Piper Sandler Companies (PIPR) 2012 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 2012. 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 a current fact, 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. During the quarter, our continuing operations performed well, and we are pleased with our results. Our strong performance reflects robust fixed income institutional brokerage revenues, particularly from strategic trading; our decision to exit the Hong Kong capital markets; additional cost reductions taking effect; and solid market share in public finance and public equity offerings. I'll provide some additional perspective on continuing operations and then move to the closure of our Hong Kong capital markets business.

Public Finance revenues were solid, and we continue to gain market share in this business. Year-to-date through September, market share was 4.9%, up 110 basis points or 29% compared to the full year of 2011. Equity capital markets improved during the third quarter, and volatility remained low, both of which contributed to higher capital raising during the third quarter for the market and for us.

We completed equity financings for our clients in healthcare, consumer, and technology sectors. We were a bookrunner on 64% of the transactions. Market share through September continued to be solid.

Turning to corporate advisory, we were active in the healthcare sector, and TMT and industrial growth also contributed. We have a solid backlog, and a number of transactions have been announced.

Equity institutional brokerage revenues rose 8% compared to the sequential second quarter, but continued to be depressed by both low volumes and volatility.

Asset Management revenues increased 5% compared to the second quarter of 2012.

As I noted at the beginning, we generated robust fixed income institutional brokerage revenues. The performance had a material positive impact on our quarterly results, and this level of revenue should not be considered the run rate for future quarters.

Client-related revenues were solid, up 22% compared to the sequential second quarter. All of the strategic trading businesses contributed to performance, and our mortgage strategy delivered very strong results.

Over the past five years, we have continued to mature and diversify our strategic trading activities. Importantly, we have developed and implemented the infrastructure and controls to manage and support the strategies. In 2011 we added a mortgage-back security strategy. The core of this is to leverage trading inefficiencies in smaller positions in primarily investment-grade non-agency MBS securities.

In early 2012, the team identified additional opportunity with the convergence of positive fundamental and technical trends.

In 2010 and 2011, fixed income institutional brokerage revenues totaled just under $80 million annually. During that time frame, we expanded our middle-market distribution and ramped and diversified our strategic trading business. Results from strategic trading will be lumpy, and our third-quarter fixed income revenue should not be considered the run rate for future quarters. However, we would now expect that fixed income institutional brokerage on average could generate approximately $25 million in revenues per quarter. We continue to believe that investing in targeted and defined strategies that leverage our intellectual and financial capital is a key component of our strategic direction and financial performance.

As we look ahead, several factors could cause volatility in the fixed income markets, including the presidential election, the fiscal cliff, and potential tax reforms.

Now I'll turn to Hong Kong. In August we disclosed that our exit from the Hong Kong capital markets would occur through a shutdown, and as of September 30, operations have ceased. We devoted considerable resources to evaluating all available candidates, and though very difficult, this was the best business decision.

I'd like to think Alex Ko, our head in that region, for his leadership over the past five years and his tireless efforts to assess various options. I'd also like to thank all of our employee partners who built a well-regarded middle-market franchise in Hong Kong and our clients for the business over the past five years.

We will continue to provide research coverage on US-listed, China-based companies by our US-based research analysts, and we'll maintain a small Hong Kong office to facilitate cross-border M&A opportunities. It is vital that we operate the business with competitive profit margins and shareholder returns. We are fully engaged with our strategy to organically remix our portfolio to higher margin, higher return businesses, namely Asset Management, Public Finance, corporate advisory, and principal investing.

We are pleased with our overall performance for the third quarter. We are benefiting from the investments that we have made over the past several years and additional operating leverage in our model. As a result, we have growing confidence that we can continue to improve our financial results going forward.

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 provide comments on our results from continuing operations and then provide additional financial detail around the discontinued Hong Kong capital markets operation.

In the third quarter of 2012, continuing operations generated net revenues of $133 million and net income of $13.5 million or $0.72 per diluted common share. Our pretax operating margin was 17.1%. Compared to the sequential second quarter, all of our businesses contributed to our performance.

For the third quarter of 2012, compensation and benefits expenses were 59.2% of net revenues, down from 63.1% and 60.6% for the third quarter of 2011 and second quarter of 2012, respectively. The improvement was mainly driven by the significant contribution from strategic trading, which has a lower compensation payout. Based on continuing operations going forward, we would expect that the compensation ratio should approximate 60% to 61% depending on the level and mix of revenues.

