Piper Sandler Companies (PIPR) 2013 Q3 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 third quarter of 2013. 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 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.

This call will also include statements regarding certain non-GAAP financial measures. These non-GAAP measures should only be considered together with the Company's GAAP results. Please refer to the Company's earnings release issued today for a reconciliation of these non-GAAP financial measures to the most comparable GAAP measure. The earnings release is available on the Investor Relations page of the Company's website or at the SEC website.

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

Good morning and thank you for joining us to review our third-quarter results. I will spend a few minutes discussing the market environment and the performance of our businesses and then hand the call over to Deb to review our financial results.

Assessing the market environment at high level, we continued to see gradual improvement in the equity markets while performance in Fixed Income markets remained significantly influenced by the Fed's plans related to their current quantitative easing program.

Addressing equity markets first, the S&P Index was up almost 5% for the quarter and 18% for the year as funds flowed into equities have been positive for each quarter this year, reversing a two-year trend of outflows. As might be expected, our Asset Management business benefited from these market trends. Market appreciation was particularly robust in growth sector stocks, which provided fertile conditions for capital raising in key sectors where we compete.

Conversely, despite the favorable market conditions, US equity trading volumes were down for the quarter and M&A activity remained relatively soft.

In the Fixed Income area, as we expected, interest rates gradually increased through most of the quarter in reaction to the Fed's guidance in June that they intended to taper QE3 purchases in the near future. This adversely impacted trading volumes as investors reduced trading activity while they assessed uncertainties related to the Fed's activities.

Rising interest rates also had a negative impact on Public Finance issuance as debt refunding became less attractive.

Early in September, however, the Fed reversed course on its plans to taper its QE3 program. Bonds rallied on the news as interest rates declined to June levels and spreads on municipal bonds narrowed. This had a positive impact on our sales and trading activities. However, new issuance activity in Public Finance remained low throughout the quarter. Despite the recent decline in interest rates, our operating assumptions still calls for a gradually increasing rate environment.

Moving on to the performance of our various businesses, our equity capital raising group produced very strong results for the quarter. Our healthcare group led the way by managing 15 offerings in the third quarter, including serving as a bookrunner on over half of these offerings. The investments we made earlier in the year in strengthening our biotech group are beginning to pay off as the biotech team made meaningful contributions to our healthcare results.

As we head into Q4, it appears that investors still have an appetite to invest in growth sector companies. Our M&A business put up a solid quarter, generating revenues in Q3 that were greater than our M&A revenues through midyear.

Year over year, we are slightly down compared to 2012, which is in line with the broader market. Despite strong equity markets and available financing, the market remains well below peak levels last seen in 2006 and 2007. We attribute the lack of market momentum to relatively low growth in the broader economy and considerable uncertainty regarding government policies.

On a more positive note, integration of Edgeview, which we closed in July, has proceeded smoothly. In the third quarter they closed their first two transactions as part of the Piper Jaffray team.

Our equity sales and trading business continues to build momentum. Q3 represented the fifth consecutive quarter of sequential improvement in revenue. The improvement was driven by better trading results and execution of a block trade where we provided additional liquidity to an underwriting client.

For the quarter, our equity business was up 28% over the third quarter of 2012 in a market where broader trading volumes have declined 4% year over year. In Public Finance, challenging market conditions adversely impacted our results where we were down both sequentially and year over year. On a year-to-date basis, our business was down 3% versus 2012 while negotiated new issue volume is down 16% for the entire market.

Our investments and expansion efforts over the past couple of years continue to bear fruit as Piper Jaffray is the only underwriter in the top 10 to actually increase its new issue volume compared to the last year.

Integration of Seattle-Northwest, which we closed in July, is substantially completed and the business is performing in line with our expectations. Fixed-income sales and trading rebounded significantly in the quarter as we overcame the rate shocks we experienced late in the second quarter. Revenue for the quarter moved back into the range we might expect for the business, given the current environment, as we managed our way through a gradually increasing rate environment through the first part of the quarter and benefited from declining rates late in the quarter.

