Stifel Financial Corp (SF) 2006 Q4 法說會逐字稿

Welcome to the Thomas Weisel fourth-quarter earnings results conference call. Just a reminder; today's conference is being recorded. Now at this time for open remarks and introductions, I would like to turn the conference over to Mr. Mark Fisher, General Counsel. Mr. Fisher, please go ahead.

Thank you and good afternoon. This is Mark Fisher, General Counsel for Thomas Weisel Partners. In the room today with me is Tom Weisel, our CEO and Chairman, and David Baylor, our Chief Administrative Officer. Before we begin, let me just get two things out of the way and then I will turn the call over to Tom.

First, I would like to remind you that today's call may include forward-looking statements. These statements represent the firm's beliefs regarding future events that by their nature are uncertain and outside of the firm's control. The firm's actual results and financial condition may differ, possibly materially, from what is indicated in these forward-looking statements. For a discussion of some of the risks and factors that could affect the firm's future results, please see a description of the risk factors in our current annual report on 10-K for the fiscal year ended December 2005.

Second, this audiocast is copyrighted material of Thomas Weisel Partners Group, Inc., and may not be duplicated, reproduced, or rebroadcast without our consent. So without further delay, let me turn this call over now to our Chairman and CEO, Tom Weisel, who will review the firm's results.

Thanks, Mark. Good afternoon. Thank you for joining our fourth-quarter 2006 earnings result call. I will provide some opening comments; then David Baylor, our Chief Administrative Officer, will provide more details on revenue, expenses, and earnings.

We are pleased with our fourth-quarter results led by investment banking revenues and private equity investment gains. Investment banking revenues were the strongest since the first quarter of 2001, paced by $15.2 million in M&A revenue. Private equity gains were the strongest since the fourth quarter of 2004.

Our performance and position in the market in 2006 was outstanding. We ranked number one in 2006 technology, IPOs, and follow-ons by transactions; and we ranked number two in transactions in 2006 for growth IPOs.

The environment for our investment banking activity improved in the summer with the rebound of the Russell 2000 growth, off the July 23rd lows, and particularly the technology component that yielded a 23% performance by the end of the year.

As we said on our last earnings call, M&A and private placements would be strong in the second half of '06, and they were. That momentum has carried into 2007. We entered this year with 11 filed and engaged IPOs; three filed and engaged follow-ons; and five announced M&A transactions. Our book- and lead-managed underwriting transactions increased 50% in '06, with 18 transactions, up from 12 the previous year.

On the private equity side, we are in the carry in several of our funds, which was a major contributor to the quarter. We recorded gains of $5.9 million in the fourth quarter of '06 versus $2.4 million in the fourth quarter of '05; and $12.4 million in '06 compared to $4.4 million in '05 for the full year.

We have instituted some changes in personnel in the brokerage business to counteract some of the headwinds affecting that business. Our efforts began to generate results in the fourth quarter. Equity commissions improved 7% over the third quarter.

We launched Discovery Research in Mumbai, India, at the end of '06 with seven publishing analysts covering 64 companies. Since then, we now have 10 publishing analysts covering 90 companies. By the end of this year, we plan on growing to 16 analysts covering 250 companies. Our focus at Discovery Research is growth companies with a mean market cap of $500 million and earnings per share growth of more than 50% for '07 and '08. Three companies have already been acquired by large U.S. corporations that we picked up since we initiated this service.

Finally, today we elected two members to our Board of Directors, Matt Barger and Michael Brown. Matt Barger is the former managing general partner at Hellman & Freidman, a private equity firm in San Francisco. Michael Brown was the former CFO of Microsoft and also was a former governor of the NASD and former chairman of the NASDAQ Board of Directors.

Now I am going to turn the call over to David Baylor.

Thanks, Tom. Our GAAP net income increased to $8.7 million in the fourth quarter of 2006 from $7.1 million in the fourth quarter of '05, and increased to $34.9 million in '06 compared to a net loss of $7.1 million in '05.

Diluted earnings per share were $0.33 for the fourth quarter and $1.34 for 2006. Adjusting for certain onetime events, including our conversion to a corporation, our non-GAAP net income and diluted earnings per share were $9.8 million and $0.37 for the fourth quarter and $23.7 million and $0.93 for all of 2006.