Non-compensation expenses were $31.5 million, just above our current quarterly goal. We had higher legal fees and recorded a legal reserve relating to a FAMCO matter dating back to 2008. Excluding that, we were well within our quarterly goal.

Now I will turn to our segment results. For the third quarter, capital markets generated net revenues of $115 million, pretax operating income of $21 million, and a pretax operating margin of 17.9%. Strong revenues and additional cost reductions drove the significantly-improved capital markets performance.

Asset Management generated $17.7 million of revenues; $2.1 million of pretax operating income; and a pretax operating margin of 12.1%.

Operating performance within the business was good. Financial results, however, were negatively impacted by the higher expenses related to the FAMCO matter that I mentioned earlier.

Assets under management were $13.8 billion, up 9% compared to $12.7 billion in the second quarter 2012. The increase in AUM was driven by market appreciation and positive net cash flows.

Now I'll turn to discontinued operations. For the third quarter, net income from discontinued operations was $6.8 million, or $0.38 per diluted common share. We recorded a significant US tax benefit, which more than offset the restructuring charges and operating expenses. We will realize net cash proceeds of approximately $19 million net of restructuring charges and above the top of the range that we discussed in the second quarter. Substantially all items related to the shutdown of the Hong Kong capital markets business were recorded in the third quarter.

In summary, revenues year-to-date from continuing operations have increased by 2%, yet we have increased our pretax operating margin 1.4 percentage points, or 13%. Year-to-date results have been driven by our exit from Hong Kong and stronger performance from the capital market segment, solid contributions from Asset Management and reduced non-compensation expenses.

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

That concludes our formal remarks. Operator, we would now take questions.

(Operator Instructions). Matt Fischer, CLSA.

First off, on the Asset Management front, the flows versus appreciation, could you give us a sense for how much were inflows and --?

Yes, between the two?

Yes.

So the majority of the increase was related to market appreciation, but we did see some growth in the net new assets versus what we've seen historically.

Okay. And then any particular products or --?

It really was very much across the multiple products and both within ARI and our MLP product, as well as FAMCO.

Okay. And then I appreciate the color you gave within fixed income and what, I guess, is a reasonable recurring revenue stream, maybe that delta, that difference, what exactly, can you give us a bit more color in terms of that additional revenue? And what is the risk that in out quarters you either beat on the upside or potentially the opposite effect where it's a hit to that $25 million run rate. Maybe just provide a bit more color there.

Yes, I would say from a quarter-over-quarter delta -- I'm just starting there -- a significant portion of that was related to the fixed-income strategic trading, primarily in mortgages. Although, as Andrew did mention in his comments, the client-related revenues were up 22% as well. Maybe a way to answer it is, if you set aside the strong MBS performance in the quarter, client-related revenues represents a majority of that fixed income institutional brokerage line. So that maybe gives you some sense of how much is strategic trading versus clients' flows.

And I would just add that we would expect the majority of revenues in our fixed income brokerage would be related to client activity.

Okay. And in terms of pipelines, maybe a bit more color there for Investment Banking by product?

So you can look at what's been publicly announced, and we have several transactions that have already been announced in the quarter, some of which have closed; some of which have yet to close.

Okay. And then in advisory, what are you thinking or what's the sense in terms of discussion levels? And when you sit here today versus the end of last quarter or a year ago, how is the sentiment out there for Investment Banking?

We would say the activity and the dialogue remains pretty constructive. There is still some uncertainty related to some of the factors we mentioned, including the election, but the dialogue is pretty constructive from what we're seeing with our client set.

Okay. Okay. Great. Thank you very much.

Thank you.

Joel Jeffrey, KBW.

Just a quick question. I must be missing something. I'm just struggling a little bit. The $0.72 you talked about from continuing operations, I'm struggling on how we're getting to that with the net income numbers or the income from continuing operations you gave us and the share count. Is there another adjustment in there that should be made?

Joel, are you familiar with the bifurcation of our earnings between our diluted shares and our participating shares?

Yes.

Okay. Because otherwise it should be consistent with that. And the shares at the 15.2 million are what's ultimately the net income applicable to the Piper Jaffray common shareholders would be divided by.

Okay. I'll go back and re-run those.

Certainly let us know if you have further questions.

Okay. And I guess the other question I have is looking at the industry numbers for the quarter, it didn't seem like a terribly strong client activity number on the fixed-income side. Can you just talk a little bit more about why you guys saw a relatively strong pickup in your client activity?

So it related to a number of things. We did have reasonable activity, and we've also ramped our middle-market salesforce in particular. It's up about 20% in the last 12 months, and that is generating additional activity for us.

