Piper Sandler Companies (PIPR) 2004 Q3 法說會逐字稿

Please stand by for real-time transcript. The Piper Jaffray conference call will begin momentarily.

Welcome to the Piper Jaffray conference call. To discuss 2004 third quarter results. My name is Valerie, and I'll be your conference facilitator today. Chairman and CEO Andrew Duff, and Chief Financial Officer Sandra Sponem are your hosts for the call. During the question-and-answer session, securities industry professionals may ask questions by pressing star and then the number one on your telephone. As informed earlier, individual shareholders and the members of the media to who have questions are invited to contact Piper Jaffray after this call to have their questions addressed. Now, I'll turn the call over to Jennifer Olson-Goude, Director of Investor Relations.

Good morning, and welcome to the Piper Jaffray third quarter conference call. Statements made on this call that are not historical or current facts, including statements about beliefs and expectations are forward-looking statements that involve inherent risks and uncertainties. Factors that could cause actual results to differ materially from those anticipated are identified in our reports on File with the S.E.C., and our available at our website at www.PiperJaffray.com and at the S.E.C.'s website at www.SEC.gov. And now I'd like to turn the call over to Andrew Duff. Andrew?

Thanks, Jennifer, and good morning to everyone joining us today. We'll cover three topics this morning. First, I'll give some highs for each of our business segments, Sandy will cover our third quarter financial results, and then we'd be happy to take your questions. Despite the continued challenging market conditions reflected in our results, we had several business highlights that I'll cover this morning. First, Capital Markets, which consist of fixed income capital markets and equities and investment banking. Equity underwriting and M&A activities flowed during the quarter are and did not offset the continued softness in fixed income institutional sales and trading, however, our public finance revenue strengthened over the second quarter and this, this business was the most active since the second quarter of 2003 in terms of the number of transactions and par amount.

We continue to maintain our strong national ranking in leading position in the upper Midwest in public finance. In addition, while equity underwriting activities flowed during the summer, we increased our share of the business. Based on the number of completed deals our rank improved to 10th for the quarter, up from 13th in the second quarter. Year-to-date, we ranked 12th, making us the leading middle-market investment bank based on completed transactions. Our equity underwriting backlog declined during the quarter as new deals were not filed to replenish those that we have completed. As in the second quarter, we did some deals down sized or withdrawn, and pricing of IPOs deals, at our below our offering range. Our M&A pipeline is healthy, and year-to-date our ratio of closed transactions to total deals has improved over last year. Despite the short-term market challenges, are working to ensure long term profitable growth of Capital Markets.

In that regard, we are very pleased to announce during the quarter are the definitive agreement to acquire Vie Securities. We believe this acquisition will enable Piper Jaffray to meet the increasing client demand for automated cost-effective equity trading services. We evaluated several alternatives for entering the electronic trading business, we ask believe Vie Securities was the best strategic fit for our clients and our firm. We will continue to offer high touch execution services and expect this new acquisition to be complimentary to our exisiting capabilities. We expect the transaction to close in the fourth quarter. Now let me comment on Private Client Services segment. We continue to execute our strategy for this business, which is to become the primarily financial adviser for or our clients. Importantly, year to date, the segment margin has improved from the low point last year, and has generally stabilized as a result of cost discipline.

Recruiting continues to be slow, but we are encouraged by the slight increase in the total number of financial advisors in the third quarter. The up tick reverses a prolonged negative trend. We are laying the foundation in Private Client Services and we believe improved financial results will follow, but they do take time. In summary, capital markets results softened in the face of a challenging market condition, but the business is fundamentally healthy. The acquisition of Vie Securities provides a critical capability that we did not have previously. We are advancing our primary financial advisory strategy in Private Client Services, although additional improvements in financial results will take time to realize. Now Sandy will provide a detailed look at our financial results for the third quarter.

Thanks, Andrew. Third quarter net income of 11.8 million, and diluted earnings per share of 61 cents declined from 16 million of net income and 83 cents per diluted share for the year ago period. Last year's results were fueled by near record fixed income institutional sales and trading activity, and strong equity underwriting. For the nine months, net income and earnings per diluted share both rose 30% to 38.5 million, and $1.99 respectively, compared to the same period last year. Net revenues increased to nearly 603 million year-to-date, up 3.1% over last year. Year-to-date, our pre-tax margin was 10.2%, a marked improvement from 7.9% last year.

