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Piper Jaffray Companies (NYSE:PJC)

Q2 2009 Earnings Call

July 22, 2009 9:00 am ET

Executives

Andrew Duff – Chairman & Chief Executive Officer

Debbra Schoneman – Chief Financial Officer

Analysts

Steve Stelmach – FBR Capital Markets

Devin Ryan – Sandler O'Neill

[Jeff Burston – AH Visante]

Operator

Welcome to the Piper Jaffray Companies conference call to discuss the financial results for the second quarter of 2009. During the question and answer session, securities industry professionals may ask questions of management. 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, 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 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.

Now, I'd like to turn the call over to Mr. Andrew Duff.

Andrew Duff

We are pleased with our improved second quarter results, which reflect a significant rebound in investment banking revenues, continued strong fixed income sales and trading, and important the operating leverage we have created in our business model.

Investment banking revenues increased across equity financing, public finance and financial advisory. Equity capital market conditions began to improve during the quarter. We were able to develop creative solutions and raise capital for or advise our clients in a number of successful transactions across every one of our focus sectors. The return on the five IPOs that we were participated in during the quarter is up an average of 41% [inaudible].

Also, higher fixed income sales and trading revenues were driven by solid client activity, favorable trading spreads and improved asset valuations. In addition, we are realizing the incremental benefits from the investments we have made over the past 12 to 18 months. We are particularly pleased with the momentum in our public finance business. We have an internal calculation for tracking economic e-market share for this business.

For the full year of 2008, our economic e-market share was 2.8%. At the end of the first quarter of 2009, our market share was 3%. At the end of the second quarter of 2009, it was 3.8%. This is the highest market share we have achieved since we began tracking it in 2004. This is also worth nothing that we are achieving these gains despite the non-investment grade segment of the public finance market stilling being essentially closed. This segment has historically generated a significant portion of our revenues. The public finance team has done a terrific job.

Finally and importantly, our second quarter performance clearly demonstrated the significant operating leverage we have created in our business model. Compared to the first quarter of 2009, our revenues increased 58% while our pretax operating income increased five-fold. We have held the compensation ratio to 60% and the non-compensation ratio dropped to 26% yielding a 14% pretax operating margin. We are committed to maintaining the positive leverage.

Looking ahead to the rest of the year, we are optimistic on the outlook for our public finance business. This business will improve further as the non-investment grade portion of the tax exempt markets begins to function. We are also reasonably optimistic on the outlook for our equity investment banking business. We are in active discussions with clients on many transactions, which largely are not reflected in a file backlog.

If markets are conducive to underwriting, as we experienced in the second quarter, we can effectively assist our clients in accessing the markets. We do think M&A will be challenged in the second half of the year as strategic buyers remain cautious and financial buyers are constrained by a lack of available financing.

Furthermore, as trading spreads tighten, we don't expect that we can sustain the robust fixed income trading profits that we achieved in the first six months of the year. However, we have added 19 senior professionals to this business over the past 12 months and we believe the business will perform well given this additional distribution capacity in trading expertise.

Now, I'd like to turn the call over to Deb to review the financial results in more detail.

Debbra Schoneman

In the second quarter of 2009, we generated net income from continuing operations of $11.6 million or $0.59 per diluted common share compared to a net loss of $1.5 million or $0.09 per diluted common share in the same quarter last year, and a net loss of $2.7 million or $0.17 per diluted common share in the first quarter of 2009.

Second quarter 2009 net revenues were $132.3 million up significantly compared to $97.7 million in the year ago period, and $83.9 million for the first quarter of 2009. Both investment banking and institutional brokerage contributed to the improved performance.

First I'll comment on revenues beginning with investment banking. For the second quarter of 2009, equity financing revenues were $23.3 million a significant improvement from the comparative period, although still below our historical quarterly averages. U.S., European and Asian activity contributed to the improved second quarter performance.

From a product perspective, we generated revenues across our product spectrum of IPOs, follow-ons, convertibles, private placement, pipes and RDs. Within the U.S. market there were 13 IPOs completed in the second quarter industry wide and we participated in five of them, including as sole book runner on Duoyuan Global Water, a leading China-based domestic water treatment equipment supplier.

