Piper Sandler Companies (PIPR) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Piper Jaffray Company's Conference Call to discuss the financial results for the Second Quarter of 2012. [Operator Instructions] 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 and 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'd like to turn the call over to Mr. Andrew Duff. Mr. Duff, you may begin your call.

Good morning, and thank you for joining us to review our second quarter results. This morning, I'll provide remarks in 3 areas: Our performance in the quarter, our decision to exit the Hong Kong market and our outlook. In the second quarter, Hong Kong Capital Markets results continued to lay on our overall performance as the business generated a $4 million pretax operating loss. I'll come back to our decision in a moment. Setting aside the impact from Hong Kong, our main businesses performed reasonably well against more difficult operating conditions. Total investment banking revenues held up well, led by very solid public finance revenues, which rose 57%, compared to the sequential first quarter. Given the low interest rate environment, public finance refinancing activity continued to represent a large percentage of the issuance during the quarter, both for us and the industry. We had several notable transactions during the quarter, including our California School short-term note program, which this year totaled just over $800 million; a $180 million sole-managed lease transaction for Owen [ph] University in New Jersey; a $104 million sole-managed bond issue for new senior living project in Minnesota; and a $300 million lead-managed general obligation issue for the city of Phoenix. Our public finance market share is 4.8%, up 100 basis points or 26% through the first 6 months of 2012, compared to the full-year of 2011. Also for the first half of 2012, we were ranked #10 nationally in par value of senior managed negotiated issues. Both metrics are evidence of our growing national franchise. Turning to Corporate Advisory, we were encouraged that we closed more transactions compared to the sequential first quarter, reflected in higher revenues. Our health care and TMT groups were more active in the quarter, and consumer also contributed. If you'll expect that a significant portion of our Corporate Advisory revenues for 2012 will be generated in the second half of the year. The more difficult operating environment negatively impacted our ability to raise equity capital for our clients, particularly through IPOs. Within the industry, no IPO was issued for 39 days following the Facebook IPO in mid-May, and until the last week of June when there were just 6 IPOs issued. The difficult conditions had a negative impact on our sales and trading business as well. Fixed-income institutional brokerage revenues decreased from the strong sequential first quarter, but we're still solid. We performed well in our strategic trading business and in the Municipal Opportunities Fund, but results were lower. Offsetting some of the decline was increased revenues from our expanded middle market sales group, which made a very solid contribution to the quarter. Equity sales and trading revenues were weaker as a result of lower client volumes and trading results. Asset management fees held steady compared to the first quarter of 2012. Now I'd like to turn to our announcement this morning to exit the Hong Kong market. We provided a supplemental schedule with our earnings release this morning that shows the financial results for the business. The losses for the second quarter year-to-date and for 2011 have been significant. We have devoted considerable time and resources to evaluating and pursuing alternatives for the Asia business. We will exit the market by the end of September, either through ceasing operations or sale of the business. The decision to exit allows us to significantly reduce risk, immediately improve our financial performance and focus our full attention on our strategy to organically remix our portfolio to higher margin, higher-return businesses, namely Asset Management, Public Finance and Corporate Advisory. We maintain our deep industry expertise in our leading growth platform and strong M&A execution in the U.S. and Europe. We may maintain a small presence in Asia to facilitate ongoing U.S. business, and we'll continue to provide coverage by U.S.-based research analysts in China-based companies. Let me provide some additional perspective. Hong Kong is a growth market, but it is also characterized by significant volatility, accentuated by the global financial crisis over the past several years. We have built a solid franchise in Asia, but it primarily consists of IPOs for China-based companies, raising capital on the Hong Kong or U.S. exchanges. Given the requirements to compete in the market, and are now product-based, the upside potential when markets are constructive, is outweighed by the downside losses when the markets are closed. Based on our size and profitability, we do not have the financial resources to build out the business into a broader, more sustainable platform, or absorb the significant losses in this market. We are evaluating the alternatives based on the best interest of our shareholders, clients and employees. Now let me turn to our outlook. The additional steps that we took this quarter will improve our performance. Also, we're well-positioned for an improved U.S. capital market cycle and continue to build on solid market share. As we look ahead to the last half of the year, we remain cautious about the operating environment. We expect that the uncertainty around Europe, the potential slowing U.S. economy, as well as the U.S. elections, will continue to weigh on the financial markets and, consequently, challenge our equity-related businesses and fixed income sales and trading. Now I'd like to turn the call over to Deb to review the financial results in more detail.

