Oppenheimer Holdings Inc. — FY2018 Form 10-K
Reporting period: Year ended December 31, 2018; filed March 1, 2019. The filing also reports fourth-quarter results. Oppenheimer is a middle-market investment bank and full-service broker-dealer, with private-client, asset-management and capital-markets businesses.
Business context and key metrics
The company served clients through 92 U.S. offices and international operations, with $80.1 billion of client assets under administration and $26.7 billion of assets under management at year-end. It employed 2,976 people, including 1,073 financial advisers.
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $958.2 million | $920.3 million |
| Income before taxes, continuing operations | $44.9 million | $19.7 million |
| Net income attributable to Oppenheimer Holdings Inc. | $28.9 million | $22.8 million |
| Basic / diluted EPS | $2.18 / $2.05 | $1.72 / $1.67 |
| Cash provided by (used in) operating activities | $168.6 million | $(16.1) million |
| Cash and cash equivalents at year-end | $90.7 million | $48.2 million |
| Total assets / total liabilities | $2.24 billion / $1.69 billion | $2.44 billion / $1.91 billion |
| Stockholders’ equity attributable to Oppenheimer | $545.3 million | $523.6 million |
Income before taxes equaled approximately 4.7% of revenue, compared with 2.1% in 2017; net income attributable to the parent equaled approximately 3.0% of revenue, versus 2.5%. These are simple calculations from reported figures, not company-defined margins.
Fourth-quarter 2018 revenue was $243.3 million, pretax income from continuing operations was $15.6 million, net income attributable to the parent was $8.3 million, and diluted EPS was $0.59.
Material changes versus FY2017
- Revenue increased 4.1%; pretax income from continuing operations rose $25.1 million. Operating expenses increased 1.4% to $913.3 million.
- Investment-banking revenue rose 47.5% to $115.4 million, reflecting higher equity underwriting and M&A advisory fees. Bank-deposit sweep income increased 51.0% to $116.1 million, primarily from higher short-term interest rates.
- Commissions declined 2.1% to $329.7 million; advisory fees declined 2.0% to $314.3 million. Incentive fees fell to $0.8 million from $27.5 million, reflecting volatility and valuation declines in sponsored alternative-investment funds.
- Principal-transaction revenue fell 37.9% to $14.5 million, primarily due to losses associated with ARS tender offers. Other revenue declined 56.3% to $15.8 million, largely due to lower cash-surrender value of company-owned life insurance and the absence of a favorable arbitration award recorded in 2017.
- Compensation and related expenses were $607.2 million, or 63.4% of revenue, versus 65.4% in 2017. Interest expense rose 63.6% to $46.4 million, reflecting higher funding costs and debt expense.
- The effective tax rate was 35.6%, versus a 10.8% tax benefit in 2017. The 2017 result included a $9.0 million after-tax benefit from the Tax Cuts and Jobs Act; 2018 included a valuation allowance on European operating-loss deferred tax assets and other nondeductible expenses.
Segments, debt and liquidity
- Private Client: Revenue increased 4.2% to $617.9 million and pretax income increased 15.7% to $149.1 million. Higher management fees, sweep income and margin revenue more than offset lower commissions and incentive fees.
- Asset Management: Revenue declined 20.2% to $71.7 million and pretax income declined 30.3% to $18.6 million. AUM fell 5.6% to $26.7 billion, primarily from $2.2 billion of market depreciation, partly offset by $0.6 billion of net contributions.
- Capital Markets: Revenue increased 17.7% to $272.7 million; pretax loss narrowed to $13.4 million from $40.0 million. Management said elevated compensation costs continued as the business was repositioned.
- Long-term debt was $200 million principal amount of 6.75% senior secured notes due July 2022; carrying value was $199.1 million. The notes are secured by substantially all assets of the parent and guarantors and contain restrictions on debt, dividends, repurchases and other actions. The company reported compliance with covenants at year-end.
- Bank call loans declined to $15.0 million from $118.3 million. Repurchase-agreement liabilities were $484.2 million, down from $586.5 million. These are financing balances associated with securities activities, not simply conventional corporate borrowings.
- Operating cash flow improved to $168.6 million from cash used of $16.1 million; investing activities used $8.2 million and financing activities used $117.9 million. Cash increased $42.5 million during the year. Management stated that operations, capital and available credit facilities should meet foreseeable liquidity needs.
- Oppenheimer’s regulatory net capital was $194.5 million, $175.8 million above its minimum; Freedom’s was $5.3 million, $5.2 million above its minimum. The company paid $0.44 per share in 2018 dividends and repurchased 236,122 shares for $5.9 million.
Outlook, risks and unusual items
Management provided no quantitative earnings or revenue guidance. It described plans to grow private-client and asset-management businesses by hiring experienced advisers and investment professionals, expand capital-markets and technology capabilities, manage expenses, and pursue selective acquisitions. Management cautioned that results depend on market activity, interest rates, client assets and transaction volumes.
- Regulation and revenue pressure: The SEC’s proposed Regulation Best Interest could increase compliance costs and require business-model changes. MiFID II, effective in Europe from January 2018, limits bundled research and trading commissions; management reported reduced research compensation and research availability. Brexit created uncertainty for the London business and its ability to serve EU clients.
- Alternative investments and markets: Declining markets may reduce AUM and fee revenue; incentive fees can vary significantly. Trading, underwriting and investment positions expose the firm to market, liquidity, interest-rate and counterparty risks, while competition and pricing pressure weigh on commissions and trading margins.
- Auction-rate securities: The company held $40.7 million principal amount of ARS at year-end, valued at $38.0 million, and had $7.3 million of additional purchase commitments under legal settlements and awards through 2020. Eligible clients held approximately $7.5 million of ARS potentially subject to future offers under regulatory settlements, but the company had no outstanding purchase commitment for that amount at year-end.
- Legal and regulatory matters: The company estimated a possible aggregate loss range of $0–$30.0 million in excess of accrued amounts for proceedings where an estimate could be made; some matters could not be estimated. In February 2019, Oppenheimer and OAM offered to disgorge approximately $3.5 million, including interest, in a proposed SEC share-class-selection settlement and undertake corrective actions; the filing said they were awaiting an SEC order. A separate trust litigation settlement was agreed in principle in January 2019 for $1.8 million. The filing also describes ongoing inquiries and other litigation, including an environmental claim in British Columbia.
- Other obligations and exposures: Operating lease commitments totaled $280.6 million. The company estimated that adoption of the new lease standard in 2019 would add $170–$215 million each to right-of-use assets and lease liabilities. Cybersecurity, business continuity, employee retention, and reputational risks are also highlighted; management reported no material cyber-incident losses to date.
Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded internal control was effective at December 31, 2018.
Important facts for investors to verify
- Whether the 2018 earnings improvement is sustainable without the large 2017 tax benefit, and how investment-banking and sweep-income trends develop.
- How AUM, market depreciation and incentive-fee volatility affect asset-management revenue and profitability.
- The outcome and cash impact of the proposed $3.5 million SEC settlement, remaining ARS obligations and other pending legal matters.
- Liquidity and financing risks, including secured-note covenants, repo and other securities-related funding, and the company’s ability to fund dividends and repurchases.
- Potential costs and operational effects of regulatory changes, Brexit, cybersecurity threats and lease-accounting adoption.
- Governance and trading-liquidity considerations: Class A shares are non-voting, while an entity controlled by the CEO holds over 96% of the Class B voting shares; Class A trading is relatively limited.