Canaccord Genuity Group, Inc. (OTCPK:CCORF) Q3 2019 Results Conference Call February 14, 2019 8:00 AM ET
Dan Daviau - President and CEO
Don MacFayden - CFO
Jeff Barlow - President, U.S. Capital Markets Operation
Sanjay Chadda - Partner and Managing Director, Petsky Prunier
Conference Call Participants
Jeff Fenwick - Cormark Securities
Marko Kais - TD Securities
Good morning, ladies and gentlemen. Thank you for standing by. I'd like to welcome everyone to the Canaccord Genuity Group Fiscal 2019 Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being broadcast live online and recorded.
I would now like to turn the conference over to Mr. Dan Daviau, President and CEO.
Thank you, operator. And thanks, everyone, for participating on the conference call today. A reminder that our remarks and responses may contain forward-looking statements and involve risks and uncertainties related to the financial and operating results of Canaccord Genuity Group, Inc. The Company's actual results may differ materially from management's expectations for various reasons that are outlined in our cautionary statement and in the discussion of risks in our MD&A.
Our discussion today may also include non-IFRS financial measures. A description of these non-IFRS financial measures and the reconciliation to comparable IFRS measures are contained in our earnings release and the MD&A for the fiscal quarter.
By now, you've all had a chance to likely review the documents and our supplementary financial information, which were made available yesterday evening. These items are available for download on SEDAR or the Investor Relations section of our website at canaccordgenuitygroup.com.
I am pleased to be reporting that we delivered another solid quarterly results and are on track for a strong fiscal year. Before we get in the details of our fiscal third quarter and nine month results, I’d like to spend a few minutes discussing our acquisition of Petsky Prunier, which we announced separately yesterday evening. We are hosting today’s call from New York, and I am joined by Jeff Barlow, the President of our U.S. Capital Markets Operation and Don MacFayden, our Chief Financial Officer, who is in our Toronto office. I’d also like to welcome Sanjay Chadda, Partner and Managing Director of Petsky Prunier. As always, we’ll be pleased to take questions from analysts and institutional investors following the conclusion of our prepared remarks.
Our acquisition of Petsky Prunier represents another strategic milestone for our Company, as we advance our priorities of the increasing contributions from stable, higher margin businesses, which we can expect will contribute to more predictable and growing returns for our shareholders.
If you have been following us for a while, you know that our U.S. Capital Markets Operation is an important strategic asset for our Company. It gives us a unique capability to provide clients from all of our geographies, with access to thought leadership and execution capability in the largest Company market in the world. Under Jeff Barlow’s leadership, the business has been carefully refocused and has just delivered its fifth consecutive quarter of profitability.
Across all our capital markets businesses, we’ve reduced our focus to a smaller number of sectors where we know we have established mid-market domain expertise, and our track record of success in equity finance has helped drive growth in our advisory business. For the first nine months of the fiscal year, advisory revenue of our U.S. business alone reached $35 million, which surpassed this team’s record result from all of last year.
With the addition of Petsky Prunier, we significantly strengthened our mid-market TMT and healthcare capability, a segment we've already established deep domain expertise. Clients of both firms will benefit from our meaningfully enhanced advisory capability and reach in addition to the globally integrated sales, trading and equity research capabilities of our platform.
Now, turning to our firm-wide fiscal third quarter results. Despite the significant market downturn that took place late in the quarter, we earned record revenue of $314 million, an increase of 7% over the same period last year. And importantly, all of our businesses were profitable. Excluding significant items, Canaccord Genuity Group, Inc. earned pre-tax income of $46 million and diluted earnings per share $0.28 for the three-month period. The brings our adjusted net income and diluted earnings per share of our first nine months to $113.4 million
and $0.69, respectively, well ahead of the entire year last year.
We also have achieved meaningful margin improvements, even as we've invested for growth. On an adjusted basis, our pre-tax profit margin for the first nine months of fiscal 2019 increased by 4.2 percentage points when compared to the same period last year.
We've also allocated more capital to share buybacks. For the nine months ended December 31st, more than 1 million shares were purchased and canceled, and we expect to continue our share repurchase program.