Given the potential for outsized impacts arising out of the Fed's policies, we continue -- we could expect ongoing volatility in the business. Nevertheless, we will continue to manage our inventories and hedging strategies to mute market volatility as much as possible.

In our Asset Management business, net new asset flows were neutral fourth-quarter. At the end of Q3 we had $10.6 billion of assets under management. The business continues to produce strong margins and meaningful contributions to our earnings.

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

Thanks, Andrew. In the third quarter of 2013, continuing operations generated net revenues of $128 million. Net income from continuing operations was $6.9 million or $0.42 per diluted common share, and our pretax operating margin was 9.4%. The results for the quarter were reduced by a $0.15 per diluted common share due to a $2.3 million after-tax charge related to restructuring and integration costs associated with our acquisitions of Seattle-Northwest and Edgeview.

Excluding these costs, our net income from continuing operations was $9.2 million or $0.57 per diluted common share and our pretax operating margin was 12.4%.

For the third quarter of 2013, compensation and benefits expenses were 61.9% of net revenue compared to 59.4% and 65.1% for the third quarter of 2012 and second quarter of 2013, respectively. The compensation ratio was lower compared to the sequential quarter due to an increased revenue base and higher than third quarter last year due to the shift in business mix driven by the strong strategic trading revenues in the prior year, particularly in the mortgage-backed strategy.

The compensation ratio of 61.9% in the third quarter of 2013 includes retention-related compensation associated with the two recent acquisitions. Non-compensation expenses were $36.8 million for the third quarter of 2013 compared to $28.1 million in the year-ago period and $31.4 million in the second quarter of 2013.

Third-quarter non-compensation expenses included $3.8 million of acquisition-related restructuring, integration, and transaction costs. In addition, intangible amortization increased $1.2 million in the quarter related to the acquisitions of Seattle-Northwest and Edgeview. Excluding these acquisition-related expenses, third-quarter non-compensation expenses were $31.8 million, which is in line with our goal of $31 million to $32 million.

Our effective tax rate from continuing operations, excluding the impact of non-controlling interest, was 29.6% for the third 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 third quarter, Capital Markets generated net revenues of $110.3 million, pretax operating income of $6.4 million and a pretax operating margin of 5.8%. Third-quarter results were impacted by $5 million of restructuring and intangible amortization expenses related to our recent acquisitions. Excluding these expenses, our margin would have been 10.3% in the Capital Markets segment for the third quarter of 2013.

Net revenues decreased 4% compared to the third quarter of 2012 due to declines in fixed-income financing revenues from fewer completed transactions and lower revenue from fixed income institutional brokerage, particularly in our mortgage-backed securities' strategic trading activities. These reduced revenues were offset by improvements in equity financing, M&A, and equity institutional brokerage revenue.

Our fixed income financing revenues were negatively impacted in part by higher interest rates reducing refinancing activities. Fixed income institutional brokerage revenues continued to be negatively impacted by lower transaction volumes due to uncertainties surrounding Federal Reserve policies.

While the fixed income market faced challenges, the strong equity markets drove increases in our equity financing business. M&A revenues for the quarter were relatively strong compared to the broader market as we completed more deals, especially in the healthcare sector.

Pre-tax operating income was lower compared to the year-ago period due to lower net revenues and higher non-compensation expenses and improved compared to the second quarter of 2013 due to higher net revenues. The non-compensation expenses were higher in the current quarter, primarily due to the acquisition-related expenses that I mentioned earlier.

Asset Management generated $18.1 million of net revenue, $5.7 million of pre-tax operating income and a pre-tax operating margin of 31.6%. The operating margin improved compared to both the year-ago period and sequential quarters due to higher net revenues. Assets under management were $10.6 billion compared to $10.2 billion at the end of the second quarter and $9.2 billion in the year-ago period, driven by market appreciation.