We currently have no public offerings on file, which is below the seven we reported on our first quarter call. I would note, however, that the files backlog is increasing a narrow slice of the equity financing market and not necessarily predictive.

As Andrew commented, our public finance business continues to perform very well. The business generated $20.1 million of revenues up 32% compared to last year and up 53% compared to the sequential quarter. Activity reflected a significant flow of larger issues, as well as a continuing base of middle market issues. The majority of the business was governmental high grade transactions. Issuance activity remains very low from high yield real estate and development finance.

Our M&A revenues increased during the quarter mainly due to a higher number of completed transactions, higher aggregate transaction value, as well as increased average revenue per transaction versus the comparative period.

Turing to institutional sales and trading, we generated net revenues of $65.6 million up 17% from the same quarter last year and up 12% from the first quarter of 2009. This performance was mainly driven by strong results from fixed income sales and trading.

Equities sales and trading revenues were $30.4 million down 14% compared to the year ago period mainly attributable to the U.S. equities business, which experienced lower gross cents per share traded and a modestly higher trading loss ratio. Revenues were essentially the same as the first quarter of 2009.

Fixed income sales and trading revenues were $35.2 million up 69% compared to last year and up 27% compared to the strong sequential quarter. Compared to the second quarter of 2008, the largest contributor to the increased performance was trading gains, which we expect will not be sustained at these levels as trading spread compress.

However, fixed income client activity in taxable and tax exempt products was solid and fixed income commissions materially contributed to the increased performance. Commissions were up 45% compared to the second quarter of 2008 and up 48% for the first half of 2009 compared to last year. Results reflect the additional talent and new products, such as corporate credits and taxable municipals.

Now, I'll turn to non-interest expenses. For the second quarter of 2009, compensation and benefits expenses were $79.4 million up from the comparative periods due to the improved performance. Compensation ratio for the second quarter of 2009 was 50% an improvement from 62.5% in the second quarter of 2008 and the same as the first quarter of 2009.

For the second quarter of 2009, non-compensation expense was $34.5 million, which included $3.6 million of restructuring charges that were mainly severance related. During the second quarter, we reduced net headcount by 3% compared to the first quarter of 2009. This is the second quarter in a row we've been below our goal of a quarterly run rate of $35 million for core non-compensation expenses. We believe this will continue and that we can now achieve a quarterly run rate in the $32 million to $33 million range for the remainder of the year.

This concludes our remarks and I'll turn the call back to Andrew.

Andrew Duff

Operator, we will now open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Steve Stelmach – FBR Capital Markets.

Steve Stelmach – FBR Capital Markets

In terms of the muni side of the business, I know you guys did that acquisition the muni team in California I believe it was 2008. Can you give us some color on that team's production given California's sort of fiscal crisis and is there a backlog of deals that have yet to come to fruition there? Just any update would be helpful.

Andrew Duff

They remain relatively active it is a lot of K through 12 activity. They've continued to be able to access the market. I would share your observation, however, with the budget deficits at the state level and often at the local level. There may be challenges ahead, but so far they've been successfully accessing the market.

Steve Stelmach – FBR Capital Markets

So you wouldn't characterize it as some backlog now that hopefully California's got their act together, at least as of today.

Andrew Duff

They've got an ongoing backlog that I'd say is similar to what's been here as they joined us back in '08.

Steve Stelmach – FBR Capital Markets

In terms of the 19 new fixed income professionals that you guys mentioned, what's that compare in terms of percent growth year-over-year, quarter-over-quarter? How should we think about that incremental 19?

Debbra Schoneman

I would say probably, I'm just thinking for the total fixed income sales business it's probably almost 15% to 20% increase I would say in professionals. In total headcount, I should say.

Operator

Your next question comes from Devin Ryan – Sandler O'Neill.

Devin Ryan – Sandler O'Neill

Just another question on the public finance, the recent additions seem to be paying off and you announced an additional hire yesterday. Is there still room there or, I guess, a desire to expand more or is it now just really about executing with the people you have as the markets open back up?