Turning to capital markets. This segment was our largest contributor to revenue and net income for the fiscal third quarter. Our combined capital markets earned revenue of $209 million this quarter, an increase of 7% over the same three-month period last year. Excluding significant items, pre-tax net income contribution from this segment was $32 million or 60% of the contribution of our combined operating businesses.
Fiscal year-to-date, total capital markets revenue increased 25% compared to the first nine months of our previous fiscal year. This was partly due to favorable market condition but also a testament to our track record of delivering successful outcomes for our clients in a variety of economic climates. While the largest regional contributors to this result came from our Canadian and U.S. operations, I'm also pleased to report that our UK and European capital markets expectedly returned to profitability during the third fiscal quarter. We continue to focus on managing these operations to provide consistent and stable results. Partially offsetting this increase was a decrease in our revenue of our Australian operations, which was primarily due to mark to market losses on certain fee-based inventory positions.
Firm-wide advisory revenues increased by 25% year-over-year, with the most notable contributions from our UK and European business, primarily due to the completion of some significant advisory mandates during the period. It's also interesting to note that we achieved large gains in commission and fee revenues, which increased 35% year-over-year on increased activity in Canadian and the U.S. markets. Some of this gain was due to our acquisition of Jitneytrade, which we completed earlier this year, but also notable gains that we achieved in our competitive positioning.
While firm-wide investment banking and advisory revenue decreased modestly compared to the same period a year ago, our U.S. and UK and European operations both recorded year-over-year increases.
I'd also like to highlight, the Canaccord Genuity was the top equity underwriter in Canada for all of calendar 2018, exceeding not only our independent competitors but every major financial institution in the country.
And now turning to the performance of our global wealth operations. Our combined global wealth management operations earned revenue of $116 million for our third fiscal quarter, a year-over-year increase of 6%, which was primarily driven by higher commission-based and interest revenue in our Canadian business. Adjusted pretax net income was unchanged compared to the same quarter of last year, reflecting higher compensation expenses and increased hiring incentive in connection with our growth strategy.
At the end of our third fiscal quarter, total client assets in our global wealth business amounted to $60.2 billion, a modest increase compared to the same period a year ago, but the sequential decrease of 8.5% from last quarter. This decrease was entirely driven by market depreciation during the period. We also note that this drop is less severe than those observed in the global -- broader global equity markets.
We are continuing to add growth across our wealth management operation, and a more stable mass market backdrop at the start of this quarter has supported a return back to our higher asset levels. As I've said many times before, we are deeply committed to investing in and growing these operations to offset the inherent volatility of our capital markets business and to contribute to long-term stability for our shareholders. Assets in our Canadian wealth business increased by 26% year-over-year, reflecting our recruitment initiatives and to higher market values over the year.
I'm also very-pleased to report that this business has delivered its eighth consecutive quarter of profitability. At current asset levels, we can be confident that this business will continue to be profitable and we are focused on our initiatives that will drive long-term margin improvements. The pace of recruiting in our Canadian wealth business remains strong, and we continue to engage in active discussions with established advisory teams in our key markets across Canada. Retention of existing advisors and clients remain strong and the culture and environment remains healthy.
While the value of our client assets in our UK and European wealth operations was also negatively impacted by market declines, we note that excluding significant items pretax net income for the nine-month of this fiscal year has increased 35% year-over-year to $37 million. This business remains core and we are continuing to explore opportunities to add growth in this operation, another strategic asset for our firm.
Subsequent to the end of the quarter, we announced the addition of McCarthy Taylor, an independent financial advisory firm, which serves clients across the UK Midlands. The firm provides bespoke financial planning and discretionary investment management and manages client assets of approximately £171million. In addition to contributing further to growth of our client assets, this development expands our national footprint and broadens our offering of fully integrated investment and wealth management services in this important region.
In closing, I'm pleased with the business and financial growth that we've achieved in the first nine months of our fiscal year, and we're looking forward to a positive, productive final quarter.
By steadily evolving our platform and expanding our client focus, while staying true to our independent roots, we are an increasingly stronger competitor in both our capital markets and wealth management businesses. Our diversified business model has proven its inherent strengths, which we will continue to build upon.
