Piper Sandler Companies (PIPR) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Piper Jaffray Company conference call to discuss the financial results for the third quarter of 2010.

During the question-and-answer session, securities industry professionals may ask questions of management. The Company has asked that I remind you that 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 would 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 third-quarter results.

Our performance reflected the lower activity industrywide in growth company IPOs and reduced equity trading volumes. However, fixed income institutional brokerage revenues rebounded from the difficult sequential second quarter. Advisory Services revenues continued the solid trend, and Municipal Financing revenues were at the highest level year-to-date.

In the third quarter, we executed two significant transactions for our firm. The first was a $230 million US IPO for RealD, a global market leader in 3-D-enabled motion picture screens. This was in our newer media vertical and one of the most high-profile and successful IPOs of the year.

Piper Jaffray acted as a joint book runner for the offering, which we successfully executed in a difficult IPO market.

The second transaction was the $200 million Hong Kong IPO from MicroPort Scientific, a leading developer, manufacturer and marketer of medical devices in China. This represents the global extension of our successful medtech franchise.

Piper was a joint book runner for the offering.

Also, we took actions that will enhance our financial performance going forward. First, let me provide some context.

Heading into 2010, we believed that the economy would recover at a much faster pace, similar to historical experience. Beginning in May, the economic picture changed. Uncertainty and volatility reemerged.

We now believe that the Company and, therefore, our business, the economy and, therefore, our business will improve at a slower pace than we originally anticipated. US growth capital-raising levels are still low by historical industry standards and may remain so for the next 12 to 18 months.

The trends in Europe reflect these same dynamics or worse. The equity capital-raising environment for European-based, middle market companies remains depressed, particularly in biotechnology, our primary specialty focus. For example, annualized year-to-date as of September 30, equity capital raised for UK-based, middle-market companies is down 67% compared to the peak in 2007.

We believe lower capital-raising activity will persist, due to the weak economy across Europe.

Asia is distinctly different. Equity capital raising by China and Hong Kong-based companies is up 78% in 2010 versus 2007. Just since September, 45% of the capital raised for IPOs on US exchanges was for China-based companies.

Our focused sectors overlap well with the equity capital being raised by China and Hong Kong (inaudible) market company.

So, given the current economic realities, we reevaluated our strategy and plan to restructure our European operations, to focus resources on two areas of strength -- the distribution of US and Asian securities to European institutional investors and M&A advisory services. Piper Jaffray is distributed to US equities in European markets since the late 70s. We expect these retained businesses to be profitable.

Going forward we will no longer facilitate the origination and distribution of European securities. Our European business on a standalone basis has not been profitable and would require significant additional investment to complete a buildout against a difficult market backdrop.

Our goal with our restructuring plan is to return our European business to being a positive contributor to our firm results. Deb will provide additional detail and take you through the financial ramifications of this action.

In reevaluating our strategy, we've also made a decision to invest further in Asia and in particular China. We have a solid early-market position in China where the characteristics of the economy align well with our growth company focus and where we believe the equity markets will experience long-term expansion.

Year-to-date through September our Asia business is slightly profitable. Year-to-date in 2010, 13% of the global capital raised by our firm has been for China-based companies. Currently we have a team of 84 in Asia. We plan to add resources across the business, continuing our industry-sector buildout.

Finally, in a slower-growth environment such as we are currently experiencing, we believe upper single-digit ROE is more realistic. The actions we are taking are designed to make progress, despite a challenged environment. As a result of our moderated view of growth, we have determined it is not probable that we will achieve the ROE target of 11% under the performance-based restricted stock grant to our leadership team in May 2008. For the grant to vest, the target ROE would need to be achieved over a 12-month period by April of 2013. As a result, we are reversing the compensation expense amortized to date related to the award.

To conclude, we have confidence in the strategy for our firm and in our diversified business portfolio with strong operating leverage. We are encouraged by the improving capital markets environment since the beginning of September, as evidenced by improving stock market performance and lower volatility, which in turn is driving improved investor sentiment. We need constructive capital markets to realize the revenue potential from our strong backlogs across capital markets, M&A, and public finance.

Also, we are pleased with the performance of Advisory Research, products continue to perform well, and the holding period by consultants due to the acquisition is beginning to lift, and our pitching of new business is picking up. And in FAMCO, the solid pace of asset inflows in the MLP product continues.

Now I would 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 two items that impacted the quarter.