Thank you, Andrew. First, I'll provide comments on our results for the quarter and then provide additional financial detail around the Hong Kong business decision. In the second quarter of 2012, we generated net revenues of $106 million and net income of $6.9 million or $0.37 per diluted common share. Our pretax operating margin was 1.6%. There were 3 items that significantly impacted our result: first, we recorded a $7.1 million or $0.39 per diluted share tax benefit resulting from the resolution of a state income tax matter. Second, we recorded a restructuring charge of $2.2 million after-tax or $0.12 per diluted share. On a pretax basis, the restructuring charge was $3.6 million, below the $4 million to $5 million range we discussed in April. The charge included $2.4 million for severance, as we pared headcounts primarily in areas where we were not realizing revenues. The remainder of the charge was $1.2 million for occupancy, as we reviewed our space needs. We estimate that this component will have a payback period of less than one year, and that we'll reduce our future occupancy liabilities by approximately $10 million. We'll begin to realize the full benefits from these actions beginning in July. And third, our Hong Kong capital market business generated a net loss of $3.9 million, which reduced our EPS by $0.21. In the second quarter of 2012, compensation and benefits expenses were 62.5% of net revenues, compared to 60.4% and 62.2% in the second quarter of 2011 and first quarter of 2012, respectively. Non-compensation expenses were $38.3 million or $34.7 million, excluding the $3.6 million restructuring charge, compared to the $35.4 million in the year-ago period, and $31.8 million in the first quarter of 2012. As I stated earlier, the positive impact from the reduction in occupancy cost will begin in the third quarter. Also, we have certain expenses that were higher in the second quarter. For example, T&E retired due to several client conferences. Now I'll turn to our segment results. In the second quarter, Capital Markets generated net revenues of $89 million and pretax operating loss of $2.1 million, a pretax operating income of $1.4 million, excluding the $3.5 million restructuring charge attributable to the Capital Market Segments. Capital markets generated pretax operating margin of a negative 3.3% or a positive 1.6%, excluding the restructuring charge, down from the comparable quarter due to lower revenues, offset in part by lower compensation expenses. Asset Management generated $17 million of revenues and $3.7 million of pretax operating income. The segment pretax operating margin was 22.1%, compared to 24.1% in the second quarter of last year and 25.1% in the first quarter of 2012. The decrease was mainly driven by lower revenues, offset in part by lower compensation expenses. Assets under management were $12.7 billion, compared to $13.2 billion in the first quarter of 2012. The decrease in AUM was driven by market depreciation and net cash outflows. Turning to the balance sheet. In the second quarter of 2012, we acquired $27 million or 1.2 million shares of our common stock at an average price of $22 per share. Year-to-date, we have acquired approximately 42 million of our common stock, and we have reached the covenant limit for this year under our 3-year bank credit agreement. Now I'll turn to our decision to exit the Hong Kong market. We anticipate realizing net cash proceeds from an exit of $13 million to $18 million. There are 3 main drivers of the cash proceeds: first, a significant U.S. tax benefit which drives the majority of the cash proceeds; second, cash realized from the value of the net assets; and third, our Hong Kong lease write-off. We provided a supplemental schedule for our Asia operations with our earnings release. As shown by that schedule, with very limited revenues generated during the time period presented, the operations had a significant negative impact on our financial results. For the second quarter of 2012, our consolidated compensation ratio was higher by 1.9 percentage points, and our pretax operating margin was decreased by 3.7 percentage points. For the full-year of 2011, the compensation ratio was increased by 1.3 percentage points, and the pretax operating margin decreased by 1.3 percentage points. In summary, the more challenging operating environment reduced our results in the quarter, but we believe we performed relatively well. The additional actions we have taken to exit the Hong Kong market, repurchase shares and reduce our cost structure will improve our performance going forward. This concludes our 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] Our first question comes from the line of Joel Jeffrey with KBW.

