lower probably next quarter than it was this past quarter, because even though we have the same spread, the asset balances are slightly lower. So it's, that's strictly a combination of balance and spread-driven number. And at this point in time, the spread's constant and the balances are slightly lower. So again, if we froze it today, then it'll probably be down slightly in that particular aspect of account and service fees. There are some other fees and things that fall in that line item, but that's the primary one.

Okay, well, I understand that's the last question, so we appreciate you all joining us this morning, and we'll talk to you again soon. Thank you.

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