Piper Sandler Companies
Q4 2007 Earnings Call Transcript

Published: 23 Jan 2008

[Operator:]

Good morning ladies and gentlemen and welcome to the Piper Jaffray Companies’ conference call to discuss the financial results for the fourth quarter and full year of 2007. During the question and answer session securities 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 reports on file with the SEC which are available on the company’s website at www.PiperJaffray.com and on the SEC’s website at www.SEC.gov. And now, I would like to turn the call over the Mr. Andrew Duff. Mr. Duff you may begin your call.

[Andrew S. Duff:]

Good morning. We are very pleased to report solid financial results for the fourth quarter against a backdrop of the challenging operating environment. Well into October market conditions were strong but the turmoil in the credit markets that prevailed in the third quarter this year resurged in November and December creating challenging financial markets. Despite these challenges most of our businesses delivered solid results in the quarter. Our equity financing and equity sales and trading businesses each generated the highest quarterly revenues since we became a public company. M&A activity was also strong. We recorded the second highest quarterly revenues since becoming a public company. Public finance revenues were in line with normal quarterly performance. In addition, the fourth quarter 2007 was the first full quarter results for FAMCO and Goldbond. Both of these businesses contributed to our top line and our profitability. However, we were not immune from the volatile markets. We felt the effects on our fixed income sales and trading, specifically high yield and structured products but, the strong results in our other businesses more than offset these lower revenues. Now, I’ll make a few comments on the year. In 2007 we set a new mission for our firm to become the leading international middle market investment bank and institutional securities firm. I am very pleased that we achieved meaningful progress against our mission during this past year. Let me provide the key highlights of our execution. First, we reentered the asset management business with the acquisition of FAMCO. This addition helps us diversify our revenue mix and provides a solid foundation for our asset management business. We are committed to expanding these revenues through organic growth and additional acquisitions. Second, we significantly expanded our Asian platform with the acquisition of Goldbond now called Piper Jaffray Asia. Combined with the successful operation we’ve built in Europe, we are now able to raise capital for our clients in each of the world’s three primary centers of finance

[Thomas P. Schnettler:]