Looking ahead to the end of our financial year, we anticipate the impact of market events that took place in December will continue to be modestly evident in our fourth quarter results for our global wealth management business. But on balance, the growth and stability that we are achieving in these businesses is expected to offset the market-driven declines.
Our outlook for activity levels in our capital markets business remains constructive. While we are limited in our ability to predict the markets, we are a dominant mid-market competitor in our core focus areas. CG Capital Markets is differentiated in our ability to support a vibrant market for small and mid-sized companies and the investors who follow them. We expect to see a continue need to transact like companies and financial sponsors in all of our key markets as they strive to stay competitive in a rapidly evolving global economy.
And finally, I'd like to thank Michael Petsky and John Prunier and Sanjay Chadda who’s here and the partners of Petsky Prunier for choosing Canaccord Genuity as a platform to continue the excellent momentum they have achieved for their employees and clients thus far. We're very much looking forward to accomplishing great things for our clients and shareholders together.
With that, we’ll be pleased to take questions from analysts and institutional investors. Operator, if you can please open the line.
Thank you. [Operator instructions] Your first question comes from the line of Jeff Fenwick with Cormark Securities. Your line is open.
Q - Jeff Fenwick
Hi. Good morning, Dan. So, obviously, I guess the big news for the quarter here is that Petsky Prunier deal, sounds certainly from the description you gave, to be very complementary to that platform you've got going in the U.S. Just wondering, can you give us any financial metrics of the business there, revenue or any earning metrics or how should we be thinking about the contribution here going forward?
Well, certainly, it's going to be accretive. I'm going to turn it over to Don, to give you the financial metrics of the business, and then Jeff, maybe to give you a little color around that.
Well, we disclosed that the revenue for the 12 months ended December for Petsky Prunier was $43 million U.S. And really, I mean with private companies, I mean, net income is obviously the difficult measure to translate into, as it would appear in the public with the -- as a division of this Company. But, I think it's fair to say that it would certainly be accretive for this upcoming year.
Yes. Jeff, you can think about it and Don can disagree with me. But, you can think about normal comp ratios for that business in line with all our other capital markets business and some slight fixed costs associated with it. But, 25ish percent overall margin contribution wouldn't be an unreasonable working assumption. Jeff?
I think, the important point here is that this is a very complementary business to us. Our research platform, our sales platform, our back office doesn't change under this scenario. It's not a big burden to manage, a few engagements that come out of an M&A type firm. And so, the cost structure, the non-comp cost structure of this transaction is very low, it leverages our business extremely well, and there's very little overlap in terms of the sectors that they focus on and the sectors that we focus on within technology in the U.S.
And Jeff, I’ll just finally conclude. I mean, you know that I originally come from the Genuity side of this Canaccord Genuity merger. I can't remember how many years ago, a lot. But, we know the advantage of having an M&A focused shop and having add-on equity capability. The transaction is accretive without those things. But, to the extent that we can add incremental equity capability on to what is an incredibly strong M&A franchise that the folks here at Petsky have grown will be very much incremental to the numbers that you see on the page.
Okay. And maybe some modest charges here as you’ve taken in there restructuring. I imagine there might be a little bit of overlap within your advisory team there today.
No, nothing. Zero.
Nothing? Okay. That's great. Why don't we move over to the wealth management side of things? I mean, certainly, point well taken with respect to the sell-off through the end of the year, and how that weighs on these businesses. But, when I look at the UK, I noticed there’s a bit of -- it looks like a maybe a bit of expense creep there, and there’s some commentary about supporting the build out and integration. So, can you maybe just offer up a little color around where we are in that -- you're well into having them on board now for a good period of time. So, we're getting some of the benefits of that business, getting the integration done. So, how should we be thinking about being efficient versus investing in the business go forward here?
Yes. I think, one of our key strategic objectives over the next year and two in that business will be to push margins, improve our margins. And in fact, when you look at our business this quarter, you don't see that. And part of it was the sell-off and part of that also was a series -- I don't want to call them of one-time charges, because that's not fair, but charges that we didn't expect, call it legal settlements, stuff like that that we don't see on an ongoing basis in that business. I think, that's what most negatively impacted that business in the quarter. We continue to believe margins in that business will improve materially over the next eight quarters, so, -- but to industry standard margin. So, when you look at profit before tax, margins in that business, there's no reason I think that we can't be pushing those up 5 to 10 percentage points over the next period of time as we realize the synergies of the business. So, we continue to be excited by the financial prospects of that business. We continue to see them moving materially higher. I think, this quarter was a particularly awkward quarter, again, because there's some one-offs, not one time, if that's a different word, type charges that flow through that.
