Piper Sandler Companies (PIPR) 2011 Q3 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 third quarter of 2011. 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 earnings release and 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'd 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. We faced an extremely tough operating environment during the third quarter. Increased volatility and uncertain macro issues weighed heavily on the capital markets. As a result, most of our businesses were negatively impacted. We were profitable in our US entities, we were not profitable in Asia. Overall we recorded a small pretax operating profit and a net loss for the quarter. Even the current challenging climate we are closely managing expenses and took additional steps to reduce non-compensation costs aggregating to approximately $7 million on a full year basis.

Let me comment on several of the key revenue drivers for the quarter. Capital raising activity was particularly weak in the third quarter, we completed just 2 IPOs. Within the US, no IPOs were completed in September. Business in Asia has been difficult throughout 2011. During the third quarter the environment became even more challenging. The hard reality is that the Asia IPO market is narrow at best. For China-based companies raising capital on the US for Hong Kong exchanges at this time. Without the ability to raise Capital Markets in these markets our results will be negatively impacted. The China market still represents a large growth opportunity and a natural fit with our middle market expertise. We have established an early lead in the market and have a credible brand. We will hold off any additional hiring and are evaluating ideas to lower cost and reduce losses to weather the downturn.

Public Finance revenues declined in the quarter. Our PAR value of senior negotiated issues remained essentially the same as the sequential second quarter. In general, however, we had lower spreads on the transactions that we completed. Conversely, we had several large higher spread transactions in the second quarter. We remain competitive in the market and continue to gain share. In the first 9 months of 2011 our PAR value of negotiated issuance was down 8% while the industry was down 40%.

We are now -- we are committed to growing our business. We added new hires and entered 2 new markets in the third quarter. We added a team of 3 in Tennessee and hired a senior banker in Indiana. For the first 9 months, we have added 10 senior bankers in our public finance business. We now have 110 Public Finance banking professionals across the country.

M&A revenues was a bright spot within investment banking and made a solid contribution to our third-quarter results. Healthcare was particularly strong. M&A continues to be a strategic focus for us given the higher return lower capital attributes of the business. We continue to work at increasing our M&A capability within other sectors. Also we've recently added an arrangement with a third-party lender providing us with the ability to offer debt financing. We've already seen success with clients as a result of this relationship.

Institutional Brokerage revenue declined in the third quarter driven by lower fixed income results. Performance improved in the middle market sales business driven by investors seeking safer, more short-term investments. The increase was more than offset however by lower performance in taxable securities and strategic trading driven by the volatile trading environment. Asset Management revenues were not immune to the tough environment and revenues were negatively impacted due to lower equity prices during the quarter. For the quarter and on a year-to-date basis however, all of the key strategies outperformed their relative benchmarks, most by a meaningful margin.

As I said at the outset, we continue to reduce our overall cost structure. We hired in selective areas such as Public Finance but reduced headcount in areas that we weren't realizing revenues or in support areas. As a result, total headcount was down compared to the sequential quarter. Also we took additional steps to lower non-compensation expenses by approximately $7 million on a full year basis. Deb will provide you with details on that in just a few minutes.

I'd like to end my comments by announcing a new role for Tom Schnettler, our President and COO and Head of Investment Baking and Equity. Effective January 1, Tom will be Vice-Chairman of Piper Jaffray and will take the lead in our Merchant Baking effort of which he was the original champion in 2007. We now have seasoned [principal] investment strategies in Merchant Banking and Municipals and they are making meaningful contributions to our results. We are taking steps to increase the scale of these activities including to raise outside capital. Tom has a wealth of market experience and client relationships and they will be critical to accelerating our Merchant Banking effort. To date we've made 14 investments, aggregating to $58 million and have completed 4 liquidity events. We now have a seasoned investment strategy and a solid track record.

In his new role, Tom's top priority is to launch $100 million Merchant Banking founded in 2012. Having Tom as the leader of the effort adds further credibility as we take the product to outside investors. He will continue to be involved in Investment Banking Client Marketing, which will keep him close to the market and allow him to source deal flow for Merchant Banking. He will relinquish his President and COO role and we will not replace the position. Tom, Chad Abraham, Scott LaRue, the co-Heads of Investment Banking, and Bob Peterson, the Head of Equities, will report to me. This new structure is consistent with reducing cost and flattening our organization.

In summary, our business strategy is sound, we're making progress and we're well-positioned for the market environment becomes more conducive to issuance activity. Also we are keeping our costs in check and focusing on improving the productivity of our people. The outlook remains uncertain as to the ability to bring companies public in this environment and we expect volatility in the markets to continue. Now I'd like to turn the call over to Deb to review the financial results in more detail.

