Piper Sandler Companies

NYSE:PIPR

Earnings Call Transcript 2019-Q2

[Operator]

Good morning, and welcome to the Piper Jaffray Companies' Conference Call to discuss the Financial Results for the Second Quarter of 2019. During the question-and-answer session, securities industry professionals may ask questions of management.

The company has asked that I remind you that the 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 GAAP financial measures, the non-GAAP measures should be considered in addition to and not a substitute for measures of financial performance prepared in accordance with GAAP. 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. I'd now like to turn the call over to Mr. Chad Abraham. Mr. Abraham, you may begin your call.

[Chad Abraham, Chairman and CEO]

Good morning everyone. I am here with Deb Schoneman our President and Tim Carter our CFO and we would like to thank you for joining the call to discuss Piper Jaffray's results for the second quarter of 2019. I would like to begin by providing a summary of the strategic activities we have announced this year and how they align with our vision to be the leading middle market investment bank.

In the first quarter we announced the acquisition of Weeden & Company combining Piper's strong research with Weeden's best in class trading capabilities which will immediately increase our relevance in this space and enhance our scale and profitability while providing support for our growing equity capital markets business. During the second quarter we announced the pending sale of our asset management business which is subject to certain closing conditions. This business line was subscale and the sale will generate additional capital we can redeploy and it allows us to focus on our core business. And earlier this month we announced the acquisition of Sandler O'Neill. The acquisition of Sandler will add the leading franchise focused on the financial services industry. Sandler shares our customer centric focus and core values and aligns very well with our existing business lines. The combination will give us market leading franchises in financial services, healthcare, and energy with growing franchises in a number of other industry sectors. This transaction also enhances the scale, diversity, and durability of the firm while increasing overall revenues by approximately 40%.

We see meaningful opportunities with these acquisitions for further investment to grow the combined business. We couldn't be more pleased to partner with such fantastic franchises as Sandler and Weeden. Our vision is to be the leading middle market investment bank, this means being a leader in the markets we compete in starting with deep sector expertise and providing candid advice with a differentiated highly productive culture. Our recent strategic activities and announcements are squarely consistent with this vision.

Turning to our Q2 results, we generated 163 million of adjusted revenues in Q2 which was flat to last year and down from Q1 when we outperformed the market and had a couple of larger M&A fees. Our adjusted revenues do not include asset management revenues which were $9 million this quarter as they are now reported in discontinued operations. Tim will provide more details related to the accounting changes and presentation of the asset management business.

We recorded adjusted EPS of $1.32 and a 12.8% margin for the quarter as both comp and non-comp expenses came in at the low end of our expected ranges. We remain constructive on our outlook for the second half of the year as our pipeline looks strong and July has been one of our best months this year. Next I will provide an update on our advisory and equity capital markets businesses before handing the call over to Deb to discuss the rest of our business lines. Tim will follow with a review of the financials and an update on capital use. We will then open up the call for questions.

Advisory revenues of 75 million were consistent with the year ago quarter and down from a strong Q1. On a year-to-date basis our M&A revenues represent 55% of our total adjusted revenues and are up 25% relative to the overall market which is flat to down from last year. Market conditions for M&A in the middle market remain conducive to transactions due to attractive valuations, ample financing with low rates, solid economic growth, and demand from PE investors. Our pipeline is strong across our industry verticals which should set us up well for the second half of the year.

Equity financing activity generated 26 million of revenues in the quarter picking up pace from a slow first quarter. The market for equity financing is favorable driven by investor demand for IPO's, health evaluations, and a rising stock market with low volatility. We expect to benefit from these market conditions with a strong ECM pipeline with several book run IPOs in our backlog.

We continue to look for opportunities to deepen our sector penetration. In the second quarter we added two Managing Directors focused on biotech investment banking. We continue to believe that biotech will be a very active segment and are focused on growing our market share. Our investment banking Managing Director headcount continues to increase on a net basis as internal promotions and hiring have exceeded retirements and attrition. During the quarter we increased our investment banking MD headcount to 92. Our strong financial performance and the diversity of our platform and resources will continue to make us a desirable home for productive bankers. However, the availability of talent as well as the quality and fit will dictate the pace of growth. As we said on our recent Sandler call we expect to have approximately 125 Managing Directors in investment banking when we close the transaction in January.

