Stifel Financial Corp (SF) 2006 Q2 法說會逐字稿

Good morning, my name is Valerie and I will be your conference operator today. At this time, I would like to welcome everyone to the Stifel Financial Q2 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a Q&A session. [OPERATOR INSTRUCTIONS] Thank you.

Mr. Zemlyak, you may begin your conference.

Thank you, Operator. Good morning, everyone. This is Jim Zemlyak, CFO of Stifel Financial Corp. On behalf of the Company, I would like to welcome everyone to our conference call to discuss the second quarter results of our 2006 fiscal year. Please note that this conference call is being recorded.

Before we begin today's call, I would like to remind listeners that this presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of fact or guarantees of performance. They are subject to risks, uncertainties, and other factors that may cause actual future results to differ materially from those discussed in the statements. For a discussion of these risks and uncertainties, please see the business factors affecting the Company and the financial services industry in the Company's Annual Report on Form 10-K and management's discussion and analysis of the results in the Company's Quarterly Report on Form 10-Q.

With that, I would like to turn the call over to the Chairman, CEO, and President of Stifel Financial, Mr. Ron Kruszewski.

Thank you, Jim, and good morning everyone. I'd like to start by first of all reminding everyone that we have slides that can be accessed on our web site that will accompany this conference call and I hope people can find their way to those because we will address the slides as we go forward with this call.

For the quarter and the 6-month, I would like to make some opening comments as to the highlights and what happened. First of all, for the 6 months, our earnings per diluted share were $1.31, which has met our expectation. For the quarter, core earnings per share were $0.50, which is lower than what we had planned for the quarter, due primarily to difficult market conditions in the last half of the quarter, primarily in the private client group and our fixed income segment. Second, we had a loss in our investment account, due primarily to the sale of the majority of the shares we received in the New York Stock Exchange transaction. In short order, what I'm saying is that we recorded a gain in the first quarter and then when the IPO was completed, we, as many firms did, had to write down that investment to the IPO price. And Jim will talk about the impact of that on the quarter in a moment. And then, also, a subdued activity in our equity and fixed income underwriting calendars for the quarter, and, frankly, for the 6 months. And I will address this later in this call.

On the growth side, we're pleased to report that our 6-month revenues were an all-time record of approximately $221 million for the quarter. We recorded our second largest revenue quarter in history. We continued the expansion of our private client group, opening 6 branch offices during the quarter, for a total of 97. Our number of investment executives in the last year has increased by 51 to 485. And so all in all, considering the difficult market conditions, we are pleased with our results of our quarter and especially pleased, as I said in the last quarter, that the integration of our merger with Legg Mason Capital Markets has far exceeded our expectation.

With that, I'll ask Jim to take you through some of the results.

Thanks, Ron. The next two slides will reconcile, as we did in the first quarter review, the quarterly and 6-month GAAP to core financial statement.

Today we reported unaudited quarterly net income of $2.3 million, or $0.16 per diluted share, on net revenues of $102.7 million for the quarter ended June 30th. For the comparable quarter of '05, net income was $5.6 million, or $0.46 per diluted share, on net revenue of $64 million. After adjusting for acquisition-related charges, principally compensation expense recorded for the stock-based awards offered to key associates of Legg Mason Capital Markets and accounted for under the Statement of Accounting Standards 123, non-GAAP net income and non-GAAP earnings per diluted share, our core earnings for the quarter ended June 30, '06 were $7 million, and $0.50, respectively. We believe core earnings provide investors, rating agencies, and financial analysts with more meaningful measure of the Company's operating performance.

Core earnings for the quarter exclude the acquisition charges of approximately $8.3 million, or $0.34 per share. Included in these acquisition-related charges are compensation charges of $7.8 million for the amortization of units awarded to Legg Mason Capital Markets Associates, severance, and contractually-based compensation above standard-based compensation, and other non-compensation acquisition charges of $507,000.

On our next slide, for the 6 months ended June 30th, we posted net income of $2.8 million, or $0.20 per share, on a record 6-month net revenue of $212.2 million, compared with $10 million, or $0.81 per share, on net revenues of $124.2 million for the same period one year earlier.

