Earnings Call Transcript - LAZ Q2 2023

Operator, Operator

Good morning and welcome to Lazard's Second Quarter 2023 Earnings Conference Call. This call is being recorded. All participants are currently in listen-only mode. After the remarks, we will have a question-and-answer session, and instructions will be provided then. I will now turn the call over to Alexandra Deignan, Lazard's Head of Investor Relations, Treasury and Corporate Sustainability. Please proceed.

Alexandra Deignan, Head of Investor Relations, Treasury and Corporate Sustainability

Good morning, and welcome to Lazard's earnings call for the second quarter and first half of 2023. I'm Alexandra Deignan, Head of Investor Relations, Treasury and Corporate Sustainability. In addition to today's audio comments, we have posted our earnings release and an investor presentation on our website. A replay of this call will also be available on our website later today. Before we begin, let me remind you that we may make forward-looking statements about our business and performance. 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, including, but not limited to, those factors discussed in the company's SEC filings, which you can access on our website. Lazard assumes no responsibility for the accuracy or completeness of these forward-looking statements and assumes no duty to update these forward-looking statements. Today's discussion also includes certain non-GAAP financial measures that we believe are meaningful when evaluating the company's performance. A reconciliation of these non-GAAP financial measures to the comparable GAAP measures is provided in our earnings release and investor presentation. Hosting our call today are Kenneth Jacobs, Lazard's Chairman and Chief Executive Officer; and Mary Ann Betsch, Lazard's Chief Financial Officer. Mary Ann will start the discussion with an overview of our financial results, then Ken will provide his perspective on the outlook for our business. After that, Ken and Mary Ann will be joined by Peter Orszag, Chief Executive Officer of Financial Advisory; and Evan Russo, Chief Executive Officer of Asset Management as they open the call to questions. I'll now turn the call over to Mary Ann.

Mary Ann Betsch, Chief Financial Officer

Thanks, Ale, and good morning, everyone. Today, we reported operating revenue of $620 million for the second quarter of 2023, an 8% decrease from the second quarter of 2022. Operating revenue for the first half was $1.1 billion compared to $1.4 billion in the first half of the prior year. In Financial Advisory, we reported second quarter revenue of $344 million compared to $407 million in the second quarter of 2022. On a sequential basis, Financial Advisory revenue increased by 26%. For the first half of the year, operating revenue was $618 million, 22% lower than the same period in the prior year relative to an overall market decline of approximately 50% in M&A completions globally. Despite these challenges, we remain actively engaged with clients in both Europe and the U.S., and private capital advisory, our primary and secondary capital raising group, delivered a strong first half. In Asset Management, second quarter operating revenue was $267 million, up 1% compared to the second quarter of 2022 and sequentially. Management fees were up 1% compared to both the second quarter of 2022 and the first quarter of 2023. For the first half of the year, management fees declined by 5% compared to the prior year period. For the second quarter, incentive fees were $6 million compared to $7 million for the second quarter of the prior year. For the first half of 2023, Asset Management operating revenue was $532 million compared to $577 million in the first half of 2022, reflecting lower management fees and incentive fees. As of June 30, we reported AUM of $239 billion, an increase of 11% year-to-date, and 3% higher from March 31 of this year. The sequential increase was driven by market appreciation of $8.8 billion, offset by foreign currency depreciation of $600 million and net outflows of $1 billion. Average AUM for the second quarter was $235 billion, increasing by 2% from a year ago and 4% on a sequential basis. Now turning to expenses. For the second quarter, adjusted compensation expense was $424 million. This equates to a 68.4% adjusted ratio during the second quarter, which reflects our current best estimate for the remainder of the year. Our non-compensation expense was $144 million in the second quarter, 10% higher than the prior year, primarily reflecting increased occupancy costs, higher travel and professional services expenses. As we reported last quarter, we've conducted cost-saving initiatives which we believe will result in a reduction of approximately 10% in our run rate cost base by 2024. Taking these actions resulted in an expense of $147 million in the second quarter and $167 million year-to-date, which are excluded from adjusted results. Our effective tax rate for the second quarter as adjusted was 31.2%, which compares to 26.4% in the prior year. We currently expect this year's annual effective tax rate to be in the mid-20% range. Turning to capital allocation. In the second quarter of 2023, we returned $47 million to shareholders, including $43 million in dividends. During the first half of 2023, we returned $234 million to shareholders, including $86 million in dividends, $99 million in share repurchases, and $49 million in satisfaction of employee tax obligations. Additionally, yesterday we declared a quarterly dividend of $0.50 per share. Ken will now share his perspective on our performance and outlook.

