Piper Sandler Companies (PIPR) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Piper Jaffray conference call to review second-quarter 2005 financial results. My name is Kelly, and I will be your conference facilitator today. (OPERATOR INSTRUCTIONS). During the question-and-answer session, management has asked that the media and individual shareholders remain in listen-only mode.

I would now like to turn the conference over to Andrew Duff, Chairman and CEO. Please go ahead.

Thank you. Good morning and welcome everyone. For comments this morning, I am going to speak to trends in the quarter, give a strategic update, and turn it over to Sandy for details on the quarter.

Let me begin with the quarter. We had mixed business results versus the first quarter; improved sales and trading on the institutional side; a very strong public finance quarter, offset by weaker Private Client Services' revenue and a slow M&A quarter.

Back to the sales and trading, fixed income was up quarter over quarter. This was driven by interest rate products, as well as the general municipal revenues -- both up. Offsetting that slightly were corporate bond revenues, which continue to be weak.

From the equities, sales and trading, we were also up for the quarter, essentially across the board. We had improved convertible sales and trading results, increased APT revenues, and our cash equity business was up as well.

Turning to investment banking, results were mixed. M&A was down significantly. Recognize this is a substantial and lumpy business for Piper Jaffray. Our backlog for the second half is now very strong.

Public finance had one of its strongest quarters ever. Our equity underwriting was soft. We had no convertible issuance in a tough environment. IPOs and follow-ons were up slightly. From a market position, our economic fee share was up 19% versus the first half of 2004, as we continue to gain share. Our backlog is also up modestly -- now at 14, up from 8 at the beginning of the quarter.

Private Client Services were soft. Fee-based revenue continued to increase, a partial offset to transactional revenue decline. Our financial adviser headcount was essentially flat to the first quarter, and we continue to work hard at the balance -- balancing the level of resources with a tight focus in driving our primary advisory strategy. That includes training on now a broad Wealth Management product set. We recognize our investment here continues to be ahead of the revenues.

Let me turn to the strategic. We continue to advance our strategic review and positioning. Our goal is to consistently achieve primary advisory status with our clients and diversify revenues, delivering more consistent performance throughout market cycles. These two objectives converge as one, as we tightly focus on specific market niches; grow our product breadth, which is incomplete at this point; and deliver consistently our proprietary knowledge, advice and products to our clients.

Consistent with that strategy, we repositioned fixed income around two focused businesses. Both areas are clearly differentiated, well-positioned, and can grow from strength. First, public finance services. We integrated sales, trading and public finance investment banking, which had previously been organized functionally. The opportunity is to grow deeper market penetration and expand into new geographies and continue to add new products. Year-to-date, we added 4 senior bankers, now totaling nearly 80.

High yield and structured products moved to corporate and institutional services. Again, we are now allied with key investment banking franchises, corporate issuers and private equity sponsors. We intend to develop a debt capability to serve their needs more completely. Over time, we will be able to add additional proprietary products to our institutional clients with aligned sales, trading and research. This follows the merger of our debt capital markets into a single Capital Markets group last year with the same objective.

We are redirecting fixed income sales efforts from a more generalist advisory across traditional fixed income products to a more proprietary product and research strength.

We announced last week a strengthening in our primary healthcare franchise. We expanded our European unit significantly, adding a team of 14 that included banking, research, sales and trading. This is a significant increase to our capabilities to provide European healthcare companies access to both UK and U.S. markets -- again, leveraging a leading, differentiated banking franchise at Piper Jaffray.

Finally, we implemented cost reduction measures, aligning our costs with our revenues. Know that we will aggressively manage these over time. We will aggressively manage these over time.

I am very confident these actions are right for our clients and position us for improved performance. Sandy?

Thanks, Andrew. First, I will review the consolidated results for the second quarter, and then I will provide details on the segment.

For the second quarter, Piper Jaffray reported net revenues of 179.7 million, down 13.3% from the second quarter of 2004 and flat with the preceding quarter. We recorded net income of 1.2 million, or $0.06 per diluted share, which compared to $13 million, or $0.67 per diluted share, in the second quarter of 2004, and 73 million, or $0.38 per diluted share, in the first quarter of this year.

As previously announced, the second quarter included a pretax restructuring charge of 8.6 million, or $0.29 per diluted share after-tax, comprised of approximately 4.9 million in severance benefits and approximately 3.7 million related to the reduction of leased office space. We expect these expense reduction measures to generate annual pretax cost savings of approximately $10 million.

Given the timing of these actions occurred late in the quarter, minimal expense savings were realized in the second quarter. Of the estimated $10 million in annualized savings, approximately 4.6 million is attributable to Capital Markets and approximately 5.4 million to Private Client Services.