Core earnings for the 6 months ended June 30th were $18.1 million, or $1.31 per share. Included in core earnings was $0.15 per diluted share for the gain resulting from the merger of New York Stock Exchange and archipelago holdings. Year-to-date core earnings exclude acquisition charges of approximately $26.1 million, or $1.11 per diluted share. Included in these acquisition-related charges are a compensation charge of $9.8 million for the difference of our pipe, which we did in the first quarter for the Legg Mason Associates, and compensation charges of $15.5 million for the amortization of units awarded to Legg Mason Associates, severance, and contractually-based compensation above standard performance-based comp. Other non-comp acquisition charges were $854,000 for the first 6 months.

Now, Ron will comment on the next few slides.

Yeah, if you look at a slide, Jim just went through a multitude of numbers, which, as we've said, we want to look at and we believe it's important to look at core earnings because of the way that we're accounting for this acquisition. And the slide that you're looking at takes a look at the impact of these acquisition costs for the first, second quarter, year-to-date, and the estimate for the full year, which we've provided in the past. And as you can see, as Jim as already mentioned, for the first 6 months, we've taken acquisition charges of approximately $26 million, or $1.10 a share. And for the year, we estimate those to be approximately $41 million, or $1.69 a share. And the important thing to remember with these charges is that the vast majority of -- substantially all of these charges are stock-based compensation and the offset to these charges are to equity. So these are non-cash charges of which we expense but then we credit the equity accounts of the firm. And that's why we believe it is important to look at core earnings and exclude the impact of these charges as it relates to GAAP.

On an annual basis, looking forward, and again we've shared with you this in the past, we anticipate that these charges will total $41 million in 2006, and approximately $25 million for each of the years 2007 and 2008, where in 2009 there will be no more of these charges because all of the stock-based compensation will have been both amortized to expense and added to the equity accounts of the firm. So, again, something that we think is very important for our shareholders to understand and it's something that we'll talk about each quarter.

Jim, if you'd walk through the results, I would appreciate it.

The next slide is our second quarter core earnings. As a result of our Legg Mason Market acquisition, we added 429 associates and 22 offices on December 31, 2005. Unless noted otherwise, our increase in revenue and non-interest expense for the quarter and year-to-date for the total Company and segment can be attributed principally to the acquisition and increased number of private client group offices and increased number of private claims, investment executives.

Looking at our line items, commissions and principal transactions, revenue increased 101% to $68.8 million from $34.3 million in the same period last year, with increases of 21% in the private client group, over 1000% in equity capital markets, and 377% in fixed income capital markets.

Investment banking revenues increased slightly to $15.8 million from $15.7 million in the same period last year. We had a significant increase in our corporate advisory fees over the prior-year quarter, but our underwriting revenues declined in a similar fashion. We will have a slide that Ron will go over to go into further detail on investment banking.

The next line item, asset management and service fees increased 40% to $14.2 million from $10.1 million in the second quarter of last year, due to a 43% increase in the number of our managed accounts and 108% increase in the value of assets under management in those accounts. This is due primarily to the hiring in Q2 of investment executives. And throughout 2005, we'll focus primarily on the asset management business.

The last item on this slide, other revenue, on a sequential basis, I will note on this that we are essentially zero for this quarter compared to $7.4 million in the first quarter. The first quarter was due primarily to the fact of the New York Stock Exchange gain and gain in other investments, while in the second quarter, we had a write-down in those investments, including the New York Stock Exchange of effectively $700,000.

Net interest revenue increased 28% to $4 million from $3.1 million in the same period last year, due principally to increased interest rates, charge to customer margin accounts, and increase in the interest earned on our fixed income inventory held for sale. This is offset by increased borrowing rates.

On our next slide, we'll look at employee compensation and benefits, the largest item there increased 79% to $74.4 million from $41.6 million in the prior-year's second quarter. As a percentage of net revenue, which is the benchmark we look at, comp and benefits totaled 72.5% in the second quarter of '06 and 65% in '05. A portion of the comp and benefits includes transition pay of $3.6 million in the second quarter of '06, and $2.4 million in '05 in connection with the Company's continuing expansion efforts in the private client group.

In addition, comp and benefits include $7.8 million and $17.5 million for the quarter ended June 30, '06 and March 31, '06, respectively, primarily stock-based compensation in acquisition-related charges for payments in connection with the Legg Mason Capital Markets acquisition. Excluding the acquisition of related charges, comp and benefits, as a percentage of net revenue, totaled 64.8 in the second quarter of '06, and 65% in the '05 comparable quarter.