Now I will turn the call over to Deb to discuss the rest of our business lines.

[Deb Schoneman, President]

Thanks Chad. The second quarter saw equity markets continue to advance despite global growth concerns and trade tensions. Our equity brokerage business generated revenues of 16 million for the quarter flat to Q1. Equity secondary trading volumes in the market were down with low volatility. We expect our revenues to increase from these levels as we move further into the year. There is some seasonality to this business with research checks increasing as the year progresses.

We expect the acquisition of Weeden & Company to close next week. Integration of the trading systems are complete and clients are excited with the resources offered by the combined platform. The addition of Weeden will add significant scale to our equity sales and trading business increasing our relevance to client. We continue to be focused on providing differentiated quality research content and best execution ensuring a seamless integration of Weeden and realizing cost synergies in the combined business.

Turning to our public finance and fixed income brokerage businesses, we generated 18 million of debt financing revenue in the quarter up modestly from a year ago and up from the slow Q1 period. Year-to-date municipal market underwriting volumes were relatively flat to last year while our revenues have increased 28%. We expect our debt financing revenues to continue to increase as we execute on some of our larger fee offerings in our specialty sectors. Demand is strong for higher yields muni offerings in this low interest rate environment and our specialization in the senior living space and project finance offerings should drive revenue growth as the year progresses.

In the fixed income markets yields fell as investors fear declining growth projections and certain parts of the yield curve remain inverted. Year-to-date we have raised 4.9 billion from municipal clients and ranked third based on the number of deals in the negotiated market. We intend to continue investing in our public finance business by expanding geographically and in our specialty groups by leveraging our market leadership to attract talent to the franchise.

We recorded 20 million of fixed income brokerage revenues in the second quarter, up 8% from the year ago period, and down from the strong first quarter. In the second quarter we experienced solid client activity across most fixed income taxable products. Tax exempt municipal bond activity slowed from the very active first quarter as a ratio of municipal bond yields to treasury yields reached historic lows keeping institutional investors on the sidelines. Despite mixed markets we have performed well with revenues up 25% in the first half versus a year ago. With low absolute interest rates and a flat to inverted yield curve, we remain focused on providing quality advice and opportunities to our clients.

Finishing up with asset management we continue to focus on client service while preparing for the sale of this business. The sale of the MLP business to Tortoise Capital Advisors will enable the team to combine with another market leader in this space and gain access to Tortoise's distribution capabilities. The pending sale of the MLP business as well as the management buyout of the equity platform in Chicago are subject to certain closing conditions including client consent. Now I will turn the call over to Tim to go through our financial results in more detail.

[Tim Carter, CFO]

Thanks Deb. My comments will be focused on our adjusted non-GAAP financial results. Starting this quarter our adjusted results also exclude amounts related to discontinued operations for current and historical periods. Given that our asset management business is deemed to be held for sale, the related operating results for the current and historical periods have been reclassified as discontinued operations which were presented in aggregate net of tax as a separate component of our GAAP income.

Our quarterly revenues were 163 million flat compared to the year ago period and down compared to the sequential quarter driven by lower advisory revenues. The 163 million of quarterly revenues excludes approximately 9 million of revenues from asset management which are recorded within discontinued operations.

Our diluted EPS for the quarter was $1.32 up $0.50 per share on a year-over-year basis resulting from lower non-comp expenses, lower tax expense related to the benefit of stock vestings at prices greater than the grand price and a reduced share count. The impact to adjusted EPS of classifying asset management as discontinued operations was a reduction of $0.10 in the quarter and $0.16 year-to-date. Although revenues were flat versus a year ago we produced an operating margin of 12.8% up 350 basis points due to a lower comp ratio and lower non-comps which included restructuring costs in the prior year period. On a year-to-date basis excluding the restructuring costs in the prior year, pretax income was up 25% relative to an 8% growth in revenues. These results reflect expense discipline and illustrate the operating leverage in our business.

Turning to our operating expenses our comp ratio of 62.1% for the quarter was at the low end of our target range of 62% to 63% driven by our mix of revenue in the quarter. Quarterly non-comp expenses were 41 million. We were below our stated range of 43 million to 45 million as approximately 2 million of our asset management non-comp expenses are now reported in discontinued operations.

