Piper Sandler Companies (PIPR) 2008 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 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 also 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.

Thank you and good morning. I believe we all recognized that during 2008 the Capital Markets industry faced historically a challenging operating environment. During the fourth quarter, economic and financial market conditions deteriorated, affecting nearly all of our businesses. We took actions to reduce our operating cost structure and to manage and mitigate risk exposures. Our actions were not able to overcome the severe market conditions, and our operating results suffered. We have two top priorities for our firm as we look ahead. First, to appropriately adjust our cost structure to enable us to operate through the near-term difficult period. And secondly, to make sure that we're well-positioned when the markets eventually turn positive.

In terms of the first priority, we took actions throughout the year to respond to the market conditions. We took additional measures in the fourth quarter as operating conditions further deteriorated. Let me review these actions with you.

We reduced net headcount year-over-year by 13%, including significant senior hires during the year. In the fourth quarter, we reduced headcount by an additional 8% from September 30 levels, but we have preserved senior client-facing talent. We ended 2008 with 1045 employees.

As a result of a difficult fourth quarter, we reduced incentive compensation, which was down significantly year-over-year. Accordingly, at my recommendation, our senior leadership team including me will not receive bonuses for 2008. For 2009 the vast majority of our incentive compensation will be variable. Most of our guarantees matured at the end of 2008 and are behind us. Going forward our compensation will continue to be performance-based but with firm results given first priority.

In addition, 2009 expense will be reduced as a result of the revised accounting treatment for stock-based compensation, which Deb will review with you in a moment. The lower expense will be reflected in a reduced compensation ratio by approximately 4 percentage points for a goal of approximately 60% for 2009, which depends on the level and mix of revenues. We also pared our non-comp expenses and our position for a $35 million average quarterly run-rate in 2009. All of the actions we have taken this year will enable us to generate profits at considerably lower revenue levels.

In 2008 our breakeven revenue level was in the mid $400 million range. In 2009 our breakeven revenue level will be in the mid $300 million range. Finally, we have a solid balance sheet with ample liquidity and sufficient capital to conduct our businesses.

We're confident that will manage through the near-term difficult period. If conditions dictate, we will take additional actions to adjust our cost structure just as we did in the fourth quarter. Our goal is to achieve profitability in 2009 despite another difficult operating environment.

Now let me turn to our second priority, which is to make sure that we're well-positioned to advance when the markets turn positive. Despite an extraordinarily difficult operating backdrop, we're very mindful that our firm has a unique opportunity to capitalize on the turmoil in the competitive landscape.

During 2008 we enhanced our talent base with 47 senior client-facing professionals. We're already seeing some of the early results. Let me give you a few examples. The California public finance team we recruited in June immediately contributed to making us the top education underwriter in that state, up from the number four position we held from 2003 to 2007. In corporate finance we extended our technology expertise to include media and telecommunications by recruiting a team of 10 senior bankers and research analysts with expertise in those areas. We added new senior leadership in our [low touch] equity business. We're seeing positive momentum in revenues, which were up 16% year-over-year. In the UK we maintained our long-term leadership position in health care underwriting while building clean technology. We added senior talent to this sector in the past year and completed our first clean tech underwriting deal in the region. These investments, together with others we have made to enhance our franchise across geography, sectors and products, positions us well to gain market share and capitalize on more positive market cycles.

We believe that our market share opportunity exists across our businesses. We also believe that we are well-positioned versus our peers to capture this share. We have deep expertise and leadership in our equity sectors and in public finance across new issue advisory, trading and investment. We will continue to focus on these core businesses because it is what we do best. The significant hiring we did this year only strengthens our position.

As a result with all Piper Jaffray partners working in concert, we will be the most capable partner in the market for our clients.

I would like to end my remarks with some comments about the year ahead, which we believe will be challenging. We expect the IPO market will be extremely limited for a good portion of the year. We do see opportunity in private placements and structured financings. Advisory activity will also be muted, but we are working hard to recognize our international capabilities for the benefits of our clients. Lower grade public finance underwriting activity will likely also be reduced for some time. We are encouraged, however, that the disruption among the largest competitors creating opportunities for us with a broader client set. We anticipate equity in municipal sales and trading will continue to perform reasonably well.

Now I would like to turn the call over to Deb to review the financial results in more detail.