The Company excludes acquisition-related expenses in its analysis of comp and benefits, a non-GAAP measure, because I believe that exclusion of the acquisition-related compensation is a more useful tool in measuring compensation as a percentage of net revenues.

The next slide we'll get to, Ron will make some comments on investment banking.

Right. Thank you, Jim.

Probably the one line item that I did want to comment, both quarter-to-quarter and year-to-year, is investment banking. As you can see from this slide, our investment banking line item is essentially flat, both for the quarter and up slightly for the year. And what the major difference is is that our underwriting calendar was subdued. And as you can see for the quarter, our underwriting fees, as a percentage of banking, declined from 87% to 42%. This was completely offset by our increase in our advisory fee revenues. And so the good news is is that our advisory business, primarily due to our merger, is very robust. And I also think the good news is is that going forward we have a robust calendar for the underwriting business. So that bodes well looking forward.

For the first half of the year, I would note to you that Stifel Nicolaus had for the first 6 months 9 lead or co-managed equity offerings, and since July 1st, in what I still think is a tough market environment, we have completed 6 equity offerings and we have a robust pipeline going forward. So that should be one of the takeaways from this call.

Quickly, we look at segments. Jim?

Thanks, Ron.

The next slide shows the private client segment. Private client net revenue for the second quarter of '06 was $54.9 million, an increase of 13% from the second quarter of '05, principally due to increased commissions and principal transactions, increase in asset management and service fees. This was offset by a decrease in investment banking sales credits, due to the decreased underwriting, as Ron had discussed. Asset management and service fees increased due to a 43% increase in the number of our managed accounts, as we've already discussed. Net revenue decreased 2% from the first quarter of '06. Private client group reported an operating contribution of $11.7 million, a 2% increase from the second quarter of '05, and a 6% decrease from the first quarter of this year.

On the next slide, equity capital markets recorded record net revenue for the quarter of $35.3 million, an increase of 277% from the same quarter last year, principally due to increased commissions and principal transactions and increase in investment banking revenues. Investment banking fees increased principally due to a $6.9 million increase in advisory fees, offset by a decrease of $1.4 million in underwriting fees for lead or co-managed offerings. ECM net revenues increased 4% from the first quarter of '06. ECM operating contribution totaled $7.9 million, a 139% increase from the second quarter of '05, and a 6% increase sequentially from '06.

The next slide is our slide on fixed income capital markets, which posted net revenue of $10.6 million, an increase of 142% from the prior-year second quarter, principally due to increased commissions and principal transactions, offset by decreased investment banking revenues, resulting from decreased Muni financing. Fixed income's net revenue decreased 7% from the previous quarter. During the '06 second quarter, fixed income recorded an operating contribution of $1 million, a decrease of 1% from the prior-year second quarter, and a decrease of 40% from the previous quarter.

Our next slide shows some other financial data. There are a lot of numbers here, but of note, total assets for the firm are over $1 billion, and total class client assets under management exceed $29.4 billion, a 26% increase from last year.

I'll turn it back to Ron.

Thank you, Jim.

I'd like to summarize by commenting on a theme, which is balance and balance in the firm. We looked at our merger, not only for growth purposes last year, but as a way to balance the revenues and the contributions of the firm. And the slide that you're looking at I think makes this point. At a year ago at this time, approximately 80% of our revenues were derived from our private client group and 21% from capital markets, while today approximately 55% of the firm's revenues are derived from the private client group and 45% from capital markets. We think that that is a very good balance to support the growth prospects for this firm.

Looking at each segment, the private client group, it has and will continue its expansion mode. We have a lot of plans in our new markets, primarily in the east and southeast, and we see continued growth in that segment. The equity capital markets business has met our expectations, and in most cases exceeded our expectations, even with the subdued equity calendar that I previously talked about. So when that, which already has turned around, when that gets back on track, we see very positive and continued growth out of that segment.

And then finally, the fixed income capital markets had a difficult operating environment. As all of us know, the yield curve, which I'm not sure if it's inverted today, I've not looked as to what happened, but certainly has been a difficult market for the fixed income group. And coupled with the fact that our public finance business is traditionally lumpy in the second half, but this year more so than historical. Most of our business in public finance will come in the second half of the year. But I really believe the fixed income business is poised for significant growth and improved profitability as the market conditions improve.

So with that, we would take any questions that any of you may have.

[OPERATOR INSTRUCTIONS.] Chris Campbell

I wanted to see how many shares were repurchased in the quarter and how many are left from the authorization?

