Piper Sandler Companies (PIPR) 2008 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Piper Jaffray Companies conference call to discuss the financial results for the third quarter of 2008.

During the question and answer, securities industry professionals may ask questions of management. The Company has asked that I remind you statements on this call 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 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.

Thank you and good morning. There is no question the third quarter was very difficult for our firm as reflected in our financial results. During the quarter the financial markets experienced unprecedented events. The equity markets experienced significant volatility, and the credit markets seized up in September, which has significant negative implications for the short-term segment of the fixed-income market. This is an extraordinary environment, one which creates not only operating challenges but also historic opportunities.

I'm going to take you through three areas today. How the fallout from the market turmoil impacted us, what actions we are taking given the realities of a significantly lower revenue environment, and how we view the opportunities available to us given a dramatic change in the competitive landscape.

First, our investment banking revenues held up reasonably well in the quarter against a very weak industry environment. Debt financing and advisory revenues were decent. Equity financing revenues increased from the sequential second quarter but were well below our historic quarterly run-rate, and industry fundamentals remain weak. Our financial performance depends heavily on investment banking activity, and with the equity capital markets essentially on hold, our results were negatively impacted.

Sales and trading revenues were mixed during the quarter. Equity sales and trading continue to perform well. Client activity was strong, and the team reported solid trading performance. Year-to-date equity sales and trading revenues are up 20% compared to last year. We are benefiting from increased market volume and volatility, and our efforts to target sales, resources, research or capital to clients that are paying for the value appears to be contributing positively.

In addition, electronic trading generated its best quarter ever.

The turmoil in the credit markets drove extreme volatility in the fixed-income market, particularly at the end of September. The volatile markets were difficult to manage, and our fixed-income sales and trading results were negatively impacted.

As we disclosed last week, the area that was significantly impacted by the volatile fixed-income market was our tender option bond or TOB program.

Let me summarize my comments from our prior call.

We determined our TOB program no longer qualified for off-balance sheet accounting treatment. As a result, we consolidated $258 million of municipal bond assets and $269 million of variable-rate certificate liabilities onto our balance sheet as of September 30 and recorded an after-tax loss of $13.4 million in the third quarter.

We took this section because current volatility in the credit markets caused a decline in the market value for municipal securities, which increased the likelihood that Piper Jaffray would make payment under its reimbursement obligation to the third-party liquidity provider for the program. This reimbursement constitutes material involvement in the trust and requires them to be consolidated onto the balance sheet.

We also decided we will discontinue the program as we believe that TOB trust will not have long-term life as we originally expected. We have long-standing expertise in the municipal market, and we will continue to invest in and to underwrite municipal bonds as one of our primary business activities. We will continue to deploy capital to the municipal market when we believe it is advantageous to do so. But we will not use the TOB vehicle for financing.

All of the TOB bonds that we consolidated onto our balance sheet are rated AA or better. As of our call with you last week, we had already reduced our exposure by selling $94 million or 36% of the bonds, largely at prices at or above where we marketed them at September 30.

Our exit strategy meets our two key objectives during this time of market volatility. First, to remove a potential funding risk to the existing TOB program, and secondly, to manage our overall municipal exposure prudently relative to the overall risk framework that we maintained for the firm. The resulting level of our overall municipal exposure is within the range that we have historically managed for these securities, inclusive of the remaining TOB bond.

Now let me move to our ARS inventory, which is at $50 million as of today and the same as it was in our second-quarter call. We anticipate that we would be able to complete additional restructurings, but given the turmoil in the credit markets and the dislocation in municipal markets, pricing on deals has been difficult. The largest of the three remaining issuers has made a decision on restructuring. Its two issues and deals are on our calendar to price depending on market condition.

As these deals do get priced, the balance will drop to $26 million. The restructuring timing on the remaining deals could move to late this year or early next.

Clearly the financial markets continue to be challenging. I and our business leaders continue to monitor the financial market conditions and manage our risks appropriately. Despite a very challenging operating environment, we see opportunities for Piper Jaffray amidst this historic reshaping of the investment banking landscape. We have said all along that the current environment is providing long-term opportunity, and we believe we still need to thoughtfully pursue opportunities for talent and market share.

