Piper Sandler Companies (PIPR) 2004 Q1 法說會逐字稿

And now I would like to turn the call over to Andrew Duff. Andrew?

Thank you, Jennifer. I'm joining today via conference call at from California. I, along with members of our management committee are hosting our annual incentive award trip to recognize the performance by our top producers across the firm. Our three annual award trips are among the ways we recognize employees' contributions. It is a very important part of our culture.

Today, our business is stronger than at the same time last year, given the improved markets and the completed spin-off. In the first quarter, we saw improved public underwriting markets and improved activity from our product lines. We continued to execute our strategies to grow the top line while managing our fixed costs to improve our margins. We made progress in both fronts in the first quarter.

Let me turn to revenue growth. Net revenue grew almost 4 percent over last quarter and was up 24 percent from last year. The most notable improvement came from a significantly more active equity underwriting market. In the first with in the equities market overall, there were three times the number of equity deals completed and twice the capital versus when one year ago. We are getting our fair share of this activity and our backlog continues to be healthy. We did see lower fixed income institutional sales activity during this quarter, which Sandy will speak to shortly. However, the improvement in our equities business more than offset the decreases highlighting the benefit of a balanced capital markets portfolio.

We continued to execute our middle market strategy. During the quarter, we expanded our fixed income capability in New York by hiring a team of 14 new sales and trading professionals. The team supports our strategy to extend our platform for middle market clients. These 14 new hires are part of a focus plan to expand our product and distribution. Since opening our New York fixed income trading desk in May of 2002, we have added 31 sales and trading employees in municipals, mortgages, corporates, bringing the total to 38 employees in this office. We are encouraged to see some signs of improvement in our private client business. Individual investor sentiment and activity in the market has improved certainly from one year ago and we have seen strengthening even since late last year. Q1 was the strongest quarterly revenue since Q2 of 2001.

In addition, we continued to advance a clear strategy for this business, one of becoming a primary financial adviser to our clients. We are focused on executing specific initiatives against this strategy. For example, we have largely worked through the attrition in FAs due to the new compensation plan we implemented last year. We have now turned our attention to growing our FA ranks, which will be accomplished largely through training professionals to become future financial advisers. To lead this critical effort, we've just announced that Tom Seitz has joined PCS as a director of business development. Tom's direct responsibility will be to continue development of best in class professional training for both developing financial advisers and experienced FAs and to assist in recruiting efforts. Tom most recently was President and CEO of the Annuity Distribution Company of MFS Sun Life Distributors in Boston. Tom will be instrumental in training developing FAs to our model working as a primary financial adviser.

More selectively, we will recruit seasoned financial advisers, but three to one, we plan to train and develop our own financial advisers, which is a longer payoff, but one that we believe long-term is better for our clients and the firm. To date, we are ahead of our plans for hiring trainees and are pleased with the quality of individual we are attracting. We do expect to selectively recruit seasoned financial advisers, but frankly, refilling the pipeline will take some time. We were essentially out of the recruiting market for the last 1.5 years as we resolved our ownership status and completed the spin-off, which dried up the pipeline. However, we have restarted those efforts. Investment research is critical to both capital markets and private client services. We continue to add coverage in sub sectors to expand existing universes. So far this year, we have expanded coverage in semiconductors, health care and banking.

In March, Equity Research hosted an Internet and wireless conference in China. This conference provided investors a glimpse into the investment opportunities in the Internet, wireless, games and online media in China. We had great attendance with approximately 260 attendees and we conducted over 100 one-on-one meetings.

Let me turn to margin. The firm overall achieved a double-digit pretax margin of 10.6 percent for the quarter. We believe we have a healthy amount of operating leverage, particularly in private client services and we saw that this quarter. We are growing the top line and improving our margins by honing the line or selectively adding to fixed expenses. That said, a 10.6 operating margin is not competitive with our peers and we clearly have more work to do. Improving the margins in private client services is the driver to improving the pretax margin for the firm overall.

Employee ownership -- I want to end with a comment on employee ownership. As we've stated, we believe employee ownership is critical to the success of our business and we intend to build ownership over time. At the time of the spin-off, employee ownership was less than 1 percent. In connection with the 2003 bonuses in February, we made the first equity grant to our employees, approximately 480,000 shares of restricted stock and 300,000 stock options. With this grant, we moved employee ownership up to approximately 4 percent. assuming all grants were vested and exercised.

