Piper Sandler Companies (PIPR) 2008 Q2 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 second quarter of 2008.

During the question-and-answer session, securities industry professionals may ask questions of management.

The Company has asked that I remind you statements 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 the Company's reports on file with the SEC, which are available on the Company's Web site at www.PiperJaffray.com and on the FCC Web site at www.SEC.gov.

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

Thank you and good morning. We are disappointed to report a loss for the second quarter. Momentum in equity capital markets is critical to our performance and these markets continue to be essentially on hold, particularly with respect to our focus sectors. We were, however, able to demonstrate improved performance in our sales and trading business compared to the first quarter of the year.

In the first half of 2008, just 39 IPOs were completed industry-wide. This was the lowest number since the first half of 2003. There were only seven small-cap growth IPOs completed in the first half of this year. The capital market environment for small cap growth companies, in terms of deal activity, pricing, and aftermarket performance, is amongst the most difficult we have ever experienced. While our equity backlog grew during the quarter and into July, the ability to bring a deal to market is very difficult. This weak back-drop significantly impacted our results for the second order.

At the end of my formal comments, I will provide our market outlook for the remainder of 2008.

On a more positive front, our sales and trading businesses recorded strong results in the second quarter, which helped to mitigate weak investment-banking revenues. First, equity sales and trading recorded strong revenues, mainly due to solid performance in US equities and improved proprietary trading results. Second, our fixed income sales and trading business recorded a strong rebound from the challenging first quarter. Part of this improvement was attributable to the high yield in structured products. As we discussed in our first-quarter call, we significantly reduced our positions in this business. As a result, we recorded near breakeven performance versus the $4.6 million in negative revenues in the first quarter.

The primary driver of the strong fixed-income results was the robust municipal performance. We captured significant short-term trading opportunities presented by the dislocation in the municipal markets. I need to note, however, that the volatility in the municipal markets has moderated to some degree, and we don't expect the same magnitude of opportunities going forward.

In addition, our TOB portfolio generated positive revenues in the second quarter, including the reversal of a $1 million loss that we spoke to on our first-quarter call.

Similar to the first quarter, we recorded no mark-to-market adjustments in our municipal auction rate inventories. When we reported our first-quarter earnings, our municipal auction rate securities inventory was $224 million. As of June 30, the balance was $85 million. As of July 14, the balance was $50 million. To date, all of the redemptions or auctions were at par. We continue to work the restructuring plans.

Let me finish my remarks with our outlook for 2008. Our original view was that capital markets would be soft in the first half of 2008 and then strengthen in the back half of the year. We are now in the second half and we do not see material improvement in the market environment or signs of more positive [TANs] particularly relating to the growth IPOs. We now believe the environment will remain challenging through the rest of 2008 and could extend into 2009.

I'm convinced that challenging markets such as these are opportune times to selectively extend our franchise, enhance our talent base with experienced teams. Our goal is to position ourselves to gain economic share when the market downturn corrects.

We've been successful along these lines in a number of areas. For example, we enhanced our biotech platform with five new hires, we've added a new sector in media, entertainment and telecom with a team of ten. We also significantly expanded our public finance presence in California with a team of 13, and they have already generated revenue since arriving at Piper Jaffray one month ago.

That said, we are also realistic about the challenging market conditions, and we will carefully evaluate additional talent. That means we are reviewing our business model to make sure that our costs, both comp and non-comp, are appropriately aligned against what appears to be a more challenging revenue environment for the remainder of 2008.

Now, I'd like to turn the call over to Deb for more details on our performance.

Thank you, Andrew.

For the second quarter of 2008, we reported net revenues of $94.9 million and recorded a net loss of $5.1 million or $0.32 per share. Lower equity financing and financial advisory revenues, coupled with higher non-compensation expenses, were the main drivers of the weak performance.

Andrew largely covered the highlights of the revenue mix but let me add a few additional comments. Financial advisory revenues were comparable to the year-ago period but declined from the solid first quarter. M&A transactions were also negatively impacted by the weak market conditions.

