Piper Sandler Companies

NYSE:PIPR

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, and welcome to the Piper Jaffray Companies’ Conference Call to discuss the Financial Results for the Fourth Quarter and Full-Year 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 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. The non-GAAP measures should be considered in addition to and not a substitute for measured of – 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 fourth quarter and full-year of 2018.

Reflecting on 2018, I’m honored to have been entrusted with leading Piper Jaffray, after Andrew Duff retired at the end of 2017. I could not be more proud to lead the talented passionate partners, who work hard assisting our clients.

Our strategies to drive shareholder value remain consistent. We are focused on driving revenues higher through market share gains, continued sector and geographic expansion and new products. Revenue growth, combined with enhanced scale and operating discipline, will power increased margins and enhanced profitability.

I’ll provide some overall commentary on 2018 and 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. I will make some closing remarks, and then we will open up the call for questions.

We finished the year strong with $223 million of adjusted net revenues, our highest quarterly revenues of the year and $1.99 of adjusted EPS. For the year, adjusted revenues were $781 million and adjusted EPS was $6.13. Revenues and earnings declined from the record results in 2017 due to fewer large M&A fees and challenging municipal markets. However, 2018 produced a number of positives.

In 2018, investment banking had another strong year led by healthcare. We sustained our strong performance in advisory services, with revenues approaching $400 million. We recorded one of our best equity financing years. We launched a new debt-financing capability through Piper Jaffray Finance, which earns six fee events. We grew our leadership position in public finance and we returned $118 million to shareholders through dividends and share buybacks.

Turning to our Q4 Advisory and Equity Capital Markets results. Despite the recent volatility, market conditions generally remained conducive to advisory engagements, driven by CEO confidence, a strong U.S. economy, ample financing availability and financial sponsors flush with capital to deploy.

Advisory revenues of $128 million represent our second best advisory quarter on record. We completed 52 transactions, with an aggregate enterprise value of $10.3 billion. Contributions were broad-based with our healthcare, energy, industrial and consumer teams, all producing strong results.

For the year, advisory revenues were $394 million. 2018 was marked by balanced advisory performance across our core sectors, as we executed on 170 transactions up from 163 in 2017. We previously discussed remixing the business towards capital-light, variable cost businesses, such as advisory. 2018 again produced advisory revenues in excess of 50% of our total revenues.

One of the key tenets of our strategy is adding scale to our core industry verticals. Through hiring, internal promotions and corporate development, we have built market-leading franchises in healthcare, energy, consumer and most recently industrials. Our industrials team had a record year with significant growth in revenues.

We’re very pleased that we’ve been able to elevate another industry team to meaningful size, adding additional diversification to our platform. We have also continued to make significant investments in growth and new hires in our FIG and tech practices.

Looking forward to 2019, our advisory pipeline remains robust with several significant transactions already announced. We believe we are set up for another strong year in advisory.

Equity financing activity in the quarter experienced the slowdown from the higher levels in the first three quarters. We generated $22 million in ECM fees in the quarter, down from the $30 million-plus level in the prior three quarters. Volatility and an equity market sell-off in December closed the IPO market early for the year.

We generated $122 million of revenues for the year. Strong valuations and stable markets through the first three quarters of the year created optimum IPO conditions in the market. Much of the market activity was centered in the healthcare space, where the strength of our franchise drove overall market share gains in 2018.

The Capital Markets business is an important tool for our bankers to continue deepening mind share with our clients and meaningfully diversified our banking business. We see several opportunities to continue increasing market share.

Heading into 2019, our ECM pipeline is strong, but it is market dependent. Our energy equity banking franchise is an example of the dependence on the market being conducive to transactions. We have a strong backlog in this industry sector, but execution of the pipeline requires some stability in the energy markets. The federal government shutdown impacted the start to the year for IPOs.

During 2018, we grew our equity banking Managing Director headcount from 84 to 90, representing 7% growth. Our recruiting pipeline is strong, with two MDs committed to joining our platform in Q1. 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.