In addition, we have added Piper Jaffray stock as an investment alternative through our retirement program. We are pleased to have employee ownership trending up. The first quarter was a solid start to the year. I continue to believe our middle market strategy represents a great opportunity and all of our businesses have the right initiatives underway to be successful. If the market remains on track and continues to strengthen, I believe 2004 can be a good year for us. Now I would like to turn it over to Sandy Sponem for a detailed look at our financial results for the first quarter. Sandy?

Thanks, Andrew. Our financial results for the first quarter reflect a stronger equity underwriting market and improving private client activity. Net earnings and earnings-per-share improved compared to the prior periods. Piper Jaffray companies reported net earnings of 13.8 million for the quarter, compared to a net loss of 3.3 million for the fourth quarter of 2003 and 4.7 million in net earnings for the same quarter last year. Earnings per diluted share were 71 cents for the quarter, compared to a net loss of 17 cents per share last quarter and earnings of 24 cents per share for the year ago period.

I will make a few comments on performance versus both last quarter and then versus last year. Net revenue of 209.4 million was up approximately 4 percent over the sequential quarter, driven by stronger equity underwriting and increased commissions and fees from equities and equity related products in our private clients business. Total expenses were 187.2 million, down approximately 20 million, or 9.6 percent from the previous quarter, which had included $24 million in charges for the cash award program related to our separation from U.S. Bancorp and a $4 million charge for the disposal of software related to implementation of a new fixed-income trading system. Partially offsetting these decreases was an 11 percent increase in compensation expense, driven by higher variable compensation due to increased revenue and higher benefits expenses from the resetting of the 401(k) match and payroll taxes for the new year. Benefits expenses are typically highest in our first quarter and lowest in our fourth quarter.

Moving onto performance versus the prior year quarter. Net revenues were substantially stronger than the first quarter of last year, up nearly 24 percent, again, due to the improved public offering markets and increased commissions and fees from equities and equity-related products in the private clients business. Our Q1 pretax operating margin also improved substantially over the prior year to 10.6 percent of net revenues versus 4.1 percent of net revenues last year. The margin improvement was achieved through solid growth in net revenues while maintaining tight controls over increases to fixed expenses. Of course, we have necessarily added public company costs to our fixed expense base.

As Andrew mentioned at the start of the call, in connection with 2003 bonuses, we made our first equity grants in February, consisting of restricted stock and stock options, both with three-year clips vesting periods. Effective January 1, 2004, we have adopted FAS 123. Restricted stock and stock options will impact our basic EPS when the restricted stock vests and its options are exercised. The equity grants will impact our diluted EPS over the vesting period utilizing the Treasury stocks method of accounting.

Now let me turn to each of our segments, starting with capital markets. Capital markets net revenue of 111.9 million were essentially flat to the sequential quarter, while pretax segment operating income grew 9.7 percent to 19.6 million. Our equities revenue improved over the last quarter, including a 3 percent increase in institutional sales and an 18 percent increase in public offering revenue. Offsetting these increases in part was a 17 percent decline over the last quarter in our fixed income institutional sales business, primarily due to compressed spreads in our corporate products. We expect the softening and fixed income institutional sales to continue, given the increase in interest rates and yields that we saw beginning in mid-March and which continued into April.

Our fixed income investment banking business was flat to last quarter. The majority of this revenue is from public financed underwriting, including financing for cities and counties, higher education, nonprofit health-care and affordable housing. While we have seen a decrease from the peak and a leveling off of this business as refinancings have largely been completed, this business does not experience the same volatility as the taxable underwriting business as cities and counties still need to issue debt to fund infrastructure or deficits.

Pretax operating margin for this segment was 17.6 percent, compared to 16.2 percent for the previous quarter. The prior quarter included a $4 million charge for million dollars charge to earnings for a software disposal that resulted from implementation of a new fixed-income trading system.

Moving on to some comments about year-over-year. Net revenues in capital markets were up nearly 34 percent versus the year ago period, driven by a $7.6 million increase in equity institutional sales and substantially improved equity underwriting, which increased by over $22 million. These increases were offset in part by a $5.5 million decrease in fixed income's institutional sales. Total segment operating expenses of 92.2 million increased by approximately 22 percent over last year, primarily due to increases in variable compensation from increased segment profitability. Capital markets held non-compensation costs to a 6 percent increase over last year, resulting in a margin of 17.6 percent versus 9.7 percent for the last year. During the first quarter, we completed deals across all of our industry sectors. In the first quarter, we completed 25 equity offerings, raising a total of 3.6 billion in capital for our clients and placing us 15th nationally based upon number of deals completed. These results compared to completion of seven equity offerings in Q1 of last year for a total capital raised of $700 million. In the first quarter, we completed 10 M&A transactions with an enterprise value of $800 million. Based on the number of deals closed, we ranked seventh among all advisers. Among middle market advisers, which excludes investment banks with average deal sizes over $500 million, we ranked fourth nationally based on the number of deals completed.

