Feb 7, 2013
Executives
Judi Frost Mackey - Director of Global Communications Kenneth M. Jacobs - Chief Executive Officer and Director Matthieu Bucaille - Chief Financial Officer Alexander F.
Stern - Chief Operating Officer
Analysts
Joel Jeffrey – Keefe, Bruyette, & Woods, Inc. Brennan Hawken – UBS Howard Chen – Crédit Suisse Devin Ryan – Sandler O'Neill David Trone – JMP Securities
Operator
Good morning, and welcome to Lazard's Fourth Quarter and Full Year 2012 Earnings Conference Call. This call is being recorded.
(Operator Instructions). At this time, I'll turn the conference over to Judi Frost Mackey, Lazard's Director of Global Communications.
Please go ahead.
Judi Frost Mackey
Good morning, and thank you for joining our conference call to review Lazard's results for the full year and fourth quarter of 2012. Hosting the call today are Kenneth 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 by 10:00 a.m. today 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 also include certain non-GAAP financial measures. A description of these non-GAAP financial measures and their reconciliations 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 your questions. I will now turn the call over to our Chairman and Chief Executive Officer, Ken Jacobs.
Kenneth M. Jacobs
Thank you, Judy. Good morning.
Thank you for joining our call. We’re pleased to report strong results for the full year and fourth quarter 2012.
Some highlights. Annual operating revenue rose 5% over last year, approaching record levels.
Adjusted GAAP earnings per share increased 10%. M&A and other advisory revenue was up 13% for the year, even as global M&A completions were down 14%.
Lazard continues to gain significant share of the advisory fee pool. In the fourth quarter, M&A and other advisory revenue increased 40% and active management revenue increased 20% compared to the prior period.
For the year, Asset Management operating revenue matched the record level of 2011. Assets under Management at yearend 2012 reached a record high of $167 billion, up 18% over the prior year.
Behind the numbers is the story of Lazard’s continuing evolution. In the last several years, we have diversified our sources of revenue in both our businesses, financial advisory and asset management.
We’re adapting to clients changing needs in an integrated global marketplace. We made great strides in driving shareholder value.
The strategic decisions we’ve made and our execution of them are positioning Lazard for continued growth and profitability. Today, Lazard is the only independent advisory firm with a fully built out global infrastructure and global industry teams.
We have a network of relationships with key decision makers in business, government and investing institutions around the world. The power of our network allows us to deliver better solutions to our clients and it becomes more powerful as the world becomes more integrated.
For example, in financial advisory, more than half of our M&A volume was cross-border, including our largest and most complex transactions. Our participation in emerging markets M&A reached its highest level ever, almost 20% of announced deals.
In Asset Management, we are equally globally diversified, meeting the needs of a primarily institutional client base around the world. Nearly half of our Asset Management revenue comes from clients based outside of North America.
Our investment strategies in global, local and emerging markets in both equities and fixed income led AUM growth in 2012. Our investment platforms continue their strong pattern of performance.
Lazard’s global network is a competitive strength and a platform for revenue growth as services evolve to meet clients’ needs. A significant portion of our 2012 revenue came from income streams that either did not exist at Lazard 10 years ago or that we’ve grown substantially.
Lazard’s middle market which we acquired five years ago had its best year ever. Our Sovereign advisory business was active on some of the world’s most prominent assignments, which included work in Europe, Latin America, Africa and the U.S.
Our advisory work on capital structure, balance sheets and capital raising continues to grow, complementing our traditional M&A business. For example, capital structure advice was key to Lazard’s role as an advisor to Deutsche Telekom on the T-Mobile Metro PCS transaction as well as our recent representation of Microsoft on the Dell buyout.
In active management, our investment platforms continue to expand. On the equity side, we’ve experienced significant growth in our international global emerging markets and multi asset strategies.
On the fixed income side, emerging markets debt and global fixed income have shown healthy growth. We continue to invest in the expansion of all our global platforms in both equity and fixed income.
