Piper Sandler Companies
Q3 2008 Earnings Call Transcript

Published: 15 Oct 2008

[Operator:]

Welcome to the Piper Jaffray Companies conference call to discuss the financial results for the third quarter of 2008. (Operator Instructions) The company has asked that I remind you that statements on this call 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 website at www.sec.gov. And now, I would like to turn the call over to Andrew Duff.

[Andrew S. Duff:]

There is no question that the third quarter was very difficult for our firm as reflected in our financial results. During the quarter the financial markets experienced unprecedented events. The equity markets experienced significant volatility and the credit market seized up in September, which had significant negative implications for the short-term segment of the fixed income market. This is an extraordinary environment, one which creates not only operating challenges, but also historic opportunities. I’m going to take you through three areas today

[Debbra L. Schoneman:]

For the third quarter of 2008, we reported net revenues of $72.7 million and recorded a net loss from continuing operations of $26.5 million or $1.68 per share. Included in the results was a $21.7 million pre-tax loss which we previously announced related to our TOB program. On after-tax basis, this loss was $13.4 million or $0.85 per share. Andrew largely covered the highlights of the revenue mix, but let me add one final comment on pipeline. Our current US equity backlog consisted of eight transactions compared to thirteen when we reported our second quarter results. We currently have two announced M&A transactions with an aggregate value of $713 million. Given the current environment, it is very difficult to complete transactions, and this may impact our ability to realize revenue from the pipeline through the balance of 2008. Now let me turn to expenses. When it became clear to us that the revenue environments would not be improving in the second half of 2008 like we originally expected that it would, we reduced headcount by an additional 3% bringing the total for 2008 to 9%. The pre-tax charge associated with the additional headcount reduction was $2.2 million and is reflected in a new line item on the P&L entitled ‘‘Restructuring Related Expense”. The reminder of the $4.6 million restructuring amounts or $2.4 million was the charge related to exiting leased office space in two locations. The annual sale associated with this action is $825,000. The severance and restructuring charges we recorded earlier in the year have been reclassified into the restructuring line item. In the third quarter of 2008, we resolved the trading related litigation matter that we reviewed with you on our second quarter call. We were able to offset a majority of the $3 million net expense that we incurred in second quarter. During 2008, we have diligently managed our core non-comp expenses. We had increased cost to support our organic growth and some unanticipated cost like busted deal expenses. However, we will be able to completely offset the increases by reducing cost in other areas like technology, professional fees, and travel and entertainment. Some of the actions we have implemented in 2008 will also benefit 2009. In total, as we look forward into 2009, we’ve identified specific actions across the firm to lower our non-compensation expenses by approximately $12 million, which represents an 8% decrease over our anticipated 2008 full year non-compensation base. A large part of the savings will come from reductions in technology related expenses and travel and entertainment. The initiatives are well underway, and we anticipate we’ll realize the savings radically over the quarters next year. Finally, I would like to end with a comment on the changes related to our TOB program that we announced last week. As of September 30th, we consolidated $258.2 million of municipal bonds as assets onto our balance sheet. The assets will be categorized as level 2 from a fair value perspective consistent with our other municipal securities. As of September 30th, we at $89 million of level 3 financial instruments and other inventory positions which was down from $142 million at June 30, 2008, mainly due to the reduction in auction rate securities inventories, the write-off of the TOB residual, and lower ABS inventories. This represents approximately 11% of total inventories down from 17% on June 30th. These figures are preliminary, and we will disclose the final numbers in our 10-Q. After the change to our TOB program, the only other off balance sheet arrangements we have relate mainly to interest rate swap contracts, the vast majority of which are for matched book interest rate swaps for our public finance clients. The other interest rate swap contracts are for hedging our inventory exposure. All of these derivative contracts are mark-to-market daily, the results of which are recorded in our P&L. We also have a small amount of off balance sheet arrangements related to commitment for firm investments. That concludes our formal remarks, and now Andrew and I will answer your questions.

[Operator:]

(Operator Instructions) Your first question comes from Devin Ryan - Sandler O’Neill.

[Devin Ryan:]

Can you talk about how you feel about your liquidity position today, and I know that you announced that your $250 million credit facility is now committed, just want to get some comments there.

[Debbra L. Schoneman:]

With the addition of that US bank line which is committed and really replaced discretionary over that line that we had, we really increased our total bank funding capacity by $150 million, and we added that line of products just looking at our overall funding needs and also wanted to have a portion of our bank funding in the form of committed line. I think that the amount of our total lines is significantly greater than what we are borrowing on an overnight basis under inventories.

[Devin Ryan:]

Can you talk a little bit more specifically about what you are seeing in the competitive environment? You mentioned that some of your larger competitors are maybe out of particular markets. Can you just give maybe some more specifics there? Where are the biggest opportunities? Is it in fixed income equities, international, or is that all the above, just want to get some comments there?

