Piper Sandler Companies (PIPR) Q1 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Piper Jaffray's company conference call to discuss the financial results for the first quarter 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. As a reminder, this call is being recorded. And now I would like to turn the conference over to Mr. Andrew Duff. Mr. Duff, you may begin your conference.

Good morning, and thank you for joining us to review our first quarter results. In early 2012, the overall operating environment generally improved. All the major indices rose, volatility remained low, credit spreads tightened and U.S. economic data showed continued signs of improvement. However, we believe the markets are still in a early stage of recovery as capital markets volumes remain well below historical norms. Against this more positive a backdrop, we were pleased with our improved first quarter results. Compared to the fourth quarter of 2011, our net revenues increased 19%. And excluding the goodwill impairment charge, our pretax profit on a non-GAAP basis increased sevenfold. Fixed income sales and trading revenues significantly improved from the difficult fourth quarter. During the quarter, credit spreads tightened, which benefited our strategic trading business and our new Municipal Opportunities Fund. Also an improved municipal trading environment and new hires in the middle market sales group contributed to the increased revenues. During the quarter, our capital-raising businesses performed well. Across the platform, we had good deal execution and we gained market share. We generated solid public finance revenues for the industry par volume of senior managed negotiated issuance increased 83% compared to the first quarter of last year. New issuance were dominated by refinancings driven by historically low yields. Our negotiated issuance increased 127% resulting in higher market share, which we attribute to our expanded platform. Compared to the difficult last half of 2011, the equity financing environment also improved, including for IPOs. In the U.S., there were 40 IPOs that priced in the first quarter, which was the highest number since the first quarter of 2007. IPOs were challenging to price as investors demanded steep discounts to comparables given poor IPO performance in 2011. Through March, however, IPOs have returned 32% in the aftermarket. Against an improve environment, our equity financing revenues increased 38% compared to the sequential fourth quarter, and all of our sectors contributed to the results. Similar to public finance, we gained equity underwriting market share compared to the full year of 2011. We attribute the improvement to the increased risk appetite for growth IPOs in our focus sectors, capturing more follow-on transactions and book-run mandates. Asset management performance was in line with our expectations. At the end of the first quarter, assets under management were $13.3 billion, up from $12.2 billion at the end of 2011. The improvement was driven equally by positive net cash inflows and market appreciation. In the first quarter, we had certain businesses that were soft, mainly in line with industry trends. Within equity sales and trading, U.S. client volumes for the industry and for us remained low and declined from the fourth quarter. Also, IPO activity in Asia remained low and, as we had expected, we sustained a loss there. However, it was reduced compared to the year-ago period due to the cost reductions we made last year. Finally, M&A revenues were well below the fourth quarter. This was due to the uncertain market conditions in the last half of 2011, which led to fewer completed transactions in the first quarter of this year. Looking ahead, we believe that an improving market environment will continue to be positive for our capital-raising businesses and fixed income sales and trading. Market fundamentals for M&A are strong and we are confident in our mature health care M&A franchise, which represents a majority of our advisory revenues. We continue to work to ramp our M&A capability in our other sectors and this will take time. So we are reasonably optimistic about our business, but we know that market conditions can change rapidly. We're focused on executing against our growth strategies while being disciplined in cost management, improving profitability and productivity. Now I'd like to turn the call over to Deb.