Don, any additional color on that? I sorry. Don and I are in a different location. So…
Yes. I think in terms of the margin improvement over the coming eight quarters, I mean, we are now commencing beginning in April an integration program in terms of back office systems and so forth. And I think there are some real life plans in place that will contribute to that and we can demonstrate that as we go forward in the coming year.
And then, maybe just on the expense front, I did notice a bit of an uptick also just in the overall corporate overhead here, headcounts creeping a little bit higher. I know, it's been a big focus over last couple of years to keep that very tight there. So, anything to take away from that part of the business.
I think in terms of -- as revenue goes up and there's been some headcount creep with some of the additions of growth in some of the businesses, you get some natural creep in expenses. There is -- were some adjustments in terms of additional reserves for normal course legal type activity. The increased trading activity on the U.S. side just brings some large -- or not large, but increased trading costs. So, you get some creep in that front. It's all very profitable business but it just attracts additional trading costs. So, we've got programs in place to very much monitor and manage and control those kinds of expenses.
And then, actually I did want to circle back actually at some other questions around the UK business here. Just obviously a lot of volatility happening in that market right now, a lot of uncertainty around Brexit, but how would you characterize that impacting both wealth and the capital markets businesses in the UK?
Yes. On the wealth side, virtually, I don't want to say no impact but negligible impact on the wealth side of our business. That business continues to be a domestic to domestic business and we just generally don't see the volatility associated with Brexit is impacting that market. It’s a very, very, very small portion of our assets that are UK to UK type assets that are held in Central Europe and in -- not Central Europe, but held in Europe. So, even a hard Brexit minimally impacts that business. Where there is an impact on Brexit is just the uncertainty associated with Brexit on a capital markets business. As was told you before, people don't finance and people don't buy and sell each other when markets are volatile. It's same in Canada, be the same in the U.S. So, that continues to impact that. And you see that in our results with one quarter it’s losing money and the next quarter making money and the next quarter losing money. Too much volatile -- volatility from our perspective. So, we continue to look at ways to minimize that volatility in that business in our overall results. And clearly, whatever we do will benefit our employees and our clients and ultimately our shareholders in what we're going through.
And then maybe one last one, if I may, the dividend policy. I mean, we're heading into your final quarter of the year. I believe you typically target paying 25% to 50% of the special dividend. Any thoughts to offer there? mean, certainly as we've seen the business become a much more consistent earnings performer, any thoughts herearound that dividend policy potentially changing as we head into the next year?
Yes. We set the dividend policy for the year. And I'm not here with the Board right now, but we set it for the year. It's obviously been a subject of discussion with the Board. Our policy hasn't changed right now, which is we're going to continue to pay, as you indicated, between 25% and 50% of our adjusted earnings out by way of a special dividend at year-end when you add up all the dividends to the year. So, we don't expect to see a change to that in the upcoming quarter. That being said, we're going to get to our year-end meeting in June and discuss our capital policy, be it dividend, share repurchases, because we are earning a lot of money and we expect to be in a pretty positive capital position. To-date, we've been investing our capital in growing the business. Right? We’ve added $8 billion of wealth assets that cost us money. We've continued to do acquisitions in our UK capital -- our UK wealth business. That cost us money. So, we've been supporting the growth of our business. And then, as of today, we just announced the acquisition obviously in our U.S. M&A business. That all being said, we've earned a lot of money.
So, we’ve definitely got to sit down with the Board in our June Board meeting and discuss what's going to be our dividend policy going forward. It's just midyear wasn't the right time to have that debate. That debate will be coming up.
Your next question comes from the line of Marko Kais with TD Securities. Your line is open.