Just quickly, I mean, thanks for all the disclosure in terms of what the charges were. We're just kind of struggling a little bit to get the kind of an operating EPS number. I mean, would you say based -- backing out all the after-tax impact that's sort of more in line with the $0.31 number, or is it more of -- or is the $0.37 number appropriate?

[indiscernible]

Yes, operator, are there additional questions?

And again, we do have Mr. Jeffrey on line.

I'm sorry, I didn't hear the answer. I apologize.

Oh, I'm sorry. Yes, the $0.31 is what we believe is appropriate from a continuing operations perspective.

And then, so thinking about the expense levels going forward, I mean, can you give us any sort of thoughts on sort of maybe a non-comp number we should be thinking about in the future quarters based on the absence of Asia and then some of the other things you've done?

Yes. So given, as you mentioned, those 2 items, the absence of Asia and the cost reduction issues that we've been working on, and so from a continuing operations perspective, we believe that non-comps in the range of $30 million to $31 million are appropriate.

Per quarter.

Per quarter, yes.

Okay, great. And then thinking about a very strong public finance quarter, I mean, is this kind of level sustainable going forward? Or is there something specific to this quarter in the market that just led to higher issuance levels?

It was a very strong quarter both for us and issuance. And I would think of the back half looking very much like the first half of the year for us.

Okay, great. And then just lastly, in terms of the share repurchase, I think you said you had reached your covenant level. So is there any way you can buy back additional shares or are you sort of maxed out for the remainder of the year?

For the remainder of this year, we are maxed out. Next year then, we have the ability to buy back shares to offset dilution again under our bank line of credit.

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

Within the equity sales and trading business, were there any trading losses in that line? Or was the kind of softer quarter purely a function of just lower client volumes?

It was largely volumes. There was a small loss.

Okay. And in the Asset Management business, you guys highlighted some net cash outflows. What products were those in? And what was the driver of the outflows?

They were spread out across a number of the equity products, to some degree offset by our solo yield product which is MLPs, which had modest inflows. So it wasn't a very significant number in any given product. So the driver for the quarter was that market valuation.

Okay. And then just on the exiting of the Asia business. To the extent you ceased operations there, reimburses in actual sale, should we expect your further restructuring charges this quarter? Do you have any estimation of what those would be at this point?

Yes. So if we do shut down versus a sale, again the range from the net cash proceeds, we believe, is within that $13 million to $18 million range. And either of those situations, but from a restructuring perspective, specifically with a shut down, it would be somewhere in the range of $8 million to $10 million is what we anticipate, which is already contemplated in that net cash proceed range, that of the $13 million to $18 million.

Great. Helpful.

All of that then gets reported in discontinued operations starting in the third quarter.

[Operator Instructions] We do have a question from the line of Joel Jeffrey from KBW.

I just have one more follow-up question. On the cash benefit you talked about from exiting Asia, will that actually flow through the P&L? Or is that just a cash benefit?

So we would have a modest gain. The majority -- the cash -- the $13 million to $18 million cash benefit is larger than what will actually flow through the P&L, but we do anticipate recording a modest gain on either of those situations, whether it's a shutdown or a sale.

We have a question from the line of Michael Wong.

Michael Wong from Morningstar. Just a really quick question. What's your AUM breakout between equity-type funds and fixed income or yield-type funds?

The vast majority is equity. There's approximately a little over $3 billion in MLP. And then some modest additional fixed income assets. All-in for yield is probably something like $3.5 billion.

[Operator Instructions] There are no further questions in the queue at this time.

Thank you for joining us this morning. Operator, that concludes our call.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.