For ongoing operations, lower M&A revenue was the main contributor to the reduced revenue and bottom-line results in the second quarter versus the comparable year-ago period. For the second quarter of 2005, other than the pretax restructuring charge, total non-compensation expenses remained relatively unchanged from the same period last year and from the preceding quarter. The compensation ratio for the second quarter was 61.4%, in line with the same period last year and the prior quarter. Year-to-date, our compensation ratio was 61.3%, a 50 basis point improvement over the prior year. The improvement was partially driven by the savings realized from outsourcing initiatives in technology and operations.

The pretax operating margin for the quarter was 0.9% compared with a 10% margin in the second quarter last year and a 6.4% margin in the first quarter. The pretax restructuring charge negatively impacted pretax margins at approximately 480 basis points.

Finally, during the second quarter, we repurchased approximately 625,000 shares of our outstanding common stock at an average price of $29.45 under our previously announced repurchase program. The remaining authorization under the share repurchase program is for the repurchase of up to approximately 350,000 shares.

Now, I will cover our segment results, beginning with Capital Markets. In the second quarter of 2005, Capital Markets recorded 97.6 million in net revenues, down $16 million, or 14.1%, from last year, and up $5.7 million, or 6.1%, sequentially. Segment pretax operating income for the quarter was 12.9 million, down 25.3% compared to the prior-year period and an improvement of 11.7% compared to the first quarter of 2005. Lower mergers and acquisitions revenues primarily accounted for the decline in Capital Markets revenue compared to 1 year ago.

The number of M&A transactions that we closed in the second quarter was down 50% compared to an industry decline of 39%. However, M&A revenues are lumpy, and as Andrew mentioned earlier, we currently have a very strong M&A backlog for the second half of the year.

Public finance underwriting was very active during the quarter, and we recorded very strong performance. Our number and par amount of completed municipal financing outpaced the industry. Our completed transactions increased 13.5% compared to the year-ago period versus an industry increase of 12%. And our par amount increased nearly 29% versus an industry increase of 7%.

For the 3 months ended June 30, 2005, segment operating expenses for Capital Markets were 84.7 million, a decrease of 11.7 million, or 12.1%, from the same period a year ago. The decline in expenses was primarily driven by lower variable compensation expense due to lower net revenues and profitability. For the second quarter, segment pretax operating margin was 13.2% compared to 15.2% in the same quarter of last year and 12.5% in the preceding quarter. The decline is compared to a year-ago period that's largely due to the lower revenues, as previously described.

Now, turn to Private Client Services. This segment recorded net revenues of $84.1 million for the second quarter, down $5.4 million, or 6.1%, compared to the same quarter last year and down $5.1 million, or 5.7%, sequentially. For the 3 months ended June 30, 2005, segment pretax operating income was $2.1 million, down 70.2% in the second quarter of 2004 and down 56.4% sequentially.

The decline in net revenues compared to the year-ago period was attributable to lower private client transactional volume. The decline in transactional revenue was partially offset by increased revenue from fee-based accounts. Total client assets increased 4% year-over-year, while client assets and fee-based accounts increased 11%. At the end of the second quarter of 2005, 16% of client assets were in fee-based accounts.

In the second quarter, segment operating expenses were $82 million, essentially unchanged from the second quarter of last year and down 2.4 million, or 2.8%, compared to the prior quarter. Compared to the year-ago period, lower variable compensation expense due to lower net revenue was partially offset by higher litigation-related expenses. In addition, in the second quarter of last year, we reduced employee loan loss reserves related to implementation of a new compensation plan.

Segment pretax operating margin was 2.5% compared to 7.9% in the same quarter of last year and 5.4% in the first quarter. The decline, as compared to both periods, was due to lower net revenues and the increase in non-compensation expenses.

A few comments on Corporate Support and Other -- Corporate Support and Other pretax operating loss was 3.7 million for the second quarter, an increase of 1.4 million over the second quarter of 2004 and unchanged from the prior quarter. The change, compared to the second quarter of 2004, was mainly due to a net $1 million gain on a private equity investment recorded in the year-ago period.

At this point, that concludes our organized comments. And we would open it up to take questions -- Andrew and I -- from the audience.

(OPERATOR INSTRUCTIONS). Lauren Smith, Keefe, Bruyette & Woods.

A couple of questions to start off. One, could you update us on the share -- your thoughts on share repurchase? You bought back a fair amount of stock this quarter. And if I heard you write, you have up to -- under the current authorization, up to 350 left to purchase. Would you consider upping that?

