Piper Sandler Companies (PIPR) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Piper Jaffray Companies' conference call to discuss the financial results for the third quarter of 2017. 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 earning release and reports filed 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. 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 non-GAAP financial measures should be considered in addition to, not as a substitute for the corresponding GAAP measures. 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.

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 results for the third quarter. We just reported the largest quarterly revenue in the history of the company, which drove record earnings on an adjusted basis. Our advisory business led the way, continuing its string of strong performance with a record quarter of nearly $150 million in revenue. Our entire advisory team should be recognized for their outstanding performance. Growing our advisory business has been a prominent leg of our growth strategy to remix our business into higher margin, less capital intensive areas.

2017 marks the fourth consecutive year of record results for this business, as our year-to-date advisory revenue of $333 million exceeds our full year results for 2016 by about 10%. We expect a strong finish this year in advisory. As you know, the advisory business can be a bit lumpy depending on the timing of deals closing, and this quarter included several large fees. We expect the fourth quarter to be consistent with the range we've experienced the prior 3 quarters, assuming market conditions remain constructive. Our efforts to rerate our business mix towards advisory began about 5 years ago, as we started investing for growth in this business, and clearly we are reaping the rewards of these investments. We believed the advisory model, with its more variable cost structure, higher margins and lower capital intensity would benefit our shareholders. Over the past several years, we have invested in developing our homegrown talent, targeted some strategic hires, and executed on a string of acquisitions across many of our industry groups, including energy, consumer, FIG and industrials. Our key objective was to transform our advisory platform into a broad-based, sustainable and much more significant business. Our 2017 results indicate we are making great progress on this transformation. Each quarter, the business was led by a different industry team. In Q1, our energy team produced the highest results. It was our consumer team in Q2. And this quarter, healthcare led the way. Strengthening our advisory practice across each of our industry groups has led to significant market share gains for the firm. When Deb goes through the financial results in a few minutes (inaudible) the positive impact the remix to advisory has had on our business model and results. Across the other areas of the firm, our performance was relatively strong or in line with markets. In equity capital raising, we were down about 10% sequentially versus more than a 30% decline in our markets. Our outperformance against the market was attributable to our strength in healthcare, where the capital raising was overweighted in that sector during the quarter. Our public finance business, which largely shows up as debt financing in the earnings release, was essentially flat sequentially, while the market was off over 20%.

Our broad-based platform and expertise in high-yield transactions contributed to our relative outperformance. As we expected, the public finance market has declined this year from record levels in 2016, with new issuance essentially flat, while refundings have declined sharply from last year. Our brokerage business encountered pretty strong market headwinds. Low volatility, low rates and a flat yield curve continued to impact brokerage volumes. Equity brokerage was down 11% sequentially, in line with market volumes. In fixed income, our results were up about 8% sequentially as effective management of capital helped to offset lower trading volumes.

Finishing up with Asset Management. Declines in this business were primarily due to our efforts to remix our product offering to a broader set of products. As we mentioned in last quarter's call, we completed the exit of our Japan strategy in Q3. However, the increase in assets from our newer products did not offset the outflows associated with the Japan strategy. While markets remain very challenging for active managers, we believe the business, adequately scaled, will provide earnings diversity and operating leverage for our firm.

Now I will turn the call over to Deb to go through our financial results.

Thanks, Andrew. As context, my remarks will be addressing our adjusted financial results. For the quarter, we reported record revenues of $242 million, which were up over 20% both sequentially and year-over-year. The positive variances were driven by a record quarter for our advisory business. Andrew spoke about the favorable attributes of the advisory model, a model that has more of a variable cost structure and less capital usage. We can see the positive impact of these factors in our results. On a year-to-date basis, we reported $634 million in revenue, 52% of which came from advisory. There are higher comp levels associated with the advisory business, so our comp ratio remains between 64% to 65%. Where we really see the leverage, however, is in the non-comp expenses, which were flat in 2017 versus 2016. The combination of revenue growth of 22% and no increase in non-comps expanded our operating margin to 18% year-to-date compared to just under 14% in 2016. Since the growth in the advisory business did not require operating capital, we see the benefits flowing to our shareholders through an improved adjusted ROE.

We report ROE on an LTM basis in our earnings release, with advisory contributing over 50% of revenues during this period. As indicated in the release, our adjusted ROE of 13.9% is well in excess of our cost of capital. By remixing the business, we are generating great results for our shareholders. We recognize there are couple of items impacting our adjusted ROE during this period. First was the positive earnings impact attributable to the tax benefit associated with the vesting of employee stock awards, and second was the reduction of equity related to the goodwill write-off. But if we exclude these 2 items, our adjusted ROE still exceeds our cost of capital.