You are going to make me dig for that one. I'm not sure that I -- I believe we have plenty of authorization. I will leave it at that. It's in the Q, unless someone can dig it up. During the quarter, we've repurchased, I believe, approximately 100,000 shares.

[Seri Lally]

On the integration, can you just give us an update on where you stand and if there is anything left to do in the back office side and what the time frame might be?

I'm sorry. I didn't catch the last part of your question. The integration is going fine. I believe that it's done. There are always technology improvements that you can do. We view that as continuous improvement. But in terms of the processing, the trading systems, we're all on one system, so there are no dual systems. Our over-the-counter trading systems and how we get to the floor all are fully integrated, complete to our back office, so there is no really nothing left on that integration side. Of course, we're always trying to improve the way that we interact with both exchanges and our clients. So I never view that that's over. But in terms specifically to the integration, that's done.

The private client side, you talked about being in a growth mode. You mentioned $3.6 million in transition pay, which looks like it cost you about $0.15. Is that an upfront payment? How long do those payments go over? And can you just kind of walk us through the payback for the brokers you've brought on? How long before they ramp?

Sure. That question, or the answer, could take probably longer than we have on this call because a number of the firms account for these transition payments in different ways. We, like everyone else, will recruit people and we look and measure what we call transition pay. That's generally for a new hire we'll, for accounting purposes, we'll spread over 5 to 7 years. And we measure that and it's almost, these are people so I hate to use the word "churn" or how it works, but the way that works and the way it's worked for us for the last 8 years is that as we grow and we bring people onto the platform, they will receive this transition pay and then they transition off.

The real question is, is that when they transition off do you keep them? And our success rate in that has been superb. The people, once they're here, stay. And so our historical measure of this transition pay, which is what I look at, is when it's over are you just losing the people that you transition and replacing them with new, and the answer here is no, as evidenced by both our growth in revenues and our growth in IE. So I don't know if that answers your question. It is something that we look at and we track and we have some management metrics to make sure that where we are satisfies our IRR cash on cash returns the way we build this business. And I think the past has proven that out. I hope that answered your question.

Okay. It sounds like it's a rolling pool of retention incentive comp that will vest over a longer time period versus being a one-time upfront payment. So it's not tied to the new brokers you brought onboard.

Well, yes. Some of the payments are rolling and some of them are one-time payments. But the one-time payments are accounted for over a period of time going forward. But you are exactly right that it is a rolling pool. And if we are successful in our growth plans that will continue to be a line item as we go forward.

Talk about the brokers that you brought onboard, particularly now with the new franchise, whether it's their seniority level or productivity and how long do you expect that to take to ramp up?

The people -- are you talking about the capital markets business or the private client?

I think you had mentioned that you had brought on a number of folks. I think it was 50 year-over-year.

Yes.

And what's involved sequentially in the private client side?

Yeah, I think it takes generally 3 to 4 months for a new investment executive to quote ramp up. And again, that's a rolling number. But if you look at our growth in revenues for the private client group, which I believe was some 15 to 18% in difficult market conditions, what the answer is there, and I can tell you that on a same-store sale basis, if you will, it's generally flat. So the growth in our revenues has come from the growth that we've added in new IE's, and in short order, the people we've hired have met or exceeded our expectations in their quote ramp up.

But on the branch side, you added 6 branches. What's the startup investment in a branch? How long does it take to get to breakeven?

The startup costs are leases and furniture and not material in individual branches. It can be material when you're looking at a number of branches. In the last 8 years, we've increased branches from 38 to almost 100. It depends. We often will have loss leaders for branches and markets that we want to be in. We track our branches by class of year as to when we added them. And if a branch is not profitable, say, after 12 months, we're putting it on a monitor system to make sure that we know why, and we generally know why, but that's how we look at it. I have no set plan as to when a branch will be profitable. We will open branches, but we don't expect to be profitable for a couple of years. If it's in places we want to be. And as I look backward, some of the best investments we've made were those kinds of investments that take 2 or 3 years to pay off. But when you run the numbers on return of investment, they're extraordinary investments.

The other expense line, it seems like it was up sequentially, about $1.5 million. What led to that and really where I'm trying to go is trying to think through what's kind of the core expense base or run rate for the 2 companies together. I know Q1 was kind of the first quarter as NewCo and then Q2. I'm just trying to get a feel for the different expense levels that would be the true pro forma for NewCo.