For the first nine months we have lowered both our compensation and non-compensation expense ratios. Third quarter net revenues declined 24.5 million, or 11.6% from the prior year period. The decrease was mainly due to three areas. First, commissions and fees declined by 2.6 million, due to reduced Private Client activity and fewer financial advisors. In addition, principle transactions decreased by 11.8 million, or 22.8%, primarily due to lower fixed income institutional sales and trading activities. Once again, the year-over-year comparisons are tough, given that the fixed income business achieved near record revenues in the third quarter of last year.

Finally, investment banking revenues declined 9.8 million, driven by fewer equity underwriting transactions. On a sequential quarter basis, net revenues decreased by about 9%. Contributing to the decline were lower revenues in Private Client Services, institutional sales and trading, and equity investment banking. For the third quarter, non-interest expenses totaled 167.7 million, an improvement of 9.3% from the third quarter of 2003. The decrease was mainly due to lower variable compensation costs. Non-compensation expenses were 53.5 million for the third quarter, down 3.5% from last year. Lower litigation-related expenses were offset by cost increases in three areas. First of the all, investments in technology, secondly, additional expenses to support our expanded fixed income sales distribution, and thirdly, new public company costs. On a sequential quarter basis, non-interest expenses improved 10.2%, primarily due to lower variable compensation costs.

Now I'll cover the segment results. Capital markets recorded 101.3 million in net revenues for the third quarter, down 19 million, or 15.8% from the year -- the prior year period. Segment pre-tax operating income for the quarter decreased 31% to 17.3 million. The decline in revenue compared to the year ago period was mainly driven by two areas. Fixed income institutional sales and trading revenue declined by 8.6 million. In the third quarter last year, this business had near record results in high yield corporatel bonds where we have proprietary research. In addition, equity investment banking declined by 8.2 million. Equity underwriting revenues had rebounded in the year ago period, given the particularly soft markets in the first half of 2003. For the third quarter, public finance underwriting and M&A revenues were very consistent with last year.

Compared to the second quarter, Capital Markets revenues declined by 12.3 million or 10.8%. The main contributor to the decline was fixed income and equity institutional sales and trading revenues. These businesses slowed by 9.7 million, caused by lower trading volumes. We did see stronger public finance underwriting sequentially, as Andrew noted earlier, the third quarter was our most active public finance period year-to-date. Segment operating expenses for the quarter were $84 million, a decline of 11.3 million from the year ago period. The 11.8% decline in expenses was mainly due to lower variable compensation costs. Segment operating margin of 17.1% was in line with the annual historical margins in this business. Now moving on to Private Client Services. Private Client Services recorded net revenues of 83.7 million, down 6 million compared to the third quarter of 2003.

The 6.6% decline was driven by lower Private Client activity, and fewer financial advisors. Net revenues also declined sequentially due to uncertain financial markets and slower summer trading. Segment pre-tax operating income was 12.1 million, down 3.6% from the third quarter of 2003, but up 2.4% from the prior quarter. Segment operating expenses were 71.6 million for the quarter, or a reduction of 7.1% compared to the year ago period. Reduced compensation costs drove the decrease. For the quarter, segment operating margin was 14.5%, though topline growth has been challenging the last two quarters, we have been able to maintain the improved pre-tax margins through cost controls. The corporate support and other pre-tax operating loss was 9.6 million for the third quarter, which was relatively consistent with the provide year period and the previous quarter. In summary, more challenging market conditions impacted results in Private Client Services and particularly Capital Markets.

However, we have maintained attractive margins in Capital Markets and year-to-date we have considerably improved margins in Private Client Services, which in turn has improved overall firm profitability.

Thank you, Sandy. That concludes our prepared comments. Now Sandy and I will be happy to take any questions.

And the first question is from Matt Fischer of IRG Research.

Good morning, Matt.

Hello, Mr. Fischer, your line is open at this time, sir. At this time, we will proceed with Justin Hughes of Philadelphia Finance.

Good morning. Just a couple of questions. First of all, what kind of financial impact should we expect from exiting the VC business, where there was an announcement, I think, last week?