[Andrew S. Duff:]

Yes, I think the more near term it just is an evolving picture I think we all recognized and the full implications aren’t visible yet. I think the most diligent are probably two-fold, one geographic expansion like we’ve continued to do in our public finance franchise and then I would say sector expansion for investment banking franchise. We also think that we’re beginning to see some asset management opportunities as well priced significantly different than they were previously, say a year ago.

[Devin Ryan:]

Asset management in terms of actual acquisitions, assets or how do you think about that?

[Andrew S. Duff:]

Yes, both.

[Devin Ryan:]

Just kind of on asset management in FAMCO it looks like assets under management declined a fair amount during the quarter.

[Andrew S. Duff:]

That was really market driven. They had a modest inflow, but market valuation reflects that decline.

[Devin Ryan:]

How has performance been in FAMCO, we haven’t seen any numbers on that.

[Andrew S. Duff:]

The products in the third quarter really largely mirrored their various indices. In some of those areas there was pretty significant volatility, for instance in the MLP area, but they largely mirrored their indexes.

[Devin Ryan:]

In fixed income sales and trading were the losses this quarter, excluding the tender option bond charge, were they realized or just unrealized losses as inventory positions declined in value?

[Debbra L. Schoneman:]

There is always some of both, but it’s largely related to unrealized losses just from where we marked inventories based on valuations at the end of the quarter.

[Operator:]

Your next question comes from Brian Hagler - Kennedy Capital.

[Brian Hagler:]

You gave us a little outlook on the equity backlog and then kind of your expectations for expenses in the fourth quarter next year, I appreciate that, but can you just maybe talk about any visibility whatsoever you have on the fixed income side and what that may look like in the fourth quarter?

[Andrew S. Duff:]

Yes, let me give you a couple of thoughts from my perspective. The most substantial part of our fixed income business is the municipal market. It’s going through a fairly severe dislocation that really began in the back half of September and has continued perhaps reflecting the broader credit markets. We’re starting to see some signs of improvement at the short end that had also seen extreme volatility, but many of those rates are actually fairly rapidly declining to what I would call more normal rates. It’s our belief that this will take perhaps a couple weeks to sort of settle down with all these new federal government programs, and then think that that can normalize and our public finance backlog is in pretty good shape. In fact we have quite a bit on the various ballots for additional financings.

[Brian Hagler:]

I know last quarter was kind of a strong quarter and then you guided that you wouldn’t replicate it this quarter, so this quarter is obviously below average. But what in a normal environment, and I don’t expect this next quarter or anytime soon, but what is kind of a normal run rate range for that business as far as revenues?

[Debbra L. Schoneman:]

I think that’s something that obviously changes a lot given the volatility in the markets and really is not going to just grow at an average run rate for that business.

[Brian Hagler:]

But $20 million, I think it was last quarter, and was obviously above average and $4 million. So it is somewhere in between?

[Debbra L. Schoneman:]

Exactly.

[Andrew S. Duff:]

Those are probably relative extremes, but if you look back over time it will actually give you a picture.

[Debbra L. Schoneman:]

Exactly looking back in history.

[Operator:]

Your next question comes from Horst Hueniken - Thomas Weisel Partners.

[Horst Hueniken:]

We have seen significant structural change on Wall Street as you know and you’ve already discussed the potential opportunity with regards to hiring people to strengthen your businesses. But I’m wondering whether you’ve yet to have seen direct impact on any of your businesses, either from a volume or a pricing perspective or are we too early?

[Andrew S. Duff:]

Yes, I think there is ongoing evolution. If you’re talking about the trading areas on the equity side the volumes in the volatility has been advantageous.

[Horst Hueniken:]

What I’m exploring is, we have mergers happening with Bear Stearns and JP Morgan. And Merrill obviously merging with Banc of America, Lehman in Chapter 11, all of this. I know the experience in Canada is when two investment banks merge very often one plus one does not equal two, but it equals something less than two. There is some market share spill, and I’m wondering whether that’s evident at all in your marketplace?

[Andrew S. Duff:]

It’s early but my comments during my text were getting at exactly that issue. We would also share that perspective, not only are couple of market participants essentially leaving the marketplace but those combinations typically do experience that you don’t maintain both of the original market shares. In fact often it is substantially reduced from the original combination, So the statistic I gave you was trying to break that down more specifically to the middle market. Those participants going through the change also have large cap global franchises that are in market that we’re less active in. So the statistic I used was underwriting fees for companies with market caps under $2 billion that would certainly be our sweet spot. Market caps of $500 million to $2 billion and that’s a pretty substantial revenue, just under $2 billion since 2006, and we believe that there is a significant opportunity right there.

[Operator:]

Your last question comes from Steve Stelmach - FBR Capital Markets.

[Steve Stelmach:]

Just real quickly a follow-up on FAMCO, did you get any indication that at least the beginning of October was any different in terms of fund flows or is it pretty much as it is trending in broader markets?

[Andrew S. Duff:]

I don’t have any of the October information. We typically review that a week or two after the close.

[Operator:]

There are no further questions.

[Andrew S. Duff:]

Thank you everyone for dialing in this morning and giving us an opportunity to update you. Thank you.