Piper Sandler Companies (PIPR) 2010 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 second-quarter results for 2010. During the question-and-answer session, securities and 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 website at www.PiperJaffray.com and on the SEC website at www.SEC.gov.

As a reminder, this call is being recorded. And now I'll like to turn the call over to Mr. Andrew Duff. Mr. Duff, you may begin your call.

Good morning, and thank you for joining us to review our second-quarter results. In short, we had mixed performance for the quarter. We generated solid Investment Banking results attributable to equity financing and advisory fee revenues, both of which rebounded compared to the sequential first quarter and improved from year-ago levels.

We also benefited from a full quarter of results from Advisory Research. These results were partially offset, however, by significantly lower fixed income revenues driven by a very challenging trading environment.

In April, we experienced good momentum across our businesses. Starting in early May, however, macroeconomic concerns, financial market volatility and credit spread widening all converged to create very challenging conditions for the remainder of the quarter. Despite the market headwinds, the Investment Banking revenues were solid.

We completed 28 equity financings globally, raising $3.5 billion of capital for our clients across our sectors. Included in these results were increased activity in Asia, which was a strong contributor to the quarter. We raised capital for two China-based companies on US exchanges and another three on the Hong Kong exchange. Also, we increased our US equity financing market share within our sectors by 50% compared to the end of March.

Advisory fees rebounded in the second quarter with 11 completed transactions. Public finance underwriting held up well quarter over quarter. However, revenues were down year over year, primarily due to lower large issuer and California businesses.

Asset Management revenues reflect a full quarter of results for Advisory Research. Revenues for both Advisory and FAMCO were impacted by the decline in equity pricing during the quarter. We're encouraged that the Advisory Research is beginning to be returned to consultant and client "buy" list from "watch" list. Putting an asset manager on a watchlist is customary following an acquisition. Also, we implemented a more cost-effective operating structure at FAMCO, resulting in a reduction in headcount.

Where our performance fell short of our expectations was in fixed income institutional brokerage. In municipal securities, which contribute approximately 60% of our total fixed income brokerage revenues, investors continue to stay on the sidelines or at the short end of a steeply sloped interest-rate curve, where the economics are much less. Credit risk became a factor in investor decisions, injecting more volatility into the municipal market and exasperating difficult trading conditions.

As a result, we continue to generate lower revenues in our municipal client flow business, and we realized lower revenues in municipal strategic trading. Also trading results in taxable products, particularly investment-grade corporate credits, were lower; credit spreads widened; our client flow slowed; and we underperformed on trading.

Let me end with a few comments on our outlook for the second half of 2010. Our backlogs continue to be healthy across equity public finance and M&A. We need constructive capital markets to realize the revenue potential from these backlogs, and currently, there is a fair amount of uncertainty in the market. We also anticipate that the municipal institutional brokerage revenues will continue to be negatively impacted by the factors I cited, making it difficult to achieve our goal of $25 million per quarter for fixed income.

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

Thank you, Andrew. My remarks will supplement the information already disclosed in our earnings release this morning. First, I will address consolidated results, and then I will review each business segment.

Andrew has largely reviewed revenues. I will just add that business mix shifted with investment banking contributing a higher percentage of revenues and fixed income institutional brokerage contributing a significantly lower percentage, which increased our compensation ratio and negatively impacted our overall margin.

Non-compensation expenses increased to $38 million for the quarter, up $2.8 million compared to the sequential first quarter. There were three main drivers of the increased expenses. First, a full quarter of Advisory Research expenses, including intangible amortization. Second, one-time costs associated with the staff reduction at FAMCO. And third, higher T&E, driven by increased business activity.

Turning to capital in the second quarter, we repurchased $30 million of our common stock at an average price of $33.50. On June 30, the remaining portion of the 100 million share repurchase authorization expired. We expect to seek an additional authorization from our board in the third quarter.

Now I'll address the business segment results. Beginning with the second quarter, we added segment reporting for Capital Markets and Asset Management. Consolidated net revenues and expenses are fully allocated to these two segments.