Yes, we did announce last week that we're exiting the venture capital business, and we're not expecting that to have a material impact on our financial statements. That business was relatively small. We didn't have significant linkages with our remaining businesses, and so that's why we decided to exit that business.

Will there be any charges or gains on exit?

No, no material impact to the financial statement.

Okay. Second of all, you settled with the -- I don't the if it was S.E.C. or NASD on IPO spending, and there was a 2.4 million settlement. I don't see anything in your income statement, is that because U.S. Bank Corp. picked that, picked that up?

Yes, that litigation matter was included in the indemnification matters supplied by U.S. Bancorp.

Okay. And then the last item on your just, Other Expenses, that went from -- it had been a run rate of you know, close to $8 million, and it went down to 1.7 million this quarter.

Right.

You mentioned, you said that lower litigation was offset by higher technology, but what - is it just litigation that is driving that, you know, basically 6 million decline quarter to quarter.

Yeah, let me talk a little by bout that. The Other Expense category includes several items that can fluctuate from quarter to quarter. We've got, as you mentioned, litigation costs in. Also, should we take any loan losses related to forgiveable loans to financial advisors, that would be in that category. Also, Minority Interest expense related to some of our Private Equity investments, and then lastly the other large category in there is Public Company costs, which that last category tends to be a little bit stable from quarter to quarter, but the other items can fluctuate a bit. So in the second quarter, we had a significant minority interest expenses that we actually disclosed on the last earnings conference call for $3 million. It was related to a private equity investment gain that quarter. In addition, our litigation costs did decrease quarter over quarter.

Okay. And most importantly, what should we consider the run rate? Was there any reversals of loan accruals, or just lower? What should we look for going forward?

We don't -- as I think you know, we don't give earnings guidance, and we particularly don't give guidance on a particular line item within the financial statements, so we don't really comment on what we think future trends will be in that line item.

Okay. And there was no reversal of accruals in there?

No, every quarter we go through a process of reviewing our outstanding litigation matters, and on a quarter by quarter basis determine whether or not we need additional reserves, or if we're over-reserved, or overexpensed, so that's a process we go through every quart per.

Okay, so there's nothing added to the loan losses this quart per

That's correct

Okay. Thank you.

Your next question from Steven Eiseman of Front Point.

Yeah, hi. Not to beat a dead horse but on the Other Expense line item, could you say what the major delta change between the second quarter and the third quarter was?

Yeah, again, it was in the second quarter of 2004, we had a significant minority interest expense of $3 million related to a private equity grain that is reflected in other income, that offset that, and then also lower litigation expenses.

Okay. Thank you.

The next question is from Tisha Jackson of Credit Suisse Asset.

Hi, how are you doing?

Good morning.

I just wanted to ask if you could maybe update us on the technology front in terms of the financial advisors, how that is coming along. And, also, just kind of how you're feeling about the Private Client Services business, and, you know, perhaps when we might be able to see some traction in terms of new assets under management, and, you know, becoming preferred financial advisor for your clients, and kind of what numbers you look at to monitor that.

Let me ask you a question first, and then I think of you got several here that I can answer. What reference are you making to the technology? Are you referring to something specific, or --

Right. I guess the last time I spoke with you all, you had mentioned that you were going to be rolling out some technology that would allow the advisors to look at their relationships, and understand the profitability of each relationship, so that they could use time management better.

Yep. You bet. Let me start with that. We are in the process of that. We started, actually, I think, at the beginning, maybe the tailend of the second quarter, but it was a big part of this quarter and will continue through the balance of the year in a series of meetings we are introducing a client relationship management tool called the Compass, and the Cube, that show each of our advisors essentially the very comprehensive view of each relationship. The number of products, the assets under management, the yield, and through that, we believe there's a big opportunity for each and every one of them to thoughtfully manage their business successfully. That will take time. Obviously, to familiarize everyone with the tool. Secondly, you asked about how we feel about that business in general. As you heard in Sandy's comments, obviously we experienced some of the softness in the equity market, as well as everyone else, but do believe we've done a nice job to maintain the margin, and also, as I referenced, this is the first quarter in some time where we've actually net added advisors. That also will be a longer term project, as we've said several times, due to our previous status, our pipeline had gone dry, and we started those efforts at the begin go ahead of the year, and we're beginning to see some of the benefits of that, but it's a long-term project.