Kenneth Jacobs, Chairman and Chief Executive Officer

Thank you, Mary Ann. The global macroeconomic outlook is improving. As inflation continues to fall, expectations are mounting that we are close to the end of the current tightening cycle. In addition, there is growing anticipation that central banks will successfully see a soft landing. This sense of macroeconomic optimism has yet to filter through to M&A completions, which have remained low since transaction volume began to slow in the first quarter of 2022. However, we believe the M&A market is stabilizing, and that conditions may be in place for the beginning of a rebound. But it's important to be realistic about the likely pace of such a recovery. Most M&A cycles see deal activity recover in fits and starts. Just as M&A completions reflect market conditions when deals were announced six to nine months ago, we expect that newly announced transactions will complete at a similar pace. In the meantime, we are seeing increasing Board and investor confidence. The gap between buyer and seller expectations is narrowing. And signs are emerging that financing, while more expensive, is becoming more accessible. We're also seeing a pickup in cross-border activity, particularly among European clients looking to engage in transactions in the U.S., while the Middle East continues to be a growing hub for capital and deal activity. Although restructuring had a slow start to the year, activity is picking up and should increase ahead of significant amounts of debt maturing in a more challenging credit environment and facing higher financing costs. In light of this evolving landscape, this week, we announced the launch of Lazard's new Capital Solutions Group, a global team focused on advising, coordinating and executing the firm's capital raising and debt advisory solutions for clients, which will complement our world-class restructuring business. Given these market factors, we believe the years ahead could deliver circumstances in which a surge in both M&A and trading activity coincide at the same point in the economic cycle. The environment for Asset Management is improving. AUM is up 11% year-to-date and significant FX headwinds are abating as the U.S. dollar has weakened throughout 2023. We are seeing momentum across the business, including growth in Europe and significant flows in global equities and emerging markets led by our quantitative equities platform and several global equity strategies. As we outlined last quarter, we believe the current market conditions create an environment that is more favorable for our fundamentally-driven investment approach, with many of our strategies outperforming on a one and three-year basis. While there remains a level of uncertainty in the markets, our Asset Management business continues to see an active new business pipeline. We are also continuing to expand our relationships with financial institutions across the globe, with increasing traction in Asia and continued success in the U.S. Turning to the upcoming leadership changes. In May, we announced that Peter Orszag, currently CEO of Financial Advisory, will become CEO of Lazard on October 1. On the same day, I will transition to the new role of Executive Chairman, in which I will principally advise clients. Having worked closely with Peter for the past seven years at Lazard, I can attest to his leadership qualities and his clear and exciting vision for the firm and its future. In recent years, we have placed new leaders in virtually every business, country, and industry group across the firm, all of whom will play an important role in supporting Peter as he leads Lazard into the next chapter in its storied 175-year history. Now let's open the call to questions.

Operator, Operator

Thank you. We'll take our first question from Ryan Kenny with Morgan Stanley.

Ryan Kenny, Analyst

Hi. Good morning. Thanks for taking my question.

Kenneth Jacobs, Chairman and Chief Executive Officer

Hi, Ryan.