A few years ago, we set a goal for ourselves to grow our equity investment banking revenues to $500 million. We exceeded that goal in 2017 and again in 2018. We have set our sights on growing our equity investment banking franchise to $750 million. I’m happy with the success we’ve had, but not satisfied. I’m excited about the challenge and look forward to winning in the marketplace.

Before I hand the call up to Deb, I’d like to welcome James Baker to our leadership team as the Co-Head of Investment Banking and Capital Markets. James joined Piper as part of our acquisition of Simmons & Company in 2016. He was instrumental in our seamless integration of Simmons and his leadership will be paramount, as we strive to build a $750 million banking franchise.

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

[Deb Schoneman, Managing Director and President]

Thanks, Chad. Both equity and fixed income sales and trading experienced a very volatile market environment in Q4, which was helpful to our equity brokerage business, but hurt our fixed income results. Our equity brokerage business generated revenues of $23 million for the quarter, which was up almost 27% sequentially and flat year-over-year.

For the year, we generated $77 million of revenues, down 5% from 2017. As we’ve discussed in prior quarters, how market participants paid for trade execution and research services is in transition at a time when the overall fee pool is shrinking. The new payment dynamics for equity research have added additional seasonality to our equity sales and trading business.

Our strong Q4 results were due to a large influx of research checks, as clients paid us for the quality of our research services and corporate access offering. We expect to see this dynamic continue in 2019.

Our discussions with long-only mutual funds indicate that 2019 could see more stability in research budgets than the industry experienced in 2018. We believe there will be opportunities in a consolidating market to gain market share for strong franchises, such as our own.

Turning to our public finance and fixed income brokerage businesses, we generated $28 million of debt financing revenue in the quarter, up 33% sequentially, as activity picked up after a slow start to the year following the federal tax law changes enacted at the end of 2017.

For the year, we recorded $73 million of debt financing revenue, down 22% and consistent with the decline in overall municipal issuance. We retained our market leadership in 2018, underwriting the second most municipal issuances in the country and ranking in the top 10 based on par values.

The strength of our market position and capabilities within specialty sectors, such as senior living, helped us to modestly grow market share in 2018. We believe municipal issuance levels will be up 10% to 15% in 2019, as market issuance rebounds to more normalized levels.

We intend to continue investing in our public finance business by expanding geographically, leveraging our market leadership to attract talent to the franchise, growing our specialty sectors and looking for acquisitions and teams that would benefit from our scale and high-quality municipal distribution.

Market conditions in our fixed income brokerage business were very challenging in the fourth quarter, as macroeconomic concerns cause yields to move swiftly lower. We recorded $15 million of revenues in the fourth quarter, down 19% from Q3. The speed of interest rate movements and the widening of credit spreads created modest trading losses, which reduced our revenues.

We generated $68 million of fixed income brokerage revenues in 2018, down meaningfully from the prior year. During the year, we experienced low relative, but rising interest rates and a flattening of the yield curve. The overall fixed income markets were very challenging and our results suffered, particularly given to our exposure to the municipal market, which saw buyers adjusting to the new federal tax laws.

Our strategy for navigating through these markets is to reduce risk and volatility in our results and drive more consistent returns by leveraging our areas of core expertise. We reduced inventory balances and VaR by 50% from the prior year.

Going forward, our objective is to further align our business with our market leadership in municipals and leave with expertise versus capital in the various client segments, where we choose to compete.

Finishing up with asset management, ending AUM declined 21% sequentially, as the equity markets sell-off resulted in significant market depreciation across all of our product offerings. Revenues decreased 20% on a sequential basis and 18% year-over-year.

Equity markets have started 2019 with gains, which should help reverse some of the market depreciation experienced in Q4. In these challenging conditions, we’re focused on providing assets to our clients, which will drive future financial performance. We believe clients appreciate our value-oriented approach and very compelling yield and growth prospects in our MLP products.

Industry-wide, active management has been depressed during this long bull market. However, we believe clients increasingly see the benefit of active management in these turbulent times.

Now, I will turn the call over to Tim to go through our financial results in more detail.