Finally, in public finance, we underwrote 123 tax-exempt issueds nationally with a total par value of 1.4 billion. Based on number of transactions completed, we ranked number four nationally. In the upper Midwest, we completed a 70 public finance issues during the quarter for a total par value of 740 million. Based on the number of issues underwritten and aggregate par amount, we ranked number one in upper Midwest.

Turning now to our private client segment. Improving investor sentiments amongst our private clients led to higher activity levels and improved results in this business. Net revenues of 95.5 million and segment pretax operating income of 12.3 million were up approximately 8 percent and 46 percent over the sequential quarter, respectively. Total expenses of 83.3 million increased approximately 4 percent over the sequential quarter and the business generated a pretax operating margin of 12.8 percent. This higher margin is consistent with the margin improvements we began to see in the last half of last year. The margin improvement over the last quarter was due to leveraging fixed expenses, such as occupancy and data communication costs and we also experienced lower litigation expenses. Partially offsetting the margin improvement was higher benefit expenses from resetting the 401(k) match and payroll taxes for the new year. Compared to the prior year, net revenues in our private client sector increased approximately $11 million, or 13 percent and segment pretax operating income nearly doubled. In addition, client assets increased by $7 billion, or nearly 16 percent. The improvement over the prior year -- over the last quarter, and particularly over last year in our private client business was encouraging. However, we still have work to do to achieve our long-term goal of becoming one of the top performers in our public company peer group. We continue to focus on implementing initiatives to support the primary advisers' strategy and holding the line on fixed costs.

A few comments on our corporate support and other segments. Corporate support and other pretax operating loss was $8.7 million, an increased loss of approximately $2 million versus each of last quarter and last year. The higher loss was primarily due to new public company costs as a result of the spin-off from U.S. Bancorp.

Let me wrap up with a few summary comments. We continued to execute our middle market strategy, making strategic hires in selected areas. We continue to realize the benefits of a balanced capital markets portfolio as the softening and fixed income sales is being more than offset by an improved equities business. We are starting to see positive improvement in private client services. We're turning our attention to hiring the right individuals to train and develop into future financial advisers. We're off to a solid start in this area. Both businesses are focused on growing the top line, yet holding the line on fixed expenses.

Thank you everyone on the call for your attention. Now we would be happy to take your questions and I'll turn it over to the operator to facilitate the Q&A portion of the call.

(Operator Instructions). Erin Caddell, Blaylock.

Good morning, guys, how are you doing?

Very good, how are you Erin.

I just wanted to follow up on some of your comments, particularly starting with the compensation expense. Just trying to parse out, if possible, how much the quarter to quarter increase was related to I guess what I would call stock-based compensation and the resetting of the 401(k) and the payroll taxes versus how much was related to the increase of revenues? Is it possible to kind of split that out?

Yes. Most of the change in compensation rate -- compared to quarter over quarter and versus last year, if you compare to quarter over quarter, it is due to the benefits expenses. We are heavily capital markets -- a little bit over a half of our revenue is from capital markets. Many of those books are highly compensated individuals. So what ends up happening is some of the benefits expenses that entail matches or payroll tax limits tend to be much heavier in the first portion of the year. And then many of those employees have maxed out by the time you get to the fourth quarter. And that's why you see the pretty large difference quarter over quarter in our compensation ratio; it's primarily driven by the benefits expenses.

So was any of it related to the peak grants of restricted and stock options in February?

If you remember, we've adopted FAS 123, which means we are expensing stock options. And of course, restricted stock was always expensed. And what we have done is we have remixed cash and equity. So we're expecting those to kind of balance out against each other. We're not changing our overall composition rate. So to the extent that we are branding equity, we've reduced the cash portion of the incentive pool.

Got it. That is helpful. And then just more broadly going forward. Obviously, you have additional grants of stock that will come presumably next February. And I guess at your annual meeting, you're requesting approval for some additional stock. Just trying to figure out how to think about -- obviously these are ultimately dilutive. They add to the number of shares. Is your goal to have the revenue growth and the business of the Company sort of offset any potential dilution from additional option grants to employees?