As Andrew noted earlier, we closed on our acquisitions of Seattle-Northwest and Edgeview Partners early in the third quarter. Both of these acquisitions have been fully integrated with our existing business line, and we are achieving the expected operational and cost efficiencies. We incurred restructuring, integration and transaction costs of $3.8 million in the third quarter of 2013 related to these acquisitions. We expect to occur approximately an additional $1 million in restructuring and integration cost in the fourth quarter.

In addition, we began amortizing the intangible assets acquired as a result of the acquisitions in the third quarter. We allocated $6.9 million to definite live intangible assets which will be amortized over periods of two to five years. Amortization expense related to customer contracts and relationships is heavily front ended to match the expected revenue generation with approximately 55% of the amortizations to be expensed in the first 12 months.

Turning to the balance sheet, in the third quarter of 2013, we acquired $29 million or approximately 900,000 shares of our common stock at an average price of $32.79 per share. We have $40.7 million remaining on our share repurchase authorization which expires on September 30, 2014.

Now I will discuss discontinued operations which includes both our Hong Kong Capital Markets business, which we shut down last year, as well as FAMCO, and asset management subsidiary we sold in the second quarter of 2013. For the third quarter, the net loss of discontinued operations was $1.5 million which was principally driven by additional expense from contractual obligations related to the sale of FAMCO.

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

This concludes our formal remarks. Operator, we would now open the line for questions.

(Operator Instructions). Joel Jeffrey, KBW.

Good morning, guys. It seems like the muni market continues to be a source of weakness for a lot of brokers. Is there any catalyst you see in the near term that could get this back to levels we were seeing a year ago? Or is this just a longer term issue that we are going to be dealing with?

I think it -- we expected to improve modestly in the fourth quarter. I am talking about new issue volumes versus the third quarter. Clearly, the increased rates has some impact on refundings. When you look at it on a longer term basis, we do think there is significant new issue volume, new capital needs across the country for a variety of capital improvements. So I think longer term we have a positive outlook, but nearer term refunding clearly are impacted by increased rates.

Okay, great. Then in terms of the fixed income trading business, can you give us a sense for how much of the revenues came from the strategic trading group or just customer flow business?

Sure. So our fixed income institutional brokerage line does have two components to that business as you are alluding to, so both our customer flow and our strategic trading. And while our strategic trading revenues are meaningful, our customer flow revenues have been and will continue to be the majority of the revenues within that fixed income brokerage line.

Okay, great. And then any -- sticking with that theme, did you see any sort of changes in your inventory levels given that we had the fairly meaningful dislocation in the muni and fixed income markets at the end of last quarter?

Yes. So, we have reduced inventory levels on several of our desks. There are some inventory levels that are up from everyone building out mortgage product for our middle markets business; but overall inventory levels, we've really, I guess, had a bias towards managing our risk down in the current environments, really across products. And inventory levels are just one measure of really our risk appetite. Other factors, some hedging, the duration of our inventory, there are a lot of things that we look at to really manage that risk.

And I guess that I would just underscore that we are very actively monitoring our hedges and our turnover, assuming some volatility in generally rising interest rates.

Great. Then, Other income was a little bit stronger than what we were modeling. Can you give us a little bit of color on where the strength in that line item was coming from?

Yes, the strength in that line was coming from realized gains in our merchant banking portfolio. There was actually some realized in and realized gains there, but the majority was realized gains and this current environment has been favorable for that business. And if the environment remains so, we believe it should drive additional liquidity events in that portfolio.

Great. And then, lastly for me, I know you guys seem to indicate that certainly the Fed actions have been a big impact on the fixed income markets. Are you seeing any change in issuer activity due to what is going on in Washington stranding the government shutdown or the debt ceiling issues?

Again, I think I would just refer back, our new issuance volume is predominantly municipal, so I would make the same comments. Some impact on refundings, but longer term, I think there's quite a bit of pent-up capital needs. So we may be in short term related directly to activity is just the interest rate impact.