Well, let me just start by, again, reminding everyone that we are organized under a 12b-1 plan, which is kind of an automated, formulaic plan for repurchasing shares. So one of the reasons why the repurchase accelerated during the second quarter is that our volumes were higher, and that the plan works as a percentage of total -- really, traded volumes. At this point, our plan is just to finish out the year with our current approved plan, and we don't have any proposals for increasing that at this time.

So it would be revisited at year end, perhaps?

Yes, that is something we look at annually.

Okay. And then could you update us on -- I am very interested in the algorithmic and program trading, and how that's positively impacting your equity sales and trading. And just give us a sense of -- I guess it came on board the end of the year. Would you say it is accretive? And just what are your thoughts there, and how you are positioning yourself with the buy-side with these capabilities?

I have a couple of comments, Lauren. Maybe the headline would be slow and growing but clearly on plan. As you stated, it came online at the end of the year. And we did not expect a material accretive value in 2005, as we introduced the products to our clients. We are progressing right on plan. And in fact, the clients that are coming online are just a little bit ahead of plan.

Over time, it gives us the opportunity to have both high touch and low touch with our key clients and the ability to manage the resources between the two. We do think it will have an impact in 2006.

Okay. Because I just was -- particularly, it was positive to see a sequential increase in the equity and institutional sales and trading, and it really wasn't the best environment. And certainly, convertibles and cash equity business had a tough quarter, so --

Exactly, it was a contributor.

Okay. And then, just sort of bigger picture -- on your Europe effort, the 14 healthcare unit, if you will, that you added in Europe is a pretty big hire. And I just -- how big is your effort in Europe, and what is your focus there, and could we see more growth out of there? And what is the contribution currently from non-U.S.?

It is relatively modest. Let me start with your final part of your question, Lauren. It is relatively modest against our overall healthcare platform, which you recognize as our leading -- one of our leading franchises. But this is significant increase there from a personal headcount; it is about a 70% increase in staff. And again, while I don't think it will have a material impact as they come online towards the end of the summer here and get integrated with our systems and get in front of clients, we do think it can have a benefit in 2006 and will be accretive. Just importantly, it's continued to build out our key franchise here in a differentiated way, and we think we can end up with a leadership position in the life sciences in the UK.

So if it was really there, it's just again on sort of this niche industry, and work -- could we think about that broadening some?

Yes. Lauren, the pattern here is to build out very carefully from where we are differentiated. I think that is just critical in today's environment.

Todd Halky, Bam (ph).

A couple of questions -- just one on the -- if I look at the after-tax impact of the charge, it looks like the actual tax rate went down about 33% from 36. That's kind of have been historic that -- that is just kind of a one-time thing?

Yes, let me comment on that. Because of the charge, what ended up happening in this quarter is our municipal, which is a revenue, which is a interest income, which is tax shielded -- comprised a higher portion of our total operating income. And so, we had a one-time benefit in the quarter. You could expect the tax rate to go up to more of a normalized rate in the subsequent quarters.

Okay, perfect. And just on the -- within -- this is maybe a two-part question -- but on the cost saves, you talked about 4.6 Capital Markets, 5.4 in PCS -- should we really see 2.5 million start of the bat next quarter? Or is that a little bit too aggressive?

No, we think -- obviously, we didn't get a lot of benefit in Q2 because the actions were taking fairly late in the quarter. But we are expecting to start experiencing the annualized run rate saves beginning in Q3. And let me just point out again, a lot of the savings is related to our reduction in workforce, and most of that were in support areas, which are fairly evenly spread across throughout the year.

Okay, so there shouldn't be anything to offset that? It should be mostly in comp, a little bit in other -- like in the non-comp.

Right.

But there is no kind of cost coming in that would offset that like --

No, as Andrew mentioned, we are very aggressively managing cost, and we are very focused on making sure we achieve all of that annualized $10 million cost savings.

So to get to my next questions -- just on the PCS business, I mean everything that we are hearing out there is that the -- it is very competitive on the pricing front to get new financial advisers -- it's extremely competitive, I guess, is the way most people are phrasing it. What are you doing? Are you kind of backing off trying to hire new advisers in order to mitigate the additional expense costs associated with there?

Yes, let me put that in some context. I think another important part of that equation is attrition, and we have made good progress there. Post our spend last year in 2004, the industry attrition rate was 15%, and we came in at 11. So I think that is a substantial accomplishment -- well below industry. And we are actually tracking a little lower this year.

From a recruiting front, we had largely anticipated this. So as you may recall, our intention is to grow 3 to 4 to 1 through developing our own financial advisers as opposed to recruiting. We would like to recruit more aggressively, but a gating factor is exactly what you just said -- frequently, in many of our markets, the trance comp (ph) available is just not an economic from our perspective. So we are not going to do it.