Thank you, Andrew. First I'll address consolidated results and then I'll review each business segment. In the first quarter of 2012, we generated net revenues of $118 million and net income of $2.9 million or $0.15 per diluted common share. Results included $3.4 million or $0.18 per diluted common share of additional income tax expense for writing off equity-related deferred tax assets. I'll provide more detail on this in a moment. After excluding noncontrolling interests, we generated essentially the same pretax operating profit as the year-ago period but with 6% lower revenues. Improved profitability was mainly due to the cost reductions we implemented last year. For the first quarter, our compensation ratio was 62.4%, down 50 basis points from the full year of 2011. As we generate higher revenues, we can return our compensation ratio to our goal of approximately 60%. For the first quarter, non-compensation expenses were $32 million, down 16% from $38 million in the year-ago period, and down 6% on a non-GAAP basis from $34 million in the fourth quarter, which excludes the $120.3 million goodwill impairment charge. We don't believe $32 million is a sustainable run rate without additional reduction as tini [ph] expenses and legal fees were lower than in recent quarters. But we expect this to return to more typical levels in Q2 and beyond. We are committed to continuing to improve our productivity and profitability. Within that context, we are assessing our staffing needs to reduce our fixed compensation expenses and further reviewing our non-compensation expenses with the goal of sustaining the $32 million we reported in the first quarter. In the second quarter, we expect that we will have a headcount reduction of approximately 2% to 3%. Also reviewing our office space -- we are also reviewing our office space to make sure that it's appropriately sized for our current needs. Our analysis is not yet complete, but we expect that our actions will result in a restructuring charge in the second quarter in the range of $4 million to $5 million for both severance and non-compensation expenses. We expect these actions can improve our ability to further increase the margin of our business. Turning to taxes. As I noted earlier, our income tax expense increased by $3.4 million for writing off deferred tax assets, additional expense related to equity grants that either vested at share prices lower than grant date share price or were forfeited. Looking ahead to the second quarter. We will have a significant tax benefit as we reversed a tax reserve due to a successful outcome on a state tax matter. Positive impact of the reversal is a tax credit of approximately $7 million. In the first quarter of the 2012, we repurchased $7 million or 288,000 shares of our common stock at an average price of $24.46 per share. We have $44 million remaining on our share repurchase authorization which expires on September 30, 2012. In addition, we acquired $8.4 million or 353,000 shares related to employee tax obligations on vesting of equity awards. Under our 3-year bank credit agreement, we have a covenant that limits our total repurchases to the amount that we issue for employee equity grants. The aggregate of 15 million that we've repurchased in the first quarter is very near the covenant limit for this year. We are starting to process with our bank group to seek some relief under this covenant. Now I'll turn to our segment results. For the quarter, Capital Markets generated $100 million of net revenues and $8 million of pretax operating income. Capital Markets generated pretax operating margin of 7.9% compared to 6.8% in the first quarter of last year. The increase was mainly attributable to lower non-compensation expenses. Capital Markets' pretax operating margin improved from a negative 3.1% on a non-GAAP basis excluding the goodwill impairment charge in the fourth quarter of 2011 when fixed income sales and trading revenues were particularly low. Asset Management generated $18 million of revenues and $4.5 million of pretax operating income. The segment pretax operating margin was 25.1%, up from 23.5% in the first quarter of last year and 24.1% in the fourth quarter of 2011. The improvement was mainly driven by lower non-compensation expenses. In summary, improved business activity and actions we have taken to reduce our cost structure helped us to improve our performance in the first quarter. We are very focused on continuing to improve our productivity and profitability as we move forward. This concludes my remarks, and I'll turn the call back to Andrew.

That concludes our formal remarks. Operator, we will now open the line for questions.

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

Can you possibly give us a little bit more detail in terms of the breakdown of your fixed income trading revenues, particularly how much was driven by muni finance versus, say, taxable?

So our municipal financed portion is around 55% to 60% of the total fixed income institutional brokerage.

And the remaining is just the taxable fixed?

It's taxable which ranges across a multiple products. You think of our middle market sales force which has some of the more plain vanilla such as the agency, investment-grade, corporates, as well as our institutional fixed income business was preferred than some other products.

Okay, great. And then sticking with the muni finance issue. In terms of issuance and sort of the outlook for the remainder of the year, can you give us a little bit more color in terms of what you're hearing or seeing from the market at this point?

Yes, I would expect that when the year is done, we'll have an up-year in issuance over last year. Again, looking historically coming off of '10 at $340 billion in issuance, $290 billion last year, our best read at this point is that it might be more like $310 billion, $325 billion. Year-over-year, the first quarter here was stronger and I think underscores that perspective. A lot of what got done in the start of the year here was refinancing if you have historically low yields. But in looking at what we're working on and across sort of the 30-day visible supply, I do think you're going to have increased volume year-over-year.

Okay, great. And then just lastly, in terms of the $4 million to $5 million restructuring charge you're talking about, is that essentially what you're talking about in terms of trying to keep you at $32 million in terms of the non-comp on?

Yes, that is correct.

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

So I appreciate some of the investment bank color that you guys gave. But I don't know if you can just dig in a little bit more into maybe across each of the businesses, what the tone of conversations are currently like with clients? And then just maybe some sense of what pipelines look like across products today versus maybe 3 months ago when the markets were a little bit more choppy?

Okay. So let's start with equity financings. There's an improving environment there. As you saw in the indices, very stable on the volatility, or relatively stable. I think there's a reasonably clear succession in the risk appetite, pretty good discounts at the beginning of the quarter and difficult pricings at end of the quarter, stronger, more in the range, even some above the range as a group. They all performed well by the end of the quarter. So I think you can see a trend there for an increased risk appetite. I'd say, we've certainly had a lot of dialogue going on about potential capital raises, looking at that marketplace and believing there's improving environment. From an M&A perspective, our backlog is improving, very good dialogues. There is something of an air pocket based on the markets in the back half of 2011. There's less closure here at the beginning of the year. I think you see that essentially across the industry. But again, the fundamentals for the M&A markets are in pretty good shape. Maybe lastly, I'd comment -- last on equities would be early recover in the Hong Kong market, which was anticipated by us, but now see signs of an improving environment and improving risk appetite and the ability for us to bring some things to market here in the second quarter and the back half of the year, I guess as we commented already on the public finance, which looks like also an improving environment.

Okay. That's the color I was looking for. And then, in terms of asset management, you mentioned some positive net flows in the release. And I apologize if I had missed this on the call, but what products drove those flows? And I guess, are you seeing more traction in the products that did drive the flows?