I'd like to discuss a couple of items in the earnings release. The non-comp expenses in Q3 of $35 million were below the range of $38 million to $40 million, which we have communicated on our prior calls. There were a few things that drove non-comp cost down in Q3, including lower legal and [C&E] expenses. These were favorably impacted by healthy market conditions, which enabled us to complete a high percentage of transactions we worked on. When transactions do not get to market, we end up absorbing the legal fees and other costs associated with deal execution. We would reaffirm our earlier expectation of non-comp expenses in the range of $38 million to $40 million quarterly. Finally, I'd like to make a couple of comments on the goodwill impairments that we have recorded in our Asset Management segment during the third quarter.

The strong headwinds from the current trends favoring passive investing, amplified by the transition in our product mix and the underperformance of some of our strategies, led to a decline in profitability of the business. These factors drove our decision regarding impairment. And as a reminder, this was a noncash charge.

I will now turn the call back to Andrew.

Thanks, Deb. Operator, we would like to open up the call for questions.

(Operator Instructions) Our first question comes from Ann Dai with KBW.

I wanted to first start with the advisory piece of the business. Excellent quarter, and I guess part of the question is you've grown so fast in this business. What's additive from here? What kind of growth do you think you can achieve off the back of this past year or 2? And if we look forward, where does that come from?

Okay. So a couple of comments. The market conditions look constructive from our perspective and continue to look that way. Low volatility, strong valuations, ample capital and business confidence. Then I think about the investments we've made, both organically in developing our own people hiring across all of our verticals. But in particular, we've made investments in energy, consumer, some subsectors in healthcare and industrials, and all 4 of those really have a runway left to go, in addition to debt capital markets' capabilities. So when we look at it, while we've had some strong growth -- when you look at it relative to the investment and our market share, it's clear to us there's substantial runway left. Maybe the last thing I'd say is, it's going to be a priority for us in the future as well. Finally, I should mention FIG. We've got a multiyear investment there, and there's very ample runway left.

Okay. Great. Appreciate the color. Maybe moving on to the brokerage business. You talked a little bit in your prepared remarks about seeing some impact from MiFID II. So I guess I'm wondering if you could explore that a little further, talk about what you are seeing today based on what's known and how much impact you might expect over the next couple of years. And also whether you're already seeing some of that in your numbers or if it's too early for that.

Yes, Ann, let me address that one. So I do think it's a little early in our numbers to really see anything yet specifically from MiFID. Obviously, you know all too well the impacts that MiFID is likely to have in the marketplace, as we -- especially starting in Europe now, they are bifurcating the value of research from the value of execution. One of the things that, as we look at our business, we had spent some time a while ago, actually, creating a pretty sophisticated system that not only tracks the breadth of resources consumed by our clients but importantly, the value attributed to those resources by our clients, which is really done through an expected commission model, which is grounded by actual client payments. And we have been very thankful for that tool, as we've started to have conversations with clients. We're in very active dialogue with our clients in Europe. And it still feels, even though we are in the fourth quarter, that clients -- it's really, as I think you have even noted in your report, it's a negotiation process going on that really -- we work with our clients to try to establish what that value is. By having the tool that we have, it really grounds for us the pricing conversations that we're having. How this ultimately plays out in the marketplace and what that looks like to us specifically, I guess our view would be, as I believe yours is as well from your report, that the market wallet, the fee pool available, will continue to shrink, and there will be consolidation in the industry. As we look at it, with our focus in small and mid-cap space, which gives us some differentiation, we have very deep expertise in certain areas like energy and healthcare. And actually, as we look at our current position in the marketplace, we believe that we are in a position to increase market share, which will be, really, the only avenue going forward to drive sustainable -- and revenue growth over time. So I don't know if I've answered all your questions in that. But in conclusion, I would say it does feel a little early to tell, but we still -- like we're positioned very well and are having the right conversations with our clients.

Okay. Yes, that does help. Last question I had for you guys was around comp. The commentary around comp historically has been that as banking becomes a bigger portion of revenue generation, you will see that comp ratio creep up. And I guess, we saw a little bit of a reversal of that this quarter. So what's driving that, and how do we think about the comp ratio trend going forward?

Yes, so I would say, as we think about talking about comp ratio and comp ratio expectations, we really need to discuss it in the context of our overall focus on operating margin and earnings growth. And one of the ways that we believe we've effectively driven growth is by hiring talent. So that is one component that does put upward pressure on the comp ratio, and that has really been in our numbers and in our comp ratio, as we have been investing in growth. You point to business mix, which is, accurately, another important component of the comp ratio. And the shift between advisory and really Asset Management on the other side of that has put upward pressure on the comp ratio. As we look at it going through -- you made specific comments about this quarter. I think when you get to a certain level of revenues, there is some leverage on the comp ratio. It is just much more muted than you would see on the non-comp side, given the variable nature of our comp. Going forward, we really think the comp (inaudible) is going to be consistent with current levels. We like the trade-off related to investing for earnings growth relative to trying to reduce the comp ratio. So I think you're going to see a lot of the same, which has been around a 64% comp ratio over the past couple of years.