And then my final question, -- sorry that there is so many here -- if we took the Private Client business and we added 2.5 million to it this quarter, it was running at a 5.5% pretax -- assuming you take the cost of that -- 5.5% -- I guess then that wouldn't be right (multiple speakers) 4.5%.

You should -- if you are trying to kind of --

Because that 2.5% pretax margin just seems unbelievably low. I don't want to -- you know what I am saying?

Yes. It is very low, and it is not competitive. And let me come back and make a couple comments to that. I do believe we have the right strategy, which is to achieve primary advisory relationships with a broad wealth management approach. And what we need to do is very carefully manage those resources at this point because they are ahead of the revenues, not only the level but how they are allocated.

But inside of that, we are on an inflection point. You saw it last year. Additionally, a couple million, 5 million revenue in a quarter expands the margin very dramatically, headed towards something more competitive. And when we have revenue softness, it comes right back down. So we've got to manage that very carefully as we rebuild the margin.

Jonathan Casteleyn, Wachovia Securities.

Just looking at your non-compensation costs, if I strip out the pretax charge, you are up nearly $1 million quarter to quarter. That is about 2%. Does that negate any of the cost saves? I understand, obviously, there is some infrastructure cost you need to continue putting into the Private Client group. And it looks like your outsourcing costs are continuing to rise. How are we to rationalize that in perspective with your $2.5 million target quarterly?

Yes, I think if you look at the non-comp expenses, the primary line that is up year-over-year and quarter-over-quarter is outside services, which reflects, as you mentioned, the outsourcing efforts that we have undergone.

The way to think about is, we have taken a number of actions over the course of the last 18 months since the spin-off to outsource certain non-core technology and operations functions, and those were kind of phased in over the 18-month period. So we haven't annualized on all of those efforts yet.

However, I think you are going to see over time, the growth in that line item moderate as we start annualizing on some of those efforts. But the way to think about it is, we have the offsetting savings in compensation expense. So for example, year-over-year, for the first 6 months, our compensation ratio was down about 50 basis points. And that is despite a 13% revenue decline. So I think that -- which would tend to work against a favorable compensation ratio. So I think we have actually more than achieved the savings that was planned, and we still believe that that was the right decision to make -- to outsource some of those non-core functions.

Okay. Can you talk about some of your equipment needs in Private Client? Are you continuing to have it to maintain workstations or upgrade workstations? Because I know some of your peer group is saying that it is an ongoing process. I am just wondering if that is consistent.

That is true. In fact, it is probably on a 2 to 3-year cycle. We are actually in the process right now of upgrading our workstations. I think that project is going to be completed in August. And we actually upgraded throughout the firm.

Understood. And then is there any quantitative cost saves by consolidating -- or actually stripping out some of the fixed income businesses, separating into public finance services and corporate institutional sales? Is there any quantitative rationale there that is strictly -- solely strategic?

No, it is largely strategic. And any immediate saves were reflected in the overall effort that we took the charge for. But it is really strategic, and it is more about the growth opportunity.

Okay. And can you comment on your investment banking pipelines? We see your M&A backlog is very strong. Can you talk about your fixed income and equity pipeline?

The equity is what is on file, which is up from 8 at the beginning of the quarter to currently 14. On the fixed income side, just what is publicly filed, as well. Our fixed income can be lumpy as well. And I think you recognize that. We can have a single transaction or 2.25 that are quite significant contributors, and the following quarter, not as much so.

And the equity is up to 14 from 8 sequentially? Is that right?

Yes.

Okay. And then any case you can quantify the percentage of APT activity in your total equity trading? I know some of your peers are running about 25%. Is that consistent with--?

Ours would be more modest and beginning its ramp-up, but certainly more modest than that.

And then, adviser headcount, do you have an internal target for headcount? A decline modestly -- 3 heads quarter-to-quarter. Is there a rate you are looking to increase, pending good trainees, or do you have an internal target?

Well, we have some internal that we don't disclose. And we are largely tracking to them.

Understand. Thanks for your time.

It is a good question. Obviously, we think that additional advisers can improve our performance. So we are very focused on it.

So do you expect to grow it throughout the rest of the year? Is there a chance this line is going to tick up or--?

Our intention is to. And again, we are working both sides of the equation. I am pleased with our attrition improvement. I think that is a solid accomplishment. And if we can continue to recruit selectively and develop the right people, that is an improving picture.

Gabriel Kim (ph), Fastwood (ph) Partners.