And I've already forgotten the name of one of them, but the Compass and the other--

Cube.

Cube?

Sorry, just company lingo.

Those two products are available, but in the process of kind of getting rolled out, and training?

Exactly. They are -- they're very indepth, and there's a significant training element to, to really understand all of the information and start applying it and using it to manage your business is going to take some time, and we've been spending quite a bit this quarter, expect in this fourth quarter, as well as next year, that there's a substantial training component.

Okay. Great. Well, thank you very much.

Thank you.

The next question is from Charles Grigg of Atlas Capital.

Good morning.

Good morning.

Again, not to beat a dead horse, I did have a follow-up question on the Other Operating Expenses. Could you give us a little color on the first quarter relative to the second quarter, because those two quarters were fairly stable.

Again, the fluctuations you're going to see from quarter to quarter will be litigation costs, loan loss reserves, and minority interest, so there was higher litigation costs in the first quarter.

Okay. And generally speaking, is it tied to activity at the PCS level, or - how should we think about that?

I, I, I -- the way I would look at is, is much like other firms in the industry when the market's bubble burst in 2000, there has been, you know, a significant increase in the number of litigation matters, and I would say it has been across pretty much all elements of the business, not necessarily focused in either Private Client or Capital Markets. And as an industry we're working through all of those matters. I do think that we're seeing the number of new matters arising is slowing, and so that's a good trend, but there's a significant backlog to work through, and there will continue to be potentially litigation expenses as we work through our portion of that backlog. We do have a very full some discussion of any of our outstanding litigation matters in the 10-Q, and I'll refer you to that, as well.

My last question was with regard to your book value and your ROE, and I want to just get a sense of -- I know you don't give guidance, but current consensus right now is in the kind of 260, to 265 range, and on a stated book that would be about a 7% ROE, and 12, 13% ROE on tangibles. How should we think about your ability to earn an adequate return on your stated book or tangible book, and what are your objectives, and when do you think you'll be able to get to those ROE levels? Because on a stated basis your ROEs just look low relative to your peers.

Yeah, we tend to measure ourselves on a tangible basis. We do have the good will on our books that was related to our original acquisition by U.S. Bancorp, and so inorder to be more comparable to the competitors, we look at tangible returns, but we don't give specific guidance, again, or --

I understand.

-- or targets, but again our goal is to be a top performer in the Public Company peer group, and I know there's not a large group there, but the firms we're focusing on are Raymond James, A. G. Edwards, and the Jeffrys Group, and I'd say relative to return on tangibles, we're fairly competetive year to date, and we want to, you know, we want to continue to be, you know, maintain in the top tier there.

Do you think the good will that was pushed down by the U.S. Bank Corp. is likely to be evaluated for impairment?

Well, obviously we follow the accounting rules, which require those, you know, to be evaluated annually for impairment, so we do, we follow that accounting process, and, you know, at this - this point, we don't see any reason why there would be an impairment of the asset, based on our valuation.

Okay. Thank you. Appreciate it.

Yep.

The next question is from Matt Fischer of IRG Research.

Hi, good morning, again.

Good morning, Matt.

Can you elaborate on investment banking backlog, just in how many equity deals now, you know, compared to last quarter's end, and how many are lead or co-lead?

A couple of comments, Matt. It's Andrew. Our current backlog is eight underwritings, which leaves us at 18th. In the second quarter, in the weaker environment, we did actually complete, albeit in some cases at lower levels, more transactions than we ended up filing. Some of the more active sectors, no doubt you see this continue to be reads and energy, neither of the which are we particularly active in, but our current ranking is eight filed offerings.

Okay, and how many are lead or co-lead?

I apologize that I don't have that flight front of me.

Okay.

Hang on, I'll get it.

If you have a follow-up question, we're looking it up right now.

Okay, and then on the M&A side, also, you sometimes give some more color on the deals in that backlog.

We don't publicly disclose it. We did characterize it as remaining healthy.

Okay. And I guess also looking at the FAs, I think you touched on it, but you had, I guess plus three in the financial advisors. I was wondering if you made -- although you said recruiting is difficult, if you have made any significant upgrades during the quarter, as far as bringing in new people, and getting rid of some of the lower performers?