In terms of pipeline, our current US equity backlog consists of 13 transactions, compared to 8 when we reported our first-quarter results. We currently have two announced M&A transactions with an aggregate value of $6 billion. Our pipelines are reasonably good in both of these businesses. However, given the current environment, it is very difficult to complete transactions. This may impact our ability to realize revenue from the pipeline through the balance of 2008.

Now, let me turn to expenses. First, compensation expense included $2.8 million in additional severance costs related to actions taken in the second quarter. Year-to-date, we have reduced headcount by approximately 7%. Headcount at June 30 included approximately 30 summer interns. Excluding these temporary employees, our headcount is down slightly year-to-date, including the opportunistic hiring we have done this year.

In the second quarter, our compensation ratio was 69.4%, up from 58.5% last year. The higher ratio was driven by the severance charge and fixed compensation expenses, such as equity amortization, all of our lower revenue base. We expect that we will continue to experience a similar pressure on the compensation ratio during the remainder of 2008, as the revenue backdrop continues to be challenging.

For the second quarter of 2008, non-compensation expenses were $43.3 million, up 24% compared to the first quarter. The increase was mainly driven by a couple of factors. First, litigation-related expenses were higher, mainly due to one matter outstanding from 2004. This trading-related matter was partially resolved during Q2, and the net amount impacting the quarter was approximately $3 million of expense. Part of the matter on which we are a plaintiff remains standing, the resolution and any benefit of which will occur in a future period. Our goal is to significantly offset the net expense incurred in the second quarter.

(inaudible) we experienced more busted deals or deals that were not completed because of the challenging market conditions. As a result, we wrote off certain travel expenses and legal fees related to these deals. The write-offs accounted for the majority of the quarter-over-quarter delta in marketing business development and outside services.

As additional context, for the first six months, non-comp expenses were $78 million compared to $70 million last year. Approximately $5 million of this increase related to FAMCO and Piper Jaffray Asia, which we didn't have last year.

Heading into 2008, we plan to modestly increase our non-compensation expenses above 2007, mainly to account for the added expenses of the two acquisitions we completed last year. However, as the revenue outlook has become more challenging, we are reviewing our non-compensation expenses to see where we can achieve savings.

Finally, our tax rate for the quarter was 65%. The rate was driven by the large amount of tax exempt municipal interest income in addition to operating losses.

That concludes our formal comments. Now, Andrew and I will answer your questions.

(OPERATOR INSTRUCTIONS). William Tanona. Please state your company name, then proceed with your question.

Goldman Sachs. Good morning. Just a quick question -- I guess looking at the revenues, you guys actually did a pretty good job, given the environment. Clearly, I took your comments in terms of the investment banking environment as being somewhat challenging. But you know, the one thing you guys do have control over is obviously the comp and the non-comp and you alluded to the fact that you are looking at the businesses and thinking about right-sizing the business. I kind of wanted to get a sense as to what your thoughts were in terms of what's the appropriate comp ratio that we should be assuming, given all of these things. In the interim, should we be expecting a higher comp to net revenue ratio than we've historically seen from you guys? Because if you look at the last two quarters, even excluding the severance, we still seem to have a significantly higher number than we've seen historically.

Yes, good morning. I will address that comp ratio. Given the challenging revenue environment that we do foresee for the rest of this year, our comp ratio will likely be similar to the first two quarters.

Bill, I would just add that we are actively at work on both comp and non-comp expenses with the more difficult point of view.

Yes, understood. I mean, clearly, I think that's a decent problem to have, to be able to control those things. But you know, as you think about non-comp, you've had some one-time items out there. If I heard the commentary correctly, you are saying that 2008 full-year non-comp expenses, all-inclusive, are going to still be slightly higher than what they were in all of 2007, inclusive?

That is correct. Including the acquisitions that we made, we do expect a low single-digit increase in our non-comp, although, as Andrew mentioned, that is something we are looking at significantly right now.

The point that Deb is making, Bill, is that the two acquisitions were both very late in last year, one at the very end of Q3 and the other in Q4, so you've got to normalize that in '08. We are going to try and hold the expenses down despite that.

