Piper Sandler Companies (PIPR) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Piper Jaffray Company's conference call to discuss the financial results for the fourth-quarter and full-year results of 2006.

During the question and answer session, securities industry professionals may ask questions of the management. The Company has asked that I remind you statements on this call are not historical. Our current facts including statements about beliefs and expectations are forward-looking statements that involve inherent risk and uncertainties. Factors that could cause actual results to differ materially from those anticipated are identified in the Company's reports on file with the SEC, which are available on the Company's website at www.PiperJaffray.com and on the SEC website at www.SEC.gov.

And now I would like to turn the call over to Mr. Andrew Duff. Mr. Duff, you may begin your call.

Good morning. Thank you for joining us. I will provide some opening comments about 2006. Tom Schnettler, our Vice Chairman and CFO, will provide details of our financial results.

Overall we are very pleased to deliver a solid year of financial results with strong topline growth and improved profitability.

Clearly 2006 was a pivotal year for Piper Jaffray. We refocused 100% of our resources on our Capital Markets business. Our solid financial results demonstrate the strategy is sound. We achieved significant progress in 2006 toward our goal of building to the leading international middle market investment bank.

Our growth strategies made progress in three dimensions -- sectors, products and geography. From a sector perspective, we invested in our existing business, increasing the number of equity investment bankers by 40%. We gained momentum in our newer public finance hospitality practice, completing four transactions representing $1 billion in par value. We expanded our expertise into alternative energy, business services and industrial growth, collectively completing 12 transactions raising over $2 billion in capital.

From a product perspective, we announced our CIT relationship expanding product breadth for our middle market clients and positively impacting our results. We continue to build out our high-yield and structured product capability, opening a Charlotte office, adding sales, trading and research capabilities. Finally, adding a financial restructuring capability with broad expertise including Chapter 11 reorganizations, sale of assets into stressed situations.

From a geographic dimension, our UK platform gained momentum. We now have over 50 people in London in investment banking, sales trading and research. We are expanding beyond our health care sector into consumer and technology and held our first consumer conference in October. We opened our Shanghai office as part of our Asian expansion efforts, now offering international investment banking and research. We currently have 17 Asian companies under coverage and held our Third Annual Internet and Technology Conference in Beijing. We significantly recapitalized the business. We paid 100% of our subordinated debt, and completed a $100 million accelerated share repurchase, meanwhile retaining additional capital to invest in our business.

Now let me turn it over to Tom for our financial results.

Thank you, Andrew. We had strong topline performance in the fourth quarter. All of our businesses generated higher revenues compared to the fourth quarter of 2005 and compared to the third quarter of 2006.

Similar to previous quarters this year, our investment banking franchise demonstrated particular strength. For the full year of 2006, investment banking revenues increased 21% compared to 2005 and represented nearly 60% of the total firm revenues from continuing operations. This momentum in our topline growth is driven by investments we made in 2006 as Andrew highlighted and in previous years.

A couple of key measures further demonstrate that we are advancing this strong platform. First, our market share for our public finance business was 1.7% in 2006, up from 1.5% in 2005 based on a number of transactions. Second, our estimated economic fee market share for our equity financings business was 1.6%, up over 20% from 1.3% last year. Third, we were book runner on 41% of our equity financings in 2006, up from 35% in 2005. And finally, from an international perspective, we completed nine transactions in the UK in 2006, which made a meaningful contribution to our total equity financing revenues. We completed two equity financings in the UK last year in 2005.

Now let me provide comments on our fourth-quarter results, including discontinued operations. For the fourth quarter, net income was $20.6 million, which includes a loss of $6.1 million for discontinued operations. The loss includes costs primarily for occupancy, severance and litigation-related expense. We anticipate we will incur additional restructuring expenses in each of the first and second quarters of 2007. These costs relate to a system conversion resulting from the sale of the Private Client Services branch network. Other than these system conversion costs, we do not anticipate any additional restructuring costs. However, it is possible that unanticipated litigation-related expense related to the Private Client business could be recognized in future quarters.

My remaining comments will focus on continuing operations. For the fourth quarter of 2006, net income from continuing operations was $26.7 million or $1.49 per diluted share. The current quarter results include a benefit of $0.73 per diluted share due to a reduction of the reserve related to developments in a particular industrywide litigation matter. Excluding the reduction of the reserve, continuing operations generated $0.76 per diluted share, up from $0.63 in the fourth quarter of 2005 and up from $0.50 in the third quarter of 2006.