Our net revenues were $76.5 million for the fourth quarter and $276.3 million for '06, up 8% for the quarter and 17% for the year compared to '05. These percentage revenue increases exclude 2005 management fees from Thomas Weisel Capital Partners, our late-stage private equity fund which transitioned to independent management in late 2005.

Our investment banking revenue increased 33% in the fourth quarter to $37.3 million and 65% for '06 to $124.1 million compared to the same periods last year. We completed 28 investment banking transactions compared to 18 in the fourth quarter of '05. For 2006, we completed 87 investment banking transactions with an average revenue per transaction of $1.4 million, compared to 63 transactions with an average revenue per transaction of $1.2 million in 2005.

Our brokerage revenue decreased 15% in the fourth quarter to $29 million compared to the fourth quarter of '05. For all of 2006, our brokerage revenue decreased 11% to $123.8 million compared to all of 2005.

Asset management revenues increased 12% in the fourth quarter to $9.3 million compared to the fourth quarter of '05. They increased 22% to $25.8 million for 2006 compared to all of '05. Once again, these percentage revenue increases exclude 2005 management fees from Thomas Weisel Capital Partners. The primary reason for the increase in our asset management revenues is increased gains on investments in private equity partnerships, which as Tom said were $12.4 million in '06 and $4.4 million in 2005.

Our primary expense is compensation and benefits. We generally referred to the remainder of our expenses as noncompensation expense. Comp and benefits expense increased 11% in the fourth quarter to $41.2 million and decreased 1% in 2006 to $152.2 million compared to the same periods in '05. As you know, and as we have previously discussed, we have targeted compensation and benefits expense, excluding the amortization of our IPO equity awards, to be within the range of 55 to 58% of revenue, excluding revenue from private equity gains and losses. For the year, we came in at 55%. We expect our compensation expense to be within our targeted range in 2007; but we expect it to be above the 2006 levels.

Noncompensation expenses decreased 12% in the fourth quarter to $25.6 million compared to the fourth quarter of '05. The decrease in noncomp expenses in the fourth quarter was mainly due to our having recorded costs in the fourth quarter of 2005 related to transferring the management of Thomas Weisel Capital Partners to a third party. Our trade processing, communications, and depreciation and amortization expenses also decreased in the quarter. These decreases were partially offset by higher legal, audit, and insurance costs.

Our noncomp expenses were $98 million for 2006 compared to $101.6 million in 2005. As I just mentioned, we recorded costs related to Thomas Weisel Capital Partners in the fourth order of '05 which was the primary reason for the year-over-year decline.

Our tax expense for the fourth quarter of '06 was $1 million, which represents a 10% tax rate for the quarter. The low tax rate resulted primarily from a $3 million downward adjustment to the valuation allowance we previously recorded at the time of our conversion to a corporation. That downward adjustment was related to capital gains in investment partnerships and other securities that we recognized in the fourth quarter of 2006.

For the full-year 2006, we have a tax benefit of $8.8 million. This negative tax rate is primarily the result of tax benefit from our conversion to a corporation in the first quarter of 2006. That conversion resulted in net $13.8 million tax benefit; also additional tax benefit resulted from subsequent downward adjustments totaling $4.1 million to the valuation allowance. The $4.1 million downward adjustments once again primarily related to capital gains we recognized in 2006 from our investments in partnerships and other securities.

In 2006, our effective tax rate after excluding our first-quarter onetime event, but including the subsequent downward adjustments, was 25%.

Since we are discussing full-year '06 results I should remind you that we incurred preferred dividends of $1.6 million in our first quarter of 2006. But in connection with our IPO, all of our outstanding preferred shares were exchanged for common stock and debt; and we don't expect to report preferred dividends and accretion in the future.

That concludes my summary remarks. I will now turn the call back to Tom who will provide you with some detail on our revenue.

Thanks, David. I would like to give you a little more detail on our three basic divisions, starting with investment banking. As David said, our revenue was $37.3 million in the fourth quarter, consisting of 28 total investment banking transactions, compared to 18 in the previous year. For the full year, we increased to $124 million up from $75.3 million in '05, completing 87 transactions versus 63 or a 38% increase.

