Piper Sandler Companies
Q4 2012 Earnings Call Transcript

Published: 30 Jan 2013

[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 2012. [Operator Instructions] The company has asked that I remind you that statements on this call that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements that involve inherent risks and uncertainties. Factors that could cause actual results to differ materially from those anticipated are identified in the company's earnings release and 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. This call will also include statements regarding certain non-GAAP financial measures. Please refer to the company's earnings release issued today for a reconciliation of these non-GAAP financial measures to the most comparable GAAP measure. The earnings release is available on the Investor Relations page of the company's website or at the SEC website. As a reminder, this call is being recorded. And now, I'd like to turn the call over to Mr. Andrew Duff. Mr. Duff, you may begin your call.

[Andrew S. Duff:]

Good morning, and thank you for joining us to review our fourth quarter and full year results. Our strategy and our diverse mix of businesses produced solid results for the quarter and the year, overcoming adverse market conditions and volatility which confronted certain of our businesses. Compared to the prior quarter, strong performance in M&A and public finance and improved results in equities more than offset the anticipated decline in fixed income brokerage. On a full year basis, nearly all of our businesses registered improved results compared to 2011. While market conditions, which were more accommodating in 2012 than 2011, contributed to our favorable results, market share gains in several of our businesses, cost discipline and exiting certain businesses such as Asia also contributed to our improved performance. As a result, our ROE for the full year reached 5.7% versus 2.3% in 2011, excluding last year's Capital Markets goodwill impairment. Deb will provide more detail on our financial performance. I'd like to focus the rest of my remarks on the firm's strategy and our outlook for 2013. The central tenet of our strategy is to generate incremental improvements to our ROE over the near to midterm. We will concentrate our human and financial resources in those areas where we can generate higher margins and improve our return on capital. In addition, we believe our diversified mix of businesses benefits our shareholders. Key execution steps in 2012 included adding resources in public finance, fixed income and M&A; creating more flexibility with our lenders; reducing costs; and exiting businesses that lack sustainability or did not contribute meaningfully to our results. I'll begin with public finance. With historically strong margins and returns, we continue to make progress toward our goal of building a national franchise. In 2012, we hired 9 senior bankers and strengthened our presence in the East and Southeast regions. We grew our market share in 2012, increased our revenues 35% and recorded our second best year ever in public finance. Our deal volume ranked second nationally. Complementing this expansion, we added to our distribution resources in 2012, increasing our middle-market sales force by 30% during the year. In addition to supporting the new issue business, the expanded sales force is able to leverage our existing infrastructure more efficiently and increase the turnover of our inventories. We intend to continue our prudent expansion of resources in public finance and middle-market sales as opportunities emerge. Our fixed income brokerage results were significantly higher compared to 2011, as we successfully deployed capital against certain opportunities we saw in the market during the year. Next, I'll turn to investment banking. We finished the year strong, achieving market share gains and capital raising in M&A. Consistent with our strategy, we selectively added resources to our M&A group and continued to improve our productivity and profitability. We believe that the strong activity we enjoyed in Q4 was at least partially driven by sellers motivation to complete deals prior to pending tax increases. While we continued to experience sluggish market activity in equity financing, we benefited from capital raising in our strongest sectors. We also continued to strengthen our position as a book runner on equity financing. In 2012, we were the book runner on 55% of our transactions, representing 75% of our fees versus 46% of our transaction and 65% of our fees in 2011. Despite flat revenues for the year with our reduction in headcount, our productivity was up year-over-year. I want to comment briefly on recent improvements to our equity trading business. Investors' continuing rotation out of equities into other asset classes has depressed volumes and commissions over the past few years. We took steps in the second half of the year to improve our product management by focusing on areas where we can be most impactful to our clients versus simply adding product scale. Initial efforts resulted in a sequential increase in revenue in an otherwise tough market. In our Asset Management business, Advisory Research remains the flagship and foundation. Despite the broader market trend of assets flowing out of equities over the past several years, the business continues to generate steady results for us as it represents 13% of our revenues and 24% of our operating income in 2012. In addition, our retail distribution strategy continued to gain momentum. While assets are moving out of most retail funds, each of our funds realized positive net inflows in 2012. There are a couple of noteworthy items I want to discuss related to Asset Management business. Early in the year, we merged our MLP business into Advisory Research. In combining the business, we realized cost synergies and improved marketing coverage for both the MLP product and Advisory Research family of products. With the extra marketing support, MLPs were our fastest-growing product this year attracting $340 million in net new assets. With respect to FAMCO, the other part of our Asset Management business, we are actively pursuing a sale of this business. Strategically, given its client base and investment strategies, it was not a compelling fit with the rest of our Asset Management business. It represented around 8% of our Asset Management revenues and has not added to earnings in the past 2 years. We are reporting this business in our discontinued operations while we pursue a sale. This will enable us to concentrate our attention and resources on Advisory Research's growth. Looking ahead to 2013, we are seeing some signs of economic recovery with potential to benefit several of our businesses. Nevertheless, we remain mindful of potential negative impact of fiscal policy on the broader markets. Our strategy will continue to concentrate our resources on those businesses that generate higher margins and return on capital. This includes selective investments to build our public finance into a national franchise, expand our fixed income middle-market sales, add to our M&A team and continue to look for ways to drive growth in our Asset Management business. Further, we will continue to look for ways to operate more efficiency and with higher productivity. Our objective is to manage our business to achieve profitability in any market environment. Now I'd like to turn the call over to Deb to review the financial results in more detail.