Even as Lazard grows, we have become more efficient and effective in the way we manage our business and more disciplined on costs. We have communicated our financial goals regarding margin targets in Capital Management and our plans to reach them.
Since the beginning of 2009, we’ve reduced our awarded compensation ratio by 12 percentage points as operating revenue has increased by 22%. Since the beginning of 2010, our quarterly dividend has increased 60% and we’ve returned more than $1 billion in capital to shareholders.
In last year’s fourth quarter we implemented cost saving initiatives that provide a further path to reaching our financial goals, both in compensation and non-compensation. We’re on track with these initiatives.
Matthieu will now provide some color on our financial results and capital management followed by Alex who will update you on our cost saving initiatives.
Matthieu Bucaille
Thank you Ken. 2012 was a solid year of performance for revenue growth, cost discipline and returning capital to shareholders.
Lazard’s operating revenue grew 5% over the year and 22% in the fourth quarter, despite a challenging macroeconomic environment and volatile global markets during most of the year.
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Assets under Management reached a record level of $167 billion at yearend and average AUM for the year was 2% higher than the prior year period. Management fees for the full year were level with 2011, reflecting the 2% increase in average AUM and change in the mix and foreign exchange fluctuations.
In the fourth quarter, management fees were up 10% from last year and up 3% sequentially from the third quarter of 2012. Incentive fees rebounded in 2012, up 66% for the year, primarily reflecting the performance at yearend of certain alternative strategies.
Turning to expenses. Our 2012 awarded compensation ratio was 59.4% compared to the prior year awarded ratio of 62% and our operating revenue increased 5% in 2011.
We held awarded compensation expense flat even as it reflected our investments in 2011, including the cost of our Brazilian acquisition. Our adjusted GAAP compensation ratio for 2012 was 61.8%, down slightly from 62% in 2011.
As we have said before, approximately 2 points of that 61.8% reflects the 2008 deferred compensation awards which had a four year investing period. Absent the 2008 awards, our adjusted GAAP compensation ratio in 2012 is in line with our awarded compensation ratio which demonstrates the high quality of our earnings.
Non-compensation expense grew 5% in 2012. This reflected higher occupancy costs in transaction related third party fees, partially offset by lower professional fees.
While we’ve seen the initial benefit of our cost saving initiatives, we expect more meaningful impact in 2013. Regarding capital management, 2012 was a strong year for returning capital to shareholders through dividends and share repurchases and we returned $540 million to shareholders.
This included the achievement of our goal to return $200 million in surplus cash one year ahead of schedule. In 2012, we also paid a special dividend and accelerated the payment of a yearend quarterly dividend.
Going forward, we intend to continue offsetting potential share dilution from equity related compensation and we plan to continue to deploy future excess cash towards dividends, additional share repurchases or debt repurchase. Alex will now provide an update on our cost initiatives.
Alexander F. Stern
Thank you, Matthieu. On our previous earnings call we announced initiatives to reduce our existing expense base by approximately $125 million, of which $85 million would come from compensation expenses associated with reduced staffing and approximately $40 million from non-compensation costs.
These initiatives are focused on realigning the firm’s investments to create greater operating leverage with increased flexibility to continue retaining and attracting the best people. We continue to believe these initiatives will improve margins while maintaining the firm’s long term growth potential.
As we announced last quarter, implementation of these initiatives is centered on support functions, financial advisory and non-core businesses. Our efforts remain focused on first reorganizing support functions to leverage efficiencies across business and geographies.
Second, devoting more resources to areas with long term potential as we reduce investments and staff in areas with low productivity. And third, renegotiating or exiting certain third party contracts.
We have made significant progress towards achieving our objectives. We have completed a majority of the cost saving initiatives, though as we previously discussed, a number of activities will continue through the first half of the year.
To date, as a result of these initiatives, approximately 200 employees globally are leaving the firm. In support functions, reductions are across the board, including finance, IT and other general services.
In financial advisory, reductions are concentrated in regions with low growth potential in the near to medium term and in areas of low productivity. We’ve also consolidated our U.S and Spain wealth management units into our asset management business, continuing to serve the high net worth clients through our Lazard Asset Management and Lazard Freres Gestion franchises.
