Piper Sandler Companies

NYSE:PIPR

Earnings Call Transcript 2018-Q3

[Operator]

Good morning and welcome to the Piper Jaffray Companies’ conference call to discuss the financial results for the third quarter of 2018. During the question-and-answer session, securities industry professionals may ask questions of management.

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 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. 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.

And now, I’d like to turn the call over to Mr. Chad Abraham. Mr. Abraham, you may begin your call.

[Chad Abraham, Chief Executive Officer]

Good morning, everyone. I’m 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 third quarter of 2018.

I'd like to start off by congratulating Deb on her appointment to our Board of Directors. Her strategic acumen and experience will be important as we execute on our growth strategies. I'll provide comments on our advisory and equity capital market businesses before handing the call over to Deb to discuss the rest of our business line. Tim will follow with a review of the financial and an update on our capital use. I'll make some closing remarks and then we'll open up the call for questions.

Revenues for the quarter were up approximately 27% from levels in the first two quarters of 2018 and returning to the levels we achieved in 2017. We continue to gain momentum in our banking businesses, and expect a strong finish to the year. Market conditions generally remain conducive to advisory engagement driven by CEO confidence, a strong US economy and ample financing availability. Advisory revenues of $114 million represent our second best advisory quarter o record, second only to the year ago period.

We completed 45 transactions in the quarter with an aggregate enterprise value of $8.5 billion. Our third quarter results were led by our healthcare team, with strong contributions from our energy, industrials and consumer team. Our advisory pipeline remains robust heading into the end of the year with several significant transactions, some of which have already been announced.

Equity financing activity in the quarter remains strong especially in the healthcare sector where we maintain an industry leading franchise. We generated $32 million in ECM fees. Our third straight quarter of revenue revenues over $30 million. During the quarter, we price 19 deals and we're a book runner on over 70% of those deals leading to higher economics. We're increasing market share as we leverage our reputation and relationships in our key industry verticals to win more mandates and continue to focus on book run deals.

We anticipate equity financing may slow somewhat in the fourth quarter as recent market volatility and the November elections create additional uncertainty. We continue to focus on organic growth in our banking franchises to broaden our sector penetration and strengthen our product capabilities. Expansion of our technology banking team is an opportunity for us, and we strengthened our software driven technology group with the hire of a managing director in the third quarter focused on application software companies.

Additionally, early in the fourth quarter we announced the hiring of a managing director within our industry leading consumer banking team. With these hires, we've grown our investment banking MD count to 89 up from 84 at the beginning of the year. Our strong financial performance, the diversity of our platform and resources, and our culture of client centric advice make us a destination of choice in the marketplace.

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

[Deb Schoneman, President]

Thanks Chad. Our sales and trading businesses are critical to equity and debt financing, and our overall strategies to further increase the alignment with our banking franchises to deliver appropriate returns on a combined basis. The brokerage businesses continue to face market headwinds; in these challenging conditions we continue to carefully manage costs and capital, while selectively adding talent where we see opportunities. Our equity brokerage business generated revenues of $18 million for the quarter, which was down 7% sequentially and 3% year-over-year.

We typically see a summer slowdown with lower clients trading volumes which negatively impacts Q3 revenues. As we discussed last quarter how market participants paid for trade execution and research services is in transition at a time when the overall sea pool is shrinking. We are managing through this transition by maintaining an active dialogue with our clients on payment expectations. At the same time, we are reducing capital put at risk in executing trades. As I noted earlier, we are selectively adding Talent where we see opportunities.

In the third quarter, we hired two senior research analysts in energy further bolstering expertise in this sector. Turning to our public finance and fixed income brokerage businesses, we generated $21 million of debt financing revenue in the third quarter, an increase of 24% from the sequential quarter as we continue to improve after a slow start to the year. Although a municipal market issuance has begun to normalize, activity is still down 15% to 20% on a year-to-date basis.