Good question. We are obviously focused on getting ownership in the hands of our employees. We believe it is key to this strategy, and so we are going to, as you mentioned, continue to give equity grants each year with the annual bonus cycle. This time, we got about a 4 percent ownership in the hands of our employees, so we're pleased with that. But going forward, we do not have any specific plans right now to purchase shares, but we would manage dilution and overhang going forward. We're expecting to generate a significant amount of the excess capital through earnings over the next several years. And so we will utilize that capital either to reinvest in the business difference, if we've got good opportunities to grow the business we'll use them to repurchase shares if we need to manage earnings dilution. It is a balance, depending on business opportunities.

Thanks, one more quick one. Just on the pipeline, particularly on the equity side, the pace of new filings and obviously the quarter results were good. But just in the past few weeks here, given the choppiness in NASDAQ and the market overall, have you seen any sort of change in tone of aftermarket performance of deals? Or just, are people getting a little bit more worried? What is the overall sort of tone of the forward calendar?

We have not seen an impact at this point. So that backlog is still healthy. We have about 25 deals in backlog as of the end of the quarter and they're our spread across all of our sectors, really.

And would you have a total dollar volume of that backlog?

No, we don't.

Okay, great. That is helpful. Thank you very much.

Matthew Fischer, IRG.

Good morning. Just to stick with the backlog discussion. As far as M&A goes, where are you now compared to where you were at the end of the fourth quarter?

We have a healthy backlog of M&A. We don't publish those figures. But the backlog is healthy and if anything, has been growing.

A little discussion on the -- the public company costs, or actually I'm sorry. If we could talk briefly about the -- you mentioned the training costs associated with private client services. Going forward, is that going to have an impact on the margin in that business segment since you are looking to increase your base 3-to-1 using new FAs?

Yes. We've talked a little bit about our recruiting plans in the past and we are planning on recruiting a mix of experienced brokers as well as trainees, but more heavily weighted towards the trainees. Our history and prior experience tells us that some of the most successful financial advisers that we have at the firm here are folks that we have hired and trained in our particular methodology of working in the financial advisory model. So we feel that we can be a little bit more successful there. The other element is that -- it is expensive to recruit inexperienced brokers and we think we can actually get a higher return on hiring and training our own financial advisers, so we're more heavily mixed toward that. It does take a period of time to ramp them up and we have stated that we think the turnaround in the improvement in our private client business is a longer time frame.

So in the near-term, the run rate for the private clients business, as far as the operating margin, is -- do you make the 10 -- the operating margins that you were able to achieve in the first quarter is a reasonable estimate going forward?

We're not giving guidance on earnings. So longer term, again, let turn the focus to longer term. We're focusing more on trainees than hiring experienced brokers.

Okay. Thank you.

Leo Harmon, Fiduciary Management.

Hi. Good morning. Just a couple of questions, if I may. Could you talk about the mix of business within the capital markets between equity and fixed income this quarter versus the last year's first quarter?

Sure. We have actually included a supplementary schedule in our earnings release and I won't turn your attention to that. It does give a breakout of our capital markets business. But we did see fall-off in our fixed income institutional business during the quarter. I will remind you that we are coming off two very strong record years in fixed income. And in particular last year, a good portion of our growth in fixed income came in the product lines of mortgages and in corporate. In the first quarter of 2004, we continued to see growth in our mortgage business. It was really the corporate side of the business where revenues declined. And I will say that in our corporate business last year, it tended to be more focused in products where we offered proprietary research. And so because of that more narrow focus, we are subject to variances in what is happening in that particular product quarter over quarter, and you can have more lumpy results. I will say that, and Andrew mentioned this -- we hired a team of sales and traders in corporate bonds that offer a product set that is much more broad. And so we believe that is a great addition to our business to kind of broaden out the corporate capabilities beyond where we are offering proprietary research. So it's a good growth focus for us in the future.

Secondly, how should we look at the other expense line going forward? Were there any onetime issues in the quarter that will sort of come out of that line? And where should we be managing that line to?

let me talk a little bit about other expenses, both versus the sequential quarter and then versus the same quarter last year. If you look at -- and it's very -- in relation to the sequential quarter, last fourth quarter of 2003 included some litigation charges. And so that is why that was a little bit higher than what you saw in the first quarter of 2004. Now litigation charges are difficult to predict if and when they're going to happen. So that is a little bit difficult to put into your run rate. And if I look at the comparison to first quarter of last year, the increase in other is primarily related to public company costs. In particular, directors and officers insurance is in that line item. And so that was a fairly significant portion of the public company costs.

And then comp expense for the year -- I know you guys talked about not giving guidance for earnings. But could to give us a little bit of guidance of where you expect comp expense for the year to be relative to revenues and where you would like to manage that ideally relative to revenues?