[Debbra L. Schoneman:]

Thank you, Andrew. First, I'll provide comments on our results from continuing operations, and then provide additional financial detail around our discontinued operations. In the fourth quarter of 2012, continuing operations generated net revenues of $141 million driven by record Advisory Revenues. Net income was $15.6 million or $0.88 per diluted common share, and our pretax operating margin was 16.2%. For the full year, our pretax operating margin was 14.1% compared to 9.3% in 2011 excluding the goodwill impairment. Our significant improvement in margin is attributable to expense reduction initiative as well as operating leverage on higher revenues. For the fourth quarter of 2012, compensation and benefits expenses were 62% of net revenues compared to 65.2% for the fourth quarter of 2011 and 59.4% for the third quarter of 2012. The compensation ratio increased compared to the third quarter of 2012 due to a lower contribution from fixed income strategic trading which has a lower payout. In addition, higher onetime benefit expenses at year end also contributed to a 90 basis point increase in the comp ratio. For the full year, our compensation ratio was 60.7% compared to 61.3% in 2011. The lower ratio in 2012 is attributable to higher revenues and the mix of high [ph] business. Non-compensation expenses were $30.7 million, in line with our quarterly goal. Due to various cost savings initiatives, non-compensation expenses were unchanged relative to the year-ago period despite a revenue increase of 51%. On a full year basis, excluding the restructuring charge in 2012 and the goodwill impairment in 2011, non-compensation expenses declined 6%. Now I'll turn to the segment results. For the fourth quarter, Capital Markets generated net revenues of $124.5 million, pretax operating income of $19.4 million and pretax operating margin of 15.6%. Net revenues increased 8% compared to the third quarter, as record M&A revenues and growth in our equity sales and trading and public finance revenues more than offset the anticipated decline in fixed income institutional brokerage revenues. Pretax operating income was slightly lower on a sequential basis, primarily due to higher compensation expense driven by the mix of business. Asset Management generated $16.4 million of net revenues, $3.4 million of pretax operating income and a pretax operating margin of 20.6%. The operating margin was lower relative to the comparable quarters due to higher compensation expense in the current quarter. Assets under management were similar to third quarter levels. Now I'll turn to discontinued operations, which includes both our Hong Kong Capital Markets business which we shut down, as well as FAMCO, a division of our Asset Management business. For the fourth quarter, net loss from discontinued operations was $3.7 million or $0.21 per diluted common share. $3.4 million of the net loss was attributable to a noncash goodwill impairment charge representing 100% of FAMCO's goodwill. There was also a residual loss of $0.4 million related to the shutdown of our Capital Markets operations in Hong Kong. In summary, we finished the year strong and made solid progress in improving our return on equity. Our full year ROE was 5.7%, more than double the previous year. The improvement in our full year performance was driven by increased revenues across most of our products related to market share gains and more favorable market conditions, our exit from subscale businesses, reduced non-compensation expenses and more efficient use of our capital. Further, as Andrew mentioned, we will continue to look for ways to improve our ROE and operate more efficiently with higher productivity.

[Andrew S. Duff:]

Thank you. Operator, we'd be happy to take questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Joel Jeffrey with KBW.

[Joel Jeffrey:]

Just a follow-up on the decision to exit FAMCO or to sell FAMCO, just want to make sure I understand it. So the loss on the discontinued operation from this business is really purely tied to the goodwill impairment you're taking because you've decided to make the sale?