With respect to non-compensative expense, we have achieved significant cost reductions with outside providers, primarily by reducing the number of vendors and renegotiating our existing contracts in data services, technology, real estate and other outsourced services. We continue to expect at least two thirds of savings will be realized in 2013, with the full impact realized in 2014.
We estimate implementation charges associated with these initiatives will total between $110 million and $130 million. In the fourth quarter, we took $103 million charge, approximately $75 million of which was in cash.
The remainder of the implementation expenses will be incurred in the first half of 2013. We believe our initiatives put us on track to achieving an operating margin of approximately 21% or 22% in 2013 on both and adjusted GAAP and awarded basis, creating a path to achieving our target of a 25% operating margin in 2014, all at 2012 activity levels.
Ken will now conclude our remarks.
Kenneth M. Jacobs
Thanks Alex. I’ll give you some perspective on our outlook and then we’ll open the call to questions.
We’re encouraged by the level of M&A activity in the fourth quarter of 2012. We’d indicate that TO confidence is improving.
This has been the missing element for an upturn in the M&A cycle as financing remains cheap and valuations are reasonable. As the global macroeconomic environment improves, we are cautiously optimistic about 2013.
We’re well positioned globally even in a slow recovery. For example in Europe last year our advisory revenue was flat while the market was down 32%.
Our U.S advisory revenue ex restructuring was up 17% while the market was up only 2%. For the rest of the world, our advisory revenue was close to its all-time peak in 2007.
In Asset Management, our yearend record AUM gives us a solid foundation entering 2013. We have traction across most of our investment platforms given our strong performance.
Almost 85% of our strategies are equity related. We are a market leader in the growth asset classes across equities and fixed income and our platform has significant capacity for organic growth.
In conclusion, we’re confident that with the breadth and depth of our platform, the strength of our network and our financial discipline, Lazard is better positioned than ever. Let’s open the call to questions.
Operator
(Operator instructions). We’ll take our first question from Joel Jeffery with KBW Brokerage.
Joel Jeffrey – Keefe, Bruyette, & Woods, Inc.
Good morning guys. I apologize.
I joined on the call just a little bit late, but in terms of your advisory revenues during the quarter, just thinking about the sustainability of that going forward, was there a lot of activity potentially tied to middle markets activity or maybe some stubbornness in there that were factored in that that may or may not be repeating?
Kenneth M. Jacobs
Look, I think generally speaking across the board we had outperformed on the advisory side of the business in 2012. Obviously the fourth quarter was a strong quarter and this is a difficult business to measure quarter by quarter.
That said, I think when you look at the components you mentioned, in particular on the middle market side, I think on that business there were clearly some tailwinds at the end of ’12 driven by some of the anticipated tax savings that helped that business. On the other hand, and that may not be there for 2013, on the other hand we’re seeing an improving M&A environment that could offset that a bit.
On the sovereign side, we continue to see a good flow of business.
Joel Jeffrey – Keefe, Bruyette, & Woods, Inc.
And then the corporate line was particularly strong this quarter. Can you just talk a little bit about what was going on there/
Kenneth M. Jacobs
Rising markets generally means rising valuations for some of the investments on our balance sheet and it really reflects that.
Joel Jeffrey – Keefe, Bruyette, & Woods, Inc.
And then just lastly for me. The comment about achieving the 21% to 22% operating margin during the year, is that based on any assumption for revenue growth or is that on a flat revenue assumption?
Kenneth M. Jacobs
I think what we’ve said consistently is that we’re shooting for the 21%, 22% in ’13 and 25% in ’14 and the assumption on the environment is the one we live in today not one we anticipate for the future. So we’re saying in the event we have an environment that looks like 2012, performance like 2012 on the revenue line, we’re confident we’ll get to the 21% and 25% in ’13 and ’14.
Operator
We’ll take our next question from Brennan Hawken with UBS.