Again, we're not giving guidance. But I will say that the compensation ratio is going to vary, depending on business mix to a certain extent because the capital markets and compensation ratios tend to be lower than private clients. So depending on the growth of those two units relative to each other, that will impact mix. Also to the degree we engage in recruiting, that can impact the mix. But we don't have any plans to in any way change our current compensation plans. So it is really more of a mix in growth and recruiting issue.

Thank you very much.

Stephen Vilgod (ph), Cathay Financial.

My question has been asked and answered. Thank you.

Lauren Smith, Keefe, Bruyette.

Good morning. A couple of questions. Firstly, with respect to employee headcount, in total I guess you were up by 28 and FAs were down by about 7, so that's like an increase of about 35. So on the private clients, I know you said you think the attrition trends there are sort of stabilizing. Is that correct?

That's true. We've definitely seen a slowdown in the attrition. Most of the attrition we were gearing to achieve, which was to the lower end producers, has happened.

So when I look at the quarter on quarter increase in headcount then overall, it has been pretty meaningful. And certainly, you've made good I guess opportunistic and strategic hires and good technology, the fixed income and then various sectors and research. So how should we be thinking about the next couple of quarters? And would you characterize this as that seasonal factor, year-end bonuses done and there were opportunities, or are there certain holes that you feel that you are strategically filling?

I would not say there's holes that we're filling, but we're looking -- we have a tremendous opportunity right now just having become public. We have the opportunity for employees to be an owner of the Company going forward. So we think we have a tremendous opportunity to recruit. We have a great platform. We like our middle markets focus. So we're going to be selectively recruiting, continue to do that. Most of the increase from year end was in the capital markets area and in research.

So it's really still, the focus being adding debt then, versus necessarily.

We've added -- a lot of it is sales capability.

Any further thoughts on adding another vertical focus to your platform? Is it still about just adding the depth and what your existing focus is?

At this point, we're concentrating on adding depth.

Just shifting gears for a second and just back to the pipeline and when you talk about I guess there's 20-plus or 25 deals, what do the mix of lead and co (ph) look like if you have that or?

We have -- nine of the 25 are lead or --

Lead or co-lead; the rest are co-managed.

Great. I apologize - sort of bouncing around with topics. But when I look at shifting gears to the expense side, I noticed that for brokerage and clearing, expenses were down, yet revenues, I would think the associated revenues were up. Anything changing there structurally or that we ought to be thinking about?

We have a program that we implemented sometime around second quarter or third quarter last year to really try and manage down the ECN charges. And so we are getting additional intelligence about where trays (ph) are being routed and have been able to manage down ECN charges because of that.

Okay. So we think this is positively sort of stabilizing?

I think mid-year, this should stabilize.

I think that is in for me. Thank you.

(Operator Instructions). Justin Hughes, Philadelphia Financial.

Good morning. First of all, on your institutional fixed income, you said that was down sequentially because spreads tightened during the quarter. Typically, investment banks speak positively about quarters where they have tightening spreads. Why is that different for you guys?

One thing that's quite different about our business is remember, we're not a proprietary trading shop. When we maintain inventories, it's for customer flow. And we tend to almost entirely hedge our inventories. We have a very high hedge ratio. So for us, the spread is what we earn on the trade because we are not trading for our own account. So when spreads tighten, our net sales commission generally decreases.

I follow your thinking there. On your share count, shares were just issued in February. And I know there is some vesting periods. What are you estimating the share count at the end of this year, and will you be repurchasing stock to offset any dilution?

I will start with the second question first. We have no plans to repurchase stock at this point in time. We will continue to evaluate that over time. And as far as impact of shares into our diluted shares, it's going to depend upon what happens with the stock price. We're going to be applying the Treasury stock method of accounting, which basically kind of technical, but basically you assume you're able to repurchase as many shares as the options have been exercised and so forth. But it depends on where the stock price is at the end of the year.

What if it's just flat from the current price?

We haven't calculated that.

Last question. Is there any update on the NASD recommended an enforcement action for IPO spending. Did they also recommended dollar amount, and is there any update there and when do you expect to resolve it?

I'm going to refer you to the disclosure we made in our annual report on form 10-K. That has an updated litigation disclosure. And then of course, when we file our 10-Q for the quarter, we will be updating that. So I will refer you to that.

Okay, thank you.

We have no further questions at this time. Are there any closing remarks?

Not at this time.

Thank you eveyone for joining us today.

Let me add my thanks as well. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may all disconnect.