Ryan Kenny, Analyst

Wondering if you could just give us some more color on the comp ratio? The adjusted comp ratio came down substantially quarter-over-quarter. How are you thinking through the trajectory of that for the back half of this year and into next year? And what activity level outlook is embedded into your comp preserving? Thanks.

Mary Ann Betsch, Chief Financial Officer

Sure, I'll take that one, Ryan. So as I said, the 68.4 that we accrued this quarter is our estimate for the remaining quarters of the year. And that takes into account our estimation of the headcount reductions that we've done year-to-date, the attrition that we expect for the remainder of the year, and the hiring plans that we have through the rest of the year. So that's sort of our best estimate fully loaded with everything that we're planning. What you see driving year-over-year, the sort of elevated comp ratio is that we do have a fixed component, as you know, from the deferrals that we had last year, and so that's driving the adjusted GAAP ratio. But you will see the headcount reduction savings coming through and the awarded ratio, which reflects what we pay our people in the current year.

Kenneth Jacobs, Chairman and Chief Executive Officer

Yes, just in terms of revenue outlook for the year. We expect that the second half of the year will be better than the first half. But it will be more weighted towards the fourth quarter is our expectation, which obviously has some risk associated with that. And that's on Financial Advisory, I'm sorry.

Ryan Kenny, Analyst

And on the comments around conditions being set for a rebound, is there any more color you can give us on how much the pipeline has increased and how foundational versus fragile it feels?

Kenneth Jacobs, Chairman and Chief Executive Officer

I would describe the situation as fragile and still in the early stages. It seems to have reached a low point, with a 50% to 60% decline in completions for the industry over the past couple of years. We believe that we are approaching the bottom now. There appears to be more dialogue and activity, but this needs to lead to announcements, which must then be followed by actual completions. It’s still early, but there are signs of improvement.

Ryan Kenny, Analyst

Great. Thank you.

Operator, Operator

Thank you. Our next question will come from Steven Chubak with Wolfe Research.

Brendan O’Brien, Analyst

Good morning. This is Brendan O’Brien filling in for Steven. To start, just want to discuss Europe a bit. Commentary on the outlook was encouraging, but it feels like central banks in Europe are running behind the Fed a bit in terms of where they are in the rate hike cycle. And we've seen how the uncertainty on the path of rates has impacted activity in the U.S. so far. Given you guys are close to the mark, it would be great to get your perspective on the dynamics at play in the region and how activity, conversations compare to the U.S.?

Kenneth Jacobs, Chairman and Chief Executive Officer

I think our experience in Europe is a little bit divorced from the market. We've had a pretty reasonably strong year relative or a strong year relative to market conditions in Europe overall on the advisory side. I think you're right that the central banks are a little behind the U.S. And we expect that conditions are going to remain tougher for longer. But on the flipside of that, you've seen this obviously very strong rebound in equity markets in Europe, which actually matched the broad indexes in the U.S., which is the first time we've seen that in a long time. So I think it's a little behind but at the same time, there are a lot of factors like there are in the U.S. that give us confidence that it's beginning to stabilize.

Brendan O’Brien, Analyst

That's very clear. Thank you, again. And then just turning back to the comp ratio, I know it's early days here but I want to get some more color on how you're feeling about the progress on your cost-cutting initiatives. Based on the slide deck, it seems as if you've already taken down your headcount in advisory pretty meaningfully. So it feels like you're running a bit ahead of schedule. And also just given your commentary on the line between announcements and completions in M&A, I was hoping you could speak to your ability to get the comp ratio back to the targeted range in 2024, or if we should be thinking about it being more of a 2025 type story at this point.

