Piper Sandler Companies (PIPR) 2013 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Piper Jaffray Companies conference call to discuss the financial results for the second quarter of 2013. During the question-and-answer session, security 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 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 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 second-quarter results. I will spend a few minutes discussing the market environment and performance of our business, and then hand the call over to Deb to review our financial results.

Overall, we experienced a mixed environment in the markets this quarter. On the favorable side, equity markets built on their strong first-quarter performance. The S&P index was up 3% for the quarter and 13% for the first half of the year. Our Equity-related and Asset Management businesses benefited from these accommodative market conditions. Stronger equity markets did not appear to have much impact on M&A activity during the quarter.

In Public Finance, interest rates remain attractive to new issuers and we continued to see healthy investor appetite for new municipal debt offerings. The fixed income trading markets, however, experienced turbulent conditions which adversely impacted our institutional brokerage results for the quarter.

Late in the quarter, the Federal Reserve signaled its intentions to curtail its quantitative easing program later this year. The reaction across fixed income markets was both immediate and substantial. The 10-year Treasury, for example, traded around 1.6 in early May, post an announcement it traded at 2.6, representing a rate increase of over 60%.

The volatile conditions across fixed income markets were even more pronounced in the municipal bond markets. With market making and municipal bonds a core part of our franchise, overall results were negatively impacted by the abruptness and magnitude of the change in municipal bond pricing. We have a long history in this business and the movements in rates towards the ends of the quarter were the most dramatic we have experienced in over 25 years. The disproportionate impact on municipal bonds was a result of both an increase in rates and a widening of credit spreads and reflected market conditions particular to this asset class.

Over the past several months, municipal bonds -- funds have experienced accelerating outflows, culminating in outflows of $13.5 billion in June, the second-largest monthly outflow on record. Demand for bonds in the secondary market have been light as investors sat on the sidelines expecting an increase in rates. The Federal Reserve announcement put additional pressure on this market, which manifested itself with widening credit spreads.

As we entered the second quarter, our operating assumption called for gradually rising interest rates throughout the year. With this prospective, we reduced inventory levels and adjusted our hedging strategies accordingly. These steps helped mitigate the impact from abrupt increases in rates, but they could not completely protect us from the marks on our remaining inventories. These marks materially impacted our fixed income brokerage results for the quarter.

Since the end of the quarter, we have seen market conditions stabilizing. We have not changed our operating assessment that interest rates will tend upward. As markets for the various asset classes gradually find their new equilibrium, however, we might see some rates easing in the near-term. We review and assess our exposure on a continuous basis and will adopt a more defensive posture in this environment with respect to our inventory levels and hedging strategies.

Nevertheless, we will continue to look for opportunities to deploy additional capital selectively during these periods of market instability. In fact, at the height of the markets' dislocation, we deployed additional capital targeted to where we saw unique buying opportunities.

Moving on to the other part of our fixed income business, how municipal debt underwriting business produced strong results for the quarter despite market volatility and the rise in interest rates. We continue to benefit from the geographic expansion which we have undertaken in the past couple of years.

Our acquisition of Seattle-Northwest Securities, which closed last week, represents an integral part of the geographic expansion. The firm was founded in 1970 and is the leading middle-market public finance firm in the Pacific Northwest. Last year, in terms of number of deals, it was the top underwriter in Washington, Oregon and Idaho. Our combination with Seattle-Northwest represents a great strategic fit for both firms. We will benefit from their leading market share in the Pacific Northwest and additional distribution and trading resources. Seattle-Northwest's customers will benefit from our broader set of products, more extensive distribution capabilities and deeper capital base. We are very excited to have this talented group join Piper Jaffray.

In our equities business, equity capital raising rebounded from Q1's light activity level, led by our healthcare and TMT groups. We continue to see improvements in our equity trading business with sequential growth in quarterly results over the past four quarters. Our M&A volumes were light in the first half of the year, but we expect improvements in the business as we execute our pipeline. We believe that our acquisition of Edgeview Partners, which we closed yesterday, will help strengthen the business throughout the rest of the year and beyond. Edgeview Partners, based in Charlotte, is an M&A boutique with seven partners and a history of success since they were founded in 2002. The acquisition is consistent with our strategic objective of growing our M&A practice. Edgeview expands our financial sponsor relationships and will benefit from our deep industry expertise and underwriting capabilities. The Edgeview team is an exceptional fit from a client and a cultural perspective and we are very pleased to welcome our new partners.