Capital raising was the big star. We had $22 million in revenue in the fourth quarter, up 51% from the fourth quarter of '05, consisting of 13 IPOs, eight follow-ons, and two private capital raising transactions. Within capital raising, private placement revenue increased to $3 million from less than $1 million in the fourth quarter of '05.

For the full year, capital raising revenue was $93.1 million, compared to $43.4 in '05, a 114% increase. We completed 72 capital raising transactions compared to 48 in '05, a 50% increase. Our average revenue per capital raising transaction increased to $1.3 million -- to just under $1 million in '05.

In the last three years, we have done 79 IPOs, of which we have completed 10 follow-ons in '06 for these companies, up from four in '05. We expect a significant increase in follow-on activity from this group of high-quality IPOs in '07.

Notable transactions in the fourth quarter included the sole-managed IPO for Netlist; the co-book-managed IPO for Double-Take Software; and co-lead-managed IPO for RRSat Global Communications. In the follow-on category, we did a sole book-managed follow-on for Occam Networks; and a sole book-managed follow-on for Cray; and a co-book-managed follow-on for Pharmacyclics.

On the private placement side, we did a sole agent HomeAway private placement that was $160 million in size; and a sole agent for Vertical Communications, which was a preferred stock PIPE of $27 million.

M&A revenues increased 14% to $15.2 million compared to $13.3 million in the fourth quarter of '05. Notable M&A fourth-quarter transactions -- we advised USinternetworking in their sale to AT&T for $300 million. We advised Broadwing on its sale to Level 3 for $1.4 billion. We recognized a partial fee for the fairness opinion in the fourth quarter.

We closed seven private placements in the second half of '06 compared to four in the first half, producing $7.8 million revenue in the second half versus $3.9 million in the first half.

In addition, our M&A revenue accelerated at $23.4 million in the second half of '06 compared to $7.6 million in the first half. We closed 10 M&A transactions in the second half compared to five in the first half. For the full year, M&A revenue decreased slightly to $31 million compared to $31.9 million in '05.

In the fourth quarter, our revenue mix by industry was led by technology, with $28.4 million in revenue; then healthcare was $6.2 million; and consumer with $2.6 million. For the full year, revenue from the technology sector increased to $73.2 million from $47.9 million, a 53% increase. Healthcare increased to $28.6 million versus $18.4 million, a 55% increase over '05. Consumer increased to $22.4 million versus $9.1 million in '05, a 148% increase.

I would like to remind you again that investment banking revenue can be inconsistent and lumpy quarter-to-quarter, and the realization of a pipeline can change dramatically.

Our first-quarter backlog is up substantially compared to the backlog we described during the third-quarter conference call. We currently have 15 capital raising transactions that have either been completed or are on file. Five have been completed -- three IPOs and two follow-ons, of which two were book-managed. Three IPOs and two follow-ons are on file and expected for the first quarter, of which two are book-managed.

In addition, we have four completed and one other announced M&A transaction so far this quarter. They include the previously alluded Broadwing sale to Level 3. We advised Microsemi on the acquisition of PowerDsine. We advised Nomura on its $1.2 billion acquisition of Instinet. We advised Netopia in its sale to Motorola. We advise Internap in its pending acquisition of VitalStream. These transactions will contribute approximately $20 million in revenue in the first quarter.

Brokerage revenue in the fourth quarter was $29 million. Compared to the third quarter both equity volumes and commissions per share increased, but were offset by higher loss ratios and lower convertible trading revenue.

Asset management revenue increased 12% to $9.3 million for the quarter, compared to the fourth quarter of '05. Revenues for the year were $25.8 million versus $21.1 million for '05, excluding Thomas Weisel Capital Partner management fees.

The increases were driven by private equity gains of $5.9 million in the fourth quarter of '06 compared to $2.4 million in the year-ago quarter. The majority of these gains were from carry in our healthcare fund, in addition to gains recognized from our GGP Funds and Thomas Weisel Capital Partners. For the year, private equity gains were $12.4 million versus $4.4 million in '05, an increase of 183%. Now I would be happy to answer questions from the callers on the line.