We reported strong top line performance in the fourth quarter. We generated net revenues of $146.5 million essentially the same as the fourth quarter of 2006 and up 58% compared to the difficult third quarter of 2007. The equities related businesses and advisory services were strong and more than offset weaker performance in the fixed income businesses. Equity financings were strong in the fourth quarter and generated net revenues of $43 million up 30% from the fourth quarter of 2006 and up 136% from the third quarter of 2007. Our equity backlog was strong heading into the fourth quarter and the financings remained active throughout the period. Compared to the third quarter of 2007, we nearly tripled the number of completed transactions and the amount of capital raised. Currently, our equity financing backlog consists of 11 transactions as compared to 22 when we announced our third quarter earnings. Advisory services revenues were also strong in the fourth quarter. Net revenues were $36.7 million up 6% compared to the year ago period and up 128% compared to the third quarter of 2007. The stronger performance was driven by improved results from the US business and contributions from Europe and Asia. Equity sales and trading also performed well in the quarter. Net revenues were $35 million up 19% from the year ago period and up 39% compared to the sequential third quarter. This performance was driven by stronger commissions and improved trading performance in US equities and the solid contribution from the Hong Kong equities business. Now, I’ll turn to our fixed income businesses. Fixed income financing revenues were $16.8 million, the majority of which represent public finance underwriting revenues. Net revenues from this business were down 37% compared to a year ago when we generated near record public finance underwriting revenues. Compared to the third of 2007 overall fixed income financing revenues were down 8%. However, public finance underwriting revenues were consistent holding up well in a turbulent environment. Fixed income sales and trading revenues were $11.1 million, a decline of 42% compared to the fourth quarter of 2006 and a decline of 19% compared to the third quarter 2007. The declines were primarily driven by lower revenues from high yield and structured products which continued to generate weaker revenues due to challenging market conditions. Now, I will cover non-interest expenses. For the fourth quarter of 2007, compensation and benefit expenses were $85.7 million down 3% from the fourth quarter of 2006 and up 58% compared to the sequential third quarter. The increase compared to the third quarter was due to stronger revenues. The compensation ratio for the fourth quarter was 58.5% compared to 60.4% last year and 58.5% in the third quarter 2007. For the fourth quarter of 07, non compensation expenses were $41.7 million of which $2.5 million were attributed to FAMCO and Goldbond. The prior year non-compensation expenses were $16 million which included a $21.3 million benefit due to the reduction of a litigation reserve. Excluding that benefit non-compensation expenses were $37.3 million. Compared to the third quarter of 2007 non-compensation expenses increased 28%, the increases were driven by business expansion including the addition of FAMCO and Goldbond, increased business activities resulting in higher marketing and travel expenses and higher legal expense. Fourth the fourth quarter 2007 pre-tax operating margin was 13.1% which compared to 28.6% for the fourth quarter of 2006 which included a 14.5% point benefit due to the litigation reserve reduction. Excluding that benefit, pretax operating margin was 14.1% in the year ago period. For the third quarter 2007 pre-tax operating margin was 6.5%. Finally, for the full year of 2007 net revenues from continuing operations were $499 million slightly less than the $503 million reported in 2006. Despite challenging market conditions in the last half of 2007 investment banking revenues rose 2% compared to 2006, equity financing revenues topped 06 by 14% and more than offset lower advisory services revenues and slightly lower debt financing revenues. Equity sales and trading revenues were essentially flat compared to 2006 while fixed income sales and trading revenues which were impacted by the turmoil in the financial markets during the last half of the year declined compared to 2006. Our pre-tax operating margin for the full year was 12.6% compared to 19.5% last year which included a 4.2 percentage point benefit due to the litigation reserve reduction. Excluding that benefit pre-tax operating margin was 15.3% in 06. Non-compensation expenses for the full year were $144.1 million compared to $113.8 million in 2006 which includes the $21.3 million benefit due to the reserve reduction. Excluding that benefit non-compensation expenses were $135 million. Increased non-compensation expenses in 2007 were driven primarily by expansion of the business including the acquisition of FAMCO and Goldbond and the implementation costs related to a new back office system. That concludes our formal remarks. Now, Andrew and I will answer your questions.

[Operator:]

(Operator Instructions) You’re first question comes from the line of William Tanona of Goldman Sachs.

[William Tanona:]

You guys mentioned a little bit about the equity backlog but I didn’t hear anything about the overall aggregate investment banking pipeline. I just wanted to get your thoughts on the overall investment banking pipeline as you enter 2008 considering that it seems that your investment banking revenues tend to be a little bit more volatile than some of your peers.

[Thomas P. Schnettler:]

That’s probably a fair characterization looking back over the last several quarters. I would say we feel reasonably good about our investment banking backlog. However, I would say the current state of the markets presents uncertainties around transaction timing.

[William Tanona:]

Then, I guess there’s obviously a lot going on with the financial guarantors right now in the market place and concerns about the public finance business and what that may mean for that segment of the market place. Obviously, that’s a pretty big part of the business for you guys. I just wanted to get your thoughts in terms of what you think the impact is going to be to your public finance business as it relates to the model lines?

[Andrew S. Duff:]

We don’t anticipate the disruption to the bond insurers will significantly impact our municipal underwriting business. However, we do think the larger impact will be to the shorter rate securities, the floaters and the auction rates and clearly the market place needs to see through and look at the underlying credits and potentially they’ll have to transitions to stronger enhancement [inaudible].

[William Tanona:]

How big of businesses are those for you guys?

[Andrew S. Duff:]

The public finance business overall if about $90 million and that’s a blend weighted towards the long term traditional fixed rate underwriting.