I apologize if this question has been asked previously. But I am just wondering, the $10 million in cost savings, how much of that do you anticipate is going to be offset by new spending? And I am just reading your press release, and it sounds like you are building out other core strengths and expanding into other areas. So how much of this 10 million do you think is going to get respent into other things?

We are very focused on achieving the $10 million annualized cost saves, as Andrew mentioned. And just to reiterate, most of the reductions were in the support areas. We resized all of our different functions that support the businesses. And so we are very focused on not respending that money by hiring back within those areas.

That said -- and I will let Andrew add a comment on to this -- obviously, we are focused on building our business. And when the right investment opportunities come along, we are going to obviously do that.

So it is really a reallocation of resources more towards the revenue areas. I would point to both the expansion in Europe as well as adding additional public finance bankers. And we will continue to do that, and they naturally can have the impact of near-term, more expense in revenue. But consistently, we see going into '06, we are building the topline and the margin.

I would add to Sandy's comment as well, we are wholly committed and believe we will achieve that 10 million. But there is other opportunities on an ongoing basis. And we will work them. We have natural attrition, including in our support areas. And we will watch each and every one of those. We continue to outsource where the economics are favorable. And we have contracts and leases that are maturing all the time, and we look at each and every one of them. We have got to manage these expenses down.

Okay, and then just in terms of your long-term goals, do you have anything out there that would sort of -- do you have any publicly stated goals here beyond just sort of -- you want to be in the industry leading margins, etc.? Do you have anything more concrete out there that we could sort of measure your progress with?

We don't have more specific notional ones, if you will, or absolute ones -- but just against the peer set. We've got a lot of work to do. We recognize that. We are hard at work. And I am confident we are making progress. Obviously, our position is not competitive. And we need to start by getting into a competitive position.

And just what is the philosophy for not putting out some sort of roadmap that we could sort of evaluate your progress by?

You know what? We are finding is industry wides because of market cycles, etc., it is not typical to be putting earnings estimates out and things like that.

I feel too particularly in our circumstance after spin out -- if you've looked at either our industry or any other that that -- tends to be an uneven road. And I think that we are just not going to be constructive. And those who follow us, I think, would offer up to -- it is pretty hard to model where we are going to go quarter-to-quarter. But --

Well, I mean, just longer-term -- I mean, forget about the quarters, right?

Well, you can look at the peer group and see that there is some benchmarks of their performance. And we have got a significant gap to close right there.

Okay, and then just last question is on your capital structure -- do you have a target -- total debt-to-cap ratio in mind (technical difficulty)?

Yes, we actually set all that out when we spun out. And I think we are currently at -- if you look at debt-to-total capital, I think it is around 25%. And debt-to-tangible capital, it is around 30, low 30s, something like that. And we feel like we have the right capital structure. We probably -- if you look at some of the competitors, we could actually be a little bit more leveraged. But we feel very comfortable with where we are at right now.

Lauren Smith, Keefe, Bruyette & Woods.

Just a quick question in Private Client -- what is the average production level currently in PCG? And if we were to think about going forward, margin improvement and the like -- just even if it is just sort of average or touchy feely -- what would you say would come from higher production levels? Because you are focused on broadening your product platform and having more wealth management mindset versus bringing on new FAs.

Lauren, let me see if I can answer that specifically to what you are asking. The productivity enhancements are by far the most accretive. We do think it is important to regrow the headcount as well and have the capacity and the infrastructure where those are mostly variable costs put on top of a fixed cost infrastructure that has capacity to add perhaps a couple 100. But the real margin expansion comes as we get the productivity up, and that is why we remain committed to having built out the product set, which is largely compete.

And now, most of our efforts are in the training -- and have a group actually of consultants that now go in FA by FA, branch by branch, and are using the compass we rereferred to, which is about your client mix, the product mix with those clients. And I'm -- set specific 90-day plans, which are reviewed. The better economics will come from the increased productivity.

And what are the average production levels currently?

I do not think we typically disclose that. But I think you can actually get to it through the FA numbers and revenues that are disclosed in the earnings release.

And how many -- what is your trainee class look like currently for the numbers?

We have been training approximately 24, give or take.

And when you think about sort of return on trainee, is like a 3, 4, 5-year lag in terms of when they become --

Lauren, it is at the long end of that -- at 4 to 5 years.

(OPERATOR INSTRUCTIONS).

Okay, I guess if there are no further questions -- again, thank you all for attending. We continue to believe we are focused on the right issues, taking the time to make the right decisions, and recognize we have got significant work to be done, but we are making solid progress. And I thank you for the opportunity to give you the update. Good day.

This does conclude today's conference. You may disconnect at this time.