Probably a blend of the two. With any integration at the time there can be some lag in expenses. So to try to answer your question to say that it was all -- the cutoff to all of these expenses, we certainly do good accounting cutoff. I don't want to suggest that we don't. But there are expenses with the transition of systems and whatnot. There is a lot of noise in there. So I'm not sure I can give you a forecast on OpEx. But if you blended the numbers, you might be able to use those numbers.

What was the cause of the $1.7 million sequential increase in OpEx?

Which line item?

I think the other operating expense.

Yeah, that's -- a lot of that is what we've been doing. Some of it is floor brokerage and some of it is travel. A lot of it is travel, as we've gotten around to our new -- we spent a lot of time going around and checking on systems and getting out and seeing clients, and so our T&E is up significantly for that time. And that's probably most of it, is what I would say are travel and entertainment. It's mostly travel.

Any other questions?

Yes. Scott Hooper

I have a couple of questions. On the --

Hello? You're breaking up.

Let me try this. Is this better?

It is. Thank you.

On private placement expense, the $9.8 million, when you buy back stock at different prices, does that affect -- is there an adjustment to be made to that since the differential between private placement price and the market price at the time of that?

The short answer is no. I mean, there is no adjustment. That was a one-time accounting measurement charge, which resulted from the fact that when we struck the deal the stock was at, say, $25, and when we got around to closing the deal, the stock was in the mid to high --

$34.

We're required to take -- we were required, for accounting purposes, to both write up equity and then write it down because we only got $25 a share.

Right.

But that's a one-time event and that number will not change.

Okay. And also, do you break out or is -- I'm sure you have it, but you didn't break out your principal transactions from your commissions, you lumped them together.

In which --

For the quarter. On --

Well, if you look at the press release, and I think we did probably on the slides, but on the press release, if you go to that for the quarter, you will see that on a sequential basis commissions were flat and up 100%. It's almost impossible to look at last year's second quarter because of all of the growth that we've had. But sequential basis, commissions were flat and principal transactions were down 4%.

No, I'm sorry. I'm not asking the question clearly. I meant in terms of between your equity and your fixed income. For the quarter, the principal transactions were almost $21 million. Just approximately, what percentage of that is fixed income and what percentage equity?

I'll tell you what, if you give me a second. Did you have another question? I will try to get that and I'll answer it.

Yeah, my third --

We did not have that in our press release and we did not disclose it, although I don't have a problem giving it to you. You are talking about on a segment basis?

Right. Exactly. The one other question I had, now that you've pretty much integrated everything, are there any specific areas of growth that you're looking, new markets, that you're looking to enter, as opposed to, for example, hiring more salesmen, say, in fixed income? For example, are you planning to enter a different market, I don't know, high yield or asset-backs, or are there any areas in investment banking where you're planning to start new areas of practice that you aren't in now?

Today, no. I mean, we're looking to assimilate what we have and get everyone working together. As I've said, one of our challenges, which I think that we've certainly got back on the right track with the equity underwriting calendar for the business that we have, but we have a very robust platform, both in fixed income and in equity capital markets. We cover almost 600 companies across a vast array of industries, and at this point I think that we're looking to drive profitability.

Okay. And just my last question is it seems to me that you should have a pretty decent free cash flow. What plans do you have for investing that money?

Well, your first comment is true, that we do have, and we try to show that we do have very strong free cash flow. And our plans to invest the money are to continue to grow. We think that our platform across all of our segments is very attractive. We're one of the few remaining entrepreneurial fully-owned, upscale-sized, regional brokerage investment banking firms left and we want to continue to reinvest our earnings into our growth. That said, we're always looking at making sure that our capital structure drives the type of equity returns that we think our shareholders demand. And that we as -- since we own a lot of it, we all demand.

Did you have time to break out the principal transactions?

I did not, although someone is trying to do it. I do not have it in front of me, as I speak. But if I get it, I will, before we get off the call, I will get that to you. You're free to call me, or our CFO, at 314-342-2228, and he'll give you that information.

If it's easier, I'll just call Jim later on.

That would be easier. Thank you.

There are no further questions.

Well, we've set a record with the number of questions on this call. The previous record was zero. So that is encouraging that people are listening. We, again, are looking forward to a lot of good things to happen with our new platform, and I look forward to talking to everyone at our next quarterly update. Have a good day and thank you.

Thank you for participating in today's conference call. You may now disconnect.