Kenneth Jacobs, Chairman and Chief Executive Officer

The GAAP compensation coverage ratio reflects past compensation practices, pay, and current revenue environments. Therefore, 2024 will depend significantly on our discipline regarding costs, compensation, and personnel, which began in the first quarter and is largely complete, although the impact won't be fully visible in the headcount until the end of the year due to the pace of departures in various locations. For 2024 and 2025, the outlook is heavily influenced by revenue trends. I believe we are more confident in achieving our margin targets on an awarded basis, rather than GAAP, since we do not have control over the deferrals in a given year. Much hinges on the overall environment. The objective of this initiative at the beginning of the year was to position ourselves for what we anticipated would be a tougher environment for an extended period. We do not foresee a rebound in 2024 similar to what we experienced in 2021. Consequently, we aimed to prepare for these challenging conditions. Simultaneously, we have reallocated funds systematically to invest in markets with more promising talent compared to some areas where we have historically invested. This strategy is evident in our actions during the first quarter, and I believe we are currently on track to achieve these goals.

Brendan O’Brien, Analyst

Great. Thank you so much for taking my questions.

Operator, Operator

Thank you. Our next question will come from Devin Ryan with JMP Securities.

Devin Ryan, Analyst

Great. Good morning, everyone.

Kenneth Jacobs, Chairman and Chief Executive Officer

Hi, Devin.

Devin Ryan, Analyst

Hi. I want to focus on the topic of investments in recruiting. Some of your competitors are aggressively hiring and highlighting the favorable conditions for attracting talent. You seem to be less focused on short-term margins or the normalization of margins as others have been. There are philosophical differences, but as you mentioned, you are making adjustments in certain areas, while there may be opportunities in others. I'm trying to assess whether we are noticing some positive trends in the market and if the revenue outlook for 2024 looks more optimistic. Does that encourage you to be more proactive with investments in the areas where you aim to grow? I would like to understand how this impacts your recruitment strategy in comparison to your peers, or if it's simply a matter of how you're positioning yourselves relative to them.

Kenneth Jacobs, Chairman and Chief Executive Officer

I think I'll let Peter take this question as it's about the future.

Peter Orszag, CEO of Financial Advisory

Sure. So the short answer is we are actively in discussions about recruiting high productivity managing directors. There are a variety of sectors where we see plenty of opportunity for expansion. I wouldn't tie this directly to exactly when the M&A cycle turns because when you're making a decision about hiring a senior banker, that's a medium to long-term investment, not a year-to-year investment. And so that part of your question is I would just say that's not really how we think about it. But we're definitely very actively in the marketplace looking for the right fit. And we're going to be selective about the people that we bring onto the platform, looking for those areas of high productivity that we can add in a profitable way. And back to Ken's point, one of the motivations for the cost-saving initiatives that we announced earlier on was to make sure that we had the room to make these investments even in a tougher year overall for the market.

Devin Ryan, Analyst

Thank you for the clarification. I have a follow-up question for Evan regarding Asset Management. Looking back at the assets under management over the past decade, it has varied between $200 billion and $250 billion. I’m curious if, as this business has developed, you believe it has reached the scale necessary to optimize its business model. Although you are performing well, how do you view the potential for this business in relation to an optimal size? Is there a possibility of significantly increasing its scale? I understand there’s an ongoing pipeline of new products that will contribute, but they seem more like incremental improvements rather than major breakthroughs. How do you perceive the potential for this business to grow larger within Lazard? Thank you.

Kenneth Jacobs, Chairman and Chief Executive Officer

Evan?

Evan Russo, CEO of Asset Management

Hi, Devin. Historically, our perspective on the business has not centered on the total size of assets under management, but rather on ensuring we achieve scale within the platforms we operate. This means being relevant in the market and actively participating in various markets. Performance will fluctuate depending on market conditions and client preferences for investments at any given time. Our emphasis isn't on the overall numbers, but on how we scale across different platforms. We have explored various avenues for organic growth and have set the groundwork for new products being developed. As you know, it can take five years or more for new areas to gain traction. Many of our largest platforms today were built over the last decade, growing to $10 billion, $20 billion, or even $30 billion. We must remain focused on building out strategically and anticipate future trends and opportunities for our clients. We will continue investing in our existing platforms for organic growth, and as we've mentioned, we are also exploring inorganic opportunities in high-interest areas where we currently do not have a presence.