Brennan Hawken – UBS
A couple of quick questions in asset management. Performance in this quarter was really, really solid.
The market performance looks really good. What were the regions or strategies that were stand outs there?
Kenneth M. Jacobs
Look, when I say on the asset management business, I think we’re really comfortable where we are in the business right now. We’ve got a lot of tailwinds in the business at the moment.
One, obviously we start the year with $167 billion of AUM compared to $141 billion last year. So that helps us.
Sentiment generally in the equity markets is improving compared certainly to 2011 and it’s probably better than any time that it’s been since the crash and you can see that in the first month of January retail flows which will see some benefit up, but as you know we’re an institutional business. The vast majority of our investment strategies are delivering superior returns in both the short and long term basis.
We’re seeing strong RFP activity at the end of last year into this year, beginning of this year. We’re seeing really strong flows into our global international emerging markets businesses.
The new platforms we’ve established are on the emerging markets business and emerging markets debt business and we had some good performance and flows into the fixed income businesses as well. In terms of headwinds, we’ve got a couple, one around the midcap business where we’ve seen some outflows which are probably performance related and in the amount business one of the senior members of our team is retiring because of an illness and so we’re going to monitor that pretty closely.
But that’s been the core strategy for a while. So overall we’re feeling pretty good about the environments in asset right now.
Brennan Hawken – UBS
I did notice thought that core IA fees ticked down a bit in 4Q. Was that driven by a one-time type of a thing or is that just the new mix so we should count on that run rate?
What’s the deal there?
Kenneth M. Jacobs
Performance fees – the average fee in any given quarter is subject to a bunch of different factors. One is a mix in the business where we’re getting inflows.
There’s a little bit of foreign exchange built into this. So I wouldn’t read in too much into one quarter in terms of the average fee.
Brennan Hawken – UBS
And then last one for me, on the advisory side, aside from the AMEX deal, is it possible to quantify how much of the pipeline might be facing any kind of anti-trust concern or anything like that? Is that something you guys can quantify for us?
Kenneth M. Jacobs
I wouldn’t know where to begin on something like that. I think when I say about the – look, we don’t give you backlog or pipeline numbers.
It’s a little tough sometimes on some of the deals which are not traditionally M&A deals or such that pick up and lead tables. But what I’d say is the following.
We have seen a strong fourth quarter. This can be sometimes a little bit of a lumpy business quarter to quarter, but I think the trends over time are pretty consistent and I think going into 2013 we tend to look at three factors around the advisory environment which you all are pretty familiar with from pervious calls.
Valuation, financing sentiment and generally speaking, valuations are still pretty reasonable. They’re up a little bit from last year.
Financing is probably as good as it’s been in our professional careers, certainly in the United States and probably even Europe for the larger companies. There’s still some difficulty around financing the small mid-sized companies.
And with regard to sentiment, that’s improved – that’s clearly better than it was at this time last year, probably any time in the last few years. Part of that is attributable to the anticipated global recovery which seems –while fragile, seems to be taking hold, particularly in the United States.
The second is around the some of the tell risk diminishing in Europe and then all that and then the third is probably around some of the resolution around election and getting through the first stage of the fiscal cliff crisis and I think all of that improves sentiment and that probably means more reasonable market for M&A over the next year or two.
Operator
We’ll take our next question from Howard Chen with Crédit Suisse.
Howard Chen – Crédit Suisse
With respect to the compensation and the accrual, Matthieu you reiterated 200 basis points related to the 2000 rewards falling out. So as we think about a starting point for comp accrual this year in your revenue outlook, is something closer to a 60% a good starting point?
Or should we think about maybe something different as you fold in the benefits and payoff from the overall program that we’re focused on?
Matthieu Bucaille
I think probably the end of year GAAP number less the 2012 accruals is a good reflection of the beginning of this year before you build in what we’re going to do in terms of the restructuring plan for – because of that kicks in – two thirds of it kicks in in ’13 and the rest in ’14.