Let me maybe make some general comments directly on that, Matt. We talked about that regrowing our FA headcount is a clear part of our strategy. We intend to disproportionately do that by bringing people into the industry that we think have related business skills and relationship management capabilities, and/or potential relationships, that they've already developed that then can be trained into what we view as the appropriate financial advisory process that's consist with where we're headed in our firm and our primary advisory strategy. We are recruiting from experienced FAs in the industry currently. Our approach there is to be quite selective. We do think we're a relatively unique value proposition, employee proposition if you will, if you look at the marketplace today, the size of our firm, our capabilities, our culture, our intention to have employee ownership, so we believe over time we'll get our fair share of that. Again, I would reference the fact that due to our previous ownership structure, we essentially had been out of that business of recruiting for really, the better part of two years, which is a pretty tough spot to be in, and had to restart those at the beginning of the year, and we're beginning to see the benefit of that. But it's going to take us time, and as we suggested, net positive here, which was relatively minor clearly, just up a couple of advisors is the first up quarter in quite an extended period of time period of time, so really signs of the progress.

Okay.

And let me go back to your Capital Markets. Of the eight filed, actually four of them are led managed, leader co, which is disproportionately a little higher for us than it typically is. Right. Okay. And and you touched on progress in turning some of the progress of turning trainees in producers,in the PCS, if you could come back to that? I'm not sure what you're asking, Matt.

Through your training programs, like when can we start to see some of the trainees, you know --

Typically we view someone as a full financial advisor in the business at the end of five years.

Okay.

And the people joining us are at various stage. Some we call a new recruit even if they've six months experience at another term. Some are absolutely brand new to the industry who we trained and licensed from the get go, but the full term of becoming a full financial advisor we view as a five year process.

Okay, great.Thank you.

Thank you.

As a reminder, to ask questions, you may do so by pressing star and then the number 1 on your telephone. And we'll pause for just a moment to compile the Q&A roster. And we do have a question from Lauren Smith of KBW.

Good morning, Lauren.

A couple of questions. One on expenses, but not Other Expenses. Just looking at just a couple of the line items, you know, occupancy and equipment, marketing and development, and outside services, the trend higher quarter on quarter. Pardon me, actually marketing down, so I'm assuming that's something seasonal, but outside services and occupancy, and equipment, do you take on additional space? Is it a function of new hires for the first one? And then outside services, what would that be attributable to? That opens or -

Right. We've got a technology project in process, and that's driving both occupancy and equipment and outside services. We are converting a -- one of our systems, or actually a group of our systems, to a more efficient and cost effective operating platform, the conversion is expected to be completed in first quarter, early -- actually, early in 2005, and so those are project expenses related to that conversion.

So if its going to be completed in 1Q '05, it's - you know, these are sort of you know, temporary?

Yeah, temporary, I would describe them as.

Okay. And then on the cash award line item, you know, certainly I know it's a function of, you know, you have to be employed there to get paid. But when we look out, I know at least, you know, initially the amounts you that you all - that you had disclosed. It looks like you would be running below that, but is there any -- I know, I guess it's a tough question to ask, but I'm just trying to think, is anything changed with respect to that, or is it literally just going to be a quarter to quarter, and it - you know, kind of moving around, depending upon how many people are on board or leave?

Yeah, that exactly right. We made an initial estimate of what kind of atrition we thought we might have, and as you know actual results come in, we'll have to true that up, so that's really what's happening.

And then on the tax rate, was there anything of note there, because it was actually lower than I know I was modeling, by like a full percentage point?

Yes, we did a year-to-date true up. Our ratio of municipal interest income to other non-municipal interest income was a little higher, which has some tax be favorability to the treatment of it, so we lowered our tax rate accordingly.

Okay.

The year to date number is a good estimate of where we think we'll be.

Okay. And then just on that, looking at the principle transaction revenue, anything else to be thinking there, other than kind of track the overall decline in institutional sales - revenues? It was kind of dead, the length quarter decline was pretty -- you know, 20%, but institutional sales, total, overall was down almost the direct amount. I mean, anything else?

Yeah, no again, in the prior year, we had the very strong results from our fixed income group particularly in the high yield area where we had proprietary research, but then length is just, just softness in volumes, basically, both in equities and fixed income.