For the quarter, Capital Markets generated 88% of revenues and 75% of pretax operating income. Asset Management generated 12% of revenues and 25% of pretax operating income. Compared to the sequential first quarter, Capital Markets pretax operating margin improved to 7.9%, a 7% increase where revenues increased 12%. The delta between the two was driven by compensation expense related to the shift in business mix, which I previously mentioned.

In the year-ago period, Capital Markets generated a pretax operating margin of 15.4%. Last year's higher performance was driven by higher overall revenues and a higher proportion of fixed income institutional brokerage revenues.

Moving to Asset Management, pretax operating margin was 19%. The first full-quarter results for Advisory Research produced a pretax operating margin in the low 30% range, fully allocated and including intangible amortization. This is in line with our expectations for Advisory Research.

FAMCO was performing at breakeven in the first half of this year, an improvement compared to the same period last year. The actions we took at FAMCO at the end of the second quarter should improve the profitability of this business and the overall Asset Management segment going forward.

This concludes my remarks, and I will turn the call back to Andrew.

Operator, this concludes our formal remarks, and we would like to open the line for questions.

(Operator Instructions). Lauren Smith, KBW.

Good morning. I guess a couple questions. First, maybe just a little more color on the fixed income side. Clearly, lowest quarter since we were in the thick of the credit crisis in 2008. And while munis is an important business for you guys, I was just surprised that it really declined to the magnitude that it did. So any additional color there? I know muni flows slowed, but are we really talking more about losses in your muni prop trading business?

No, actually, our muni flow, as you suggested, Lauren, did slow. And both the flow book and the strategic trading had reduced profitability, but they were both profitable.

Okay. Then maybe, can we just look at some of the more specific product area and maybe just give us some either linked quarter or year on year up, down percentage? I'm just still trying to get my arms around just the magnitude of the falloff in the quarter.

Okay; so it's more -- the other significant impact was corporate credits, where we've been extending into industry sectors where the investment bank has gone. And to -- we underperformed there, and there were losses, Lauren, so we've reduced our inventories across the board and narrowed our -- renarrowed our focus. So that should lead to improved performance, but that was the additional factor.

Okay. Okay. And then I guess just shifting gears to the M&A side, you guys had a huge order, and congrats there, but quite frankly, took me by surprise. And when you look at the public data sources, I just rechecked this morning Dealogic, and even your website, there is a huge disconnect between the number of deals; 11 deals you guys said you closed in the quarter and what is out there. So I'm just trying to, again, get my arms around that. And included in that 11, is there anything on the restructuring side of the business, because that is an area where you guys have been investing.

Okay, so the restructuring was relatively modest in the quarter. There were two relatively large transactions Invatec and Switch & Data, which both closed in the quarter, Lauren. And prospectively, we would say we've got a good backlog, but the volatility in the market is potentially going to impact our ability to complete it all.

Okay.

So our M&A line, really, over time, can be lumpy. It just depends on the mix in the quarter, and we had a couple here that were relatively large.

Yes. No, no, I understand that, but even looking at your website, you guys have that you had five deals close in the quarter, and so, I'm just -- are some of these deals technically not closed, but whatever the way your engagement letter is structured, you recognized a portion of the fees?

No, they were closed.

All closed deals.

Two of them were relatively large. And on a global basis, there were actually 11 in the quarter.

Okay. All right; that's it for me for now. Thank you.

(Operator Instructions). Christopher Nolan, Maxim Group.

Thanks for taking my call. You mentioned in terms of the municipals, increased credit risk. Is this related to budgetary problems at the state and local levels? Or is it just related to overall increased risk tolerances or decreased risk tolerances as it were?

Yes, I think it's a combination of those factors. There's clearly crosswinds here and increased volatility with concerns around the budgetary issues and a lot of the issuers. You know, the primary driver for a lot of their revenues is real estate assessed valuations. Those are declining. Meanwhile, they have fairly significant liability. So the view to the marketplace is shifting quite regularly. It's relatively volatile.