[Debbra L. Schoneman:]

Correct. What we have done, given our intent to sell and the status of that sale, is recorded this as classified and I guess I would say it's held for sale, which puts it down in discontinued ops. And when you do that, that requires you to write-down your net assets to net realizable value, which ultimately caused us to write-off 100% of our goodwill based on the projected sale price.

[Joel Jeffrey:]

Okay. So just sort of borrowing that goodwill impairment FAMCO actually would have been -- it looks like it might have been modestly profitable during the quarter?

[Debbra L. Schoneman:]

Right. What you see in discontinued ops in that line is the profitability for all the time periods represented.

[Joel Jeffrey:]

Okay, great. And then just thinking about the outlook for the muni market in 2013 and particularly first quarter. I mean, can you give us any sense for how things are tracking, if they can -- if you expect it to continue to be as strong as it's been? I know you've built out the business, but just sort of from a more organic standpoint.

[Andrew S. Duff:]

Yes, it's obviously early in the quarter, the calendar is building at these absolute levels. It's still attractive for refunding. So we feel constructive about the environment.

[Joel Jeffrey:]

Okay, great. And then I know you've made a series of headcount reductions and exited some business. But again, can you just give us a sense for -- remind us where you believe you can get the comp ratio down to over the longer term?

[Debbra L. Schoneman:]

The -- our target comp ratio, again, as we look at it, it's very dependent on level and mix of revenues. So at the level of revenues that we have been at here and -- so if you look at 2012, our target compensation ratio is 60% to 61%. For the full year, we were at 60.7%. And ultimately, it really is a function of, as we drive revenues up, we can bring that comp ratio below the 60%, but we need additional revenues to do that.

[Operator:]

Your next question comes from the line of Devin Ryan with Sandler O'Neill.

[Devin Ryan:]

So just following-up on the FAMCO decision as well. I just want to get some thoughts here. I mean, did something change more recently that made you feel like that business wasn't a good fit or as good of a fit, maybe as it had been? Or is it just more a function of the fact that it's been a drag on results? So that's, I guess, part one of the question, and then I have a couple of follow-ups on that.

[Andrew S. Duff:]

Okay. So it's been a consideration and part of a strategic process after the acquisition of Advisory Research to think about how these 2 businesses work together. A large part of FAMCO's assets as well as revenue and profitability is in the MLP product, and that fits very nicely with Advisory Research, fits the brand, fits the marketing, fits the research philosophy broadly. And so that was a decision we made approximately a year ago and moved it over. When you look at the remaining products as opposed to sort of bottoms up fundamental research there on the equity side, more of a tap -- top down macro approach. And then secondly, they have some fixed income assets, neither of which fit particularly well. Additionally, there's some client concentrations that aren't necessarily a fit. And when you look at all of that, we got to the conclusion that integrating MLP to Advisory and concentrating all of our attention on their growth with a single brand over time made the most sense.

[Devin Ryan:]

Okay. And then just in terms of the process of the sale, are you guys in just the very early stages of that? Or has there been interest and maybe we could expect something in the reasonably near term here? And I guess that's part 2 of the question.

[Andrew S. Duff:]

Yes. We would expect to finalize something in the first quarter. And if it goes according to plan, you'd close in the second quarter. Some discussion is with one of the remaining partners that came with the business that's actually tied to the remaining couple of products and key clients. So it's logical.

[Devin Ryan:]

Okay, great. And then just in terms of the capital that will free up, any plans for that outside of just kind of continuing to look at growth opportunities and expand some of the businesses that you spoke about?

[Debbra L. Schoneman:]

So there's not a lot of capital that's freed up from that, given the fact that Asset Management businesses require very little capital. So it's really quite minimal.

[Devin Ryan:]

Okay. And just also on some other comments you made about looking to expand your businesses, you highlighted public finance. What type of opportunities are you seeing out there currently to do that? Is it hiring teams of individuals and are there opportunities to do that? Is there still potentially something that could occur on the acquisition landscape? And also, what does the competitive environment look like right now in public finance, specifically meaning are some of your larger peers, are they as engaged in that business today, have they pulled back some which is maybe creating more opportunity for a firm like yours?

[Andrew S. Duff:]

So let me see if I can answer those sequentially, and if I miss something let me know. First of all, the growth over the last 3 years, I'd characterize as organically. Individuals, teams has worked very well for us, gotten us into now 8 or 9 new states in the East, Southeast very successfully. They've pair [ph] our platform. They've ramped in a way that made sense. Their clients have been very comfortable with the firm. We've had the appropriate distribution, and we view that as the primary opportunity going forward. We're still engaged in talking to a fair number of people with changes going on in the marketplace and other firms. There still are some smaller firms that have very concentrated franchises that would be complementary. So that's a -- remains a possibility, and we continue to look at that. And then lastly, the larger firms really isn't our direct focus and where we would look to grow. They often focus on the very largest issuers, and the vast majority of our business really is truly in the middle market. And that's the part of the marketplace we'd intend to stay and grow and feel like we've got good runway in building a national franchise and no reason to shift gears there.