As Deb discussed we plan to close on our acquisition of Weeden next week. We do not expect our comp ratio to change in 2019 as a result of this transaction and we maintain our guided range of 62% to 63%. Non-comp expenses related to Weeden are estimated to be 6 million to 7 million per quarter post close in 2019. However, this increase will be partially offset by asset management non-comp expenses of 2 million to 3 million per quarter that are now reported in discontinued operations. With these changes we estimate that are non-comp expenses from continuing operations will be 45 million to 47 million for the third quarter reflecting two months of Weeden expenses and 47 million to 49 million for the full fourth quarter. Weeden is expected to be neutral to our EPS during 2019 and accretive in 2020 resulting in incremental earnings of $0.20 to $0.30 per share as cost synergies are fully realized. We will provide additional guidance regarding our comp ratio and non-comp expenses that incorporate the Sandler O'Neill transaction later in the year.

Our adjusted tax rate for the quarter was 9%. We recorded a $3.5 million tax benefit in Q2 related to restricted stock vesting at prices greater than their grant date price. Excluding this benefit our adjusted tax rate was 26% for the quarter. Going forward we maintain our full year estimated tax rate range of 25% to 27% excluding the impact of stock vestings.

Finishing up on capital we continued to return capital to shareholders through dividends. On a year-to-date basis we have returned an aggregate of 25 million or $1.76 per share to our shareholders. This includes the annual special cash dividends of $1.01 per share that was paid out in the first quarter. In addition today we declared a quarterly dividend of $0.375 per share to be paid on September 13, 2019 to shareholders of record as of the close of business on August 23, 2019.

Our transaction with Sandler O'Neill which we expect to close in January 2020 will enable us to deploy excess capital and the expected cash proceeds from the pending sale of the asset management business. We also expect to raise approximately 150 million of debt to finance a portion of the cash consideration. Those who missed our Investor Presentation related to the acquisition can find a replay of the call on our website. As Chad and Deb have noted we have taken significant strides in the transformation of our business over the last few years. We have reduced the capital intensity of our business, deployed excess capital in a strategic manner, and meaningfully increased our earnings power. Thanks and we can now open up the call for questions.

[Operator]

Thank you. [Operator Instructions]. Our first question comes from the line of Devin Ryan from JMP Securities. Your line is open.

[Devin Ryan, JMP Securities]

Hey, great, morning everyone.

[Deb Schoneman, President]

Hi Devin.

[Devin Ryan, JMP Securities]

I guess first question here just on Weeden which obviously you mentioned slated to close next week and the close date was pushed out a little bit. Not sure if there is a connection but if you can give some context around how Sandler O'Neill changes the calculus at all or maybe changes how we should think about kind of longer-term accretion opportunities I know we're going to get I guess some more detail when the Sandler deal gets closer to closing. But just any kind of high strokes you could give us just to think about for additional synergies, I think you've mentioned 0.5 million initially, so what other kind of drivers could exist now adding Sandler to the overall platform?

[Deb Schoneman, President]

Yes Devin, so one of the things when we spoke about Weeden even before the Sandler transaction was the opportunity to really increase our relevance with clients and become much more important to them. And really what I see with the Sandler acquisition is just increasing that primarily from a research perspective. We will bring on over 200 more names under coverage and really this will have an even increase in bigger research platform and footprint to add to Weeden's execution capabilities.

[Chad Abraham, Chairman and CEO]

Yes, yes Devin I would just add obviously one of the things we're trying to do with Weeden is have another way for clients to pay us our other great franchises and healthcare and energy and consumer and tax, trying to monetize that in multiple ways on the trading platform. Obviously Sandler has a very well respected financial services franchise so it's just another vertical that we hope we can monetize both from getting paid for research but also trading.

[Devin Ryan, JMP Securities]

Got it, okay. Helpful color, thank you. And then follow up here just on the M&A advisory business, the fees in the quarter were kind of on the low end of the range and it was close to our model so it wasn't overly surprising. And then I also heard the activity or the comment on activity thus far in July in pipeline so I'm just trying to confirm whether kind of it is purely timing that the year is still kind of evolving as you thought kind of maybe your six months ago or so or if there's any other themes in the middle markets that are changing the backdrop or stretching out the time to close deals or anything else we should be thinking about?