As Andrew highlighted, we reversed the expense related to the performance-based restricted stock grant award. The compensation expense associated with the award was $6.6 million or $786,000 per quarter. As of the third quarter of 2010, we will no longer amortize this expense.

The 308,000 restricted shares will remain outstanding and will be included in the calculation of EPS. If, at April 30, 2013, we have not achieved the award's vesting provisions, the award will be forfeited.

The reversal of compensation expense reduced our reported year-to-date compensation ratio to 59%. The compensation ratio, excluding the reversal of performance award amortization related to periods prior to 2010, was 60.5%.

The second item that impacted the quarterly results was related to our plan to restructure our European operations. We anticipate we will incur a total estimated charge of between $8.3 million to $9.8 million, $800,000 was incurred in the third quarter, and we estimate an additional charge of between $7.5 million to $9 million will be incurred in the fourth quarter.

The charge includes costs for severance, occupancy and technology.

With our sole focus in Europe consisting of a distribution of US and Asian securities to European institutional investors and M&A, we expect to achieve profitability going forward. As a result of this move, we estimate that 2011 EPS will improve between $0.30 to $0.35, and return on adjusted equity will improve between 80 to 90 basis points. The improvement includes the benefit of tax-loss carry forwards.

The net operating loss in the UK tax jurisdiction increased our consolidated tax rate for the third quarter to 48%. Approximately 6.7 percentage points was attributable to the loss in the UK, which was increased due to the restructuring charge. We do not recognize a tax benefit from UK net operating losses, because in the fourth quarter of 2008, we recorded a 100% valuation allowance against our UK-based deferred tax asset.

Also, because of the additional $7.5 million to $9 million restructuring charge that we will incur in the fourth quarter in the UK and our inability to record a tax benefit against that, the tax rate will be significantly increased.

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

Thank you. Operator, we are ready for Q&A.

Thank you. As a reminder, securities industry professionals may ask questions of management. (Operator Instructions)

Our first question coming from the line of Devon Ryan from Sandler O'Neill.

Good morning, guys.

On the European pullback, I guess at the end you gave some ROE numbers, but to try and get a sense of what we should expect from a revenue impact, what percent to revenues where the businesses that you're getting out of? And then, I don't know if you gave it, but what type of expense saves we should expect going forward as a result of the restructuring?

Okay. Let me start with the revenue side. The revenue impact would be around $9 million to $11 million, but split fairly evenly between our investment banking and our institutional brokerage revenue line items.

From an expense perspective, if you look first at non-compensation, the impact will be between $5 million to $6 million US annually across really all of the expense categories, fairly evenly distributed amongst those.

From a compensation-expense perspective, while this obviously will have a positive impact to the comp ratio over time, in the near term we anticipate the comp ratio will remain fairly consistent to that year-to-date number that I gave of 60.5%, adjusted for that performance grant, on a firm-wide basis.

Okay. I am just trying to reconcile. So, call it $10 million in revenues and $5 million to $6 million coming out in expenses. So, so in terms of profitability there, I mean that would be positive?

I'm just trying to -- I guess --

Yes, the compensation piece, you are only excluding the non-comp expenses when you're looking at that?

Yes. So essentially you're saying that there may be some higher just comp expenses in general for the firm, kind of keeping that comp ratio at 60%. So you're not getting as much leverage out of the comp from headcount reduction in Europe?

And I'm talking in the near term here. I am looking at the fourth quarter specifically.

Okay, okay. Got you.

And then just looking at the share count declined a bit in the quarter, was that just related to the performance awards that were charged off, or were there any repurchases? I didn't see any commentary in the release.

Yes, there was a commentary in the release. It is not related to the reversal of the performance grant as those shares will remain outstanding until ultimately the April of 2013; and if that hurdle is not met by that time, then those shares will be canceled.

We did repurchase about 1.4 million shares between Q2 and Q3. Within the third quarter, that was 500 -- let me get you the exact number here -- 548,000 shares in the third quarter.

So what you are seeing is the full quarterly impact of the shares that we bought back in the second quarter and then the weighted average effect of what we bought back in the third quarter.

Okay. And then just on investment banking, it would be helpful if you guys would give just a little more detail on the pipelines by product. I guess specifically on the IPO pipeline, I know there's been a number of deals kind of coming into the pipeline throughout the year, but just get a sense of how the markets are feeling today as some deals have been getting done, and whether you feel like the fourth quarter you may be able to get some of the deals that have essentially been in the pipeline for the last few quarters, done.