[William Tanona:]

Then one last question, the non-comp expenses obviously kicked up here pretty considerably in the quarter. Were there any kind of onetime items in there? How should we be thinking about that in terms of a run rate looking into 2008?

[Thomas P. Schnettler:]

First of all, there weren’t any substantial onetime items in that. So, looking forward in to 08, I would look at our full year 07 non-comps of $144 million. I would increase that to account for a full year impact of FAMCO and Goldbond and some increase due to growth in the business. Our overall goal is to reduce non-compensation expenses as a percentage of revenue and we continue to be very focused on that.

[Operator:]

Your next question comes from the line of Douglas Sipkin of Wachovia

[Douglas Sipkin:]

Just a couple of quick questions; one, I’m hoping you guys can provide some color around maybe not Goldbond specifically or now Piper Jaffray Asia but, what percentage of the revenues in the fourth quarter were attributable to Asia?

[Thomas P. Schnettler:]

We don’t break that out. Goldbond contributed as we said both to our top line and to our profitability. Piper Jaffray Asia as we now look at our combined resources of what we had prior to the acquisition as well as Goldbond was a meaningful contributor especially to the equity financing business where we had a pretty good flow of China based transactions in the fourth quarter.

[Douglas Sipkin:]

Can you give us an update on when you guys might plan on accessing the debt markets in a broader way? I know you guys talked about first redeploying the capital. It looks like that now has run its course and it’s been somewhat effective. Where are we now in terms of you guys potentially going out into the markets and getting some leverage.

[Andrew S. Duff:]

Well, we continue to look at that and feel that it’s an option that’s available to us. Obviously, the turmoil in the credit markets probably make that a little more expensive than it would have been prior to sort of the back half of 2007. I think we’re looking at available options and also using some judgment around timing relative to current market conditions and our need for capital. It’s something that continues to be under review.

[Douglas Sipkin:]

Finally, and my numbers could be wrong but, I believe I had about $8.3 billion in AUM at the end of the third quarter and you guys have $9 now. One, are those numbers right? And two, what accounts for the big change quarter-on-quarter?

[Thomas P. Schnettler:]

Your numbers are correct and they did bring in some substantial new business in the fourth quarter.

[Douglas Sipkin:]

So, most of that increase obviously flow with the markets. I think the S&D was up a little bit.

[Thomas P. Schnettler:]

Yes it was. It was flow, it was net new assets.

[Douglas Sipkin:]

So, we can say maybe net new assets of like $500 million or so?

[Thomas P. Schnettler:]

Yep. And, I thought that was particularly impressive for an organization obviously going through an ownership change. So, a job well done.

[Operator:]

Our next question comes from the line of David Trone of Fox-Pitt.

[David Trone:]

The revenue delta in the quarter sequentially was $54 million. Is there any way you can tell us how much of that was due to Goldbond and the full quarter effect of FAMCO?

[Andrew S. Duff:]

FAMCO you can really see in the asset management line. So, that’s really FAMCO. Goldbond again, we don’t break out that as an operating unit within investment banking institutional brokerage. Again, Piper Jaffray Asia overall, the combination of Goldbond and our prior existing Piper Jaffray resources in Asia was a meaningful contributor to the fourth quarter and in particular again, in the equity financing area.

[David Trone:]

How could you help the investment community understand just how strong the organic growth was then?

[Andrew S. Duff:]

I would say that the vast majority of certainly that delta from quarter-to-quarter was driven by our core business in the US.

[David Trone:]

I assume you would have noticed that four of your peers either specifically or indirectly have kind of disclosed higher comp ratios on the year and you guys were not in that cap. Is there any color on that? Are you feeling any comp pressure? I know one of those four did have lower revenues so the math kind of works that way but, the other three actually had revenue growth and still felt some comp pressure. So, what are your thoughts on that?

[Andrew S. Duff:]

Clearly, providing competitive compensation for our top talent is always a priority for us. We do think about the mix of cash and equity and how that should be most effective and appropriate for our employees. But, when we looked at the year in total and particularly in the strong fourth quarter we believe that we adequately accrued compensation.