[Tim Carter, Managing Director and Chief Financial Officer]

Thanks, Deb. My comments will be focused on our adjusted non-GAAP financial results. We finished the year strong with quarterly revenues of $223 million, up 3% compared to the sequential period, but down compared to the year-ago period, which benefited from outsized municipal results fueled by tax reform.

For the year, we generated revenues of $781 million, down 10% compared to last year’s record revenues. Despite the decline, several of our businesses, including advisory services, public finance and equity brokerage, experienced strong momentum and recorded their best quarterly results of the year.

As Chad and Deb highlighted, there is increased macroeconomic uncertainty heading into 2019, but we’re confident in the strength of our diversified platform providing results across market cycles.

Our diluted EPS for the quarter was $1.99, higher on both the sequential and year-over-year basis. The sequential change was driven by an increase in revenues, slight declines in our comp and non-comp ratios and a lower share count due to our share repurchase activity in the fourth quarter. EPS was higher compared to the year-ago period, primarily due to a lower federal income tax rate, lower comp ratio and reduced share count.

For the year, diluted EPS was $6.13, down from 2017 due to lower revenues and offset in part from a lower federal tax rate. Our adjusted ROE for the year was 13.6%, down from 14.2% in 2017. We remain focused on generating an ROE in excess of our cost of capital, while investing for growth and returning excess capital to shareholders.

Turning to our operating performance, the comp ratio was 61.5% for the quarter and 61.9% for the year, both below our target range of 62% to 63%. The compensation ratio declined compared to prior-year periods, reflecting the impact of the new revenue recognition rules adopted in 2018, under which client reimbursed deal expenses are no longer netted within revenue. Our compensation ratio is dependent on investment opportunities, and we continue to believe that in the near-term, a 62% to 63% rate is appropriate to drive growth.

For the quarter, non-comp expenses were $45.5 million, slightly above our $43 million to $45 million per quarter range. The increase compared to the year-ago period was primarily due to higher reimbursed deal-related expenses related to adoption of the new revenue recognition rules that I previously mentioned.

For the year, non-comp expenses were $181 million, excluding $3.8. million of restructuring costs, our non-comp expenses averaged approximately $44 million per quarter, which is at the midpoint of our guided range. We continue to carefully manage non-comp expenses, as these costs are an important source of operating leverage.

Going forward, we expect non-comp expenses to trend higher, as deal-related expenses increase with growth in banking. With this increase, we expect our quarterly trend to be at the high-end of our stated range.

Our adjusted tax rate for the quarter was 26%. Looking at our tax rate going forward, we believe it will be in the 25% to 27% range. excluding the impact of stock vestings. As we’ve reduced municipal inventories throughout 2018, we generate less tax-exempt income, which increases our effective tax rate.

Finishing up on capital, we continue to be focused on driving attractive returns for our shareholders. Our dividend policy, which returns between 30% and 50% of our adjusted net income each fiscal year is one way of meeting this objective. This includes an annual special cash dividend payable in the first quarter of each year in addition to our regular quarterly cash dividends.

For 2018, the Board determined a payout ratio of approximately 40% was appropriate to balance shareholder returns with capital retained for growth and share buybacks. Based on our adjusted net income, the total dividend for 2018 will be $2.51 per share, representing an approximate 3.2% yield based on our average share price during 2018.

We have already paid $1.50 per share through our regular quarterly dividends, so our special dividend for the year will be $1.01 per share. The Board also approved a regular quarterly dividend of $0.375 per share for the first quarter of 2019.

During the fourth quarter of 2018, we repurchased $39 million, or approximately 572,000 shares of our common stock at an average price of $68.59 per share, as the market provided opportunistic buying opportunities. For the year, we repurchased $71 million, or approximately 961,000 shares of our common stock.

Our 2018 share repurchases more than offset the dilutive impact of stock awards granted during the year. Despite increased issuance of restricted equity grants from growth in our business and equity grants for acquisitions, our outstanding share count has continued to decline over the last several years.