Thank you, Andrew. First I'll address consolidated results and then I'll review each business segment. Of $98 million of revenues we generated a small operating profit but a net loss of $3.6 million, or $0.23 per diluted common share. Andrew reviewed revenues for the quarter so I'll provide additional information on expenses. For the third quarter, compensation and benefit expenses were $65.3 million compared to $66.1 million in the third quarter of 2010 which was reduced by a $6.6 million expense reversal related to performance-based restricted stock grants that were no longer expected to be earned. Compensation and benefit expenses were $83.4 million in the second quarter of 2011. The decrease compared to both of the previous quarters was due to lower performance.

For the third quarter of 2011, compensation and benefits expenses were 66.5% of net revenues compared to 56.7% for the third quarter of 2010. The prior period included the reversal of compensation expense related to the performance-based award which reduced the ratio by 5.6 percentage points. For the second quarter of 2011, the compensation ratio was 61.3%. The higher compensation ratio for this quarter was driven by the impact of fixed compensation costs on a reduced revenue base, a change in business mix and personnel investments in public finance and fixed income sales. Non-compensation expenses were $32.6 million which included some one-time items that benefited the quarter. With the additional expense work that we've completed we expect the run rate to approximate $34 million per quarter in the near term. The savings primarily reduced technology, occupancy and outside service expenses. We continue to work to further reduce our non-compensation costs.

Finally let me provide some information on taxes which had a number of components this quarter. Our US business generated income on which we booked a tax expense. Asia generated a loss and given the current level of cumulative losses and the deterioration in the Hong Kong operating environment, we recorded a 100% valuation allowance against our deferred tax assets for our Asia business, or $2.3 million. As a result, if we generate additional losses in Asia we will not record a tax benefit, and if we generate a profit we will not record tax expense. Finally, our UK operations have returned to profitability and given our projected profitability in the UK, we reversed a portion of the valuation allowance that we recorded in 2008, this amount was $1.1 million.

Now I'll turn to segment results. For the quarter, Asset Management revenues generated 14% of revenue. Assets under management declined due entirely to the significant drop in equity prices during the quarter resulting in lower revenues for this segment. With the fixed nature of certain expenses such as salaries, benefits and non-compensation cost, pretax operating margin was compressed to 4.9%. Capital Markets generated 86% of revenues. As Andrew has already reviewed, revenue significantly dropped off in Capital Markets particularly in Asia. We have recalibrated compensation but also need to accrue a certain level to remain competitive. The majority of the cost reduction measures will benefit the capital market segment and non-compensation costs declined 8% and 13% compared to the year-ago period and the sequential quarter respectfully. This concludes my remarks and I'll turn the call back to Andrew.

Operator, we are ready for questions.

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

Good morning.

Good morning, Devin.

I just want to dig into the fixed income, sales and trading results a little bit. When you look at those numbers it looks like revenues declined by about $8 million from last quarter so just try to think about the delta sequentially. How much of that would you attribute to negative marks on trading securities, I think you mentioned that a little bit in the release, versus just lower trading volumes given clients being a little less active?

The client flow was actually up slightly especially in our middle markets area so that decline is really related to the lower performance and as you talked about marks on inventory both across strategic trading and really across our taxable products broadly.

Okay, great, that's helpful. So in terms of just thinking about I don't know if you can have a normalized number in that line item, but you still think that somewhere $20 million to $25 million a quarter and fixed income sales and trading is still reasonable to think about going forward?

Yes with the market improving, that is an accurate number.

Okay, great. Secondly, just on the other income loss within the Asset Management, were there any one-time items in there that you could highlight or anything that drove the $1.5 million loss?

That was again unrealized marks on a number of seed investments that we have in a number of strategies including the new Municipal opportunities Fund that we rolled out in the second quarter.

Okay, great. And then just on the buyback, I didn't hear, see whether or not you have purchased any shares, but with the stock is was 70% of tangible booked, just wanted to get your current thoughts on the buyback here and whether or not you still have I think it was $57 million remaining on authorization?

We do still have the $57 million remaining on our authorization. We have invested capital in other areas that we believe provide -- will provide attractive returns for the Company including the new Municipal Fund, Merchant Banking, areas like that. Overall, we do intend and our goal is to offset the dilution of employee grants over time.

Okay. All right. And then just lastly on the Investment Banking front, could just get a temperature check on what clients are thinking or doing right now, obviously the markets are for the most part closed, but are clients still waiting and ready to do an offering or an M&A deal once the market settle? Or are you seeing deals just get canceled all together or postponed indefinitely with clients just walking away?

So why don't I answer that in 2 parts, let's start with the Advisory, the M&A. It feels like the middle-market M&A is-- market is still open, the financial is getting a little more expensive but we believe we'll continue to work through a pretty solid backlog there without meaningful disruption at this point. From a capital raise, we do also have pretty strong backlog. I would say that really needs to see some volatility reduced here. One way you can watch it, at least we do is the [BEx]. It really needs to be more or less in the lower 20s for a period of time before you think you can see the risk appetite and start bringing to market IPOs. So we went into the quarter at 15, it got as high as almost 50, we're hovering around 30. If that calms down in the coming weeks it should open up a bit and we certainly have clients that would like to come to market.