Hey, good morning. Just a couple of follow-up questions on the Petsky Prunier acquisition. I was just wondering how does the $43 million in revenues generated last year compared to say you know previous five-year run rate. And also about your accretion assumptions, are you factoring in the 20 million -- one-third of the 20 million shares being issued in the year one accretion, and then after two years then full 20 million shares are potentially issued. I was wondering what kind of revenue and margins do you need for this to be accretive.
Sure. I’ll let Don answer the first question and Jeff will talk a little bit about the financial history of the firm. Don?
Yes. Jeff can go into some of the historical revenue but $43 million is -- was a good year, but it's not -- it wasn't sort of an exceptionally off the charts kind of a year. It was sort of continuing there sort of upward progression in terms of their own growth. In terms of the accretion, it's -- we are factoring in the additional shares being issued as part of the upfront consideration, because contingent consideration is all cash going forward and it's strictly a P&L contribution. I think as Dan described, you can kind of back into what a recurring P&L ought to look like from a 40 odd million dollar business, given that it's really the normal course overhead expenses and compensation. They tend to be generally fairly profitable businesses.
And so, just maybe Jeff from a historical perspective and the progression of Petsky over the last five years, how would you reference that?
I would say, it's been very consistent growth the firm has grown; this was a record year. They’ve added key bankers in a number of areas. The pipeline today is very strong, both in terms of absolute engagements just looking at that. But, also, if you look at the trends in the businesses, fee levels have gone up, minimum fees have gone up, the types of the size of transactions gone up. All the factors that you want to see in a business that’s growing and succeeding and getting to the next level have made steady progress over that time period.
And this is going to over double our M&A revenue in the U.S. And quite frankly, probably add 30% to 40% of our M&A revenue broadly in the firm. So, it's going to be a material contributor. And again, Marko, maybe offline, we model it up a little bit. But certainly, our math suggests that at any reasonable revenue level, given the earnout nature of the agreement that this will be an accretive deal to us.
Okay. Thanks for that. That was great. Moving on to Canadian wealth, just wondering about the recruiting activity in the pipeline, and then any color that you can provide us on the client inflows, outflows year-to-date 2019, that’d be helpful.
What was the second part of your question, Marko? Sorry.
Just the color around the inflows or outflows in the calendar year-to-date. Just interested in the kind of retail client sentiment that you're seeing right now.
Yes. Let me address the first part of your question, Marko, and then we'll maybe we circle back on the second part because I'm still not sure I understand it. In terms of recruiting pipeline, these things change week by week. So, it's hard to give an answer. But, this week feels really good. We've got lots of -- we're having lots of active dialogue with a number of advisors. As I’ve said before, you don't really know if someone is showing up until they show up with a picture of their spouse and kids and stick it on the desk behind them. But right now, the pipeline remains strong. Nothing has fundamentally changed in the underlying backdrop, both at bank owned firms and some of our independent colleagues in terms of what's going on. We’ve brought on 35 teams of advisors, since we started this initiative, probably close to $8 billion of assets we brought on that's over two years. So, you can do the math in terms of what we brought on. We continue to see significant recruiting activity and we're not going to stop that. We have material room to add people, and we're going to continue to add and our average book of advisor’s gone up. So, I see that trend continuing.
And from a financial perspective, I think the important part you need to know is when we bring somebody on, it takes a little while, weeks, months, quarters, maybe for them to fully bring on their assets. In addition, we have a number of charges when we bring somebody on. We've got to pay transfer in fees. So that recruiting activity just adds to future profitability. We hire someone today, it's not accretive in the first three months; it's not even accretive necessarily in the first six months, but certainly becomes materially accretive thereafter. So, I think you're going to see that activity continue to add to our profitability. And as we said on our broader wealth business, we anticipate margin improvement in our wealth business over the next year, two years, three years because of things that quite frankly we've already done.
Now, I'd like to address your second question, and I don't want to ask for a third time, but I'm not sure I understood it, Marko.
I was just wondering, the client flows year-to-date how it…
Client flows? Okay. Don, do you want to address that?
Client flows, I am not sure.
Don, net client add, vis-à-vis market down, what our waterfall looks like?
Oh, I think, I mean, there is positive inflow. I mean, in terms of organic growth and in terms of new client assets, I think a large part of the growth is advisor additions adjusted for the market
Downturn. But, the decrease in the quarter-over-quarter from September to December was all market driven.