Okay. So essentially it was this quarter these guys have essentially ramped up to where you view their production is being sustainable?

Yes, I think that is a fair characterization, and we're continuing to hire into the business. But the hiring in the last six, eight months is probably now essentially ramped.

Okay, great. Thanks for taking my questions.

Thank you.

Devin Ryan, Sandler O'Neill.

So just a clarification, the 22%, is that from last quarter?

Correct. That's the sequential increase.

Okay. And then the products that you're highlighting would be primarily in Public Finance?

Yes, it is a broad mix with our middle-market salesforce. They do a lot with our municipal calendar, but also are active across the full taxable product set -- mortgages, agencies, governments, short-term securities.

Okay. And then just lastly, point of clarification. In terms of that $25 million normalized number, I know that it's a target and then it can bounce around quite a bit from there. But that number is primarily comprised of what you view as the core client flow business and a lot less of the strategic trading business.

It is inclusive of both, Devin, but the majority we believe will continue to come from client activity.

Okay. Great. And when we think about the strategic trading gains, are the majority of the gains realized or unrealized? And is that book turning over frequently so that essentially any quarter you guys could be positioned differently? Or is that performance going to be more tied to the markets moving up and down in whatever products that you're positioned in?

Yes, they adjust the strategies continually based on their perspective and evaluation of the underlying securities, the risks involved. And we continue to be active in the mortgage-back strategy. We would anticipate that the results would moderate from the very strong third quarter.

Right. So, in terms of thinking about, say, this quarter to some other strong quarters where I know strategic trading has been driven by the muni prop business, was this quarter a large percentage of the positioning within MBS, or is it just that was what drove the outsized portion of the revenues? I'm just trying to think about how you guys move around within -- I know it is a broad strategic trading, but within the different buckets of different products.

So we have three municipal strategies currently and have been active in thinking about and diversifying into other asset classes over time, have been in the mortgage-backed strategy now for about a couple of years and did add capital in the spring when they added to their core view of some attractively-priced securities based on their structure and their underlying quality to some convergence of some fundamental and technical dynamics in the mortgage-backed market that we thought were favorable.

Okay, I got you. And then, within the equity sales and trading business, revenues were up 8% sequentially in a quarter where industry volumes were obviously down a bit again, quarter over quarter. And I know it's coming off a depressed level, but you guys obviously outperformed industry trends and I would suspect a number of other firms that are going to be reporting here in the next couple of weeks on the equities business. So just wanted to see if there was something maybe in last quarter's results or this quarter's results to help that comparison or anything else we should be thinking about there.

Yes, you definitely have hit it when you talked about Q2 being low. So that was something that impacted the increase this quarter. We did see between the two quarters, just better trading performance in terms of the capital that we put to work on the desk.

Okay, great. Okay. That's it for me. Thanks for taking my questions.

Thank you.

David Trone, JMP Securities.

So I guess the more basic question that everybody is really thinking about is, if you could make $20 million, you could just as easily lose $20 million, right?

I wouldn't view it that way, necessarily. As to the mortgage-backed strategy, David, we view the risk in this quarter as a bit asymmetrical. We selected attractively-priced securities based on their underlying value structure, our analysis of how they perform in various markets environments and then the market forces provide an additional upside.

Okay. And is this -- just trying to size the risk that's being taken or the reward, too. Is this as big as you would reasonably expect it to ever be, or could this -- are we not necessarily at the edge of scale?

If you look back at our strategic trading after the last four or five years, David, it can be lumpy quarter to quarter, and I would anticipate that would be the case going forward, as well.

I know lumpy, but is this about as big as we would expect to see a gain, or could we turn around some day and see it be [50] or something like that?

This is probably in the range of what we've seen historically. And again, you probably know this, but non-agency mortgage-backed securities are the number one performing asset class this year. And we had capital applied to that, and it was very favorable. I'd say it's on the higher end of what we've seen.

Okay. And the positions -- do you personally and others have a pretty fairly rigorous process of monitoring what they are doing?

I can start with that one and then if Andrew wants to make any additional comments. So we have risk management policies and limits with our strategic trading, just as we do with any of our other desks and with our other businesses. We do have real-time risk management tools that the trading flow goes through, and our risk management team monitors that on an intra-day basis.

And one of the key things for me, too, is we have a financial risk committee made up of senior management. Andrew and I both sit on there as well as heads of businesses and trading desk heads. And we meet monthly at a minimum and to review all of the policies -- again, both strategic trading, as well as their other inventories, really looking at how -- making sure everything is in line with limits and looking at the go-forward strategies as the various desks are proceeding them. And actually, it flows up even to the audit committee from the standpoint of looking at the risks across these various desks.