Devin Ryan, Analyst

All right. Thanks very much.

Operator, Operator

Thank you. Our next question will come from Jim Mitchell with Seaport Global.

Kenneth Jacobs, Chairman and Chief Executive Officer

Hi, Jim.

Jim Mitchell, Analyst

Good morning. Maybe just jumping back to sort of the pre-tax margin targets and the cost saves, I think you had talked about getting back to a normal type of revenue environment, say, 2018, 2019, that can get you back to sort of those historical margins potentially next year. Is that more of an awarded comment? Is that still possible if we can get to sort of '18, '19 revenue levels in '24? I just want to make sure I understood the comment.

Kenneth Jacobs, Chairman and Chief Executive Officer

I think that's a pretty good direction. As we get to a normalized revenue environment, we should get back to our margin targets on an awarded basis.

Jim Mitchell, Analyst

Okay. And maybe just following up on your announcement on the Capital Solutions Group, it seems like Lazard has been providing those services. So just want to make sure I understand the strategic importance of putting them all together under one roof. And I think you mentioned it's still separate from restructuring, but complementary. Wouldn't it make sense to put them all together even restructuring, just trying to get a sense of how you feel like that's going to help drive growth from here?

Kenneth Jacobs, Chairman and Chief Executive Officer

What this is really addressing is the significant rise in the private credit markets and accessing that source of capital. It's a very flexible, accretive source of capital that now competes, if not leads, traditional financing banks and public markets for our corporate and restructuring client base. Coordinating our discussions with these capital sources is a unique proposition at this moment. We are ensuring that we operate similarly to a capital markets desk, engaging with all these sources of capital daily, maintaining knowledge of their availability, and making that accessible to our corporate and restructuring clients.

Jim Mitchell, Analyst

Okay, that's clear. Thanks.

Operator, Operator

Thank you. Our next question comes from James Yaro with Goldman Sachs.

James Yaro, Analyst

Good morning, and thanks for taking my questions. Maybe just starting with you.

Kenneth Jacobs, Chairman and Chief Executive Officer

Hi, James.

James Yaro, Analyst

Good morning. Peter, maybe just to start with you, I know you've yet to take over CEO. But you've obviously talked a little bit about the future so far this morning. So maybe just any thoughts, any early thoughts on your plans and outlook for the future of the business?

Peter Orszag, CEO of Financial Advisory

Yes. Well, look, obviously we'll have a lot more to say in October. So I'm going to hold the bulk of it for that moment, which seems more appropriate. But at the broadest level, we start from a position with fantastic people and a really remarkable brand, a lot to build on. On both sides of the business, I see significant room for expansion, both in Advisory and in Asset Management. I think maybe with regard to anything more detailed, it would be better for us to wait for October.

James Yaro, Analyst

Fair enough. Okay. And then we've seen a number of mixed signs as it relates to antitrust. On the one hand, certain challenged deals in the U.S. appear likely to close but at the same time, we just received new proposed antitrust guidelines. How are you thinking about the risks of enhanced global antitrust scrutiny and the impact on large cap M&A? And I guess it'd be interesting to get your views on both the U.S. and globally as well.

Peter Orszag, CEO of Financial Advisory

It's Peter again. I believe there are notable differences between the U.S., the UK, and the EU. Starting with the U.S., there is an intriguing dynamic at play. While it's true that new proposed guidelines have emerged, there are also new agents and filing requirements that have been introduced. The significant development in recent months has been the court decisions, particularly the latest ruling. The key question is whether the courts will continue to rule against the FTC and DOJ. If they do, it's possible that deals will move forward but will require additional time for litigation and incur extra legal costs. This is a pivotal moment to observe. As you may have heard, Lina Khan spoke about this earlier in the week and indicated she would continue her current approach. If a few more court decisions favor the private sector, we might see the trend I mentioned, where deals advance but include extra time and expenses due to the confidence that they will be approved in court. In contrast, the UK and EU present a different situation and environment. It will be important to monitor how much they deviate from the initial tendencies seen in the U.S. We have observed recent cases that suggest a perception of full coordination, yet there have been notable divergences as well. This is a key aspect to watch for regarding the EU and UK authorities.