In our Asset Management business, revenue gains were commensurate with the performance of the equity markets. Our assets under management for the quarter exceeded $10 billion. The business continues to produce strong margins and meaningful contributions to our earnings.

Now I will turn to call over to Deb to review our financial performance for the quarter.

Thank you, Andrew. In the second quarter of 2013, continuing operations generated net revenues of $100 million. Net income from continuing operations was $4.4 million or $0.25 per diluted common share, and our pretax operating margin was 3.3%. For the second quarter of 2013, compensation and benefits expenses were 65.1% of net revenues compared to 60.7% and 60.4% for the second quarter of 2012 and first quarter of 2013, respectively. The higher compensation ratio was due to a change in revenue mix driven primarily by trading losses in fixed income and fixed compensation expenses on reduced revenues.

Noncompensation expenses were $31.4 million for the second quarter of 2013 compared to $34.8 million for the year-ago period, which included restructuring charges. Noncompensation expenses increased from $25.3 million in the sequential quarter, which was reduced by the receipt of insurance proceeds for the reimbursement of prior legal settlements.

Our effective tax rate from continuing operations excluding the impact of noncontrolling interest was 27.4% for the second quarter of 2013. Our reduced tax rate for the quarter was due to the impact of tax-exempt interest income, representing a larger proportion of our pretax income than prior periods.

Now I will turn to the segment results. For the second quarter, capital markets generated net revenues of $81.8 million, a pretax operating loss of $2.1 million and a pretax operating margin of negative 2.6%. Excluding the impact of noncontrolling interest, the capital market segment was modestly profitable for the second quarter.

Net revenues decreased 7% compared to the second quarter of 2012 due to declines in M&A revenue from fewer completed transactions and lower revenue from fixed income institutional brokerage. The reduced income from fixed income institutional brokerage were partially offset by improvements in equity financing and equity institutional brokerage revenues.

As Andrew discussed, our fixed income institutional brokerage revenues were impacted by the speed and magnitude of the rise in interest rates in the second quarter of 2013. The reduction in these revenues was driven by three factors. First, we experienced both realized and unrealized losses in several of our customer flow and strategic trading inventories. Second, strategic trading net revenues, though still positive due to the diversification of our strategies and solid performance of our teams, was down significantly from prior quarters. And lastly, the fixed income institutional brokerage revenues were reduced by $2.7 million related to losses on noncontrolling interest.

Going into the quarter anticipating an increasing interest rate environment, we reduced inventories and adjusted our hedges. Although the hedges worked directionally as intended, they did not offset the full impact of the market move, given the magnitude of the increase in interest rates, the widening of credit spreads and the resulting decoupling of hedging correlations.

Pretax operating income was lower compared to the year-ago period, primarily due to lower revenues, and less in the first quarter of 2013 due to lower revenues and higher noncompensation expenses.

Asset Management generated $18 million of net revenues, $5.5 million of pretax operating income and a pretax operating margin of 30.4%. The operating margin was higher compared to the second quarter of 2012 due to higher management fees and in line with the operating margin in the first quarter of 2013. Assets under management were $10.2 billion, unchanged compared to the end of the first quarter.

Turning to the balance sheet, in the second quarter of 2013 we acquired $25.7 million, or approximately 800 shares of our common stock at an average price of $32.23 per share. We have $69.7 million remaining on our share repurchase authorization, which expires on September 30, 2014.

Now I will discuss continuing operations, which includes both our Hong Kong capital markets business which we shut down as well as FAMCO, a division of our asset management business. The firm completed the sale of FAMCO in the second quarter of 2013. For the second quarter, the net loss from discontinued operations was $1.9 million, which was principally driven by expense from contractual obligations related to the sale of FAMCO.

As Andrew noted earlier, we have closed on our acquisitions of Seattle-Northwest and Edgeview Partners. We expect to incur restructuring and integration costs of approximately $3 million to $3.5 million in the second half of the year related to these acquisitions. Our noncompensation expenses are expected to increase by approximately 4%, bringing our quarterly goals to $31 million to $32 million. We do not currently expect acquisitions to materially impact EPS in the second half of 2013.

In summary, although we experienced a very challenging fixed income environment in the second quarter, we believe we performed relatively well. We will continue to be prudent about our inventory balances and hedging strategies in anticipation of continued interest rate increases and market volatility.

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

Operator, we are ready for Q&A.

(Operator instructions) Joel Jeffrey, KBW.