Do you view (multiple speakers). I'm sorry, go ahead.

No, go ahead.

Do you view the shift to be something which is systemic, something that's going to be with you for a long term? I guess to put it another way, do you anticipate that the lower municipal volumes will be sort of endemic to the market for several quarters to come, just as the states work through their budget issues?

Yes, so let me make a couple comments. From a new issuance underwriting volume, the actual full -- first half of the year, year over year, was relatively flat. So we do see that really essentially all issuers with a couple of exceptions have been able to access the market, even those with very public deficit issues, some of the big state issuers, California, Illinois, are still coming to the market successfully.

What is more dramatic is the secondary trading and the volatility around the credit spreads on those issuers. But to date, new issue volume is still actually holding in. That may moderate over time, but it hasn't so far.

For this particular quarter, aside for the Investment Banking, is it fair to say that the new issue volume was the cost for the fixed income mix on that? I'm just trying to get my hands around the issue around the Investment Banking number for municipals.

So if you look at Investment Banking and you're looking at the debt component of our financing, that is the public finance new issuance; that is primarily what that is. The real decline that I was referring to relative to the mix of business has more to do with our sales and trading business than the Investment Banking side.

Great, thank you.

Devin Ryan, Sandler O'Neill.

Good morning. In Investment Banking, obviously, it's been a challenging capital markets environment for most of the year. But just want to get a sense of whether clients are starting to scrap plans of going public or raising capital or think about it. Obviously, pipelines are still really good and the pre-file pipelines sound like they're still there. But just want to get a sense from you if you are starting to see clients just throw in the towel and say maybe we'll come back to the markets at another time, maybe next year or something like that.

So, we're all monitoring it. We have had success; the markets have been opened as recently as last week. We were involved in a couple of those underwritings that -- one of which went particularly well. So it's selective. August, potentially, is going to be a slowdown, but after the Labor Day weekend, we're just going to monitor it. Ultimately, it just does, to your point, depend on the volatility. At this point I would not say that we are advising clients, that it is unavailable. We're just monitoring it closely, trying to time it. And we believe we can get a large part of our backlog done.

Okay. And on the fixed income side, not to beat this to death, but I'm just really trying to understand the numbers here. Relative to last quarter, just for overall fixed income, can you just give us a sense of how much the client activity portion declined, or client flow declined?

I would say from a client flow perspective, we have seen that impacted. This whole year, we've seen some additional decline in the second quarter versus the first, but I would say really the primary driver is the ability to generate trading profit to the extent that we had in the first quarter.

Got it. And just thinking about the level of trading profits, I know it kind of moves around from quarter to quarter. But if you look back over the last call it year or so, is there any way you can give us some type of percentage of how much that has contributed to overall fixed income trading revenues, about what type of gain rates they're posting?

You know, it's really challenging when you look at '08, which was a very challenging year; look at '09, which was a year that was just so favorable from a trading environment.

Now, as we look at this year, that's been the piece that's been most impacted. So I don't know if I can actually give you what -- there's just been so much change over these three years. I think -- I'm just trying to think from a quarter-over-quarter perspective, we have --

I guess maybe my question is, if $25 million a quarter is roughly the expectation? Or for a normal environment, about how much of that would be -- would you expect would be principal gains?

You know, over a long period of time, it would probably be two-third customer flow, one-third trading profits. And we've seen bigger extremes, to Deb's point, in the last couple of years around that. But over time, that would probably be a range that is more applicable.

Yes; and I think we tend to -- if we're modeling that out and thinking about the future, somewhere in that 25% to 35% range. I think the -- a significant portion of the delta between the first quarter and the second quarter was attributed to our strategic trading business, which slowed, but as Andrew previously mentioned, remained profitable in a very challenging market. And then the other piece was really our other corporate credit products.

Got you. Okay, that's very helpful. And then, just thinking about the employee headcount falling, you mentioned FAMCO. Was that really the primary driver? And then just any expectations or an update on the recruiting front would be helpful.