For the fourth quarter, continuing operations generated revenues of $146.6 million, our strongest quarter for Capital Markets revenues since becoming a public company again in 2004. Revenues rose 24% compared to the fourth quarter of 2005 and rose 26% compared to the third quarter of 2006. Within investment banking, revenues were $91.7 million. Fixed-income and equities financings and advisory services all delivered at or near record quarterly revenues. Within institutional sales and trading, revenues were $50.8 million, up 9% compared to the same quarter in 2005. Compared to the third quarter of 2006, revenues rose 17% due to higher revenues from high-yield and structured products, interest rate products and cash trading.

Now I will cover non-interest expenses. For the fourth quarter of 2006, compensation expenses were $88.6 million, up 33% from the fourth quarter of 2005 and up 28% compared to the sequential quarter. The compensation ratio for the fourth quarter was 60.4%, up from 56.1% last year and up from 59.5% in the third quarter of 2006. This ratio reflects increased personnel investments ahead of revenue generation as we build out certain areas such as high-yield and structured products, our financial institution's investment banking, our restructuring business and as we expand internationally. We also had some increased compensation expense to remain competitive with the market.

For the full year of 2006, our compensation ratio was 57.9%, the same as 2005. As we continue to grow our business, we expect our compensation ratio will not be substantially different in 2007.

For the fourth quarter of 2006, non-compensation expenses were $37.3 million, excluding reducing and litigation reserve, up 6% from the fourth quarter of 2005 and up 17% from the third quarter of 2006. The main drivers of the increase compared to the sequential quarter were increased occupancy expense, mainly due to onetime expenses associated with the move of our London office as disclosed in our third-quarter 10-Q and higher travel and entertainment and legal expense, mainly driven by increased deal activity and higher recruiting fees.

For the current quarter, pretax operating margin for continuing operations was 28.6%, of which 14.5 percentage points were due to a benefit from the litigation reserve reduction. Excluding the litigation reserve reduction, pretax operating margin was comparable to the year ago period and up from 13% in the third quarter of 2006. For the full year of 2006, non-compensation expenses increased just 2%, excluding reducing the litigation reserve and the restructuring charge recorded in 2005 on a 19% increase in revenues. The combination of strong net revenues and disciplined expense management drove an improvement in pretax margin in 2006.

Pretax operating margin was 19.5%, including a 4.3 percentage point benefit from the reduction of the reserve, up from 8.6% in 2005, which includes a 2 percentage point decrease for the restructuring charge in that period. Excluding these special items, pretax operating margin was 15.2% in 2006 compared to 10.6% in 2005.

As Andrew highlighted, 2006 was a pivotal year for Piper Jaffray. We are focused on the work ahead of us to build our business profitably and provide competitive returns to our shareholders. We made solid advances in 2006.

I will turn it back to Andrew for some final comments.

Thank you, Tom. Let me review our 2007 priorities. First, continue to build our new sectors -- alternative energy, business services and industrial growth. Second, to utilize our expanding debt capabilities across all sectors. To expand principal activities such as private equity investments, proprietary high-yield trading. To re-enter the Asset Management and continue to seek finding the right partner and fit. And finally, to continue to build our industry sector capabilities in both Europe and Asia.

Operator, we are now ready for questions.

(OPERATOR INSTRUCTIONS). Lauren Smith, KBW.

Congratulations on a good quarter, good year. I guess a couple of questions to start off with. Could you just give us a little more color on this tax benefit? Excuse me, the benefit from the litigation reserve?

Sure. While we don't disclose specific reserve amounts for particular matters, we can tell you that this involved a large industrywide case, involving allegations related to IPO allocation practices. And due to developments in that litigation and pursuant to the standards of FAS 5, we took a reduction in the reserve that we had previously on our books.

Okay. It is just that is such a big number, so I'm just curious if this is -- you feel you were ultraconservative? Is it necessarily one matter or a host of matters and whether this is, you know, very Piper Jaffray specific or kind of a trend?

Well, this is related to a specific matter as I said.

And it wasn't industrywide issue.

Okay, that is helpful. And with respect to your comments about taking additional restructuring expenses in the first half of '07 related to system conversion, anyway to sort of scale that out even if it's sort of a range that material -- do you anticipate it being material?

Yes, we anticipate that the additional restructuring expenses related to this systems conversion project will be less than $5 million.

Okay. That is helpful. And I know you gave some color about the comp ratio on an annual basis right that you said you would not expect '07 to be meaningfully different at least where you stand now than full-year '06. But is that kind of -- do you think a ratio in and around 58% is realistic? Given where you came in on Q4, you are certainly adding breadth and scale, businesses, geographies, products; all the things that we touched on, or is there anything specific do you think to 4Q that should lend us comfort to think that that number can actually trend down sort of sustainably?

Well, our objective in looking forward at the business would be to have a comp ratio similar to the one we recorded for the full year this year.

