Piper Jaffray Companies (NYSE:PJC)
Q1 2016 Earnings Conference Call
April 28, 2016 9:00 AM ET
Andrew Duff - Chairman and Chief Executive Officer
Debbra Schoneman - Chief Financial Officer
Hugh Miller - Macquarie
Michael Adams - Sandler O'Neill & Partners
Good morning and welcome to the Piper Jaffray Companies’ Conference Call to discuss the First Quarter 2016 Earnings Results. During the question-and-answer session, securities and industry professionals may ask questions of management. The Company has asked that I remind you that statements made on this call that are not historical or current facts, including statements about beliefs and expectations are forward-looking statements that involve inherent risk and uncertainties.
Factors that could cause actual results to differ materially from those anticipated are identified in the Company's earnings release and reports filed 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. 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, the call is being recorded.
And now, I would like to turn the call over to Mr. Andrew Duff. Mr. Duff, you may begin your call.
Good morning and thank you for joining us to review our first quarter results. Markets had a material impact on our results this quarter, so I will discuss these impacts for few minutes and also review progress we are making on our important initiatives. Deb, will then discuss key elements of our financial performance. We produced solid results in the first quarter against market conditions which were generally difficult for most of our business groups.
The highlight of our quarter was our advisory results. This business outperformed the market with a very strong start to the year. For some context our advisory revenue in the quarter exceeded our full-year results from most years prior to 2014 and the indication of the strength of our business and the investments we have made over the past few years.
Elsewhere trading, capital raising and asset management markets were challenging this quarter. We experienced volatile conditions in both equity and fixed income markets, which depressed results in each of these areas. The primary indicator for volatility in the equity markets is the volatility index or the VIX. It spent most of the quarter above 20 and spiked above 25 several times during the quarter.
Historically, we see an uptick in our trading commissions during periods of higher volatility. This quarter however, trading revenue for most firms did not reflect the higher volumes. We believe increased trading volumes were being directed to low type service providers. Volatility of these levels normally subdues equity capital raising and this quarter was no exception.
Capital raising was very light for the market and our firm. As volatility subsided at the end of the quarter and into April we might expect to see some early signs of issuers coming back into the markets to raise capital. Volatility also extended into the fixed income markets during the quarter.
As we’ve indicated for some time we have generally been interest rate neutral in our market exposure. We managed our rate exposure well; however we experienced episodes of rapid widening or even gapping of credit spreads in certain asset classes during the quarter.
As a result our trading P&L was adversely impacted by our exposure to credit sensitive products. In public finance we saw capital raising activity in the market start the year constructive levels that were up sequentially but down the year-over-year compared to a very strong market at the beginning of 2015. Our public finance business which has been outpacing the market for an extended period lagged the market during the quarter.
Nevertheless the investments we have made in the business over the past couple of years continues to perform well and we're comfortable that we will pick up the pace of activity in the second quarter. In our asset management business, the broader equity market started the year with a slight gain in values.
While the benchmarks we track our products against generally were down to start the year. Market values for one of our major products MLPs declined almost 5% through the end of the quarter and 32% year-over-year. We started to see some recovery in valuations late in the quarter, which has continued into April.
In addition to market depreciation we are confronted with the ongoing trend of investors favoring passive vehicles over active managers. This trend is most pronounced in domestic equities particularly in the larger cap funds. This has adversely impacted net assets rose primarily in our domestic value products countering this trend we are seeing more activity relative to our small-cap value product where our performance remained strong.
In addition we have accelerated our efforts to find product teams to add to our platform with particular emphasis on global or yield oriented products. Last year we undertook several initiatives. And I would like to provide an update on these starting with our acquisition of GKST business. We closed the transaction last October and the increases we are seeing in our fixed income flow activity are commensurate with what we expected with the additional sales and trading talent that joined us.
For the most part, our expansion into FIG is meeting our expectations. This initiative was largely executed through a significant hiring effort across both investment banking and equities. We added a couple more bankers to round out the team this quarter. We allow for certain period of time for the new producers to season on our platform.