Yes. I think it looks a lot like the industry where the flow still is oriented towards yield. Though we saw it in some of our fixed income and we continue to see inflows into our MNL -- MLP, excuse me, or MLP product, which obviously is a yield product. And I think that would really mirror the industry less so in the equity products. Again, I personally believe there will be a shift in that at some future point, it's a multiyear trend, not in the equities but in the fixed income.

Great. And just also in terms of the buyback, you gave some comments about the covenants that you currently have with the banks. And so we would love to get your thoughts on -- is there a level of appetite that you have for buybacks or assuming that you can have these covenants loosen a bit? Do you have any sense of how much more aggressive you'd like to get on the buyback assuming the stock remains at the current levels?

Yes, ultimately, it's going to depend on what we do negotiate with the banks and our ability to do that. And like I've mentioned, we are in the early stages of doing that. We do have $44 million remaining under our current authorization. And ultimately, once and if we get approval from the banks, we will file an 8-K. So that will be then more apparent in terms of what ability we have to buyback stock.

Okay, got you. And then just lastly, in terms of the comp accrual, you mentioned -- I know that 60% or in that range is kind of the target, and this quarter was a little bit higher than that. I mean, how would you characterize your thought process for the comp accrual this quarter? How much was maybe being a little bit conservative to start the year given kind of the uncertainty of our revenues for the full year? And maybe just lastly, is there a revenue level or an annual revenue level where you feel like the 60% is reasonable?

Okay. So first starting with the first quarter accrual, I -- we are being very mindful of the volatility in our business and trying to make sure that we stay current with our compensation accruals relative to what might happen later in the year. In terms of what revenue level we need to see to reach close of that 60%, it's around $130 million to $135 million and really what happens there is then you get the leverage on the fixed expenses that are within our comp ratio.

Okay, got you.

Yes, Devin, I guess the last -- it's Andrew -- comment I'd make is I do think you've characterized that correctly. We don't want to get caught having to accrual a lot at the back-end of the year. So we're just being mindful throughout the year.

Your next question comes from the line of the Matt Fischer with CLSA.

Just I guess real quick to touch back on the restructuring charge, the $4 million to $5 million, how much of that or what portion of that is severance?

We don't have that detail at this point as we are still working through our plans across both the non-comp and compensation.

Okay. And then you spoke about some of the trends, appreciate the color. But as you move through the quarter and you start to -- as you get through the end of March and into April, where these trends still intact? Did we have -- does anything changed in terms of chatter and general activity levels?

So I would say the trend is directionally the same. Obviously, some volatility in the last, call it, 5, 7 trading days, the vix [ph] did move up. But I would say none of that takes us off trend as of now.

Okay. And then, just to touch on the book value, the decline in tangible book in book value, you're purchasing shares below book value. Could you kind of explain the dynamics there why it's declined?

The reason that it has declined is the way we calculate our book value and tangible book value. It's using our basic share count at the end of the quarter. This excludes any restricted or participating shares that we have and that is weighted into the EPS. So we had a number of shares that vested relative to the employee grants that we have made in prior years during the quarter, and that more than offset the amount of shares that we repurchased. So that basic share count increased at quarter end. So then it was really that share count that drove the decrease in book value and tangible book value per share.

Okay, got it. I guess the one thing to touch back on the buybacks. I guess you did roughly $15 million and the $8 million to offset the equity awards plus the $7 million repurchase. And I guess when you do get this, is that $30 million, is that kind of a reasonable target if you can get these covenants listed? Or would you look to expire the full $44 million by the end of -- within 2 quarters?

I think the best way to answer that is just to say we're going to seek an additional authority, but we're disclosing that we're in that process. But until it's complete, I think it's just inappropriate to comment. And as soon as we're through it, we will file an 8-K. Clearly, our intention is to increase our share repurchase, and we've been limited now for some time.

There are no further questions at this time.

Okay. Maybe I'd just wrap up and say that I think we're making solid progress here. The non-comp efforts that we really engaged in and we've been talking to you about started about this time a year ago. And when you've got a run rate improvement from $38 million to $32 million, which we ought to be at by the end of the second quarter entering the third and fourth, that's essentially $24 million of additional margin, and we've done that kind of really across the business and mindful of what resources we needed to maintain the business in the future. But we're able to accomplish it with a lot of hard work and, in a parallel path, continue to make the selective investments in our growth that we think are appropriate in our higher-ROE, higher-margin business. The public finance franchise continues to evolve and grow and build in the East Coast with the middle market sales force following behind, some additional trading capacity built with that, the asset management, investment and a set of retail products like mutual funds and distribution that can complement very high quality institutional products that we've built over the years. And lastly, when you get to our equities business, adding M&A resources so you can build out the other 3 verticals to the degree of our M&A franchise and our health care. And finally, to work to get to a sustainable margin in our Asia business. So I just conclude by saying I think we continue to make very good progress on exactly the right mix. Thank you very much. That concludes our remarks.

Thank you, sir. This does conclude today's conference call. Thank you for your participation. You may now disconnect.