Thank you, Andrew. In the fourth quarter, industrywide market conditions eroded further, significantly reducing activity in equity financing, mergers and acquisitions and public finance. For example, during the fourth quarter of 2008, only one IPO was completed in the US, ending the year with the lowest level of IPOs since the 1970s.

In addition compared to the third quarter of 2008, the number of completed merger and acquisition transactions declined by nearly 30%, and the par value of total public finance underwriting declined by 23%. Furthermore, pricing in the aircraft asset-backed securities market further eroded and our hedges on the remaining TOB portfolio were negatively impacted by historic market aberrations.

Against this difficult backdrop and due to a goodwill impairment, we reported a net loss from continuing operations of $153 million or $9.76 per diluted share. These results compared to net income from continuing operations of $6.5 million or $0.37 per diluted share in the fourth quarter of last year. Net income from continuing operations in the third quarter of 2008 was a loss of $27.5 million or $1.75 per diluted share.

Fourth-quarter 2008 net revenues from continuing operations were $59.4 million compared to $147.9 million in the year ago period and $73.5 million in the third quarter of 2008. Comparative results for 2007 and 2008 in my comments have been restated as I will more fully described in a minute.

Equity financing, advisory and public financing activities all declined significantly during the quarter. Equity, sales and trading reported solid performance, but client activity declined. Fixed-income markets continued to erode, and we recorded losses in structured product and in the TOB portfolio. However, municipal sales and trading, municipal proprietary trading and taxable sales and trading all performed well.

Now I will review the items that significantly contributed to our lower financial results. We recorded a $130.5 million pretax non-cash charge for the impairment of goodwill of our Capital Markets business. This goodwill largely resulted from the 1998 acquisition of Piper Jaffray by U.S. Bancorp. Under accounting rules this goodwill was retained by us when U.S. Bancorp spun off Piper Jaffray as a separate public company on December 31, 2003. The charge represents 52% of the Capital Markets' goodwill balance. We recorded no impairment to the goodwill or intangibles associated with the acquisition of fiduciary Asset Management.

We also recorded a $7.7 million pretax loss associated with our Structured Products business. $1.4 million represents a 100% reserve against a receivable from Lehman Brothers. The remaining amount of the loss was primarily related to mark-to-market adjustments on our aircraft ABS inventory, which is now reduced to $15 million.

In addition, we recorded a $10 million loss relating to our remaining TOB municipal portfolio. This was driven by severe dislocations between the municipal securities and the associated hedges. Approximately half of the $10 million loss was realized as we unwound TOB trust, sold bonds and unwound the related hedges.

As of January 29, we held $29 million of the $258 million TOB bonds, which we consolidated onto our balance sheet by September 30.

To continue we recorded a $9.7 million pretax restructuring charge, which included $6.7 million for severance costs associated with an additional 8% reduction of personnel in the fourth quarter and $2.6 million related to leased office space.

Finally, we recorded $3.9 million a pretax expense for a write-off related to travel and legal expenses for equity financings that were not completed because of the deterioration in the Capital Markets. In aggregate, these charges totaled $161.8 million pretax or $146.3 million on an after-tax basis toward $9.33 per diluted share.

Now let me turn to the change in stock-based accounting treatment and restatement. First, let me provide some background.

Stock-based compensation is a critical accounting policy for Piper Jaffray, and as such is provided in our critical accounting policy section of our quarterly and annual SEC filings. As we have provided in that disclosure under FAS 123R, compensation paid to employees in the form of stock options or restricted stock was generally amortized in a straight line basis over the vesting period of the award, which was typically three years and was included in our results of operations as compensation expense. The majority of our restricted stock grants provided for continual vesting after termination, provided the employee does not violate certain posttermination restrictions.

Our experience has been that the vast majority of our employees either stayed employed with us or forfeited the stock during the three-year period. Therefore, we believe that our vesting provision met the FAS 123R definition of a substantive service requirement.

The historic changes to the industry during the fourth quarter of 2008 caused us to analyze whether or not the posttermination restrictions in the applicable stock-based award would continue to meet the criteria for an in substance service condition. During this extensive analysis concluding in January, in consultation with our auditors, Ernst & Young, we reevaluated whether or not our posttermination provisions met the criteria under FAS 123R based on the manner in which those complex criteria are interpreted in practice and concluded they did not.