Okay. Then I guess just finally, in terms of the fixed-income environment, clearly a very challenging environment and your kind of commentary seemed to suggest that the business environment isn't as robust right now in the third quarter, at least in the start of the third quarter, as maybe it was in the second quarter. You know, given the jumps that we've seen in that institutional sales and trading/fixed income line, what do you think that we should be looking at or kind of would you average the two quarters of what we've seen in the first half to get a normalized run rate for the back half of the year?

You know, Bill, you are in the right zone. What I was trying to communicate is the dislocations in the municipal area were really as severe as I've ever seen in my career, probably starting in the tail end of the first quarter, and our various trading areas really did an exceptional job. They were in the right place at the right time and took advantage of that very successfully. I think it would be hard to replicate that quarter after quarter. I say that from the perspective of I think actually some of the volatility is going to moderate.

Great, thanks.

Devin Ryan.

Sandler O'Neill. Good morning.

So clearly, as we've been talking this morning, it's a really challenging environment. Can you just talk a little bit about what you are optimistic about and opportunities that you are seeing, whether it's adding talent like the team of senior-level bankers in the municipal finance business that you announced, or building out other products or even geographies? Can you just talk a little bit about that for us?

Sure. Geographic expansion remains a very high-level key objective of ours. We are adding additional talent in our Asian platform and really transforming that from what once was bringing companies public in the New York exchanges to now really a global capability and more activity right in the region -- Hong Kong Exchange -- and developing the capabilities that Goldbond had. We're looking at other regions more broadly from Europe.

Additionally, the team hiring environment is unlike any I've actually ever seen as well. Take the group in California. What's unique about it is you have long-standing, well-developed, well-working teams on platforms that, in a regular, normal environment I will call it, would be highly unlikely to move and are compelled to, for one reason or another, typically go through a process to look at a couple of firms. I actually think we're managed by that. By the time we're selected, there's a high degree of confidence that it's a good, long-term fit and the economics around that are reasonably favorable. But I mean, this is -- the 13 professionals had a leading share in higher education in California for a very long time, and that successfully transformed our platform and we've already done a number of underwritings in just the weeks that they've been here. So I believe we will see more opportunities like that. Having said that, recognize, we've got to have balance around that because of the uncertainty and the lack of capital raising, particularly on the equity side.

Right, okay. Given the significant recent declines in the stock price, I also just want to get your thoughts on the buyback.

Yes, I will address that one. As you are I'm sure aware, we have a $100 million authorization that runs through June of 2010, and we do anticipate executing a portion of that repurchase authorization during the remainder of 2008. It's just we did not purchase any shares in the second quarter.

Right, okay. On the tax rate, it looks like the first-half tax rate is about 55%. Is this a good level to think about for the rest of the year? I know you mentioned kind of this quarter being helped by the mix of revenues and the municipal business helping.

I think, given the current environment, the rate is very difficult to predict. I can say, however, we do expect that the large amount of (inaudible) interest income will continue to drive a large tax benefit for us.

Just finally, one more -- on the equity trading -- sales and trading side, you mentioned principle trading helping the sequential increase. Was this the biggest driver of that increase, or was it just client activity?

It was essentially US equities trade.

Right, but on the actual from principal investing now?

No, client activity.

Steve Stelmach.

Steve Stelmach, FBR. Andrew, if you could, could you give us your outlook maybe a little bit longer term for the municipal bond industry? There's I guess both a legislative and a rating agency push to get municipal bonds ratings more on a global scale? Can you give us your feel for what that means in terms of margins, in terms of volumes, in terms of your business outlook?

Yes. When you say global ratings, I gather you are referring to a corporate rating system (multiple speakers).

Yes, a corporate equivalent.

Yes (multiple speakers). There is a large part of me that thinks that's a constructive idea, that in fact when you really look at the underlying creditworthiness and track record of municipals and you go back 40 or 50 years, and the default rate is really very, very, very low, that in fact, if you used a corporate rating system, many of them would probably enjoy a higher rating, which then leads me to wonder if, frankly, we really needed to insure all of those. I think it got started largely to access money market funds on the short end. I think you might normalize into something that makes more sense and could be more functional. That might have a little bit of spread decline because there's a credit standard that's more easily understood. Having said that, I still think there's a pretty healthy volume for the years to come. I mean, it's really financing a lot of infrastructure that clearly is needed from one end of the country to another.