A question on the fixed income trading side of the business -- if muni prices stabilize here or don't move one way or the other meaningfully for the remainder of the quarter, just from trading volume alone, do you guys think you can get back to that $25 million per quarter in revenue you talked about in the past as a run rate?

Yes, we do. There might be slight change in mix between flow and trading, but we do anticipate that we will do that.

Can you give us a sense on typically how much of your business is flow driven and how much of it is driven by marks on the portfolio?

So, Joel, I would talk about that in two -- maybe in customer flow versus strategic trading because there are marks on the portfolio that can happen in both of those businesses. So if you think about our customers flow business, which has been and will continue to be the majority of the revenues, we do hold also the majority of our inventory in that side of that business. And we did experience trading losses again, as we talked about, both realized and unrealized, on that side of the business, again, given everything we've talked about with the increase in rates, increase in spreads. And then on the strategic trading side, we did also experience the challenging trading conditions, but on that side our net revenues were positive, just significantly lower than they had been in prior quarters.

Okay, great. And thinking about the advisory business, are you guys seeing it now -- are we through this hangover we have had in market M&A's that came from the pull-forward in the fourth quarter?

We feel like we are, if I can just speak to our backlog and the activity we've got going on, exactly. It was sort of a Q1/Q2 event with the very substantial Q4, and we expect starting in Q3 to have a strong rebound.

Are there any areas in specific that you are seeing the most strength?

It's really across our core industries, and very excited again to have addition of the Edgeview team too now.

Lastly for me, how much cash do you currently have on the balance sheet?

I can actually look at our fourth quarter. It's just so you can understand how we manage the business from a cash perspective, is we are a net borrower every day to finance our inventory. So the cash we hold is typically for our reserves required for customer deposits or other capital requirements in various legal entities. So I may have where we are at the end of the quarter here, if you will just give me one moment.

We were, at the end of June, about $69 million, and that excludes $27 million which was held aside and segregated for regulatory purposes.

Great, thanks for taking my questions.

Michael Wong, MorningStar.

After pruning some underperforming businesses and acquiring some higher-margin ones recently, do you have any updated overall guidance for the Company's compensation ratio or normalized operating margins?

So, from a compensation ratio, in particular, this quarter was higher, as I had spoke to, given the trading losses. We had previously guided a 60% to 61% target. Actually, with the acquisition of Edgeview, there are some retention-related compensation items, so that target we see going forward as being 61% to 62%. Of course, that really depends on revenue mix, as I've talked about in the past, as well as just overall level of revenues. As overall revenue levels move higher, we could see that ratio coming down over time. But in the current environment, we are targeting the 61% to 62%.

Okay. I was just hoping you could talk a bit more about your merchant banking business. Would you say you are still just probing the waters in that, or have you made a fairly firm strategic commitment to building that out?

I would say it's the latter. So we built a portfolio internally in the firm over a three-to-four-year period, created a track record. And then, as you know, we went externally about a year ago and raised $50 million into a fund and contributed to that $50 million in firm capital and feel very positively about our original deployment of that. So it's a strategic initiative that, based on what we believe will be a strong track record, we intend to grow those assets primarily externally.

Okay, thank you.

(Operator instructions). Brian Hagler, Kennedy Capital.

Joel touched on a couple of my questions, but if we could maybe get into a little more detail, it sounds like on the fixed income institutional side, if we look at quarter-to-date results, we are tracking on the more normalized $25 million-type revenue number. Is that correct?

On a go-forward basis, that is correct.

We would expect that, no change.

Okay, and can you give maybe a little more detail? It sounds like you are obviously more optimistic on the advisory side. Can you just give some maybe pipeline information there, or some numbers to back your optimism or what you look at?

We look at pipeline, Brian, but we don't disclose it. Some of it is public information; a lot of it is not. And then we would just point you to what we have been saying since Q4's very strong year end that we thought was a pull forward, that we saw a very strong back half of the year and relatively low activity in the first half. And we are very much on track for that and look to the business that we've had over the years.

Great, I think that's all I had; I appreciate it.

And there are no further questions at this time.

Let me just conclude by again saying we recognize the impact in the quarter of the dislocation in particularly the munis to our second-quarter results, but we believe our business is performing well, very active in the capital raising on both sides of the house, strong M&A pipeline and are very pleased by our two strategic acquisitions now closed. Thank you all for joining us this morning.

Ladies and gentlemen, with this, we conclude today's presentation. We thank you for joining. You may now disconnect.