Okay. Thanks for taking my questions.

Thank you.

Chris Johnson with Goldman Sachs.

Good morning.

Good morning, Chris.

So just looking at the equity's business. Q3 was pretty similar to Q2 and I'm just trying to wonder if there's any color around that you can give us as volumes obviously were considerably stronger this quarter?

So we participated in that, the trading environment was reasonably challenging at times but our business abroad was a little bit lower, Hong Kong market which was significantly more volatile.

Okay. And then maybe could we just touch a little bit on the M&A business and maybe give some more color around what drove the sequential pickup?

So ours tends to be quite lumpy, it was a strong quarter that had been built earlier in the year, weighted towards healthcare which not unusual for us. Still have a pretty healthy backlog and I just said it feels like the middle market advisory business is still open a little bit more expensive than the financing side, but available. So when you look at our quarter to quarter we can be relatively lumpy like this.

Okay. And then --

So it was a solid quarter with a solid backlog.

Okay. And then just lastly on comp as we think about sort of the flexibility with respect to this line going forward, I mean is there like a floor level that we should be thinking about or how-- I guess how should we be thinking about sort of what the base is here?

So ultimately it is dependent on revenue levels and mix of business. I think what you're seeing here is where we're hitting that point where we have less flexibility on the variable side of comp as we're hitting in certain businesses more of-- the fixed portion is becoming a bigger component which is what drove the comp ratio up and we do see that moderating somewhat in Q4. But to move the comp ratio towards the low 60s again we need to get back towards the second quarter type revenue numbers which is about $136 million.

Okay. Thank you very much.

So and when we speak to the fixed, and naturally we have support areas that are relatively fixed salaries, we have growth initiatives particularly in the public finance fixed income area and that hiring tends to have a more fixed quality about it for the first year.

Okay. Thank you.

That all should end- shows up in lower revenues.

Joel Jeffrey with KBW.

Good morning.

Good morning, Joel.

Just a question on the Merchant Banking side. I know you-- I guess you talked about raising Merchant Banking Fund in 2012, can you give us some sense of how long does that take to actually flow through to your bottom line in terms of either benefits from EPS or ROE?

So our experience to date is we're focused on late stage investments in private companies, equity or equity linked, and targeting return time horizons of somewhere around 24 to 36 months. And that's how these original portfolio has performed. Depending on the environment it could be 4 years.

So just so you understand we have a Merchant Banking effort ongoing internally which is starting to mature to these levels that Andrew has been talking about and now we're looking at raising a Fund and putting some outside capital to work as well.

Okay, great. And it sounds like from your comments that you guys are certainly focusing on the growth in the public finance segment, I apologize if I missed this, are there any sort of regions that you guys are specifically targeting?

Yes, it's really the Eastern, Southeastern part of the country. We've got a long-standing franchise that I think I could best describe as covering the western two-thirds of the country and we have just been methodically trying to create a presence in the Eastern, Southeastern part of the country, New York, Connecticut, Pennsylvania, Tennessee, opened an office in Florida a couple of quarters ago.

Great, thanks for taking my questions.

Thank you.

(Operator Instructions) Matt Fischer with CLSA.

Hi, good morning.

Hi, Matt.

Good morning.

First off the, I don't know if I missed this, the swing in other income from roughly $4.1 billion to $1.2 billion, give me some color there. And I'm looking at where you break out the different business units.

Yes you're looking at Asset Management specifically?

No, it's the-- underneath the Institutional Sales and Trading line, other income 1157.

Yes. So this line item, and you can see it's moved around a lot over the quarters, within that there's some the interest cost related to our long-term debt and that is frequently offset by gains and from investments in the Merchant Banking business that we were just talking about. So it's that movement and volatility primarily and the returns on these firm investments including Merchant Banking that drives the change there.

Okay. And then so you had some I guess mark-to-mark losses-- mark-to-market losses that offset or just a function of the global markets being down 20%?

No, it's more so that the gains weren't as high to offset all of the long-term debt cost that are flowing through that line.

Okay. And then I guess in connection to that with the Volcker proposal that was published last week, have you looked at that and does that potentially impact any of your businesses particularly Merchant Banking?

We don't believe we're going to come under the Volcker Rule.

Okay and you don't think that --

Should not have a meaningful impact to us.

Okay. Okay, great, thank you.

Thank you.

There are no further questions in the queue at this time.

Thank you all for joining us and look forward to updating. Thank you.

Thank you, ladies and gentlemen, this does conclude today's conference call. You may now disconnect.