[David Trone:]

I think I missed it; you probably talked about the unusually low tax rate?

[Thomas P. Schnettler:]

I don’t think I referenced it in my remarks but, the tax rate is driven by a couple of things. One is higher proportion of tax exempt interest income to total revenues and also, the higher contribution for Goldbond which does carry a lower tax rate.

[David Trone:]

How should we think about that going forward?

[Thomas P. Schnettler:]

I would look at our overall effective rate for 06 which was 35.7% and then there will be some reduction from that level given the contributions now going forward from Piper Jaffray Asia which will carry a lower tax rate.

[Operator:]

Our next question comes from the line of Devin Ryan of Sandler O’Neill.

[Devin Ryan:]

Increasing principal investments has been a focus of the company. Can you talk about how the current environment is making you feel about the principal investing opportunities? I guess specifically, is the current dislocation in particular, asset classes, providing attractive opportunities? Or, is the risk reward not attractive enough given the volatility we’re seeing here?

[Andrew S. Duff:]

Let me make a couple of comments. We have both equity and fixed income proprietary strategies. We have been developing these over the last couple of years in a disciplined manner with a focus on risk management. For the fourth quarter and the full year our proprietary strategies contributed positive net revenues. We remain cautious and thoughtful but, have been able to execute those strategies in a profitable manner.

[Devin Ryan:]

Can you talk a little bit about the advisory services strength in a bit more detail here? I guess specifically were there particularly large deals that closed during the quarter? Or, was it just more a function of a lot of smaller deals closing?

[Andrew S. Duff:]

It’s really both. We had a couple of large transactions which are not inconsistent with other periods of strong results in that line item. But, also a significant number of transactions so it was really both and again, it was a near record quarter for advisory services. We had both factors contributing.

[Devin Ryan:]

Finally, can you give any disclosure regarding or even an approximate size of the trading losses due to the inventory markdowns? And, I guess, specifically what asset classes suffered the biggest markdowns?

[Thomas P. Schnettler:]

We had net positive revenues in all of our trading areas including the fixed income areas. There were not net trading losses on any of the desks.

[Devin Ryan:]

Right but, were there markdowns to your inventory or your holdings?

[Thomas P. Schnettler:]

We had some modest markdowns in various areas but, again net positive revenues on all of our desks.

[Operator:]

Your next question comes from the line of [inaudible] of Blackrock.

[Analyst:]

I just have one quick question as you kind of look out and think about the pre-tax operating margin where do you kind of want to see that a year or two from now as you kind of start to gain traction from the organization as you look ahead?

[Andrew S. Duff:]

Well, we certainly want to see it north of where we are this year and that will depend on really accomplishing some of our goals in terms of some of our new initiatives as well as just building out our core business. I don’t know that we’ll throw out a specific number but, I think something several points north of where we ended up this year would be a goal for us over the next couple of years.

[Thomas P. Schnettler:]

Steve, maybe another way to think about that is looking at our peer group and it has been our intention as spun and reorganized the company to a capital markets investment banking orientation that we be the top performer in the group and that would get you in that same range; mid teens.

[Operator:]

(Operator Instructions) Your next question comes from the line of [Joel Jeffrey] of KBW.

[[Joel Jeffrey]:]

Just a quick question; in terms of the acquisition of FAMCO, I believe there was a contingency payment that could be paid out based on assets under management growth. Has that been reached?

[Thomas P. Schnettler:]

Yes, there was an additional opportunity. On December 15th we did pay them an additional $900,000.

[Operator:]

(Operator Instructions) There are no questions at this time.

[Andrew S. Duff:]

Let me close the call by a couple of thoughts. I’m confident we have the right strategy for our firm. I am proud of our achievements against this strategy in 2007. I look forward to updating you on further progress in 2008. Thank you for joining us.

[Operator:]

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