We continue to manage inventory levels to be reflective of trading opportunities in the market. At the end of 2018, inventory levels were approximately $630 million, down 55% from the end of 2017. Inventory levels in 2019 will be dependent upon client demand and market opportunities.

Finally, given our level of capital and strong cash generation from earnings, we repaid $125 million senior note at maturity in early October. The financial strength of our balance sheet gives us the flexibility to fund all of our current and potential growth initiatives.

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

[Chad Abraham, Chief Executive Officer]

Thanks, Tim. In December, the financial markets reminded everyone how quickly calm waters can turn choppy. Increasing uncertainty driven by geopolitical and macroeconomic risks have created more volatile markets. Our clients need our trusted guidance more than ever.

I’d like to thank all of our employee partners, whose experience and dedication helped guide clients to superior financial results in 2018. Deb, Tim and I and our employee partners look forward to the challenges and opportunities that 2019 will inevitably bring.

We can now open up the call for questions.

[Operator]

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

[Devin Ryan, JMP Securities]

Hey, good morning, everyone. How are you guys?

[Chad Abraham, Chief Executive Officer]

Good, Devin.

[Tim Carter, Managing Director and Chief Financial Officer]

Hi, Devin.

[Devin Ryan, JMP Securities]

I guess, first question here just on the advisory business. So you guys clearly have a robust kind of platform with financial sponsors. And just thinking about that part of the business, I mean, their model is based on transaction – transacting and they have record levels of dry powder, so there are some nice secular tailwinds there.

So I’m just curious kind of your views around, if we get volatility kind of that continues something similar to the 4Q. Does that you truly shut things down or based on kind of the business model and the amount of dry powder that’s out in the market could you actually potentially have a scenario where there’s still kind of a reasonably healthy level of activity? I’m just trying to think about kind of some different scenarios here, particularly for that segment of the market?

[Chad Abraham, Chief Executive Officer]

Yes, Devin, I guess, I would say, we really didn’t notice much of a slowdown in transactions. I think with a couple of months of volatility, you can certainly point to a few transactions. But I think that volatility and angst would need to last for a good four, five, six months before you’d really start to see it impact deals. And certainly with the start of the year and the stability of the markets, we don’t really see much change to the pace we saw last year.

[Devin Ryan, JMP Securities]

All right, great. Great, thanks. A follow-up here, just you had another nice year of organic senior bank recruiting and there are some of the comments around continuing to kind of fill out FIG and tech and some of the other sectors. I guess, just kind of tied to that, I know you’ve spoken about and you guys have done a number of kind of tuck-in acquisitions. So are you still – are you looking at anything, or having conversations, what sectors? And then I guess that’s kind of the point, is there anything inorganic that could really induce kind of the headcount expansion over the next New Year?

[Chad Abraham, Chief Executive Officer]

Yes. I think, Devin, obviously, if you go back four or five years, we’ve done a number of things. We didn’t get any of those transactions done last year. I think our MD headcount growth will really be continued – a combination of organic growth. We added the six net MDs. Last year, I think that’s a pretty good target on a net basis. Again for us, this year – and yes, we’re having a number of conversations, I would say, the boutiques certainly notice the progress we’ve made in M&A and there’s obviously no guarantees, we get transactions done.

But we’d like to keep growing that MD headcount organically and then augment it with being able to add teams or larger transactions. And I think, you’ll certainly see more organic growth in our areas of strength, where we have full built out platforms. But certainly on some of our industry teams, there’s the opportunity to do something larger.

[Devin Ryan, JMP Securities]

Got it. Okay, great. Maybe pivoting a bit just to asset management, the decline in AUM, I apologize if I missed it. But was that primarily or all driven by just the mark-to-market or were there any kind of flow to one direction or another? And then if there were outflows, any expectation for continuation there? Just trying to think about the direction of AUM there?

[Deb Schoneman, Managing Director and President]

Yes, Devin. So the total decline in AUM versus the third quarter was about $1.5 billion, about $1.2 billion of that was market depreciation. So the vast majority, but there were some net outflows. And the way I think about that going forward is, this business has natural attrition in assets over time. And for us, it’s really about targeting some investment in sales and distribution to really offset that with net inflows, and that’s what we haven’t had enough of as we look back over the last year.