This determination necessitated a restatement of our results for 2008, 2007 and 2006 to recognize the expense for all of the affected equity awards in the year in which those awards were deemed to be earned rather than over the three-year vesting period as had been our practice. The total expense impact resulting from the revised stock-based compensation treatment was $81.5 million pretax, $51.7 million after-tax, which includes the unamortized expense for the affected equity awards that were granted in 2008, 2007 and 2006 and an accrual for the equity awards earned in 2008, which will be granted in February 2009. The total expense was largely non-cash. The cumulative impact on stockholders equity was an increase of $29.9 million after-tax, essentially all driven by the tax benefit associated with the increase in expense.

As a result of the revised stock-based compensation treatment, 2009 and future years' compensation expense based on current compensation plans will reflect all of the cost related to the annual stock-based compensation awards respective to each year. Therefore, compensation expense will be more closely matched with the revenue generated in a particular year.

Compensation expense for 2009 will be reduced as a result of the revised stock-based compensation treatment and will be reflected in a lower compensation ratio by approximately 4 percentage points. Outstanding equity awards will continue to invest on a three-year cliff schedule.

The supplemental restated schedules attached to our earnings release display the impacts to our financial results for 2008, 2007 and 2006. Finally for the full year of 2008, continuing operations generated a net loss of $183.5 million or $11.59 per diluted share. For the full year of 2007, continuing operations generated net income of $24.6 million or $1.36 per diluted share. For 2008 net revenues from continuing operations were $326.4 million, down 35% from $504.4 million reported in 2007. Equity sales and trading revenues were $129.9 million, up 9% year-over-year. Fixed-income sales and trading produced positive results for the year of $6.3 million despite severe conditions throughout 2008.

Within fixed-income, sales and trading, municipal sales and trading, municipal proprietary trading and taxable sales and trading revenues were strong and in aggregate doubled for the previous year. Due to the turmoil in the financial markets, lower revenues in investment banking, high-yield and structured products and TOBs largely offset these results.

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

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

Can you guys add any additional detail into what businesses or products the additional 8% reduction in headcount came from during the quarter?

It was really spread out across all the businesses, including support areas, the largest concentration being in investment banking.

Okay. And then just kind of a general questions here, when the markets eventually do return to a more normal environment, just given the platform that you have in place today, can you give us a sense of what you think is an attainable ROE or at least just some qualitative commentary around that?

Yes, I think one of the things to look at there is given performance award that we have in place for management, which looks at a low teens number, essentially 11%. So as things return to normal, we would look at something more in the low teens.

Okay. And then just lastly, are the $3.9 million in charges related to the travel and legal expenses for deals that were completed, did any of this reverse if the deals do get completed, or are those just charges that are gone?

In the theory, yes, if those transactions are completed in a timely basis where we felt that the expenses were indeed related to that specific deal, you could do that, but we anticipate that it is highly likely that that would not occur.

Right, okay. Thank you very much.

Steve Stelmach, FBR Capital Markets.

Just a real quick question, a few questions, first one on the comp expense. There is a clarification. Is the $49 million that you recorded in the fourth quarter, is that a decent run-rate off being equal given the changes in the stock-based comp, or does that not reflect those changes that you made?

I think actually fourth quarter is fairly typical of what you would see at these revenue levels given our change in accounting treatment. Because fourth quarter of 2008 really reflects more of the go forward accounting treatments where we will have the accrual of equity based on the revenues that are generated in the quarter and don't have the amortization of historical grants any longer occurring in that period.

Okay. So we should expect -- we should not expect a big delta lower because of the change in comp expense going into Q1?

Right. I think it really comes back to Andrew's comments around our goal for 2009 of the 60% ratio comp ratio.

And that reflects about a 4 percentage drop that would have been there with the prior year's amortization, which is no longer there.

Okay. And then turning to public finance, it seems to me that eventually there's going to be a large backlog for municipal underwriting at some point, given the strained budgets of the states and local municipalities. One, is that something you would agree with? And secondly, if so, what has to happen legislatively or from a guarantee perspective to soft of jump start the muni market again?

I really would agree with that assessment. What we're seeing currently is high-grade, actually very high-grade, AAA, AA financings are coming quite successfully with good investor demand. What is lagging is lower grade inclusive of even A or BBB.

One of the things I believe needs to happen is the historical ratios where you would finance below treasury yields say something in the neighborhood of 80%, 85%; I think when you look at the investor base and the volume that is likely to come, I think those relationships will change so. So really where I'm heading is I think we need to develop a broader investor base that is not just -- that does not get the traditional tax-exempt benefit. And some of the things we're reading that Congress is considering is other ways to support those state and local governments with a credit so they can actually issue on a taxable basis, which I believe would significantly expand the investor base.