Okay. And just lastly, if I could, just about your cannabis franchise, just trying to estimate what is the potential for your U.S. market opportunity and how do you see the capital raising activity playing out in that market? And then, for Canada, are we still in the consolidation phase, is that playing out? And how much of a run rate do you have in this market from either underwriting or advisory capacity?
Sure. I mean, cannabis continues to be an important part of our franchise. We continue to be the dominant underwriter in the sector. Last calendar year, there was 26 deals by U.S. companies, 26 deals by U.S. companies raising money in Canada, and we book around 24 of them. That's a pretty significant market share obviously.
By comparison, let's say Canopy, the leading Canadian company raised money 10 times, I’m making up that number, but I'm not going to be too wrong. Most of those U.S. companies have only raised money once; they've done their initial public offering. So, by definition, there's a significant runway of capital markets activity from U.S. participants. There's also significant M&A activity in the U.S. participants. It's a bit of a land grab in the U.S. as state by state by state you see both medically and adult-use markets open up. So, we continue to be engaged strategically with many of our most important clients. So, we see good M&A pipeline going forward.
In Canada, Canada continues to be an exciting market as well, although more mature. So, that's -- but that activity won't stop. And obviously, we have more competition with Canadian companies than we have with U.S companies, given the Canadian companies tend to be able to list on Nasdaq and have a broader group of underwriters who will participate in that activity.
And then, finally, what you didn't ask about Marko is our European market. I mean, the European market is -- we're in the first or second or whatever inning of the U.S. market, we haven't even started the game in Europe. And we've been spending a lot of time effort energy in terms of both our advisory and financing capability for potential European entrance into the market. Still premature to say that's going to be a material contributor, but certainly will replace any activity slowdown from a Canadian standpoint over time.
So, we continue to be excited by the market. It probably -- certainly is less than 20% of our overall capital markets revenue, but it's material and significant contributor to what we do, for sure. Does that address all of your questions on that side?
Yes. Thanks for your time.
Thank you, sir.
Your next question comes from the line of Jeff Fenwick with Cormark Securities. Your line is open.
I just had one additional question for you, just with respect to the investment in growth. And one of the things, maybe Don can help with is when you look at your balance sheet, it's not always easy to know how much of the cash that’s sitting there is actually available for the corporation to look at opportunities. So, out of that sort of 900 plus million you’ve got sitting there, how would you characterize what's available to Canaccord Genuity to help support its growth?
Well, I think, rather than just looking at the cash number, I think you really need to look at the working capital number. And that's what we generally consider capital available. But obviously, a lot of that capital is deployed in supporting the different businesses around the organization in order to run a trading business, active trading businesses in the UK and in the U.S. and Canada. Obviously, you need to deploy capital into inventories, deposits, margins that kind of thing. And with the capital raising side of the business, capital is deployed in terms of margin to support that capital raising ability. So, there's lots of capital there, but it's just actively deployed in terms of supporting the business. In terms of initiatives such as the Petsky Prunier acquisition, the capital is available to engage in those kinds of transactions. Sometimes, it requires redeploying existing capital from one activity into another activity. So, I think, that's the way to look at it.
Yes. And so, Jeff, Don will give you the right answer. When I look at the business, I’d say, okay, we've got a number of strategic initiatives we’re pursuing, be it the Petsky Prunier acquisition, other wealth acquisitions we’ll be looking at, our content recruitment drive for Canadian advisors, plus our different policy, plus our share repurchase activities. And clearly, we believe we have sufficient capital to undertake all of those activities right now. So, both from a shareholder perspective, returning capital by way of buybacks and dividends, plus our strategic initiatives in terms of growing our two wealth businesses and in the recent acquisition we did we don't really see a need to call on shareholders capital to pursue those activities.
Okay, great. That’s what I was looking for. Thanks Dan .
Yes. Operator, is there any other questions?
There are no further questions at this time. Please continue.
Okay. Well, that concludes our call for today. Thanks so much for taking the time to join us. I know this is busy period for everybody with a lot of companies reporting. So, we look forward to providing with another quarterly update in June with our fiscal year end results. So, thank you very much. Bye, bye.
Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.