Higher interest rates and tax law changes have diminished refunding activity and while new money issuance has increased in 2018, it has not increased sufficiently to offset the decline in refunding. The decline of refunding has had the most impact on our state and local government sector. However, our performance in the specialty sectors has helps to offset some of those declines. Our public finance pipeline remains robust and we expect Q4 to be our strongest quarter of the year in this business. Marketing and brokerage business remain challenging as low relative but rising interest rates and a flattening yield curve depressed volumes and trading spreads.

We recorded $18 million of revenues this quarter down slightly from Q2. We continue to be focused on carefully managing costs and capital allocation to optimize return. Inventory balances have been scaled back from the beginning of the year to reflect the current market environment. We expect challenging market conditions to persist through the end of the year as the market adjusts to rising interest rates. We believe these conditions will continue to put downward pressure on our revenues in this business. Finishing up with asset management, AUM trended down during the quarter as client rebalancing created outflows that were partially upset with market appreciation.

Revenues increased modestly on a sequential basis and we improved our operating margin in the quarter as cost reduction efforts earlier in the year started to hit the bottom line. Now I'll turn the call over to Tim to go through our financial results in more detail.

[Tim Carter, Chief Financial Officer]

Thanks Deb. My comments will be based on our adjusted non-GAAP financial results. Our revenues for the quarter were $216 million, up compared to the second quarter of 2018, and down compared to the year ago period, which was a record. This current level is more consistent with the levels we experienced in 2017. We expect revenues in the fourth quarter to remain strong driven by our advisory and public finance pipelines. Our diluted EPS was a $1.86 for the quarter, more than double our EPS for the sequential quarter, but down on a year-over-year basis.

The sequential change was driven by a 24% increase in revenues, primarily a result of significant improvement in advisory revenues, as well as lower non-compensation expenses. I'll discuss our non comp expenses in more detail later in my remarks. EPS was lower compared to the year ago period primarily due to an 11% decline in revenues. Prior year advisory revenues which were a record for the quarter included several large fees.

Turning to our operating performance, the comp ratio for the quarter was 61.8%, slightly below our target range of 62% to 63%. The decline compared to the third quarter of 2017 reflects the impact of new revenue recognition accounting rules adopted this year under which client reimbursed deal expenses are no longer netted with in revenue. Non comp expenses were $44 million consistent with our $43 million to $45 million per quarter range and down from the second quarter which included $3.8 million restructuring costs. The increase compared to the year ago period was primarily due to higher reimburse deal related expenses. Again related to the adoption of the new revenue recognition rules.

We continue to carefully manage non comp expenses as these costs are a driver of meaningful operating leverage. Our adjusted tax rate excluding the impact of stock vestings was 26.1% for the quarter, 90 basis points above our year-to-date tax rate as we generate less tax benefit from municipal tax exempt interest from lower average inventory levels. Finishing up on capital, we continue to be focused on driving attractive returns for our shareholders.

On a year-to-date basis, we have returns an aggregate of $42 million or $2.75 per share to our shareholders. This includes the special cash dividends of a $1.62 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 December 14 to shareholders of record as of the close of business on November 28. In addition to cash dividends during the quarter, we repurchased $6.8 million or approximately 90,000 shares of our common stock at an average price of $75.06 per share.

We have reduced inventory levels to be reflective of limited trading opportunities and reduced customer flow activity. Inventory levels at the end of Q3 were down approximately 42% from the end of 2017, but remain consistent with Q2 levels of approximately $800 million. Based on the current market conditions, we expect to continue managing inventory to these levels.

Finally, given our level of capital and strong cash generation from earnings, we paid off our $125 million senior note which matured in early October. We believe our cash flow from operations and capital will fund the majority of our current growth initiatives. Given the strength of our balance sheet, we can also access the debt capital markets to fund other growth initiatives as needed

I will now turn the call back over to Chad for his closing remarks before Q&A.