You know, we feel like that's a very good growth area for us. We have a long-standing, very solid franchise and very high share in a number of areas, but from a geographic perspective, we've largely been upper Midwest/Western part of the country. You know, we changed our status in California overnight with the team and have the eastern half of the country as an opportunity.

Okay, great. That's helpful. And then just real quickly, a follow-up on the non-comp side -- could you sort of provide maybe a goalpost to what you guys are thinking in terms of possible dollar amount of savings you could see on the non-comp side?

No, I think, right now, we are early in the announcement. In looking at noncomps, we are looking at various areas there, so at this point, we, again, just reiterate what I said about the full year. We do anticipate low single digit increases versus '07, again including the acquisitions that we made.

Okay.

That shows some moderation (inaudible) and that effort is underway.

I got it. That's helpful. Thank you very much.

Steve Scinicariello.

Just a couple of quick questions -- if I heard you correctly, on the non-completed deal expenses and I do the math on that, it appears that's about $4 million in the quarter. Is that about right?

It was the majority of the delta in the marketing expense, business development and (inaudible) categories.

Okay. I would assume kind of given as the market environment kind of transitions, that eventually that kind of should not be repeated as things start to turn and hopefully improve, so would you agree with that?

I would agree with that statement from the standpoint as things begin to improve. I think, to the extent the market environment continues to be challenging, it is possible that we could see additional busted deal expenses.

Having said that, you are right, Steve. That reflects a prolonged market window being closed, and we age our backlog and write them off at the appropriate time.

I got you, got you. Then the other thing I just wanted to ask about was, in terms of kind of positioning for the future, to gain that share when things eventually do improve, I mean you are sitting in a position of having tons of excess capital when it's so dire that it just seems like you are in such a great potential position to kind of achieve some of the things you want to achieve over the long term. I know you talked about some of them, but you know, I just kind of wanted to hear maybe a little bit more of kind of the game plan from here and what you are seeing, and maybe the wish list of things to do in this environment, because it seems like you are well situated from here to deploy that capital.

Steve, let me make a couple of comments. The headline would be I very much share your perspective. We've got the capital we need to operate our business, we've got capital for growth, and that's a good position to be in currently.

The priorities are similar to those that we've talked about since we exited the private client business and have had the resources, geographic expansion that I talked about. There are opportunities to maybe expand beyond Europe in that region.

Asset management -- we continue to look at a number of opportunities, believe we got a very solid start with FAMCO. There are a variety of new products, most likely debt products. We are being very thoughtful about that. The fact that previous efforts didn't succeed maybe turned out to be a benefit (multiple speakers) much more dear and could you find the right partner today? So we are thinking about that.

Then I would say also, very importantly, sectors -- you know, what we accomplished with media and telecom really transformed our tech into an MET franchise in one swoop with a very experienced team with long-standing client relationships. 13 senior investment bankers in California more than doubled our California business, a very substantial group. I believe I made some reference to this in the first call; I will say it again. I think we have as active recruiting dialogue going on across the Company as we ever have. These cycles are a very opportune time to do that. High quality, experienced people with relationships and internal group dynamics that are functional are available really not out of their choice and we can look pretty attractive in that.

I have to balance all of that, Steve, with recognizing, for our key equity sectors, the window has essentially been closed. I mean, flat out closed. Now, that may extend for a period of time and I need the balance but I'm willing to invest and take some short-term pain for a substantial intermediate/longer-term gain, up to a point.

No, that makes sense, and that's what I look forward to seeing. Thanks very much.

Lauren Smith.

KBW. I guess a couple of follow-ups -- I guess, first off, if you could just -- with the headcount reductions, as well as additions, could you just walk us through what has been since, say, year end, what you've cut in terms of headcount, and then what you've added in terms of hires? Because the net number is higher so I just want to get a sense of how many you've gotten rid of over the past six months versus how many have been hired over the similar time frame. I'm assuming a lot of that has been backloaded over the past three months or so.