So, from a -- the decline is almost entirely related to FAMCO. There were not any other significant changes going on within our headcount.

And prospectively, we did accomplish a fair amount of the targeted recruiting in the first part of the year into the early spring, which is typically when we try and accomplish that. We probably have a handful of positions left. We're not actively recruiting in very many areas at this juncture. And a lot of that had been focused on Asia, and a little bit in London, and we're largely done with that.

Got it. And then just one last one and I'll hop off. On the expense front, on the non-comp side, that ticked up in the quarter. Obviously, it's the first full quarter with Advisory Research. Was that primarily the driver? Is there anything else in there? And I guess, looking at the other expense, that seemed to tick up as well. So just trying to think about a good run rate going forward would be helpful.

Yes; so of the -- it was about $2.8 million, up from the first quarter. $2 million of that $2.8 million was specifically related to the full quarter of Advisory Research, including intangible amortization, which is the big piece that you are seeing bumping up in that other expense category.

The other item that was in the quarter, which was about $0.5 million, was related to our restructuring charges within FAMCO. So that would really be the only unusual item, I would say, in the quarter.

Great. Okay. Thanks for taking all those questions.

Jason Harbes, Goldman Sachs.

So, I just have a couple questions here. One, just specifically on the comp rate, that obviously ticked a little bit higher, and you mentioned some of the severance. I was just curious what that would have been excluding the severance charges with some of the FAMCO employees.

So, actually, all of our restructuring charges, whether they are real estate severance, run through our non-comp. And if they're large enough, we break them out into our restructuring line, as you've seen in the past. This quarter, we did not feel they were material enough to do that. So the change within the compensation ratio, which did tick up quarter versus quarter, and if you look at it overall for the year, we're at 60.2%. That incremental change, that's really what I'm talking about being driven by our shift in business mix away from our fixed income institutional brokerage. So that is the primary driver of that change.

Okay. And then I guess just assuming a more sort of normalized business mix, what would be a reasonable sort of target comp rate for us to think about?

Yes, we've been -- there's obviously been variability quarter to quarter that we've seen this year. Generally we've approximated the 60% that we have discussed in the past; year to date, the ratio is 60.2%. I think the full-year ratio, obviously, is going to depend on the product mix and overall performance, but we still anticipate being within a range around that 60%.

Okay. And then just sort of on the capital allocation front, are there any updates there? You mentioned going back to the board to perhaps seek an additional repurchase authorization. But are there any sort of updated thoughts on sort of capital structure?

At this point, we are most focused on refinancing the $120 million note that's coming due at the end of this year. That's the non-callable note that was put on at the end of last year. And ultimately, our goal right now is to focus on the outset of dilution from employee grants. So I think what you are talking about is, over time, we do intend to look at remixing the debt equity mix of our capital structure. Right now, we are most focused on refinancing that note.

Okay. Any sense on timing on that one?

On the note?

Yes, on the refi.

Yes, it's non-callable, so it comes due on December 31, so we would look to be refinancing that, obviously, right close to year end.

All right. Thanks a lot.

(Operator Instructions). Steve Stelmach, FBR Capital Markets.

Andrew, just real quick, if you mentioned it, I apologize, but is your ROE target still that 12%? And if so, do you need the capital management or the restructuring of the balance sheet a little bit to obtain that, or is it just simply a function of capital markets?

So, the target is 10% to 12% by 2012. And the big drivers -- our capital management is a component, but the big drivers are threefold. Is one, maturing the really significant investment we made in senior hires in the last two years, largely in our Investment Banking footprint; it ramped the productivity. Number two, our international footprint becoming profitable. Number three, the remix into the asset management business, so we're making progress on all three of those fronts. Having said that, it was clearly offset in this quarter by the significant reduction in our fixed income business.

Okay. So no real change to targets or strategies. Just sort of market conditions were outweighed (multiple speakers) progress this quarter.

Exactly.

Yes, okay. That's fair. All right, thank you, Andrew.

We have no further questions at this time.

Okay; that concludes our call. Thank you for joining us this morning.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.