(OPERATOR INSTRUCTIONS) Rich Repetto, Sandler O'Neill.

Well, your correlation with the Russell growth in 2000 growth indexes pretty much bore out in the second half here. I guess, first question is trying to understand, I guess, the private equity gain. Now are any of these type recurring gains on the carry here in the healthcare or are other funds?

Well, if you recall, we have a slide when we went public that kind of showed three different components where private equity gains could come from -- waived management fees, the carry in these funds, and the investment that we have made in these funds.

So, as time goes by, we have kind of gotten through the J-part of the curve of most of these funds. In some cases, we are into the carry; in other cases we are yet to be into the carry. As the business environment improves for growth, mainly tech and healthcare, which is primarily the industries that these funds are invested in, the fortunes of these funds ought to continue to improve.

You know, I'm sure there's no guarantees, but the outlook for the private equity gains in the asset management line looks positive, then?

Well, I say it looks positive; but on the other hand, I want to -- this can be very, very lumpy. We have absolutely no control over when or how these gains could be realized. So, from that standpoint, we lack considerable visibility. David, would you want to elaborate on that, also?

Yes, I think because of the vintage of these funds, I think that the losses that we were likely to experience in these funds were experienced in earlier years. Now, the surviving investments that are really going to generate the return of these funds are starting to increase in value.

As we record these things into the underlying funds -- record them at fair value -- now we are starting to see increases in the carrying value of our side-by-side investments in our general partner interests. And we are starting to see some carry off with some of the other funds.

But it is very, very lumpy. I think in particular, private equity funds tend to focus more heavily on valuation at the end of the year. They are not reporting quarterly earnings. Their quarterly reports are relatively informal. But I think they really sharpen their pencils at the end of the year. So you tend to see a lot more activity at the end of the year.

Understood. Okay. That helps. David, just a follow-up. This past year you guided to noncomp expense, I think it was $96 million or around there; or it was 95 to $96 million. Any guidance for '07 on the noncomp side?

I think we guided a little closer to $98 million. I think we hit $98 million. We have a relatively good budget for next year. But I think it is heavily dependent on the level of business activity. It is also heavily dependent on how we build out some of our businesses that we have told people over the last several quarters that we intend to do.

But in general, we don't have any large initiatives in the noncomp area that I would expect to increase those expenses materially, either in terms of building capital expenditures, or additional facilities, or anything like that. I would just tend to expect to see them probably, possibly, fluctuate if we add additional people, or if the level of business activity picks up. T&E might go up a little bit.

Okay, and I think it was $98 million if you include that there was two $1.5 million onetime charges.

Right, right.

Then I guess my last question, Tom, like I started off, your back half -- and you took the time to sort of highlight the back half and how it is different from the first half. You got the Russell 2000 growth looking up pretty good so far this year as well.

I guess the open-ended question to say, what is the outlook for the first half of, say, '07? We got a good luck at the pipeline that you already went through; but going out a little bit farther than that?

Well, if you look at just the overall backlog in IPOs, it is up about 40% today versus the end of the year. I think the price action of the growth area has been extremely good. Many of the IPOs that have been done in the fourth quarter and the first quarter here have gone to very substantial premiums.

We are pricing an IPO tonight, Salary.com. We have got a 35 million share book for 5 million shares. So if this environment that we are in right now continues, I think the year is going to be extremely good for the kind of things we do.

Okay. Congrats on an excellent quarter. Thank you.

Lauren Smith, KBW.

Could you just talk a little bit more about the brokerage revenue line? I know you noted in the press release that you had increased loss ratio, declining convert trading revenues. But I am just trying to get a feel for -- to have it down Q on Q, and Q3 is typically your softest quarter of the year, I am just trying to get my arms around some of the moving parts this quarter and how to think about looking into '07.

Okay, well, I think, to help you out I think that both our volumes in brokerage and our cents-per-share commission, as Tom said, our commissions were up 7%. So our volumes were up quarter-over-quarter from the third quarter. Our commissions were up quarter-over-quarter from the third quarter. What hit us was a decline both in convertible trading revenue and an increase in our loss ratio.

The decline in convertible trading revenue really was the result of the fact that there was a lot of convertible issuance, which we were not participating in. In a market like that, the trades tend to go to the people that are doing the convert underwriting. That is really what happened in the fourth quarter of '06.

