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Executives

George Ball - Chairman

Ben Morris - CEO

Rick Berry - CFO

John Unger - SVP and General Counsel

Bruce McMaken - EVP

Steve Cordill - President, Asset & Wealth Management Division

Analysts

Devin Ryan - Sandler O'Neill

Sanders Morris Harris Group Inc. (SMHG) Q3 2008 Earning Call November 11, 2008 10:00 AM ET

Operator

At this time, I would like to welcome everyone to the Sanders Morris Harris Group third quarter Earnings Call. All lines have been placed on mute in order to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

I will now turn the call over to George Ball, Chairman of Sanders Morris Harris Group. Thank you. Mr. Ball, you may begin your conference.

George Ball

Thank you, operator. Good morning, everybody. Welcome to Sanders Morris Harris Group's earnings release conference call for the third quarter of 2008.

With me here today are Ben Morris, Chief Executive Officer; Rick Berry, CFO; John Unger, Senior Vice President and General Counsel; Bruce McMaken. Executive Vice President; Steve Cordill, President of the Asset & Wealth Management Division; and by phone the other members of management.

In a moment I'm going to turn the call over to Rick Berry. He’s going to discuss our financial results for the third quarter of the year and it will be followed by a question-and-answer session.

Before we begin, remember that during the course of this conference call, we may discuss some non-GAAP measures in talking about our company's performance. If you do, you can find a reconciliation of those measures to GAAP measures in our earnings press release; Rick?

Rick Berry

Thanks George. I'd like to remind you that statements made during the course of this call that are not purely historical are forward-looking statements regarding the company or management's future intentions, hopes, beliefs, expectations, and strategies for the future. Because such statements deal with future events, they are subject to various risks and uncertainties and actual results might differ materially from those projected in the forward-looking statements.

Important factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in today's press release, and in our annual report on Form 10-K and quarterly reports on Form 10-Q filed with the SEC. You should not unduly rely on any forward-looking statements and we assume no obligations to update them. You should have a chance to review our earnings release. It outlines in some detail the components of our third quarter results. I will not cover that material at any length, therefore, but will answer any questions later.

We recorded net income of $29 million during the third quarter or a $1.03 per diluted share, compared to $1.8 million or $0.07 share during the prior year quarter. Those earnings have several factors impacting them. Quarters results included an aftertax gain of $30.1 million on the sale of the company’s ownership interest in Salient Partners and its Endowment Fund Affiliates

Without that gain the company would have lost $1.1 million or $0.04 per diluted share during the 2008 quarter. The loss was attributable to the decline in the company’s merchant and warrant portfolios, including our SMH Capital Advisors Credit Opportunity Fund investments. The marketplace herd all of those securities like everyone else’s. The amount was $4.2 million or $0.15 per share. In other words, without the portfolio impact or the Salient sale we would have netted $0.11 per share.

George Ball

Keep in mind that our net income the quarter contained two months of Salient Partners earnings that component was $2 million taking out Salient in both the ’07 quarter and the ’08 period. Asset and Wealth Management pre-tax earnings were $0.13 a share last year and $0.14 this year. That’s an 8% increase.

Almost all of our Asset and Wealth Management units earned more than they did a year ago. Nonetheless, the declining markets naturally decreased assets under management. The drop from the prior quarter was $600 million or 6%. Good net money flows and comparatively good investment results helped to the cushion the decline.

Rick Berry

Our capital markets business earned $1.1 million during the quarter, compared to $2.4 million during the 2007 quarter. As one would expect in this environment, the investment bank lost money, offsetting it, the prime brokerage division Concept Capital continued to show higher earnings and the institutional equity in Fixed Income businesses were also profitable.

George Ball

We expect to shortly enter into an agreement to effectively sell 80% of the Capital Markets division for cash and a note with those proceeds to offset in part by the working capital employed in the business. The completion of the sale is predicated on a the approval of new ownership and the formation of a second dealer. Those approvals are expected to occur in the first quarter of next year. Sanders Morris Harris Group is going to retain a 20% interest in the Capital Market Division, subject to an option for the purchase or divide the remaining interest, which exercisable through the end of 2009.

This is going to make the public entity of Sanders Morris Harris Group an almost entirely Asset Wealth Management company. We think there are some extraordinary potential for us in the asset and wealth management channel both internally and externally. The former were around the Edelman franchise in particular, as proven and expandable aloe. We believe we can grow the Asset and Wealth Management business significantly in this era of opportunity. We delay consummating acquisitions for the moment as we felt and feel that prices were and are, coming down.

Rick Berry

Along that lines keep in mind that we have no funded debt. Our working capital consisting of cash and customer revivables less current accounts payable was $26.3 million. Our portfolio of liquid and near liquid securities totalled $64.7 million at September 30. The Salient sales should generate cash flow of at least $0.25 a share aftertax for the next few years. Although that stream will not count as earnings, it is visible cash-flow.

George Ball

And with that we will be really pleased to answer any questions.