Howard Chen – Crédit Suisse
And then Ken, the comment you made regarding a significant portion of your revenues and growth were in business that were either incubating or the firm wasn’t involved in a decade ago. I was hoping, could you help us frame in any way maybe the relative growth or contribution of some of these businesses such as middle market, EM and Sovereign as we see it all lump together in the financial advisory revenue line?
Thanks.
Kenneth M. Jacobs
Look, I think we’ve been reluctant to break a lot of this stuff out for competitive reasons obviously. So I’m not going to start to do it on this call.
What I’d say is the following. If you go back 10, 12 years ago Lazard was primarily a large cap MTO.
It was basically core-emanated and over the last decade or so we’ve really diversified the revenue stream. Obviously the first step was the restructuring business which is now the global leader.
The second investment was around the private fund advisory effort which is capital raising for private equity funds and now increasingly also involved in a lot of the secondary sales from units. A third was the investment in the middle market business and some of the geographic expansion into Australia and some of the other emerging markets.
And then lastly we’ve taken some businesses which have always had a presence at Lazard. The Sovereign Advisory business and the Capital Structure business we have really leadership and excellent people has really grown pretty dramatically over the last few years or so.
And we just hope to continue that.
Howard Chen – Crédit Suisse
And then finally for me, I just wanted to revisit. As noted before, the overall performance has been great.
I realize that one quarter’s flows are lumpy, but is the slowdown that we saw in the back half more a function of some of the factors you noted regarding the midcap and thematic products and the management team there or is there something else timing related really driving a bit more of a subdued flows picture.
Kenneth M. Jacobs
I think generally speaking we’re pretty comfortable with where we are positioned. RFPs are up, market sentiment is better, we have great performance across a lot of asset classes and importantly, we have a lot of capacity right now.
And quarter to quarter is tough to tell ,but the one thing I noted about the quarter is AUM jumped pretty dramatically and for the year we had net inflows of against some of the issues that you noted and look, in 2012 between the institutional side industry wide flows were very, very slow. I think our gross flows last year were close to almost $27 billion which was probably one of our best years, if not our best year in that regard.
Operator
We’ll hear next from Devin Ryan with Sandler O'Neill.
Devin Ryan – Sandler O'Neill
Good morning. Just wanted to come back to the Sovereign Advisory business one more time.
Obviously a solid quarter and appreciate the comments, but for us it’s obviously very hard from the outside to track that business problem more than some others. So just want to get some color this quarter and just the improvement in that business.
Is it more situational for you guys? And then do you feel like that business is trending one way or another?
Just want to get some color since again its’ a little bit hard for us to really follow that from the outside?
Kenneth M. Jacobs
That’s understandable and I get that. Look, all of our businesses are lumpy from quarter to quarter, but if you look at the trend, you can get a good feel for it and obviously the trend on the Sovereign Advisory business has been pretty strong for the last few years or so.
It’s a business which historically Lazard had a presence in and it’s been historically associated with some of the more difficult emerging market stories and I think one of the things we’ve managed to do over the last several years is to not only expand the breadth of the business. We have done business on almost every continent in the world and continue to.
It’s clearly the market leader in the business and obviously we’ve spent dollars in some of the – most of the things going on in Europe over the last couple of years or so. We see a lot of opportunity in that business going forward and in addition to that, we’ve also invested some stability that’s important to success in this business with some deeper understanding of some of the more esoteric financial products and I think we’re unique in that capacity from an advisory side and that really is helpful to the business.
Devin Ryan – Sandler O'Neill
Just moving onto the asset management business. I understand that the incentives for you are generally more elevated in the fourth quarter driven by primarily the alternatives business.
Is it possible to put in some perspective or just give us any sense of the performance in the alternatives business in 2012? I’m just trying to get some perspective around the performance fees at the end of the year here and then relative to maybe how well that business did this year.
Kenneth M. Jacobs
It was across the board. The performance fees don’t only relate to the alternative business for us.
We had some built into some of the – many of the loan-only funds as well. So it’s not as black and white as you present it and it’s unlike I think a lot of the other people that you perhaps follow.