[Chad Abraham, Chief Executive Officer]

Thanks Tim. In closing, we're pleased that revenues have returned to levels north of $200 million. The year started slowly but momentum in many parts of our business has been growing, and we look to be well-positioned for a strong finish to the year. My partners across the firm are excited to continue building upon the foundation we have established over the last several years, as we execute on our strategic objectives. Recent volatility has impacted the markets, but it is likely a healthy pullback. We remain focused on delivering quality service to our clients in all types of markets. We can now open up the call for questions.

[Operator]

[Operator Instructions]

Your first question comes from the line of Devin Ryan.

[Devin Ryan, JMP Securities]

Hey, good morning, everyone. How are you guys? Hi, so I guess the first question here on capital by my calculations there's a fair amount of excess capital in the system today, which clearly can be valuable in periods of volatility. So if you can be helpful just to get any kind of qualitative or quantitative sense of what you think is kind of excess capital today and then the ways you could be opportunistic here. I'm sure there's some consideration on the float for the stock.

We've seen the obviously stock sell-off and so I don't know if there's a price in the stock where the benefits of repurchases outweigh kind of the float issue, and then the other kind of thought would be M&A opportunities for the firm to acquire, if there is anything to update us on there.

[Tim Carter, Chief Financial Officer]

Yes. Devin, really I'll take that to start. We do feel like we are in a good capital position in terms of having capital to be able to deploy. We haven't specifically disclosed the amount of capital that was obviously part of the decision that drove us to paying off the senior note here in early October. It indicates that we feel like we have adequate levels of capital to continue to invest in the business. And I think from an overall perspective we want to continue to take a balanced approach. Obviously, the dividend piece is a way that will continue to provide some of that capital back.

We like that approach. It's consistent and the way we've structured it through the dividend payout ratio helps I think investors understand sort of that level of capital that's going to come back. We saw this bias as you pointed out to look at other corporate development activities. And we're positioned to be able to do something on that front. And then I think on the buyback, obviously, we did a little bit here in Q3, and we've got plenty of authorization to do more. And I would say that from a share price perspective, I mean, it's certainly become more attractive over the last of weeks.

[Devin Ryan, JMP Securities]

Great, thank you very much, great color. In terms of just kind of the M&A outlook, good to hear that I think still feel quite constructive and I know the middle markets where you guys are big player, are quite a bit different than kind of the larger cap end of the spectrum particularly with a lot of financial sponsor activity and private to private activity. So I'm just curious from your experience how much public equity volatility influences decision making or how focused companies whether it be a strategic or sponsor are on in the public markets particularly in this scenario where the economy remains reasonable, but you just have maybe a little bit more volatility than normal if you go back to some other period. How that is affected activity?

[Chad Abraham, Chief Executive Officer]

Yes, Devin, I'll take this. It's Chad. I would say most of the clients we're talking to still feel pretty good about the business, their business the economy, I really think CEOs like to transact when they're confident in their own business. So we haven't really seen it impact the pace. I think it all depends on how long that volatility sticks around. I mean certainly if we have several more weeks or a couple more months with this volatility. I do think that would eventually impact the middle market deal landscape, but it certainly hasn't for us so far and we have plenty of transactions what I would say sort of ready to land at the airport, and now it's just a matter of can we get them queue done by year end.

[Devin Ryan, JMP Securities]

Got it, okay, very helpful. And then just one on recruiting. I think you guys added on a net basis five senior investment bankers year-to-date, as we just think about kind of a next year or just kind of the future hiring plans, is that about what we should be thinking about it's kind of like a normalized level or would you like to do more but just you can't kind of predict the timing of people come in or is that effectively a number that that's essentially in the budget, so you're trying to be somewhat balanced around hiring and the cost of hiring relative to the kind of timing that it takes for someone there to ramp up in revenues to come in.

I'm just curiously the five seems like a reasonable number, but just how that would look relative to kind of what you would like to do?