[Chad Abraham, Chairman and CEO]

Yeah, no I think it's playing out pretty much how we thought. Obviously you can see from our number of transactions we did more transactions in Q2 in June in advisory than we did in Q1 and we did quite a bit less revenue. I think we've said many times where the larger fees and larger deals fall has a lot to do with revenue for the quarter. Obviously we had some significant fees in Q1. I think Q2 shows that we're still on a good pace from number of transactions and how the year plays out, it just has a lot to do with how many of the fees will be larger, how many gears will we get into, will we close the bigger fees in the transaction. We feel very good about the back half pipeline. Obviously we commented on July, we've had some good closings, we've had some good signings. I recognized one month doesn't make a quarter but we still feel good about the back half. And then yeah relative just to the overall market backdrop certainly the total market size and fee size I think by any measure is flat to down. Obviously if you're in a down market you have to gain share to grow and obviously it's getting harder and harder to grow competitively on market share which is one of the reasons we're super excited to add Sandler to the equation.

[Devin Ryan, JMP Securities]

Got it, thanks. And then just last one for me just on the fixed income brokerage business. So you had a phenomenal first quarter and then your second quarter results are actually still pretty elevated relative to what I would say that the recent trend has been. So let me just get a sense of whether the cadence of that maybe through the quarter if things kind of have been reverting to something that's closer to the maybe more recent trend before the first quarter or if there's other drivers here where we could maybe remain at a little more elevated level, just trying to think through some of the puts and takes in that business?

[Deb Schoneman, President]

Yeah, so a couple of things going on Devin, first of all one of the things we're seeing here is with the rate outlook continuing to at least be perceived to be low here. We're seeing investors really deciding that they just can't wait any longer, they need to come in and put money to work. So we are seeing for this year more increased activity than we may have seen in some of those prior times. And I would say that the second quarter holistically the decline from the first quarter was really related to the municipal market and activity being not quite as strong but I think as we look at the municipal outlook, see that continuing very similar to the second quarter.

[Devin Ryan, JMP Securities]

Great, thank you very much.

[Operator]

Our next question comes from the line of Mike Grondahl from Northland Securities. Your line is open.

[Michael Grondahl, Northland Securities]

Yeah, good morning and thanks. In the advisory business for 2Q any sectors stick out or anything you want to call out there in terms of where the strength was?

[Chad Abraham, Chairman and CEO]

Yes, when we look at -- it was pretty balanced across our industry sectors. I would say if we had a stronger industry group we did pretty well in Q2 in energy. And some of that was off of very slow Q1 in energy so we had a nice pickup in energy in terms of the number of deals.

[Michael Grondahl, Northland Securities]

Got it and then can you kind of do the same for July, it sounds like while you said that was the best month of the year, what stuck out about July, what industries?

[Chad Abraham, Chairman and CEO]

Well, what I said was it was one of the best months of the year and so it's just off to a good start in terms of closings. In Q2 we said we did 46 transactions. Obviously when you look at the average fee that was lower in Q2. Some of the closings we've had some more significant higher fee closings in July, we've had some good signings and I would say that sort of balanced across industries. We're definitely benefiting from our advisory platform being bigger and broader across our industry teams. But again as I just said one month doesn't make a quarter but we certainly feel good about the start.

[Michael Grondahl, Northland Securities]

Got it, got it, good. And then if we step back the equity financing revenue about 25 million this quarter, the March quarter 13 million and a year ago 30 million, are you kind of for a quarter or two do you feel good about kind of being at the higher end of that wide range, just you mentioned some book run IPOs and what not, just how do you think about that the next couple quarters?

[Chad Abraham, Chairman and CEO]

Yeah, I think obviously just to remind everybody Q1 at our ECM number I think that was one of the slowest quarters we've had in the last few years. Just going back obviously we lost January with the government shutdown, we were under penetrated in biotech and healthcare in Q1 and so we're -- it was a slow quarter. I think 25 million if you look at it over the last few years is a lot closer to our average and certainly more where we expect to be kind of on a quarterly basis. IPO's -- the IPO's were working on our being priced quite well, good demand, upsizing. But we recognize this market, it's very hard to predict how ECM looks three, four, five months from now. But the conditions are out there in terms of good stock market performance, plenty of capital, deals have worked. The backdrop is there for us to kind of continue at that pace.