Okay. So the pipeline going into the fourth quarter actually looks a lot like going into the third quarter. I think we had 15 on file from IPO perspective, and we have one M&A transaction. So it's quite similar to the third quarter.

That does not include Hong Kong where we have a very active calendar as well.

And as to the start of the quarter, we've had a number of underwritings that have gone reasonably well. So we think the market is reasonably constructive at this point.

Okay. I guess I'm just trying to tie that together, then, with the reduced expectations going forward, the reduced kind of ROE targets. If things seem like they may be getting a bit better in the markets, at least so far this quarter have been opening up a bit more than it has been maybe the last couple of quarters. Just trying to reconcile those two things.

So, those comments were a moderated, intermediate view, not intended to be a comment on how we feel about this quarter, which actually feels pretty good. But if you look at our current ROE and what it would take to vest and achieve that, and our intermediate view in Europe, they are more moderated.

I mean, still the IPO activity on any kind of a historic look-back is pretty moderate. That's not to suggest that we don't think it is currently improving. And when you look at that from the perspective in ROE that is hovering around 4%, the ability to get a full year in at '11 between now and May of 2013 is pretty unlikely.

So the heart of this is, we wanted to take actions that improve our performance in ROE very much in the near term, irregardless of the modest environment, I will call it. Not overly challenged, but not back to any historical norms. And said very directly and simply, we need improvement now.

Okay. Thank you.

Thank you. (Operator Instructions) Steve Stelmach, FBR.

Good morning. Just a quick question on the headcount and I joined a little bit late, so I do apologize if you mentioned it. You talked about headcount reductions in the capital markets segment; that's both within the US and Europe, correct?

No, that was a US comment, and it is relatively modest spread across the capital markets.

Okay. And I was going to -- in reference to the total number of employees, which is essentially flattish -- we are down one quarter over quarter was there an area where you guys were building out headcount during the quarter?

No, the significant news is discontinuing the buildout in Europe.

Okay.

Growing distribution model and the M&A model.

Yes, okay. That clarifies it; thanks very much.

Thank you. Matt Fischer, CLSA.

Good morning.

Just, on the regional breakdown, taking into account the restructuring and also maybe some investments in Asia, what are you looking to achieve in terms of your regional breakdown in revenue and even earnings?

So are you speaking international, in essence?

Yes, I'm talking about -- right; so I'm talking about US versus Asia, versus now Europe, which is obviously going to be a smaller piece?

So, I think from a longer-term perspective, right now I believe in the third quarter we were a little over 11% of our revenues internationally.

We do really feel that will grow primarily in Asia, as Andrew spoke about the opportunities we believe are there.

I guess on a longer-term basis, if we look even just specifically -- I guess on a firm-wide basis, we would like that to get to be 20%.

Okay. Okay. And if we could touch on the comments you made regarding 2011, the $0.30 to $0.35 --

Yes?

Can you readjust that? I just kind of heard it halfway, and I just want to make sure I heard it correctly.

So, in essence, what we're looking at is, as a result of the actions that we are taking in Europe, we believe there would be an improvement in 2011 EPS between $0.30 to $0.35, and part of that is from the improved profitability of the business, and part of it is then due to the related ability to utilize our net operating loss tax carryforwards as we will not be required to accrue any tax expense against those profits until those NOLs are used up.

Okay. Okay. Great. And that's the 80 to 90 basis points of additional ROE?

Correct.

Okay, and then also I guess then just to touch back on the tax rate, you mentioned the 6.7% UK loss kind of built into that 48% for the quarter.

Yes.

So, you would look at sort of 41% as a run rate? It's still -- you know, the prior quarter was, I believe, 37%, 38%.

Right. I think the thing to look at -- I think yes on our core business, that's in the ballpark. I think what you really need to look at, though, for quarter for specifically is the fact that this $7.5 million to $9 million anticipated charge for the UK, again will not have any tax benefit against it, nor would any additional losses that we would take in the UK during the fourth quarter have any tax benefit associated with it.

Right, okay.

Yes, so it will be significantly higher. Just ultimately I think we should be able to account for that somewhat as you look at those calculations.

Okay. Great. That's it. Thank you.

Thank you. Mr. Duff, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Thank you all for joining us this morning, and we will look forward to talking to you in the fourth quarter.

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. Have a great day.