Thus we expect revenues to ramp throughout the year for both banking and non-deal commission areas with the pace of the ramp determined to a certain extent by market conditions. Our acquisition of Simmons & Company International closed late in the quarter and we are happy to officially welcome them into the Piper Jaffray family.
All the key leaders and producers are now part of the firm. This combination is occurred during the time in which their markets are very difficult. We have worked closely with the teams in Houston and Aberdeen since we announced the transaction last year. And we intend to manage the business to be accretive to non-GAAP earnings in 2016.
Finally, we significantly expanded our debt capital markets and restructuring capabilities last year. This team is starting to gain meaningful traction in 2016. Maybe most important, the team began coordinating closely with the Simmons team once we announced the transaction. Their capabilities represent a very attractive and timely addition to Simmons product mix from which we expect to realize some revenue synergies and what might otherwise be considered challenging markets in energy.
I will now hand the call over to Deb to discuss our financial performance.
Thank you, Andrew. That market color provides useful context for our financial results. I will be referring to our non-GAAP adjusted results in my comments this morning.
For the quarter, we generated $0.70 per share in adjusted EPS, which represents a 50% decline in EPS sequentially and 39% decline year-over-year. The sequential decline primarily was attributable to a 22% decrease from record revenues reported last quarter and inherent operating leverage from revenues at that level.
I think it’s useful to discuss the year-over-year comparison in EPS in greater detail. With very similar revenue levels in the two periods that compares and isolates the impact of our initiatives and revenue mix on the operating margin. First, revenue mix plus the ongoing absorption of the FIG team adversely impacted the comp ratio for the quarter. The significant addition of FIG professional, the Young & Ernst in the second quarter of last year. So the comp ratio at the start of 2015 excluded that impact.
Our previous guidance suggested a target comp ratio of 64% this year, as these professionals begin to ramp up their revenue production as the year progresses. This quarter’s elevated comp ratio of 66.4% exceeded that target largely due to mix.
Advisory compensation funds at higher rates than most of our products and this quarter it represented almost 54% of our revenue versus 20% in the year ago quarter. We expect the comp ratio to move back inline during the year as our revenue mix shift into a more balanced blend, and as the FIG team increases their productivity levels.
The non-comp ratio also adversely impacted EPS with revenues flat year-over-year our non-comp expenses increased 11% due to our corporate development activities. While the absolute level of non-comp expenses is in line with our guidance. It [indiscernible] the operating margin by nearly 300 basis points at these revenue levels. We should see improvement in the non-comp ratio to revenue growth from our various initiatives.
We help to mitigate the near-term adverse impact on EPS through share repurchase activity over the last 18 months. As Andrew noted, most parts of the firm registered weaker results both sequentially and year-over-year largely due to the impact of difficult markets. The major exception with our advisory business which was down slightly from a record fourth quarter in 2015, but nearly tripled the revenue versus a year ago.
After two consecutive quarters of 80 plus million in revenue, I think it’s important to add some context. In 2014, we started to realize in a meaningful way the impact of our investments in this business. In the five years prior to 2014, our average annual advisory revenue was less than $80 million per year.
Based on the robust level of advisory activity, we have enjoyed over the past three to four quarters, we could expect to see some cooling off in the near-term. However, with the incremental additions from our FIG build-out and the Simmons team, we expect that our advisory revenue for 2016 will surpass our record level established last year.
I will briefly address the current and expected activity levels in other parts of the firm. In equity capital raising and volatility continues to subside we could expect to see a gradual improvement in equity issuance as the year progresses. Our debt capital markets team is starting to gain through the traction and should be constructed to our revenue outlook going forward. Relative to public finance coming off our record year in both revenue and market share in 2015, we believe the first quarter represented the reloading period for the team and we expect the business to strengthen in Q2 and throughout the year.
Our brokerage activities present the mixed picture. On the positive side, our major initiatives in FIG and GKST are making positive contributions to equity and fixed-income commissions respectively. Unfortunately, the markets are not entirely cooperative. In equities, we need to arrest the trend of trade volumes moving away from us by attracting consideration for our significant expansion of coverage.
In fixed income, we will continue to cautiously manager our risk profile as we assess the quality and direction of the market on an ongoing basis. In asset management, we are cautiously optimistic that the recovery in MLPs we saw late in the quarter and into Q2 is sustainable. Our internal view with that asset class [within overall] position and we will see how the markets play out.