So our trading P&L -- our trading activity in the bonds was generally lower; and so our P&L in convertible trading was lower.

Our loss ratio really, for whatever reason, was 66% in the first quarter. Our realization -- our retention rate was 66% in the first quarter, 68% in the second quarter, it spiked to 75% in the third quarter, and went back down to 67% in the fourth quarter.

Obviously, we would like to try to get it up; but our loss ratio was -- our retention rate was very high in the third quarter. And in the fourth quarter was more normal and more typical of what we have seen historically.

Okay, that's helpful. Any update, while we are just still talking about brokerage -- or I should say any change on the hard dollar front? Meaning did you have any maybe additional clients that you might have moved to hard dollar (multiple speakers) check?

No, not in the traditional brokerage business. But we are ramping now Discovery, so that hard dollar line should be going up over the course of the year.

Okay, that's helpful. Thanks. Could we also -- I guess the one other item -- if we could just talk about as we think about '07 on the tax rate front. So the tax allowance or the deferred tax asset this quarter was reduced. So I guess what you would have left at year-end is somewhere, what, around $11 million or so? Is that right?

Yes; I think what is going to really reduce our tax rate is the valuation allowance. I think when all is said and done at the end of this year, that is going to be $1 million to $2 million. So I think our free pass in terms of generating capital gains that are not taxed should be over sometime next year. That is really how the tax rate is reduced.

Right. So over the course of '07, so when we think about maybe -- I know you can't pinpoint necessarily. But the earlier quarters into '07, I mean, it is probable that we will have similarly very low tax rate?

I doubt it will be similar to '06. Like I said, I think we will have somewhere between $1 million and $2 million of the valuation allowance left, so that will shelter somewhere between 2 and $3 million of private equity gains from taxation. So you can assume that 2 or $3 million of private equity gains in '06 won't be taxed; in you could build that into your model.

Okay, that is very helpful. I guess just lastly, then, for me, an update perhaps on the asset management side. You added a team. I know you are looking to add more breadth and product there. Maybe just give us a quick update, Tom.

Sure. So we are hopefully in final stage of discussions with a candidate to bring in as the CEO. We continue to have discussions with either lift-out or acquisitions of other verticals beyond what we have done with Ken Korngiebel and his group in the small and midcap [growth]. They are mainly in the small and midcap value and international areas.

So we are very hopeful that we will have a more complete team, both in terms of management infrastructure and other investing verticals, so that we can really ramp over the course of the year assets under management. We have been working hard on this the last three months.

Right, so you feel like you're coming to sort of the end of the looking process, and we might be hearing something?

I mean, just bear in mind people get paid in January and February. So we were not going to pay people for '06, so they need to get paid; and then we will be making our moves.

Great, thanks very much.

(OPERATOR INSTRUCTIONS) David Trone at Fox-Pitt, Kelton.

I had a couple of questions; they were answered. But I wanted to go back over this pipeline, David, because it has been so very important to the stocks. You mention the 13 capital raising for this quarter; and I think it was five done, five on file. So that implies -- so then that is three privates would be the balance of that, right? If I wrote my numbers down right here.

No, we have had -- we currently have 15 transactions either completed or on file, so five have been completed.

This is just capital raising, right?

Yes, that's right.

Okay.

So the remainder doesn't include any of the privates.

Okay, so it is five done, 10 filed, no privates counted in this 15.

Right. That's right. Because they are not on file.

Right; I thought you may have done some by now.

No, we haven't.

Okay. Then where was that equivalent number when you started the fourth quarter?

Well, I think it is up by four or five. I would have to go back and look at that specifically.

Okay, so it was about 10 or 11. So your capital raising pipeline clearly up; and your M&A sounded like it was about flattish, at about five.

That we have either completed or announced, yes.

Okay, okay, great. Just circling back on the brokerage side, so it sounds like we should probably be thinking conservatively about that line running about 30 per quarter; is that reasonable?

That is conservative.

Okay. Good. Okay, that's all I had. Thanks.

William Tanona at Goldman Sachs.