Okay. But you would not characterize anything specific to comp in Q4 that might have -- we witnessed it creep up to north of 60%? You just think over the balance of the year you will have more flexibility to keep it down in sort of the annual run-rate?

You know, our compensation this year really reflected a number of areas of investment which I spoke about, and although we will continue to invest in the business, we think our full-year compensation ratio is indicative of what our objectives would be going forward.

Okay. And then just lastly for now, unless I missed it in the press release, but did you note how much stock was repurchased in the quarter?

During the quarter we completed the accelerated share repurchase program in early October. Beyond that, we did not repurchase additional shares during the fourth quarter.

Okay. Terrific. Thank you very much.

Douglas Sipkin, Wachovia Securities.

Just a couple of questions. First off, I don't believe you made any specific comments around the backlog. I think, and correct me if I'm wrong, you have done that in the past. Any color around the equity pipeline, the M&A pipeline, etc.?

Our equity backlog -- currently we have 10 transactions on file, and we are bookrunner or lead manager on four of those 10. We have seven announced M&A transactions in the backlog.

And how does that compare to I guess the start of '06? I know that is changing market dynamics but generally speaking?

I don't have that number specifically for comparison.

Okay. No problem. Also, any more color on buybacks or capital investments in '07? Obviously there is a lot of opportunities out there. I know you guys highlighted Asset Management, private equity. Anything that we can expect to hear within the next three months or so around any of those capital items?

Well, in terms of capital investment in new opportunities for the firm, we cannot comment on specific opportunities, but just maybe suffice it to say that our objective continues to be to redeploy some of the capital we generated from the PCS sale in the growth of our Capital Markets business, and that remains a significant priority for this management team.

Doug, I would just add to that we are committed to reentering the Asset Management business. We think finding the absolute right fit to re-enter is very important. We have a number of criteria around investment performance, cultural fit of the team and importantly valuation, and we are committed to getting three out of three of those right. We continue to explore those possibilities actively.

Would this be more of a traditional Asset Management business or more of an alternative Asset Management business? I mean what is the objective of the firm or a combination of the two?

You know, institutionally oriented and likely to be potentially a combination of both.

Okay. And then just more technical, you guys mentioned that the uptick in occupancy expense this quarter, some of that had to do with relocation. Roughly where should that be trending in '07 normalized?

Well, we had approximately $1.2 million of onetime expenses associated with the move of our London office. We have simply outgrown our existing facilities and moved to a new location during the fourth quarter. So those are the only one-time costs within that item.

Okay. No, that is helpful. And then just I know you guys paid down your debt. At what point -- is it at some point in '07 or '08 that you would maybe think about reinstituting some leverage?

Well, we would intend to run the business longer-term certainly with some leverage in the balance sheet. Really that is going to depend -- the timing of that will depend on capital deployment really to execute some of the growth strategies that we have talked about.

David Trone, Fox-Pitt Kelton.

First question, if you look at your segment reporting, you have other income going up a good deal to $4.2 million. Could you give us a little color on that?

So that is mainly due to increased net interest income.

Okay. So that is not something you normally account for in the trading segments?

Not -- I mean there are certain parts of that that are and other parts that are not.

Okay. Fair enough. And then your fixed-income deltas were pretty strong on both the trading and the investment banking side. Could you just maybe not quantitative-wise but in a qualitative way just talk about the strength split between munis and your other debt businesses?

I would say on the underwriting side most of the strength in the fixed-income underwriting really came from the Public Finance sector, and that included some of the specific areas of expertise that we have built out in hospitality for instance. Andrew referenced that specifically, lead to good lead managed business for us and impacted those results positively.

On the fixed-income trading side, that is probably most significantly impacted by the build-out of our high-yield and structured products area where we saw significant period over period positive development.

Okay. Great. And then one last question. You mentioned in response to I believe it was Lauren's question that you did not buy back in the quarter outside of the accelerated program. Why was that?

Well, we completed a substantial part of the total authorization in early October. $100 million of the total authorization of up to $180 million. So I think having completed that we will now continue to sort of evaluate our capital needs as we build out the business and Capital Markets conditions, and so we intend to pursue that over time. The authorization is through the period ending 12/31 of 2007.

Okay. And just off of the top of my head, I recall $80 million?

Is the remaining amount, yes.

Okay. Thank you.

Steve Scinicariello, BlackRock.

Great quarter. Just a quick question. With regard to the '07 goals, those several areas that you enumerated, I know you certainly have plenty of excess capital to make some headway in each of those areas, but do you really feel that you will be able to show some progress in expanding the capabilities in all of those different areas, or is that just kind of the wish list on an ongoing basis?