Any sort of time horizon on that? Are we talking quarters or years do you think?

I would expect I cannot personally predict what is going to come in the package here, the stimulus package, but I do believe these are components being discussed. So it could be certainly in 2009.

Okay. And then just lastly on the public finance, Andrew, if guarantees are necessary on some of the underwritings, are you seeing a divergence between underwriters that have or are affiliated with banks versus underwriters who are not affiliated with banks in terms of their ability to underwrite deals?

Could you clarify what you mean by guarantees? Are you talking about --?

In terms of letters of credit?

Yes. Our experience has always been that as an advisor to a client, we're very able to go out into the marketplace and identify potential letter of credit banks and get them the most attractive terms and conditions. We certainly have not experienced any disadvantage by not being owned by our commercial bank in that way.

Good. And then last question or last topic, Piper Jaffray Asia, can you give me any comments there on what is going on in the business and then maybe give some idea of where headcount stands versus where it was maybe a year ago?

Yes, we will start with the last first. We have had headcount reductions there, as well that look like the rest of the Company. In fact, that is probably the best way to articulate it. Similar dynamic. Sales and trading reasonably active. Performed reasonably well. The capital raising, underwriting is no different than here or in Europe. Very, very limited ability to get capital raised on a public basis.

Okay. So other than just general market conditions, that acquisitions was moving along as you would expect?

Yes, and I would say too, I would reiterate we're very committed to our global footprint. We think it is very important to most of our clients and our investors.

David Trone, Fox-Pitt Kelton.

I don't know if you mentioned it and I missed it, but what was the cash loss in the quarter?

We did not actually disclose actual cash loss, and the important thing to note is that the goodwill, which is the largest piece of that block, is actually non-cash.

Right. Sure. So you had about a balance of $38 million at the end of the third quarter, and presumably I guess you're not going to say either what the fourth quarter is now. But can you at least mention if you took any steps to boost the cash?

I think really when you look at the way we manage our balance sheet, we do borrow from the banks on a routine basis, and from the repo market to finance our inventory positions. Now those positions have actually been coming down. So from that standpoint, it is really not as if we're trying to maintain a particular cash balance per se. We have adequate bank lines. We have actually increased that by one bank during the quarter and have previously announced we moved half of that to committed lines. So we feel very good about that.

So the U.S. Bancorp is still 250?

Correct. And I think overall from a general perspective, we've did utilize -- there was a negative cash from operations if you look at full-year 2008. Now when we look to go into '09 as Andrew made comments about our view towards profitability in '09, we do not believe that that will continue.

Okay. Thank you.

Horst Hueniken, Thomson Weisel Partners.

I would like to just delve into the accounting change just so I better understand it. You have disclosed that the accounting change had an impact of $0.28 for the nine-month period ended September 30, which is equal to $0.093 per quarter. I'm wondering whether that is firstly sort of linear over the nine-month period, and whether we could infer that had you not made the change in accounting, your loss would have been $0.093 less in the fourth quarter? I'm understanding that correctly?

I guess I have not looked at it specifically from that perspective. I think what you're saying generally, though, is accurate from the standpoint that in 2008, you ultimately saw a benefit in the nine-month restatement because we were taking previous year's amortization expense, which was coming through and pushing that back to 2006 and 2007. So I think from that perspective if you look at generally in concept what you're talking about, I think that is accurate.

Okay, good. You also mentioned that you are no longer meeting the criteria of FAS 123R and recognizing that there are a number of criteria and it is all complex, but I guess I'm just trying to get my head around, is it that you expect the employees to behave differently in this environment, and therefore, you're not meeting the criteria anymore or am I a little bit off the mark here?

Yes, I think that the historic changes to the industry during the fourth quarter did cause us to analyze all of our facts and circumstances relative to whether or not our posttermination provision actually did meet the in-substance service qualifications that are needed to amortize the expense under FAS 123R. What we learned during that analysis is really that we had not ever met that from the standpoint that -- we learned that SEC really has stated that they do not believe that noncompete provisions really qualify for in substance service commissions. We also gained a better understanding of how the complex criteria you mentioned, it does get complex. But how (inaudible) is actually interpreted in practice since 123R has come out at the beginning of January '06. So it was not so much --

So it seems like it is a combination of experience plus the environment for us just to take a harder look at whether you were in compliance or not, which led to your conclusion? Am I reading --?