[Devin Ryan, JMP Securities]

Got it. Okay, I appreciate it. And then maybe a question for Tim, just on kind of expenses and operating margins. I mean, if we’re going to extrapolate a more negative environment or anything kind of recovered here quarter to date, so hopefully that’s not the case for 2019. But in that 62% to 63% comp ratio, I know there’s some cushion, because you’re growing.

So I’m just trying to think about kind of the flex there. And then on non-comp expenses, I heard kind of the commentary on the guidance and you have revenue recognition that kind of also think about in the mix based on investment banking. But I’m just trying to think about kind of in the scenario, where at some point in the future, we do face kind of stronger economic pressures, kind of the amount of flex on whether it be comp or non-comp expenses that would then kind of think about kind of the margin flex?

[Chad Abraham, Chief Executive Officer]

Yes, Devin, we obviously have been focused on growth and wanting to continue to invest in the business. But you’re right, we’ve got some ability to leverage that and look at reducing it. I’d say, even in some ways the fourth quarter gives you an example of some ability to bring that down based on where we’re at from an investment standpoint. So, we were able to come in below the range from that standpoint. There’s probably even a little bit more availability or room from there.

But again, trying to grow the business, but do have the ability to make some changes there if we face some more significant headwinds. Similarly, on the non-comp side, I mean, there are components of that, if business activity slows, there is some ability to adjust down on some of those more variable non-comps around P&E, some of those pieces.

And I think, you would have some reduction in the deal-related expenses potentially as well. So you may be able to move a little bit on that as well, but I’d say, the comp side is the easier piece to control.

[Devin Ryan, JMP Securities]

Okay, great. And then just last one here on capital. I appreciate that you guys are clearly returning more capital to investors and the special dividend is a big way. To do that, I’m just curious as you think about stock, and it’s not a Piper issue, you have an entire kind of financial sectors come in, in fair amounts from the highs.

And so is there a point where you think about potentially getting more aggressive on share repurchases or taking some capital out of the business to buyback stock just given that there seems to be value here? And just trying to think about the kind of balancing repurchases versus the dividends and special dividends, and then I also appreciate that there’s float dynamic to think about as well. So just love an update there and how you guys are thinking about potentially you buying stock as part of the capital plan?

[Chad Abraham, Chief Executive Officer]

Yes, Devin, so you did – you saw what we did here in the fourth quarter and we felt like there were opportunities. I think, we’ll continue to be opportunistic, I think, as we go forward as well. There are – you point out, we are focused on as well the liquidity and float in the stock. So, there’s some level of balance there.

But we’ll continue to look at ways to return capital to shareholders through buybacks and we could be opportunistic. Again, there’s this bias of having capital as well to deploy for growth. So we’ll continue to keep all of those things in consideration in terms of the levels that we do on each of those areas.

[Tim Carter, Managing Director and Chief Financial Officer]

Yes, Devin, I would just add, I mean, obviously, we don’t really look at it as, hey, how much do you have to buy every quarter. We look at it relative to the stock price and what the opportunity is. And clearly with the share price in the entire financial services market, like you mentioned in Q4, there were a lot more opportunities. So I think we really look at the buyback opportunistically and we’ll balance that with our quarterly dividends and special dividends.

[Devin Ryan, JMP Securities]

All right, terrific. I’ll leave it there, and congratulations on the nice end of the year.

[Chad Abraham, Chief Executive Officer]

Thank you.

[Tim Carter, Managing Director and Chief Financial Officer]

Thanks, Devin.

[Deb Schoneman, Managing Director and President]

Thanks, Devin.

[Operator]

Thank you. [Operator Instructions] I’m showing no additional audio questions in the queue at this time. I’d like to turn it back over to management for any closing remarks.

[Chad Abraham, Chief Executive Officer]

Okay. Thanks, everybody. Have a great day. We’re certainly looking forward to 2019.

[Operator]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.