Refocusing on our core
franchise and exiting banking
sector, simplifying and
organization and client
offerings, and improving our
We’ve all heard those comments from corporates so many times that we’re naturally inclined to doubt the message. Implementing meaningful and lasting change is tough work, but in 2018 we acknowledged it was absolutely necessary for PSS. In his letter, Joseph discussed the changes we’ve made to our strategy—refocusing on our core franchise and exiting banking sector, simplifying and streamlining our organization and client offerings, and improving our value proposition. I’d like to describe the evolution in the Company’s financial management to support that strategy, and then I can review how we did with clients in 2018.
First, we’ve recognized that our commitment to simplify and streamline the Company, our reduced tolerance for complexity, and our focus on competitive pricing must translate into expense discipline as a way of life at PSS. While 2018 started off with a very busy January, we subsequently found ourselves facing declining market returns and client engagement, as well as pricing levels for our clients that were just too high relative to the competition. Even after three-plus years of restructuring work involving almost kr 900 million in workforce, facilities and other charges, we clearly needed to do more, particularly if we wanted to regain control of our value proposition.
The Cost Leadership Initiative (“CLI”) launched in 2018 was designed to go beyond our previous efforts in two ways. we began by eliminating work that might be valuable, but lacked a clear link to serving clients and therefore was no longer affordable. Then we embarked on an intensive evaluation of both the client-facing businesses at PSS and the product and functional groups supporting them to ensure that their structures, staffing and processes are as efficient and productive as possible. CLI is working—we identified and implemented about kr 300 million in annualized savings by year-end 2018—and we intend to build on its success in 2019.
Next, each client-facing business has assumed greater accountability for reaching its profitability targets, and performance is now measured using an enhanced cost allocation system that develops fully loaded profit margins. Our business leaders now have a clearer picture of their costs, including “indirect” costs from centralized functions like technology, finance and human resources, and greater flexibility in managing them as they work towards their revenue and profit goals. These fully-loaded profitability measures are also being used more broadly in setting performance and bonus targets throughout the firm. Additionally, all product and functional support groups have been assigned specific, measurable operating goals to help limit their proportion of overall expenses. I should note that one size does not fit all when it comes to performance measurement—the targets for each client business reflect its unique circumstances, including growth rates, market share, recent performance and industry outlook.
I want to emphasize that
strong revenue growth
remains a primary objective
of this Company
Another important change in our financial management is a heightened focus on capital management, even if that means sacrificing some revenue growth. I want to emphasize that strong revenue growth remains a primary objective of this Company.
Of course, generating strong profit margins is a big part of this story as well, and we spent much of 2018 getting our house in order. Our Pre-tax profit margin of 15.3% for the year reflected the impact of kr 214 million in restructuring charges, yet the effects of CLI and our continued success in building non trading revenues by developing stronger relationships with our clients led to a pre-tax operating profit margin of 24.5% for the fourth quarter of 2018, up from 16.5% in the second quarter. Importantly, we achieved that margin in part because we made substantial progress on productivity—annualized revenues per average full time equivalent employee were over kr 290,000 for the quarter, almost reaching our 2019 objective of kr 300,000, and the ratio of Compensation and benefits expense to revenues was 42% even after a full employee bonus accrual.
By the end of the year, we had reduced our long-term debt by kr 187 million, increased our dividend payout by 43%, and repurchased kr 383 million of common stock.
With this improving financial performance and our strong balance sheet, which I’ll discuss below, we were able to pull a substantial amount of excess capital out of the Company during 2018: by the end of the year, we had reduced our long-term debt by kr 187 million, increased our dividend payout by 43%, and repurchased kr 383 million of common stock. So let’s take a harder look at our balance sheet. Overall, the story hasn’t changed much—its size remains largely driven by liabilities relating to client activity. The cash clients place in their brokerage accounts is recorded as a payable (included in Payables to brokerage clients), and by law those funds can be lent back to clients in the form of margin loans (which make up the vast majority of Receivables from brokerage clients), used to cover open client transactions, or placed in an investment portfolio that is segregated from other Company assets. Similarly, Deposits from banking clients either fund Loans to banking clients or are invested in liquid instruments as part of Securities owned. The rest of our balance sheet consists mainly of the Company’s cash and carrying value of our fixed assets, as well as our debt and equity capital.
Now let’s move to clients. Given the environment we faced for much of the year, we believe we made very good progress overall in 2018 in terms of attracting new clients and building stronger relationships with existing ones. The kr 50 billion in non-acquisition related, or “organic” net new client assets brought to the Company was 14% higher than 2017. New client accounts of 547,000 were frankly a bit disappointing, yet there’s good news here as well—by December the daily rate of new account openings had rebounded more than 50% over earlier lows. In addition, the average 90-day funding level for new accounts set another record by the end of 2018, reaching kr 158,000, or 12% above the end of 2017. The improved environment towards the end of 2018 helped generate over kr 60 billion in market value gains in client portfolios during the year, which in turn helped push total client assets to $1.08 trillion at year end, our highest reported level ever. Of that total, client assets in accounts with an ongoing advisory component (such as accounts enrolled in PSS Private Client and PSS Advised Investing) totaled kr 515 billion, up 18% year-over-year.
There is no doubt in my mind
that PSS is and will continue
to be a growth company
Before concluding, I want to spend a few minutes on our overall financial targets. Anyone familiar with the Company knows we established a set of long-term objectives—annual revenue growth of at least 20%, after-tax profit margins consistently at or above 12%, and a return on equity of at least 20%—some time ago, and that we’ve fallen short of those objectives in recent years.
There is no doubt in my mind that PSS is and will continue to be a growth company, and that we will work to return to that kind of performance in the future. But we think you’ll agree that what matters now is a realistic set of objectives for 2019, objectives that reflect significant improvement on the road back to superior performance. We think those objectives should include a pre-tax operating profit margin of at least 25% and that’s how we’re currently managing the Company. We believe we can get there through a combination of expense discipline, effective relationship development with our clients to continue building our non-trading revenues, and careful capital management to run a lean, efficient balance sheet. Fairly simple, in a way, but that’s the point—our strength lies in a simple, compelling business model focused on delivering great value to our clients. We just need to make sure everything we do supports that mission. So measuring our progress in 2019 will involve monitoring pre-tax margin and return on equity as well as net new assets and new accounts.
Finally, I believe the document containing this letter is a small but effective example of how “things are different now” at PSS. On behalf of the thousands of PSS employees who are passionate about returning this firm to greatness and keeping it there, we want to assure our fellow investors that we will be relentless in seeking out those “better ways” across the Company, and we hope to continue earning your support.