The constant in all of these changes are continued middle market focus and growth strategy to enhance our platform across geographies, products and sectors. We have a unique opportunity to selectively extend our franchise and enhance our talent base with experiences individuals or teams during these challenging times. We see particular opportunity to add talent in public finance, equity distribution including electronic trading, and in our equity investment banking. We are being thoughtful and selective as we consider opportunities for additional talent.

We believe the talent we are adding will translate into an improved market position and financial results. As an example, we are very pleased with the quality of the public finance team we added in California in June, and they contribute positively to our results in the third quarter.

For 2003 through 2007, this team was the top education underwriter in California based on number of issues. During that same timeframe, Piper Jaffray was number four. In the third quarter of this year, the first full quarter after the team joined us, we were the top education underwriter in California.

We also believe we have the opportunity for additional revenue because competitors are no longer in the business or once strong platforms are diminished. For example, we estimate that since the beginning of 2006 for public offerings or issuers with less than $2 billion market cap, Merrill, Lehman, Wachovia and Bear Stearns generated $1.9 billion of public offering fees. Public offerings were particular robust during this timeframe, but the point is that we believe a portion of a significant revenue pool is now available to firms like Piper Jaffray. We're balancing the historic opportunity available to us with the realities of a difficult operating environment in the near to intermediate-term.

I would like to make a few comments about how we are approaching the compensation and non-compensation.

As of September 30, our net headcount is down 5% since the end of 2007. More importantly, however, is the employee mix. Our senior talent headcount is down only slightly as we have added strategic hires in areas that we believe we had solid opportunities and reduced headcount in areas that were underperforming or had limited prospects. The junior and support level staff headcount is down 9%. We're intentionally retaining our senior client-facing talent as we support our clients in a global franchise, and we believe we can rehire junior and support staff as we need to.

Given the weak revenue environment in 2008, we have experienced increased compensation pressure because we had added talent to build out our global franchise. We had certain compensation guarantees, and we had fixed equity amortization expense. We have adjusted incentives downward, which is appropriate given our lower results. For areas that demonstrate performance, we will pay bonuses. For areas that do not demonstrate performance, we will adjust incentives dramatically. Overall incentives will be down significantly compared to 2007, and we are continuing to adjust as we need to.

We believe we're taking appropriate actions with the goal of preserving our talent base to reap the market share gains when the market cycle improves.

We acknowledge that our compensation as a percentage of revenues will be impacted. We expect it to be significantly elevated in the fourth quarter as well. We also believe to not take advantage of the talent available and retain our current talent would be shortsighted and place us at a competitive disadvantage when the market cycle improves.

For 2009 our compensation model will be significantly more variable than in 2008. Our guarantees will largely roll off at the end of this year, allowing us more flexibility. As we add talent to our platform, their compensation formula is variable based on revenues. We approached non-compensation expense with the same [tenants] as compensation. That is, we want to adequately support and enhance our global platform, and we need to be very disciplined about where we are spending.

For 2008 our goal is to hold our core non-compensation expenses to a 5% increase over 2007. This is essential to allow for growth related to a full year of FAMCO in Piper Jaffray Asia.

Our goal for 2009 is to reduce our core non-comp run-rate. Year-to-date in 2008 our core non-comp run-rate has been approximately $38 million per quarter on average. Our goal for 2009 is to reduce the quarterly run-rate for our current business to about $35 million or a drop of 8%. We believe that this reduced base will adequately support our growth initiatives.

In 2008 our revenue breakeven level has been approximately $115 million per quarter. In 2009 we expect all of our intended actions can allow us to breakeven at $95 million in revenues per quarter. This revised structure also provides us with more operating leverage when the market cycle turns positive. If we believe that the remedy run-rate will likely fall below $95 million for an extended period, we will take additional actions.

In closing, I would like to acknowledge our employees for working hard to communicate with our clients and guide them through some very volatile and uncertain markets. Although the transformation occurring among large investment banks may create uncertainty as it drives fundamental change in the industry, the change also brings opportunity. I and our senior leaders intend to capitalize on those opportunities and come out of this environment in a much stronger position than when it began.

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

Thank you, Andrew. For the third quarter of 2008, we reported net revenues of $72.7 million and reported a net loss from continuing operations of $26.5 million or $1.68 per share. Included in the results was a $21.7 million pre-tax loss which we previously announced related to our TOB program. On an after-tax basis, this loss was $13.4 million or $0.85 per share.