Ann, I would just add and underscore what Deb said, that we think we're effectively executing on a pretty high level of growth, which is using some compensation but providing some pretty meaningful operating leverage. And it's showing up in our margin. It's showing up in our ROE.

Our next question comes from the line of Devin Ryan with JMP Securities.

I guess, maybe first one here just on the M&A advisory strength, obviously a great quarter there. And I think the outlook commentary sounded constructive. I'm just trying to kind of parse through that a little bit. And after you have such a great quarter, is there some element of rebuilding that needs to occur within the backlog? Or is the trajectory just broadly higher and people are just more active, and so things are still good coming off the great result?

It's more the latter. Our pipeline is in very good shape. And we expect to finish the year strong. Maybe the context we give it, as I think I mentioned, is in terms of the range of our prior 3 quarters. But we expect to continue the solid performance.

Okay. All right. Good. And then maybe one on the equity underwriting pipeline here. You've seen a nice recovery in that business relative to last year. But we're still tracking below some prior levels. My view is that we're below kind of the industry potential. And so I'm just curious how you feel about your position in that business. Are you still adding senior bankers more on the equity underwriting side? And how do you feel about kind of the momentum there relative to maybe some historical context?

So our outlook sounds like it would be pretty similar to yours, that while there's been a recovery, it's still well below some historical industry high-water marks. And the pieces are in place. You've got good valuations, strong performance by what's being underwritten, relatively low volatility. And we'd expect that environment, if you would, to stay the same. And we've got an expanded footprint that we continue to invest in. And in particular, I could just point to the example of Simmons. Our combined resources has dramatically expanded their equity capital raising from what I would maybe characterize as a relatively modest co-managed business to now where we've led managed, I think it's 9, 10 offerings. We get very good economics on some pretty large capital raises. So there's a lot of runway there in a favorable environment, in addition.

Okay. Great. And with respect to maybe the fixed income business and then the brokerage side, I'm not sure if you can give us any kind of background here. But how did that business kind of trend throughout the quarter? We've had several tougher periods before this. But we did see a little bit of improvement in kind of interest rate expectations into quarter end. Yield curve steepened marginally. I'm not sure if that kind of led any pickup an activity. Really what I'm trying to get at is, what do you feel like is the biggest factor holding client activity back? Is it the interest rates, is it just uncertainty in the markets? I'm just curious there.

Yes, I would say the quarter felt pretty consistent to us. But my outlook would track what you're saying. You've got an environment with very low volatility, low interest rates. The yield curve flattened quite a bit going into the middle of quarter, and the point you just made is true. Now it's reversing. I think we started the year, I'm talking [2s to 30s] at about 125. It got down to 85, and now it's reversing. That would be positive if it extended. If we end up with higher rates notionally and a positive yield curve, that would be quite beneficial. And we have not seen that now for multiple of years.

Okay. Great. Last question just around inorganic opportunities. I know you guys are always looking. So I'm just curious if there's anything that feels like it might be moving in the right direction in terms of conversation? Or are there conversations currently? And just to kind of remind us of what some of the areas are that are an area of focus.

So I'd say, we do feel that we've got a competency there. We've found very good fits culturally, complementary businesses. And then we're very mindful of how we integrate and feel we can do that very successfully and create synergies. Again, I'd reflect on the most recent Simmons, where our combined resumes delivered some very positive results in business activity that neither of us would've gotten independently. And we would say, there's room, really, across most of our sectors, from a subsector view, additional spaces in really all of them. Energy, maybe E&P, healthcare. There's some areas that even with our big footprint, we're relatively underpenetrated. Consumer additional subsectors, much like we did with PCG group. And certainly in FIG, there's an area where we've got relatively modest market share, even compared to middle-market competitors. So we see room across the board. We'd continue to grow our public finance business as well, both geography or industry sector or there's an advisory business there as well that we've got a relatively modest share in. So we see ample space, and we're actively looking.

(Operator Instructions) And at this time, there are no further audio questions.

Thank you, operator. And thank you, all, for joining us this morning. Have a good day.

Ladies and gentlemen, that will conclude the Piper Jaffray Companies' 2017 Third Quarter Conference Call. You may now disconnect your lines, and have a wonderful morning.