[Michael Grondahl, Northland Securities]

Got it, got it and then the last month or so you've gone through the Sandler announcement. Any interesting feedback or kind of being a couple weeks or so into it that you can just share at a high level?

[Chad Abraham, Chairman and CEO]

Yeah, I guess I would just share -- I would just share a couple of things. I think we got tremendous feedback, a lot of commentary just on bringing two strong brands together, expertise from some of our good industry sectors with sort of the powerhouse in financial services. So frankly I think I have really enjoyed getting that feedback. I think but more than that what's been exciting especially on the fixed income side of the business is just the eagerness for the two teams to start working together. I think we're really going to be able to leverage both distribution forces and fixed income to help our corporate finance business but also help our municipal business I think would be part of the theory. It's just the relationships in the boardroom across industries. I think that's proving to be true. I think the feedback from one major constituency for us is private equity. I think we have good private equity relationships, they have certain private equity relationships, I think all of us can leverage that across those sectors. So, obviously we've got to executing, get the transaction closed and then execute next year but we're very pleased with the feedback that we've gotten from clients so far.

[Michael Grondahl, Northland Securities]

Got it and one housekeeping one, Tim could you give some Weeden comp and non-comp percentages I think for 3Q and 4Q pretty quickly, could you rattle those off again?

[Tim Carter, CFO]

Yeah Mike, so from a comp ratio perspective I mean, think about it from a full firm perspective we really for 2019 don't expect our comp ratio to change. We would expect to stay in the 62% to 63% range from a full firm perspective. On the non-comp side I mean there are some sort of some puts and takes but by adding Weeden in and then we now have asset management as discontinued ops what we talked about is really for Q3 because it's only a partial quarter for Weeden. Our non-comps would be in this 45 million to 47 million for Q3 and then for Q4 we would be in this $47 million to $49 million range for the quarter on non-comps.

[Michael Grondahl, Northland Securities]

Got it. Thanks a lot. Thanks Guys.

[Operator]

Our final question today comes from the line of Bill Dezellem from Tieton Capital. Your line is open.

[William Dezellem, Tieton Capital Management]

Thank you. I had a question relative to the Weeden acquisition. It has been three year [ph] you are incorporating with the accretion numbers that you gave today, revenue drove into that assumption versus solely expense synergies?

[Chad Abraham, Chairman and CEO]

Bill, sorry can you just say that one more time.

[William Dezellem, Tieton Capital Management]

Yes. I'm trying to understand relative to the accretion that you referenced with Weeden, the degree to which you're assuming cost synergies only versus extra revenue from the transaction that you're anticipating?

[Tim Carter, CFO]

Okay, yeah, sorry. We're really thinking of that in terms of cost synergies as it relates to the go forward and the additional accretion that we get in 2020. It's not a revenue change from a go forward assumption perspective.

[Chad Abraham, Chairman and CEO]

Yeah, I would just add I mean we're obviously hopeful that Weeden is going to benefit from selling our -- that group is going to benefit from selling our strong research platform and we know we're going to benefit from their strong execution platform. But our assumptions for accretion are very much focused on cost although we hope to prove over the next couple of years that we will get some revenue benefits.

[William Dezellem, Tieton Capital Management]

Great, thank you folks.

[Deb Schoneman, President]

Thank you.

[Operator]

We have no further questions in queue. I'll turn the call back to the presenters for closing remarks.

[Chad Abraham, Chairman and CEO]

Thanks operator. The second half of 2019 will be focused on executing our strong pipeline and implementing the integration plans of our announced acquisitions. The strength of our franchise and our balance sheet should continue to attract individuals and firms who share our client centric values and want to partner in building the leading middle market investment bank. We are pleased with our financial performance and strategic initiatives in the first half of 2019 and look forward to updating you again following the third quarter. Thanks everyone and have a great day.

[Operator]

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