James Yaro, Analyst

Okay, that makes a lot of sense. And then just one other quick one that I feel obligated to ask, which is just there were a few press reports a few months ago about a potential sale of Lazard. I just wanted to see if there were any comments that you could make on this.

Kenneth Jacobs, Chairman and Chief Executive Officer

No. No comments beyond what we did make in the first place.

James Yaro, Analyst

Okay, fair enough. Thanks a lot.

Operator, Operator

Thank you. Our last question will come from Brennan Hawken with UBS.

Brennan Hawken, Analyst

Hi. Good morning. I snuck under the wire. Thanks for taking my question. And Peter, welcome and congratulations on the new role. Looking forward to working with you.

Peter Orszag, CEO of Financial Advisory

Thank you.

Brennan Hawken, Analyst

I completely understand, Peter, the importance of being cautious and that makes a lot of sense. However, I would like to ask a philosophical question regarding Lazard stock. When you look at the historical performance of Lazard stock and the various ways to generate value, could you consider whether all options are on the table? In the past, investors have inquired about potential opportunities that weren't previously seen as viable or appealing. I'm often asked by investors if a new viewpoint could lead to exploring all possibilities for reconsideration. Is that a reasonable philosophical question to think about at this point?

Peter Orszag, CEO of Financial Advisory

Sure. Look, as I said, we'll have a lot more to say in October. It is fair to say we're taking a fresh look at everything. That doesn't mean that the answers are going to change. But it does mean that we're taking a fresh look at everything in the run-up to October.

Brennan Hawken, Analyst

Right. Okay. Thank you. I appreciate that. And then just a couple of ticky-tacks. I don't think you guys provided AUM which you normally provide sort of quarter-to-date, so any maybe update on AUM and flows. And could you give a sense, the advisory was quite strong. We're hearing restructuring picking up from some of the competitors. Was that a strong contributor here? And how's the outlook for restructuring for the rest of '23 and into '24?

Kenneth Jacobs, Chairman and Chief Executive Officer

Two parts to the question. Why don't I let Mary Ann take the AUM question, and then I'll answer the restructuring question.

Mary Ann Betsch, Chief Financial Officer

Sure. So we've decided, Brennan, going forward that because we give the AUM and the composition of the change every month that we're not going to be doing that mid-month anymore because it can change a lot throughout the course of the month. You'll have it as of the end of the most recent month at any point in time. So we won't be doing that going forward.

Brennan Hawken, Analyst

Got it.

Kenneth Jacobs, Chairman and Chief Executive Officer

Okay. And then on restructuring, no, it wasn't a particularly big part of the quarter. It was a contributor, but not a standout.

Brennan Hawken, Analyst

And the outlook?

Kenneth Jacobs, Chairman and Chief Executive Officer

The outlook for restructuring is improving, as there is more activity. With significant maturities approaching in the next few years, we anticipate an increase in restructuring activity. Credit conditions may be somewhat more challenging than originally financed, and interest costs will be significantly higher. The stress on companies is greater, which suggests we might experience a rise in restructuring activity alongside increased M&A activity.

Brennan Hawken, Analyst

Yes, okay. Thanks. Ken, I know how much you appreciate my multi-part comments, so here's my point.

Kenneth Jacobs, Chairman and Chief Executive Officer

I love your multi-parters. They're great.

Operator, Operator

All right. Thank you. We have no further questions in the queue. So I would now like to conclude Lazard's second quarter 2023 earnings conference call. You may disconnect at any time. Thank you.