Steve, several of those are well underway. The new sectors -- alternative energy, business services and industrial growth -- all got underway this last year. The expanding debt capabilities also include our relationship with CIT that got underway last summer. High-yield is also well underway. So those are all extensions of effort that made significant foundation and progress in the previous year.

Reentering the Asset Management business, we have got to get exactly the right fit. So the timing of that is unknown. We are focused on it. It is a key priority. And our build-out in Europe has also continued and underway. An example would be the UK, which originally was a Healthcare platform, and we expanded it already into consumer and technology last year. But there's quite a bit of room for growth in really virtually all of those areas.

Great. And so you will feel because you have kind of got the ball in motion in all these areas that you will be able to make even more headway in each of those areas as you look ahead into '07 as well then?

Yes, we do, and we intend to do that. It is also reflected as Tom talked about in our compensation ratio, which is at the high end of our range. We recognize that and we are managing it, but it also reflects really very substantial investments made in those areas and on into '07.

Great. And it sounds like you should be able to because these things are already in motion, you probably should expect to see some pretty tangible results materialize by the end of '07 as well then?

That would be our intention.

Great. Well, keep up the great work.

William Tanona, Goldman Sachs.

Just a question on the comp because I missed the early part of it, so I did not know if you explained it. But the uptick in the comp, was that related to anything FAS 123R or kind of just a new hiring or what drove that? Because typically you guys have always had a lower comp to net revenue ratio in the fourth quarter.

It was not driven by 123R, so it really was, as I stated earlier in the call, increased personnel investments ahead of revenue generation in certain areas that we are building out significantly. And I can specifically refer to our high-yield and structured products area, building out our financial institutions investment banking group, our restructuring business and our expansion internationally.

Okay. And then just help me understand a little bit about the discontinued operations and why you are expecting that to continue into '07 considering you have sold that to UBS and why wouldn't that be just an ongoing charge for your existing business?

Well, the specific charge that we anticipate, charges we anticipate in Q1 and Q2 relate to a systems conversion project, which is really necessitated by or occasioned by the sale of the Private Client business. So to support our Capital Markets business going forward, we need to undertake that project. And the timing of those charges is really dictated by the financing -- applicable financing standard -- accounting standards.

I guess I'm just surprised that that is not just an ongoing operating expense and why that would be considered part of discontinued operations if you have to upgrade your systems on the institutional side?

But it is a transition really, I think is the point, from a very different business mix. We had 92 retail offices, 860 advisors in that trading activity, and we selected a system that could support that. We now have a pure institutional-oriented business. We need a change in systems.

Okay. And then I guess lastly, looking at the institutional brokerage business, year-over-year it was pretty much flat. You guys obviously have been making investments across the board. What do you think it is going to take to kind of jumpstart that revenue stream and get that moving in the positive growth direction?

Well, we have a number of things that we have undertaken where we are seeing some good progress. So you see a positive comparison certainly in the fixed-income area, mainly driven by the investments we have made in high-yield and structured products, which are positively impacting that. We had some positive year-over-year comparisons in terms of our algorithmic and program trading area, which also contributed to some modest growth on the equity side. We continue to build out our convertibles trading capability, really began some new activity in terms of trading stocks in the UK, UK domestic stocks. So all of those are going to be helpful as we go forward, but that is all positioned against a backdrop of a difficult set of market conditions as it relates to traditional cash business.

Understood. And then I guess sorry, one more. The private equity you also highlighted in terms of an opportunity there to kind of get more involved. Is that something you plan on doing from an organic basis and building out and using some of your excess capital to seed some of those opportunities, or would you view that as being more of a kind of an inorganic strategy?

I would say organic is probably the better term. It is mainly opportunities that bring our proprietary knowledge to our clients and investing alongside of them.

Douglas Sipkin, Wachovia Securities.

I'm just curious; one of your competitors had been highly successful partnering with small boutiques that have a specialty in a particular sector from an inorganic banking growth perspective. Is that something you guys would ever consider, or is it always going to be building the business on your own, moving into specific business silos?

I think the opportunity to do that is real, but it is really very selective. If you are going to acquire in our industry and put two investment banks together, you are at risk for very duplicative probably in the sales trading and research area. But if we can find an opportunity to either expand an existing sector or enter a new sector that is really very complementary, we would certainly consider it.

There are no further questions at this time.

Thank you all for joining us this morning. Clearly 2006 was a very full year for our firm. We are very confident of our strategy. We have a lot of work ahead of us, but we are confident about our prospects to deepen our sector expertise, broaden our product offerings and expand our geographic presence. Thank you all for joining us.

Thank you for participating in today's conference call. You may now disconnect.