Andrew referenced the passive versus active trend in the market. Our net asset flows reflected the impact of this trend as the large investor in our [All Cap] product shifted to passive investments during the quarter. Those assets together with deleveraging in our MLP fund accounted for the majority of net outflows in the quarter. Across our other asset management products, our focus is to continue to produce better returns for our investors. Where our performance is strong, Small Cap for example, we are seeing a reasonably good level of interest in the product.
We have also seen some opportunities to expand our product offerings and add talented teams as firm separates distribution for manufacturing of asset management products. We have strengthened our overall platform in recent years including marketing, product management, and trading areas and represent a stable and competitive home for teams seeking a new platform.
Thanks Deb, that’s a very good summary. Before we get into Q&A, I would like to sum up with a couple of comments here. Clearly, we can never immunize the firm from the impacts for the market as this quarter demonstrates. Our objective however, is to position the firm to produce the best possible results for our shareholders across a range of market conditions. The diversification in our business and the number of material investments and initiatives we have undertaken over the past year are specifically intended to achieve this objective.
The firm continues to make important strides. Today, our performance in a tough market is better than how we performed in a relatively good market just a few years ago. Our strategy continues to play out is intended by maintaining management discipline and with opportunistic improvement investments we continue on our path to improve shareholder returns.
Now, we would like to open up the call for questions.
[Operator Instructions] And your first question will come from the line of Hugh Miller with Macquarie.
Hi, good morning.
So I wanted to start for the couple of questions on the capital markets and I appreciate some of the color you had given us. Since we think about that kind of the pre-tax margins in that business, I think you mentioned just kind of the shift towards a more M&A advisory business was a bit of a headwind in the quarter.
I guess as we think about that business in general advisory I guess have use kind of a higher margin business relative to kind of fixed income commissions that underwriting most types of things. Can you give us a sense of how we should be kind of thinking about that margin what where the drivers I guess to why it was kind of down given the strengthen and kind of some of the investment banking arena relative to the trading businesses?
Yes, so I think in essence you are saying that advisory business is really strong, which is higher margin business why do that necessarily drive a lower margin in our capital market business, am I understanding that general question.
Yes, okay. So part of it is you’re talking about one quarter of business where we do have from a comp ratio perspective - talked about higher comp ratio driven by the advisory business.
Now you are correct advisory tends to have lower fixed cost or non-comp I should say and so ultimately higher margin, but we have a broad business. And overall, as we look at the revenues that came in our other businesses, which do have higher non-comps in some case more fixed cost structure.
One quarter there is no way to flex and adjust that is non-comp expenses relative to that significant decline in revenues and in number of those products. So it’s challenging when you are looking at one quarter versus what you might do over a longer period of time if your business mix was to shift in that direction on a more permanent basis.
Gotcha. Okay, that’s helpful. Thank you. And then obviously you mentioned as you see kind of the revenue ramp you levered to the investments in [indiscernible] and Simmons et cetera. What’s the time horizon and what you guys would expect to kind of get more towards the targeted comp ratio goal?
So when we talk about our guidance for this year even with the FIG investments in there. We had talked about 64% and obviously we are higher than that this quarter probably from what I just described in our mix of business. As our investments ramp and I will give you some context on this in a minute and we do believe this year the mix shift more towards a normalized basis. We do expect that comp price should have come back in line.
So as we talk about that overall revenue mix for the year and some of the context that we just provided in our comments, we feel good about our public finance business, the equity capital raising should increase if the markets continue to stabilize here. Asset management should benefit from improved valuations and specifically with our Fig investments that we have a pipeline that very much supports that would be in line for the full-year with our expectation.
Okay. Great that’s helpful. Thank you. And then looking at asset management, obviously you mentioned that you view kind of the MLP business is oversold. What are you seeing in terms of - you’ve indicated that is not really more of a flow issue, but what are you seeing in terms of just appetite for that asset class being that it’s oversold you know as a volatile environment. Are you seeing demand for that or has that kind of the way in just given the volatility.