So, we ended the year at 1,238 employees. We've taken reductions of 7% of that. The other thing to note is our June 30 numbers include 33 summer interns, so if you exclude them, our headcount is down slightly from year-end, but really accounts for the fact we have reduced by 7% and has added headcount in certain areas as Andrew has been mentioning.

So it pretty much sounds like the 10 in public finance and the other I guess 13 you cited is kind of where we've seen --

So 14 senior bankers, them we will probably have some support associated with them in California, 10 in the MET, 5 in biotech. Having said that, we are looking hard at the headcount, still.

Okay, so there is -- it's an ongoing process, so we shouldn't think about it as being finished quite yet?

Correct.

And then in terms of -- oh, just one follow-up on that. Where did the public finance team come from? You said they had all been -- were they all lifted out of one institution or is this an aggregate from different places?

Lauren, it was UBS. You may know this; they had started a process to sell the business and they then announced that they were going to shut it. Today, they enjoy the number two underwriting position nationally for several years so --

That was great; thank you. Then, looking at the institutional fixed-income business, I think you had said that there weren't any marks this quarter, so then there's a pretty big sequential delta. So should we think about $20.8 million, give or take, as sort of a reasonable run rate? I'm assuming that include some additive revenues from this new public finance team.

First of all, let me just clarify something. When I was talking about the marks, I was being very specific about the auction rate, Lauren, that we are working through with those restructurings, because that had been an issue in the marketplace. There were marks required and there aren't as we redo everything at par.

So, back to your question, it really is a combination of a better trading environment, additional underwriting, and you are seeing the ramp of some of the additional resources. Now having said that, I'd also -- the final caveat (inaudible) is the municipal trading was very, very successful. But you saw dislocations that were really unique. There was a point at which municipals yielded 125% of treasuries. That is very unusual, and created big opportunity.

Okay, okay, thanks. Then just to follow-up, circled back to Devin's question on the institutional equities, you know, I can appreciate that you said it's really more core client flow and not so much an increase, a meaningful increase in [prop] trading, though. Maybe you could just ferret that out a little bit because, with such a weak underwriting quarter, to have that number be up pretty meaningfully Q-on-Q and year-on-year, I mean is there something going on in terms of do you feel like you're getting market share, or penetrating a certain account base where maybe you didn't have as much of a presence? I just want to get a better sense for the kind of underlying trends going on in the equity side.

Yes, Lauren, I can address that. We are really seeing a couple of things happening, just the increased volatility in the equities market tends to increase volumes, and our commission revenues are up significantly. In addition, we've been able to manage our loss ratio down. It was really the combination of those two things that have created that increase in those revenues.

Okay, so overall then, when we think about [prop] trading relative to the total, I mean, you know, it is pretty -- should we be thinking about it as being pretty small, kind of single digits?

Yes, I think that is correct, and it was really that we saw an improvement over where it was in the first quarter.

Okay, great. Then just last one in the sort of bigger picture -- you know, geographic expansion has always been high on your priority list. We could look at the revenue distribution and see that you've certainly made positive strides there. When you look at the mix, I don't know what it was in 2Q, but in 1Q, you know, Europe 6%, Asia 7%. That's up, you know, still small single digit but up a lot year-on-year. When you think about the next two or three years, how would you envision potentially that balance shaking out?

Yes, Lauren, I continue to expect that to expand. It actually didn't in the second quarter. You know, those markets are also challenged and when you netted it all out, we were actually I think 14% -- 12%, excuse me, outside the US, so it downed just slightly in the quarter versus previous quarters but still looking at it historically, a pretty solid growth rate. I would expect that to extend and continue to grow our business more rapidly outside the US than inside and think that percentage will get to and be at north of 20%.

Great. Thanks very much for answering my questions.

Brian Hagler.

Good morning. Kennedy Capital. I guess my question was touched on earlier, as far as the busted deal expenses; they appear to be $3 million or $4 million or so. If I understood your response correctly, it sounds like those could potentially continue in this environment. But is it safe to assume that they will maybe be a little bit less than that in coming quarters?