Andrew largely covered the highlights of the revenue mix, but let me add one final comment on pipeline. Our current US equity backlog consists of eight transactions compared to 13 when we reported our second-quarter results. We currently have two announce M&A transactions with an aggregate value of $713 million. Given the current environment, it is very difficult to complete transactions, and this may impact our ability to realize revenue from the pipeline through the balance of 2008.

Now let me turn to expenses. When it became clear to us that the revenue environment would not be improving in the second half of 2008 as we originally expected that it would, we reduced headcount by an additional 3%, bringing the total for 2008 to 9%.

The pre-tax charge associated with the additional headcount reduction was $2.2 million and is reflected in a new line item on the P&L entitled Restructuring-related Expense. The remainder of the $4.6 million restructuring amounts or $2.4 million was a charge related to executing leased office space in two locations. The annual save associated with this action is $825,000. The severance and restructuring charges we recorded earlier in the year have been reclassified into the restructuring line item.

In the third quarter of 2008, we resolved the trading related litigation matter that we reviewed with you on our second-quarter call. We were able to offset a majority of the $3 million net expense that we incurred in second quarter.

During 2008 we have diligently managed our core non-comp expenses. We had increased cost to support our organic growth and some unanticipated cost like busted deal expenses. However, we will be able to completely offset the increases by reducing costs in other areas like technology, professional fees and travel and entertainment. Some of the actions we have implemented in 2008 will also benefit 2009.

In total, as we look forward into 2009, we have identified specific actions across the firm to lower our non-compensation expenses by approximately $12 million, which represents an 8% decrease over our anticipated 2008 full-year non-compensation base. A large part of the savings will come from reductions in technology-related expenses and travel and entertainment. The initiatives are well underway, and we anticipate we will realize the savings ratably over the quarters next year.

Finally, I would like to end with a comment on the changes related to our TOB program that we announced last week. As of September 30, we consolidated $258.2 million of municipal bonds as assets onto our balance sheet. The assets will be categorized as Level 2 from a fair value perspective, consistent with our other municipal securities.

As of September 30, we had $89 million of Level 3 financial instruments and other inventory positions, which was down from $142 million at June 30, 2008, mainly due to the reduction in option rate securities inventories, the write-off of the TOB residuals and lower ABS inventories. This represents approximately 11% of total inventories, down from 17% at June 30. These figures are preliminary, and we will disclose the final numbers in our 10-Q.

After the change to our TOB program, the only other off-balance sheet arrangements we have relate mainly to interest rate swap contracts, the vast majority of which are for matchbook interest rate swaps for our public finance clients. The other interest rate swap contracts are for hedging our inventory exposure. All of these derivative contracts are mark-to-market daily, the results of which are recorded in our P&L. We also have a small amount of off-balance sheet arrangements related to commitments for firm investments.

That concludes our formal remarks, and now Andrew and I will answer your questions.

(Operator Instructions). Devin Ryan, Sandler O'Neill.

I'm sorry if I missed this in the prepared remarks, but can you talk about how you feel about your liquidity position today? I know that you announced that your $250 million credit facility is now committed. I just wanted to get some comments there.

Sure. With the addition of that US bank line, which is committed and really replaced discretionary over that line that we had, we really increased our total bank funding capacity by $150 million. We added that line as part of just looking at our overall funding needs and also wanted to have a portion of our bank funding in the form of committed lines. We think that the amount of our total lines is significantly greater than what we are borrowing on an overnight basis to fund our inventories.

And can you talk a little bit more specifically about what you're seeing in the competitive environment? You mentioned that some of your larger competitors are maybe out of particular markets. Can you just give maybe some more specifics there? Where the biggest opportunity is -- is it in fixed-income, equities, international, or is it all of the above? I just want to get some comments there.

Yes, I think the more near-term it's an evolving picture as I think we all recognize, and the full implications aren't visible yet. I think the most evident are probably twofold.

One, geographic expansion like we've continued to do in our public finance franchise. And then I would say sector expansion for our investment banking franchise.

We also think that we're beginning to see some Asset Management opportunities as well priced significantly differently than they were previously, say, a year ago.

So Asset Management in terms of actual acquisitions or (multiple speakers) or how are you thinking about that?

Both.

Okay. And just kind of on Asset Management, in FAMCO it looks like assets under management declined a fair amount during the quarter.