Okay. And I guess just lastly, and it's just sort of bigger picture and I know a little touchy feely but, when you looked over the courts of the quarter and the progression in Private Client, did it it start to get meaningfully better at the back spend in because I know now that you know, certainly different customer base, but it does sort of shed light on the change or hopefully improvement in the markets, but with Schwab and Ameritrade and some of the others that have reported activity, and September's up, and even early October indication trading is up. Are you starting to feel anything differently from your client base when you look out in the branches and the like?

First of all, we don't really comment about monthly progressions within the quarter, but I would say the market generally speaking continues to be pretty challenging. They feel like there's still uncertainty around what's happening with the economy, interest rates, et cetera.

And then just one last question on Vie Securities. I know when you first announced this, you said it was immaterial to '04 and '05 earnings? Is that being kind of conservative do you think, you know, if it's closing in the the fourth quarter, and you know as you bring on that platform, which seems to be already, you know, in place, which seems like it would just be sort of a plug in into your institutional business.

Yeah, Lauren it's Andrew. Our view that is obviously we're going to close here at the tail end of this year, so it understandably doesn't have an an impact. That it's going to be take us a year to get it effectively in front of our client base.

Okay. Thanks very much.

As an additional reminder, to ask questions, please press star and then the number 1 on your telephone. And the next question from Aaron Kadell of Hobb Day Capital.

Hey good morning, guys.

Good morning.

Just a follow up question to the last on Vie. Is there any calculation you can make on the good will or basically that the capital and tangible impact of that transaction?

We have announced the purchase price, which was $15 million, and that's about it.

So you don't have a -- is, is there anytime estimate you can give of the good will?

No, we're not disclosing or talking but to that at this point. When that closing we'll have a very full some discussion of that. Fine. Okay, thanks.

The next question from Justin Hughes again of Philadelphia Financial.

Hi, just one follow-up. I think Warren touched on this a little bit. On the loan loss provisions, that's related to the FAs, correct?

Yeah, in the prior year we took an $8.8 million loan loss provision when we transitioned to the new compensation plan, assuming that we were going to have a little bit of atrition related to that and particularly they were planning at the lower end to have atrition.

We took that the second quarter of '03, and anticipated that it would probably take about a year.

Okay. And that's because you're expecting on the new plan that you would have more of the brokers leave, but when they leave early, don't they have to pay back those loans?

Yes, in theory, they're written that way. Our experience is, and our assumption was that in fact it might be very challenging to recoup. That many are leaving the industry. In fact frankly, many of them are leaving the industry, so we took a charge in anticipation of difficulty in recollecting.

I gotcha. Okay, so assume that it could would be hard to recollect those. Aren't there new loan forgiveness as you hire ne FAs to replace them? I mean aren't those forgiven over time as well?

We still use loans in our recruiting on occasion, and they're typically set up with a forgivable nature.

Yeah, and the cost of ongoing recruiting, such as forgivable loans is included in compensation costs on the financial statements.

so those loans, those loan forgiveness, I think it's over two years typically --

Yean, if the employees -- if the financial adviser is here is producing returns and some working with their clients, the loan forgiveness is considered compensation, and it is accrued to them as compensation during the time period of the loan.

Okay. I follow now. Thank you.

the next question is from Adrian McKay of Freestyle Fund Management.

Good morning. Could you guys at least qualitatively characterize your over all backlog in terms of deal flow, M&A, and whatever you generally view from that standpoint now, compared to when the second quarter call took place?

The filed public equity underwritings, as we disclosed, are now currently eight. Half of them led or co-lead. That's down from the end of the second quarter as we actually completed more transactions in the third quarter than got filed, and our M&A backlog, we don't disclose specifically, but did make a qualitative comment as we did at the end of the second quarter, remains healthy, and our close rate remains consistent.

Can you -- if you put the whole picture together, where does that leave you, on a relative basis.

We don't make forward-looking statements. That's as much qualitative comment that I think I can effectively give you.

All right. Thank.

And at this time there are no further questions. Mr. Duff, are there any closing remarks?

No, thank you all very much for the attendance and the good questions. Have a good day.

This concludes today's Piper Jaffray 2004 third quarter results conference. You may disconnect.