Just to follow-up on the investment banking pipeline, I'm just trying to -- we obviously threw a lot of numbers out there. So in the press release, it says you guys had seven IPOs, two follow-ons, and five M&A transactions. Tom, you mentioned 11 IPOs, three follow-ons, and five M&A transactions at the beginning of the year. Which one is it?

It is 11 at the beginning of the year, 15 now.

Okay, 15 now; and five have been completed; and 10 are still filed, yet to be executed?

Right, exactly.

Okay. Then the $20 million that you gave in terms of investment banking revenues, that was what has already been achieved through these deals, correct? That is not --?

That is just M&A and those five deals, right.

Okay. Great, that's helpful. Then, on the asset management side, I obviously understand that the private equity businesses going to be very lumpy from quarter-to-quarter. But as you think about that from a full-year perspective, you would expect that the asset management revenues are going to be higher in 2007 than they are in 2006?

I wouldn't bake that in. I think that we had an exceptionally good year in '06, and I would tend to be conservative and say that we would be lucky to produce the same results in '07 in the private equity area.

Okay, that's fair. Then on the asset management side, can you tell us how much you guys have invested in terms of dollars into all your new funds, including Ken's? And where we stand in terms of assets under management in those products?

Sure. David, do you want to answer that?

If you mean --. Well, there are two ways we can invest in them. One, we can invest our own money in the products, and I don't think that is what you mean. The other one is -- how much have we really invested in building out the businesses?

Which question did you have, Bill?

I would actually say both of them, and in terms of total assets under management as well for the third one.

We [seeded] these products with -- all of the combined products with eight figures of assets under management. So 10 to $15 million in total assets under management of firm capital.

Our investment in these has been -- was minimal in 2006. Primarily because, for example, with the Portland team, what we did was we built out an office in Portland, which is primarily a capital expenditure. We leased space there. That will be expensed over the next five to 10 years. Then we agreed with them that we were going to invest money to grow their business over the next three to five years.

So in terms of P&L, it didn't have a material impact in 2006. We pay them their salaries and relatively modest bonuses for 2006. The primary issue was agreeing with them to continue to fund and support their businesses through the buildout process.

Okay. Do you guys -- are you disclosing what you have in total assets under management yet?

We are not.

Okay. Then, I guess, on the expense side, you obviously indicated that the noncomp expenses are going to be dictated by business activity, which obviously makes sense. But if you assume kind of the same environment in '06, do you still kind of go with that $98 million noncomp expense? Or is there still room to kind of push that downward?

Well, I think as Rich pointed out, that $98 million includes $3 million of writeoffs for two different spaces that we subleased. I think if you combine that with our growth, some of the headcount growth we project in asset management and some other areas, I think $98 million -- that will probably offset the $3 million that was written off for real estate. So that is a reasonable number.

Like I said, we don't have any large initiatives that are going to result in significant increases in noncomp expenses. We don't have anything remarkable that is going to result in a significant decrease. We continue to manage them aggressively. But I can never predict how well we are going to do in managing them down from year-to-year. It is just a constant vigilance.

Great. Then just two more, sorry. Tom, did I hear you right that you said the compensation to net revenue ratio should be moving up in 2007?

Yes, I said that. I think that when we look at our bottom-up model, and when we start to expense some of the equity awards that we made this year, next year -- obviously, they will be expensed over the next four years -- I would expect to see that move to the 56 to 57% range in '07.

Okay, thank you. Then lastly, the changes that you made in the trading businesses, can you kind of just highlight what those were, and what you kind of expect in terms of benefits from those changes?

Sure. Well, we had some major changes in personnel in our New York office in the institutional sales area. We have changed quite a few people in our trading activity. We announced that Steve Blatney joined us at the end of last year, and we are building out our electronic trading capability. And we have added to the middle markets teams.

Those are essentially the changes in the brokerage business if you will. But that is outside of the expansion we have done in converts and Discovery Research.

Great, thanks.

Ladies and gentlemen, that is all the time we do have for questions today. Mr. Weisel, I will hand things back over to you for any closing comments.

Thanks a lot for your attendance, and look forward to talking to you in the quarter.

Again, that does conclude our conference. We thank you for joining us and wish you all a great afternoon. Goodbye.