Yes, I think, you know, it is very dependent on the market environment. I do think that it will likely be moderated from what we saw in the second quarter.

Okay, that's it for me. Thanks.

[Horse Heinnekin].

Thomas Weisel Partners. Good morning. You've made good progress, I see, winding down your exposure to the auction rate municipal securities and I'm particularly impressed that there were no marks. I'm wondering whether the credit quality of the balance is any different from the portion you've already wound down and also perhaps whether you are headed for 0, both on auction rate municipal securities and variable-rate demand notes. I'm just trying to get a sense what the target is.

Okay, well, let me separate those two out. The variable-rate note business we remain very active in, despite some of these rating changes, including on the mono lines, you get a little volatility, but that market is functioning really relatively very, very well. In fact, I think he weeklies are yielding under 1.5 and the dailies are 1-ish or a little lower. So that's highly functional. We are active in it. In any given time, we are going to have some -- you know, we've got a pretty substantial book. We will have some in inventory, and I would expect that to continue.

To the auction rate book, we've got restructuring plans for the balance of our book. We would anticipate that would be completed in the third quarter and largely I should say. There isn't a particular credit quality difference. It was much more the timing and the process that the issuers went through. These are nonprofit entities and have a variety of processes they use that came to a conclusion about when and how they wanted to restructure. But we do have a restructuring plan for all of them.

Okay, that's clear and very helpful. In regards to the litigation expenses that are contained in the non-compensation expenses, are you able to quantify how much they are? I'm trying to get a sense of whether this is a one-time item or a recurring item.

Just to clarify, you are talking about the legal matter which was discussed in our script?

Yes.

So for that particular legal matter, it equated to a net expense of $3 million in the second quarter (multiple speakers) in essence we are continuing to work through that, being a plaintiff on the remaining portion of that and do expect to significantly offset that net expense in the future.

Okay, all right, thanks for that. Perhaps my final question is to Andrew again. You do state in your press release that you are evaluating appropriate actions to position your firm for a more prolonged market downturn. I'm wondering if you are able to elaborate on what those options might be and what you're timing might be in coming to a decision.

I would tell you that we anticipate actions that will reduce both comp and non-comp expenses, and we are actively making those evaluations right now and expect them to be timely.

William Tanona.

Goldman Sachs. I just had a couple of follow-ups here. First is the book value, tangible book value. Obviously, with the loss in the quarter, seeing the book value and tangible book value go up as much as it did, just surprised by that. What was driving that?

Part of it has to do with the fact that even though we are reporting a loss, because part of that is related to the equity amortization, it still does increase our overall equity. So equity is increasing even though we have reported a loss, because of that equity amortization.

Okay. It's only just the equity amortization, or are there other things in there as well?

Yes, it's primarily that.

Okay. Then I guess just lastly, in terms of looking at where your stock price is below tangible book value and looking at the goodwill that's on your balance sheet, I think there's obviously some accounting rules that allow you to attest for kind of impairment of goodwill, and I know that was pushed down goodwill. But any chance that you would take the opportunity to kind of write down that pushed-down goodwill from the USB spinoff here, given where your market value is?

Yes, we do our impairment testing in the fourth quarter of each year. We don't believe currently that we have any triggering events in the second quarter that would have caused us to look at that analysis any earlier in the year. So that's where we came out in the second quarter.

We will go through the process in the fourth quarter.

(inaudible)

Okay, I guess just, you know, I don't think that your -- I don't know if I recall but was your stock actually blow tangible book at that point in time?

Yes, there's just a number of factors that go into a goodwill announcement when you do that. It's not solely related to that. Really, the accounting standards require you to test it once a year unless there are triggering events that would cause you to need to do that earlier.

(OPERATOR INSTRUCTIONS). At this time, there are no further questions.

Okay, let me close the call. Thank you all for dialing in. I would reiterate we are positioning our firm for long-term growth but are clearly realistic about the current environment. We are focused on making sure that our expenses are aligned with the more prolonged time period of muted revenues but significant growth opportunities. Thank you.

Thank you.

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