Question-And-Answer Session

Operator

Thank you very much. (Operator Instructions) Our first question comes from the line of Devin Ryan. Your line is open.

Devin Ryan - Sandler O'Neill

Hey good morning, guys.

George Ball

Hi, Devin.

Devin Ryan - Sandler O'Neill

Related to the sale of the Capital Market units, what specifically is going with that? What’s going to be included in that? And then I didn’t hear a price, are you ready to kind of disclose that as well?

George Ball

Devin, we would rather not talk about price at this moment, because the agreement and the funding have yet to be signed. We do expect to be able to announce that in the next few days. The units of that will be the investment bank, the Fixed Income business, portions of our Institutional Equity business and the Prime Brokerage or Concept capitalization.

Devin Ryan - Sandler O'Neill

Okay. And in terms of the corporate allocation, because obviously there is some revenues and expenses from the Corporate Support segment. Well, how much expense -- I guess, I am trying to think about what the recurring earnings rate of the company could be? What type of expense will be also going with this business?

George Ball

The corporate overhead that’s related to the Capital Markets business, you understand we don’t publicly disclose any sort of breakdown in the corporate overhead as far as how it’s allocated either Asset Wealth Management or the Capital Markets businesses. I think overtime, we could certainly see a reduction in that corporate overhead, though several million dollars on an annual basis. Certainly not something that can go away immediately but over time that’s very possible.

Devin Ryan - Sandler O'Neill

Okay. And what are you planning on doing, if you are not looking at acquisitions currently, what are you planning on doing with, I guess, one, the capital from the Salient and Endowment businesses and then two, from the capital that you’ll be receiving from the sale?

George Ball

Devine, we certainly are looking at acquisitions. There are several that we have and continue to look at, but just as I said before, prices are coming down and if you think that there is going to be a pre-holiday sale, you are foolish to buy at full prices in the middle part of the summer. So we have been delaying consummation.

Devin Ryan - Sandler O'Neill

Right.

George Ball

And so far, we have been right, the prices are coming down. We may well think that they are coming down a bit further. We are not trying to be cynical or clinical in that but that’s our professional judgment. So, that’s a timing consideration rather than a hesitation.

Devin Ryan - Sandler O'Neill

Sure.

George Ball

And then secondly, we certainly could consider and I’ve talked about a distribution of some capital to the shareholders, we made no decision along that lines. There are certainly are things either in growing our existing businesses, including very much of the Edelman business or acquisitions that could use, the capital, which we have or will be getting.

Devin Ryan - Sandler O'Neill

Okay, okay, okay, and just kind of moving along here to just some other things. In the Prime Brokerage, the end results would be a record and you can touch on it briefly, I mean, was that all driven despite of volatility in the quarter and due to higher clientele activity or is there something else in the numbers there. Could you just look what’ going on?

George Ball

[Spreger Mike] Do you want to speak to that? D o you want to speak to that. [Spreger Mike]is on the phone. (inaudible)

Look, I will answer, A, the volatility certainly helped, B, we have added prime brokerage price and C, importantly we have added a dimension of administrative, of book-keeping services to a number of those Prime Brokerage clients. That has expanded our revenue per client on a ex-fee basis or on a fee basis that has added considerably to the revenue into the net income. Volatility plus is added dimension to that business.

Devin Ryan - Sandler O'Neill

Okay sure. And then just in Asset and Wealth Management business. Can you update us just in terms of what percentage of revenues are recurring based and how much is transactional? Just trying to get a sense of with the declining asset levels. How much that’s going to impact results, relative to maybe of a little bit of higher volatility period where transactions are up to some degree.

Rick Berry

The vast majority of the businesses are fee based business throughout that channel, the commissionable business is far less and has become even less overtime. So if you would need a rough figure I would tell that somewhere in the neighborhood of 85% of the businesses are fee-driven businesses. The very vast majority of decline and tell them we have got which is high net worth individual. The mass affluence channel, some institutional and then if you go into the ultra affluent, you have got some there as well.

Vast majority of all those relationships are premised on a fee which is related to assets. If you look at the asset base in general as George had mentioned it was down 6%. So far less than some of the damage that you saw across the Street ,that was attributable to the widely held diversification among the portfolio's that they had for clients. But a vast majority of the revenues coming out of those businesses are fee-based.

Devin Ryan - Sandler O'Neill

Okay thanks. That’s helpful. And just lastly, can you repeat again when the, this capital markets transaction is going to be completed. Is that the beginning of 2009.

George Ball

We expect to announce the signing of the agreement in the very near future. In a matter of days. We, then need to get an approval of the new owner and the formation of a second broker-dealer and expect that in the first quarter of next year.

Devin Ryan - Sandler O'Neill

Okay, great. Okay thanks a lot guys.

Operator

(Operator Instructions). At this time I have no further questions in the queue.

George Ball

Operator, thank you very much. Thanks everybody.

Operator

Thank you. At this time your conference has completed you may disconnect you lines.

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