[Devin Ryan:]

Okay, great. Appreciate that color. And then within investment banking, clearly phenomenal Advisory quarter end. I get it that a lot of your clients or some of your clients may have been incented to get something done before year end. So with tax changes, so that maybe boosted results a bit. But just more broadly, it seemed that activity did pick up in the fourth quarter from announcements perspective. So just curious to see if you're also seeing that trend and how you feel about how the backlog is building today.

[Andrew S. Duff:]

So we remain constructive on M&A. A lot of the key drivers are still in place. Cash on the balance sheet, slowly improving economy, many businesses looking for some additional growth. We did experience what we felt like, to some degree, was trying to close everything while you could in a known tax environment. We're currently rebuilding the pipeline and believe that 2013 is going to be a solid year. There is a rebuild here at the front end.

[Devin Ryan:]

Okay, great. And I apologize, just back on FAMCO, and not to cover on some numbers, but should -- in terms of where tangible book value is going as a result of the sale and clearly, we don't have a price yet, but how should we think about where tangible book value could go?

[Debbra L. Schoneman:]

So given the fact that we've marked the balance sheet to the net realizable value, from this point it should ultimately be pretty neutral on tangible book value.

[Operator:]

[Operator Instructions] Your next question comes from the line of David Trone with JMP Securities.

[David M. Trone:]

A couple quick questions, one more specific. Did you have anything -- I was kind of surprised about the equity trading results. The quarter seemed generally soft externally. Anything behind your positive delta there? And I know last quarter you had some kind of prop gains, anything like that in the quarter?

[Andrew S. Duff:]

No. It was really all flow business. And as I commented in the script, David, we really concentrated in our core areas of strength. We had been looking to broaden the product. And in fact, we changed gears a little bit to just focus on our key areas of strength where the marketplace was looking for liquidity and allocated our capital more efficiently and did get a positive result, right, against the trend for the quarter, so we believe we can continue that.

[David M. Trone:]

Okay. And Andrew, kind of a big picture strategic question. The -- and if I look back over the years I've covered you guys, there's been moving to fixed income and then that sort of didn't work out. Asia, Europe, FAMCO, does this -- it's been -- it seems like it's been a struggle to kind of move outside the core. And between that, looking back and looking at the companies that have sold themselves, does it make you kind of change your thinking about independence?

[Andrew S. Duff:]

It doesn't, David. And I guess I would have a different view on our expansion efforts. I think our expansion into Asset Management has been entirely successful. It's a meaningful part of our revenues and earnings now. It's been very steady, has had modest growth that I think very much reflects the marketplace. As we all know that net outflow by retail investors from equity products is going in consistently since '08. Potentially a turn. Only a couple of weeks here, but the first change to inflows. So we think that's core to the strategy has gone very well and distinguishes us. Our growth in public finance has worked particularly well and consistently. And I certainly would acknowledge Asia was a challenge with the volatility coming out of the financial crisis, and we made a decision to keep an M&A presence with the brand we built, but not trade securities on that market. So we're very constructive on the progress we're making.

[David M. Trone:]

So then the opposite of that then what about making an acquisition, is that something you'd consider? Or do you feel like you're a little gun shy after some of the FAMCO and things like that?

[Andrew S. Duff:]

Yes. Again, it would be focused on the key areas for growth. So yes, I think that was asked a previous question. If there was an opportunity on a public finance franchise that was complementary, we'd certainly consider that. We're trying to grow our M&A. Again, there was a franchise ability there that was maybe complementary, boutique-like, those would be very good opportunities in our key areas of growth. On the Asset Management side, we're more weighted towards organic growth, a lot of capital tied up in the acquisition. We've made a really good investment in complementary retail distribution that's got traction in a tough market, so less likely there. I think we can grow it organically.

[Operator:]

We have no further questions in the queue at this time.

[Andrew S. Duff:]

Okay. Thank you for joining us. We're confident of our strategy is sound. We're making progress. With our sector expertise, straightforward advice, we think we provide real value to our clients. We thank all of our employee partners for remaining focused on executing on behalf of our clients. Thank you very much.

[Operator:]

This concludes today's conference call. You may now disconnect.