That is correct. That is absolutely correct.

Lauren Smith, KBW.

A couple of questions. I guess first off, with respect to compensation and going forward, I guess this has really been a psychological shift where we focusing on firm results first and then allocate or focus on I guess various business or product areas. Are you managing -- or I guess the question really is, what kind of hurdles can you give us a sense for? Are you kind of gauging as firm -- I mean, could you just put may be a little more framework around that if you can for us?

Sure. If you look historically, as you may recall, we have been right in this area. We were I think 58.5 for the prior couple of years, and it is a mix of product areas and traditional payouts. What we're trying to articulate is we're going to think of that first as firm results secondly in those areas, and the comp ratio that we are inferring here now of 60% is really the driver.

Okay.

And if you start there as opposed to end up there, if you follow me, I think you get a different result.

Okay, that is helpful. And then when you look at your breakeven revenue run-rate now, you have lowered from mid-400s to mid-300s. We all certainly hope this environment gets better sooner, not later. But as you continue to look at your business and manage it and deem whether further cost saves, headcount reductions or what have you might be necessary, how far out are you looking? Right now they must really want to be playing catchup, but at what point -- how far out will you look and then say well, the market environment does not look like it is getting better. Maybe we need to retool.

I think for us it is an ongoing basis, and I think I would most directly give you a timeframe that it is quarter by quarter that we have kind of assess our current performance and say what if anything do we see as a trendline is changing that. And if it is deteriorating, we need to move quickly, and if we think it is improving consistent with our view of '09, we would proceed as we have.

Okay. A separate question. Could you just comment again or give us with respect to the goodwill, did you say 52% of the Capital Markets goodwill, did I hear that right, has been written down? Is that what you said?

That is correct.

So does that imply there is, if we were to remain or god forbid things get worse in this lackluster kind of capital markets environment, is it possible that you could have another goodwill write-down or charge?

I mean I think it is something that we have to continually look at in terms of the goodwill valuation. So I think it is possible if the market continues to deteriorate.

Okay. Just one more. FAMCO, the AUM declined pretty meaningfully. Could you give us a sense of what was flows versus market depreciation?

That was almost entirely market depreciation. Again, if you look at it on a percentage basis, it pretty closely tracks the S&P 500, which is actually the benchmark of the bulk of their products, and they really performed right around the benchmark across the board.

Okay.

So no real significant flows either direction in the quarter.

(Operator Instructions). Brian Hagler, Kennedy Capital.

I just had a couple of follow-up questions on your aircraft ABS portfolio and your tender option bond portfolio. I believe you said the balance on the aircraft ABS is down to $15 million. Is that correct.

Yes.

That is correct.

And the tender option bond portfolio is what?

It is a little under 30 -- (multiple speakers)

You talked about obviously the additional write-down on the aircraft portfolio was due to deterioration in that market. So it sounds like both of these portfolios are mark-to-market quarterly?

Yes, that is correct.

Okay, and at what levels roughly do you have kind of these two portfolios written down to? For example, is the aircraft ABS down to, I don't know, $0.30 on the dollar, or can you give us any sense of that?

Well, what we actually look at there is because of the illiquidity in that market right now. We look at really what investors would require for returns in similar types of products. And so we have been continually increasing the level of that return that we view as expected in that marketplace and marking that appropriately, and it is depending on the security and the risk associated with that varies.

Okay. And depending on what kind of package we may see from the government in the next week or so, could these potentially be assets that could be positively influenced by that if your Company is deemed eligible to participate in that program?

Actually we do not anticipate tapping into any of those programs. We have not to date nor would we expect to. I don't believe we anticipate a significant impact to either the aircraft market or the -- well, it depends on the municipal market. And again, I would just highlight after the third quarter when we brought down the balance sheet, we have sold roughly a third of it quite quickly and said our intention was to wind it down in an orderly manner and exit the product completely, the TOB, and we're down to less than 10% of it. So that is our intention.

There are no further questions at this time.

Okay. Thank you very much. While we expect the 2009 business environment to remain challenging, it is in these kinds of environments that firms can distinguish themselves. For Piper Jaffray we believe this environment presents a once in a generation opportunity to substantially advance our long-term competitive position, market impact and contribution. Our opportunity is real, and we are a wholly committed to it.

Thank you all for joining us this morning.

This concludes today's conference call. Thank you for your participation. You may now disconnect.