Great. Thanks for taking my questions.

Devin Ryan, JMP Securities.

Good morning. Maybe following up on that question from Joel on the government shutdown, any impact on the equities business or issuance? Or do you expect any delayed impact if this continues?

So, I think one of the measures that ultimately has an impact is the [VICs], the volatility, and that is still in a range where the risk appetite and capital raising are functioning quite well.

Can you speak a bit to your expectations for Edgeview and Seattle-Northwest? I am not sure if you can give any additional detail around revenue expectations. I know that you said that they are going as expected, but any additional detail in terms of how they started to contribute.

I am assuming that given when they close there's probably very minimal revenue contribution, but you are carrying the cost as well. So also would like to know if that could have some positive impact on the comp ratio just as additional revenues come on board and you have a little more flexibility on the actual ratio.

So, related to the revenues we have seen contributions from both Seattle-Northwest and Edgeview in the quarter, really in line with our expectations. So we feel good about that. And then how that may impact the compensation ratio, definitely over time as revenues grow they can have a positive impact on our compensation ratio, but the mix of business also impacts that.

And the one thing I would add is there is in some impact to our comp ratio for the accounting -- impact of amortization of acquisition-related compensation that was part of the structure of both of those deals. So, as you have -- do have more revenue, we also have some additional comp expense related to the acquisition.

Okay, but is it fair to assume that given when these deals close that the revenue contribution is only a small percentage of where you expect they will be on a full run rate basis?

I would say that's fair. Both closed in late July, had some transition.

Yes. Okay, great. Coming back to the fixed income in institutional business, maybe looking at Joel's question a little bit different way, can you give us any sense of customer activity and how that trended this quarter versus last quarter? Obviously, last quarter was negatively impacted from the strategic and then this quarter maybe had some positive impact. So that created a little bit of noise on the comparisons, but how was customer activity in the third quarter relative to the second quarter?

I would say that client activity remained quite low but built during the course of the quarter. And it really is driven around the macro uncertainty of some of the issues being resolved in Washington and we would expect as they get resolved, which we do anticipate, that volume should trend upwards.

Okay, great. And last question, on the integration restructuring expenses, what is the majority of that comprised of? Can you give a little bit of detail in terms of what is -- what are the components of that?

Yes. So, the vast majority is severance-related as we combine these organizations, especially in the Seattle-Northwest transaction. There were a lot of cost synergies, so that is primarily what is driven by the other piece I would say that's fairly meaningful. It is just the technology is there were duplicate contracts and we were -- had some charges related to consolidating technology between organizations.

Great. Thanks for taking all my questions.

(Operator Instructions). Michael Wong, MorningStar.

Good morning. I believe you said that Edgeview completed two M&A deals in the order. So that means nine were already in Piper Jaffray's pipeline, which I would say is pretty good. Are you seeing continued momentum in your M&A field or has it stalled quite a bit lately?

No, as we have been saying throughout the year, our pipeline was weighted towards the second half of the year and we continue to execute on that. Depending on market conditions, we anticipate having a solid close to the year and the trend to continue.

And looking at the equity sales and trading revenue, the second quarter of 2012 was actually -- you have had a pretty gradual increase there. Is there anything specific you have been doing to build that up, build that out, or would you say it is just a somewhat better environment and you are just participating in it?

I would say it is more than that. There are some share gains. And I would note that we are driving revenue increases without growing the headcount. We are managing our capital very effectively. Our loss ratio is down year over year, and the environment is conducive to capital markets clients considering block trades. But our focus has also been very much on areas where we are the most differentiated, putting all of our resources in capital there, and actively managing our sales coverage. So part of it is market share gains as well.

Sounds good. Thanks for taking my questions.

And there are no further questions at this time.

Well, thank you all for joining us. In summary, we produced strong results in our equity-related business in the quarter and improved performance in our fixed income. We continue to focus on increasing revenues, gaining market share, and enhancing our return on equity. Thank you for joining us.

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