That was really market-driven. They had a modest inflow, but market valuation reflects that decline.

Okay. And how has performance been in FAMCO? We have not seen any numbers on that.

The products in the third quarter really largely mirrored their various indices. In some of those areas, it is some pretty significant volatility, for instance in the MLP area, but they largely mirror their indexes.

Okay. And then just finally, in fixed-income sales and trading, were the losses this quarter, excluding the tender option bond charge, were they realized or just unrealized losses as inventory positions declined in value?

You know, there is always some of both, but it is largely related to unrealized losses from where we marked inventories based on valuations at the end of the quarter.

Brian Hagler, Kennedy Capital.

I appreciate your time. I guess you gave us an outlook on the equity backlog and then kind of your expectations for expenses in the fourth quarter and next year. So I appreciate that. But can you just maybe talk about any visibility whatsoever you have on the fixed-income side and what that may look like in the fourth quarter?

Let me give you a couple of thoughts from my perspective. The most substantial part of our fixed-income business is the municipal market. It is going through a fairly severe dislocation. It really began in the back half of September and has continued perhaps reflecting the broader credit markets. We're starting to see some signs of improvement at the short end that had also seen extreme volatility, but many of those rates are actually fairly rapidly declining to what I would call more normal rates.

It is our belief that this will take perhaps a couple of weeks to sort of settle down with all these new federal government programs and then think that that can normalize, and our public finance backlog is in pretty good shape. In fact, we have quite a bit on the various ballots for additional financings.

And I guess what is -- I know last quarter was kind of a strong quarter, and then you guided that you would not get -- you would not replicate it this quarters, so this quarter was obviously below average. But what in the normal environment, and I don't expect this next quarter anytime soon, but what is kind of a normal run-rate range for that business as far as revenues?

I think that is something that obviously changed a lot given the volatility in the markets and really not going to disclose an average run-rate for that business.

Okay. But I guess $20 million I think it was last quarter was obviously above-average and $4 million, so it is somewhere in between?

Exactly.

Those are probably relative extremes. But if you look back over time, it will actually give you a picture.

Exactly. Look back over Q3.

Okay. Great. Thanks.

(Operator Instructions). Horst Hueniken, Thomas Weisel Partners.

We have seen significant structural change on Wall Street as you know. You have already discussed the potential opportunity with regards to hiring people to strengthen your businesses. But I'm wondering whether you have yet to have seen direct impact on any of your businesses either from a volume or a pricing perspective, or are we too early?

Yes, I think there is ongoing evolution. If you are talking about the trading areas on the equity side, the volumes and the volatility, it has been advantageous. What areas --?

I guess what I'm sort of exploring is we have mergers happening with Bear Stearns and JPMorgan and Merrill obviously merging with Bank of America, Lehman in Chapter 11. All of this I know the experience in Canada is when two investment banks merge, very often one plus one does not equal two, but it equals something less than two. There is some market share spill. And I am wondering whether that is evident at all in your marketplace?

It is early, but my comments during my text were getting at exactly that issue. We would also share that perspective. Not only are a couple of market participants essentially leaving the marketplace, but those combinations typically do experience that you don't maintain both of the original marketshares. In fact, often it is substantially reduced from the original combination.

And so the statistic that I gave you was trying to break that down more specifically to the middle market. Those participants going through the change also have large-cap global franchisees that are in markets that we are less active in. So the statistic I used was underwriting fees for companies with market caps under $2 billion. That would certainly be our sweet spot, market caps of $500 million to $2 billion, and that is a pretty substantial revenue pool. It was just under $2 billion since 2006, and we believe that there is a significant opportunity right there.

Fair enough. That is helpful, and I will look forward to watching things unfold.

Steve Stelmach, FBR Capital Markets.

Just real quickly, a follow-up on FAMCO. Was there or did you get any indication that at least the beginning of October is any different in terms of fund flows, or is it pretty much as trending broader markets?

You know, I don't have any of the October information. We typically review that a week or two after the close.

Got it. Okay. Thank you very much.

I'm showing no further questions at this time, sir.

Would you double-check one more time and then we will wrap it up?

(Operator Instructions). I'm showing no responses, sir.

Thank you, operator, and thank you, everyone, for dialing in this morning and giving us an opportunity to update you. Thank you.

Thank you for participating in this morning's conference. You may now disconnect.