Okay. Thank you very much.

Michael Wong, Morningstar.

I was just wondering if you can talk about whether you believe that future debt financing demand may have been pulled forward by the generally absolute low-level interest rates and maybe tightening of credit spreads? I know that your debt financing was sequentially a bit lower, but just in general, do you believe that debt financing demand has been pulled forward lately?

Yes, I would not characterize it as pulled forward. There's still a pretty healthy bit of refunding in the mix versus new money, issuance of debt. But I would not characterize it as pulled forward. To the point you made, it was actually sequentially down for us quarter to quarter.

Okay. And just going back to the decision to shutter the Hong Kong operations, was it just so unrecoverable that you couldn't do what you did in Europe such as refocusing on just M&A and trading and distribution of US securities?

Well, there is a bit of analogy there. We have a small office that is going to facilitate cross-border M&A, and we have the same thing in Europe. We don't see the same opportunity in Europe. We have distribution of our US product, and we don't see that opportunity in the Hong Kong market. So that would be the difference.

Okay. Thank you.

Thank you.

Brian Hagler, Kennedy Capital.

Just a couple of housekeeping items. First of all, the higher legal fee and legal reserve related to FAMCO, could you talk about how much that was, and did that flow through the other operating expense line?

It did flow through the other expense line into our Asset Management segment. And other than that, we really can't talk about the amount of that.

Okay. And you also talked about realizing cash proceeds of $19 million from Hong Kong operations. Did you talk about the timing of that?

Did not talk about the timing of that. It is really related to US tax credit. A significant amount of that is available to us now based on carrying some of that back to prior years' gains. And then we do believe that within early 2013 we will be able to recover -- get back the vast majority of that.

I guess that leads to my next question was, should we tax-effect that and assume that you're going to basically realize, it looks like $0.75 a share? But it sounds like you might have some tax credits that offset that.

So from a cash perspective, the $19 million is the tax-effected net cash that we received from deducting the net loss from our tax basis in Hong Kong, which sought to be a much larger number. So that $19 million is already tax-effected and is the net cash flow.

Okay, great.

Does that answer your question?

And then lastly, I may have missed this, but when you talked about strategic trading being very strong and driven by mortgage-backed securities, was that QE3 related, or what do you think was the catalyst for that?

It was a number of things. Another way you could characterize it is pretty straightforward demand/supply; a pretty good appetite for higher yielding securities. At the same time, the underlying housing fundamentals have been improving, and there was also a more favorable capital requirement for risk assets announced in mid-June. And then lastly, QE3, which I think actually started in September. So it's really a combination of all of those factors throughout the summer.

Okay. And with that just starting in September, have you seen that strength carry over in this quarter?

The strategy continues to perform well, but again, we'd expect it's going to moderate from the strength of the third quarter.

Great. Thanks.

Thank you.

Matt Fischer, CLSA.

Just one additional question. Regarding these shares, you're down about 5% or just under 1 million shares this quarter. Can you discuss the ability to repurchase shares going forward and what your strategy is there?

Yes. So, as we have discussed before, we are limited by the bank covenant on our debt facility, which ultimately comes through at the end of 2013, and that restricts us to the ability to repurchase stock to offset dilution. We have done that this year. We also worked with our banks to have an amendment to purchase another 25 million, which we did. So that was all completed by the end of Q2. So for this year, no ability to repurchase shares but, as we move into 2013, again have the ability to repurchase stock to offset dilution.

Okay. And then is the difference between Q3 and Q2 just the average shares? There wasn't any --?

Yes, correct. It is just averaging.

Got it. Thank you very much.

Yes, thank you.

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

Yes, just to ask one of the earlier questions a little bit differently, just to clarify. Did the amount of capital that was allocated to the strategic trading businesses change dramatically from last quarter, or were the substantial gains this quarter just more a function of outsized performance on a similar sized portfolio?

Yes, it has stayed fairly stable, growing just modestly. It really is more the result of outside performance on capital that was allocated to, in particular, the mortgage strategy.

Got it. Okay. Thanks. That's helpful.

At this time, presenters, there are no further questions.

Thank you. Let me close the call. We're pleased with our performance for the third quarter. We're benefiting from the investments we have made and the additional operating leverage, and we remain confident that we can both -- can contribute to improved financial results going forward.

Thank you very much for joining us. That concludes our call.

This concludes today's conference call. You may now disconnect.