[Chad Abraham, Chief Executive Officer]

Yes. I think in our final number for the year will end even one or two hire. So six or seven in total. I think that's a number we would like to accomplish every year on a net basis. We're not laser focused on we have to get that number as we wouldn't really sacrifice sort of quality, productivity ability to hit that number. It's a little bit of a function to -- do we have as many internal MD promotes as we had last February. We're just starting that process. We've done quite well externally recruiting this year, but I think you're right sort of that six number would be a good target for us.

[Devin Ryan, JMP Securities]

Got it, great, okay, thank you. And then just last question here just on expenses and how you guys are thinking about the expense trajectory, and really more from the angle of, if volatility does persist how should we think about the flex in expenses? I know there's kind of an element of investment that's running through the compensation ratio. So there may be some flex there to the extent revenue environment were to shift or within non comps or other areas that you would say would likely either flex or we should think about kind of being an offset or to decline to the extent a revenue environment were to become more challenged?

[Tim Carter, Chief Financial Officer]

Yes. Devin, maybe I'll hit on that first on the comp side of things. I mean I do think for this year we're likely to end sort of that low end of the range that we've been talking about it, 62%, but it does become sort of dependent on business mix and some of the components that you talked about but also the investment need. So I think from a more --from a go-forward basis, we still feel like that 62% to 63% is the right range. Again we might be on the low end of that this year, but thinking about it in terms of what we want to do from an investment perspective that range still feels appropriate.

There is some ability to manage that if we see some level of downturn. I think on the on the non comp side, again we can still think about it in sort of that that 43 to 45 range, some of that obviously includes the deal reimbursement expenses that get grossed up so if there's some again slowdown on that can that ship down towards the low end. I think that's right and there always becomes some level of variability that we can pull into play. The other dynamic if you go all the way down to them just I talked about the tax rate a little bit.

We are now more at the top end of the range that we had talked about. And from a go-forward perspective that's probably more appropriate given the level of inventory and the reduction in sort of that tax exempt benefit that we get as we've reduced inventory. So tax rate probably ends up at the high end of our range going forward.

[Chad Abraham, Chief Executive Officer]

Devin, I guess, it's Chad. The one thing I would add is in relative to invest in banking sort of in the points of volatility, what really drives the flexibility is just how much fixed comp sort of contracts do you have. And I would say over our history, we've managed that very well. We have very, very few fixed contracts. So we're like my partner Scott Banking always says, we're very focused on a volunteer army and making sure that we can pay for production and the people that are going to deliver deals.

So we can keep comp fairly variable with revenues.

[Devin Ryan, JMP Securities]

Got it. It's great. Thank you. I'm --just sneak one more in here just on the fixed income business because you guys have done a really nice job kind of managing inventory down. And kind of de-risking that business and I heard the comment about kind of staying kind of flat on inventory. I guess this quarter, are we kind of at the level where you feel is appropriate for that business amount of capital and kind of assets in that business or is it just kind of the ebb and flow being opportunistic. And then just bigger picture around the fixing of brokerage. Is this volatility in the market healthy for that business or is there anything else that you're seeing or hoping for that would maybe drive a change in direction?

I know it's not a huge driver today but just trying to think about some of the nuance within that.

[Deb Schoneman, President]

Yes, Devin, it's Deb. Relative to inventory level, this is a level that we see, and we will be at. I will say however if anything we're trying to see where we can continue to manage that down over time. And so that step I said more where our focuses than necessarily trying to be opportunistic maybe as we had been more in historically. Relative to the volatility in the marketplace and is that helping us?

We're not really seeing that show up significantly in client flows. You think from a client perspective. There's both uncertainty, rising rates and then a very flat yield curve. So not -- it's not driving as much activity over time I think what will really help that business is just higher rates. So as that plays out over time I think that's where we see a healthier market.

[Operator]

At this time. And there are no further questions at this time.

[Chad Abraham, Chief Executive Officer]

Okay. Thanks everybody. We look forward to talking to you about Q4. I hope everybody has a great weekend.

[Operator]

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