That’s number one. And number two, I just think it reflects the strong performance over a wide class of assets where we happen to have performance fees.
Devin Ryan – Sandler O'Neill
I understand there’s other incentive fees within there, but just the delta, the upside delta I thought was generally more driven by the alternatives. But that’s fair enough if that’s not the case this quarter.
Kenneth M. Jacobs
Yeah and look, this was not a bad year for performance fees. It was a good year.
It wasn’t a great year and I think again as I say, obviously the alternatives matter, but we also have some performance fees built into some of our loan-only classes as well – funds as well.
Devin Ryan – Sandler O'Neill
And then just lastly for me, you’re clearly some headcount reductions with the cost initiatives, but just want to get your perspective on appetite for actually hiring and bringing in some talented senior bankers, what the environment looks like for you guys right now.
Kenneth M. Jacobs
Sure. Built into our numbers are efforts for margin targets in 2013 and 2014 and into our cost initiatives is based – we carved out room for investment consistent with historical levels.
So we’re going in places where we see talent and we see opportunity to invest and I think the environment is still positive for that right now because of what’s going on in some of our larger competitors. But we’ll be disciplined about it.
And I think it applies to both sides of the business equally. In other words if anything there’s really some opportunities in asset management right now that we think are exciting and we’re going to look at those pretty carefully as well as on the advisory side.
Operator
(Operator instructions). We’ll hear next from David Trone with JMP Securities
David Trone – JMP Securities
Good morning. My question was ready asked and answered, but I just want to double check.
Sorry to ask again on this comp ratio. So the adjusted GAAP and the awarded probably converge for good say second quarter?
Kenneth M. Jacobs
I laugh at the second quarter because in fact comp is only done at yearend. So everything else is an estimate for what’s going to happen during the year.
But I think the substance of my answer would be the following. I think if you take out once and for all the ’08 grants, we’ve got a balance now which should continue between the awarded and the GAAP.
Of course depending on what happens with revenue, the GAAP will always reflect more of past compensation than the awarded will, but the key thing is that we have kept our referral policy consistent now for three years. Our vesting by the way is three years, a third in year two, two thirds in year three which means that it fully reflects now what we’ve done over the last couple of years.
So I find that it should stay pretty balanced going forward and maybe some fluctuation by a point or so in ’13 or even in ’14 but it’s going to stay pretty close.
David Trone – JMP Securities
And then shifting abruptly here to 10,000 deal, I get questions all the time about you guys taking market share from the budge racket firms and the reasons behind that and I know we had post world com Enron, we had a shift of boards focusing towards un-conflicted advice and that’s been about 10 years now. Do you think as a driver of market share that has run its course?
Or do you think that’s still something that’s an important factor? Not in terms of maintaining market share, but in the context of expanding it.
Kenneth M. Jacobs
I think there are a whole bunch of things going on here and I can only speak from our experiences as opposed from others. The first is I think what we do in our platform is unique.
It’s global. It’s integrated.
It cuts across all the different industry groups and it has a very strong capability in M&A, but it’s complemented by a really deep understanding of balance sheets and markets and increasingly of many of the esoteric financial products that are out there. And that complete approach that is being able to have a strong local view which is critical to the advisory business.
That I think is the single most important success factor in the advisory business, starting with that strong local presence and being able to layer on top of that a global view and a deep industry knowledge and then being able to help think through very carefully the implications for balance sheets and stocks and capital raising is what separates us from both our large competitors and our small competitors because I really think we’re the only ones who can do this globally. That’s number one.
Number two is obviously there are some things that have gone on in the market, particularly in the United States that encourage the use of independent advisors. I think that’s been helpful, but it’s not the only thing that matters.
And then third, obviously three’s a transition in the business model going on in the larger firms, which has not settled out yet. So I think for now I think for the foreseeable future, I think we have a model which should do well in these markets.
Still be ups and downs and some market will get their act together and do a little bit better. But I think generally spiking the trend is pretty positive for us.
Operator
At this time there are no further questions. This will now conclude the Lazard conference call.