Andrew Duff

We continue to add in that area. We've got a footprint now growing on the east coast, which we had not previously had, and we've got people in Boston, Hartford, New York, I think further down the seaboard and there's plenty of opportunity there. So selectively right profile on the individual and their clientele we'd absolutely continue to expand.

Devin Ryan – Sandler O'Neill

Sorry if I missed this just on fixed income generally, but can you quantify or even qualify kind of the overall level of client trading volume in the second quarter maybe compared to the first? And essentially what I'm trying to do is get some sense of how much of the revenue strength is attributable to trading volumes versus gains on improving valuations in the quarter.

Debbra Schoneman

Well, let me start by just saying that while significant portion of the fixed income sales and trading revenues were driven by trading profits, we did see very strong client activities throughout this year coming from the additional talent we added that we had just discussed with the 19 professionals. And we're also seeing additional activity in new products and additional credit products, as well as taxable municipals.

Andrew Duff

Let me just add a thought or two to that. As we commented on, we've been investing in that business fairly consistently in the last 12 months. As it's currently constructed, we'd anticipate annual revenues in the $65 million to $75 million range. We are going to continue to invest in the business and that may grow over time. Clearly, our run rate level is above that and that really does reflect the very favorable trading environment.

Devin Ryan – Sandler O'Neill

So like $65 to $75 annual, okay.

Debbra Schoneman

In a normalized –

Andrew Duff

In a more normalized environment.

Devin Ryan – Sandler O'Neill

In terms of equity underwriting, you spoke about being somewhat optimistic there. Do you think this could be a better capital raising summer than we general see given that there seems to be some demand by clients as the windows open and especially if equity markets remain relatively stable?

Andrew Duff

Potentially, it's rare, though, that you don't have some of the slowdown in August, which is frequently followed by a very active fall. But I don't see any signs that this would be they unique environment that you wouldn't have some kind of modest slowdown in August. Having said that, I share your observation what's come to the market is typically at the top of the range and several instances above and then traded quite well.

Devin Ryan – Sandler O'Neill

Can you just give some more detail, sorry if I missed this as well, on the earnings allocated to participating stock awards and how this is calculated and how we should think about it going forward?

Debbra Schoneman

Just to clarify, we were required to adopt a new FASB staff position, which actually became effective January 1, 2009 because of our loss position in the first quarter we were not required to adopt it. Under this new staff position, we're required to allocate our undistributed net income to unvested restricted shares, or participating securities as they're called, and then to common shares.

So that's where you see the bifurcation of the earnings in the release. So in essence what you're seeing now for the shares that are reported, both the basic and fully diluted, relate to just the common shares. The slight difference has to do with some small option dilution. The income that you see the $2 million that's allocated to participating shares, that relates to the income that we would attribute really pro rata between the common shares and 100% of our unvested restricted stock grants.

Devin Ryan – Sandler O'Neill

So we should essentially think about it as some percentage of the net income before you kind of back out those shares?

Debbra Schoneman

Yes, so we're bifurcating the income in the same relation that you would bifurcate the shares between common shares and 100% of our unvested.

Operator

(Operator Instructions) Your next question comes from [Jeff Burston – AH Visante].

[Jeff Burston – AH Visante]

Just a question on normalization of the fixed income business, can you just talk about what you see happening that will in fact normalize this business and over what period of time you expect that to happen?

Andrew Duff

I think the dynamic that we're pointing to is the significant credit tightening of the spreads and the favorable trading environment it's been relatively unique for the last six months and as that would normalize. I'm not sure I can give you a specific timeframe, but when we just look at it over a longer economic cycle, it has been particularly favorable this spring, to some extent reversing the very, very unfavorable environment of the 12 months preceding it.

[Jeff Burston – AH Visante]

So not related to volumes of financing but really spread tightening.

Andrew Duff

It's more spread tightening, and I would think the volume environment might actually improve.

Operator

There are no more questions at this time. I'll turn the conference back to you.

Andrew Duff

Overall, we are pleased with our recent performance and confident in our business as currently positioned. We'll continue to drive our business forward and work to sustain our improved performance. Thank you all for joining us this morning.

Operator

Ladies and gentlemen, that concludes our conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a good day.

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