So we had during the decline in 2015 we had net inflows every single month. The first quarter of this year it was essentially neutral. So it has moderated, we have not been in a significant outflow today. I would be of the mind that potentially here we could start as it stabilized and improved re-ramping.
Gotcha. And as we think about kind of the margin profile, the pre-tax margin coming in at close to 10% for the asset management business. Obviously it’s a highly leverageable business. But are there ways to see improvement in the margin for that business without seeing a meaningful raise in AUM or just a function of having to kind of right thought it in growing the business?
Yes, so let me just start there asset management comments as well. Is that business overall, our asset management business fees - reported pre-tax operating margin was 17% for the quarter. Now we have reported and shown it without the investment loss, because the investment gains or losses that we have on our capital is invested [indiscernible] compensation one way or another on that.
So if you look at the core business margin of about 23.4% this quarter, down just slightly from where it was in the fourth quarter, and obviously down from what was just under 34% in 2015. Your question that is what can you manage that to these types of revenue levels.
I think we can improve the margin if the revenues were depressed for a period of time here, which is not actually what we believe it’s happening given the valuation trends we are seeing in MLPs but to get back to the margin levels that we saw in the first quarter of 2015, we likely need to see some improvement in revenues. Again if we are going to stay down at these levels for what we believe are longer period of time then obviously when we would take cost actions to improve the margin.
Gotcha. And so I apologize yes I was quoting the pre-tax margin for the capital markets, but you’re correct with those. And then as well as we think about kind of the shares issued in the Simmons transaction. Do you have a horizon now what’s you’d now expect to be able to repurchase those shares I know that’s the target but what’s the time horizon in which you think it will be able to complete that?
Yes, you’re absolutely right. We do fully intent to offset the dilution of shares related to Simmons and just for perspective we bought back 40 of the 60 that we did issue as part of that transaction. And at the end of the day we want to maintain discipline in terms of the price and we believe it will serve our shareholders well by just being opportunistic in our buyback. So I can’t speak to an exact timeframe.
Okay. Understood. And obviously its early days now with the deal but as you kind of seen the markets develop a bit in the energy space. Do you have any updated guidance as to kind of the accretion you are anticipating from the Simmons transaction?
Yes. Let me say couple of things. So the M&A environment is extremely challenging with volatility I think that’s kind of intuitive pretty hard to put deals together when you have this level of volatility offsetting that to some degree is our products set where we’ve got restructuring and debt advisory and again I touched on that, we are very encouraged with the dialogues there and in fact couple of mandates.
We did endeavor collaboratively with them to look at the cost structure and make some adjustments to help us through what’s probably more difficult period. So we had at the time of purchase talked about their prior trough in revenues for a 12-month period being $85 million, we would believe that this trough with this level of volatility may go lower than that, we’ll go lower than that. But we’re committed to it being accretive in 2016.
Okay. Thank you very much.
[Operator Instructions] Your next question will come from the line of Michael Adams with Sandler O'Neill.
Good morning guys. I would like to start with another question related to Simmons deal. So initially you guys have discussed I believe something around 20% book value dilution, we didn't see that this quarter. So I’m just wondering could there be some residual impact or is there anything else you can do to explain that delta, because the numbers did come in a bit better than expected?
Right, so when we talked about that initial dilution in the tangible book value per share, we were looking at the Simmons transaction and isolation. There are other things that impact our tangible book value per share. For example, annual grant issuance is part of our compensation which happens in February that added just under $40 million to equity, so that was - I would say probably that primary driver of what drove it outside of the Simmons transaction.
Got it, okay. That makes sense. And then sticking with the capital markets side of the business here, Andrew you mentioned that with credit spreads gapping out that some of the credit sensitive products, you recognizing trading losses there. Would you mind quantifying that for us to so it’s got a little bit better feel for the fixed income sales and trading now that you’ve got GKST in the mix?
So couple of things I’d say Mike is that from a flow activity the ramp with the additional salespeople and trading capabilities is very much in line with what we would have anticipated. The productivity of the group is actually ahead of what we would've participated. The trading P&L in the quarter was challenged across all our fixed income trading we were profitable, but less than we typically would be and part of that is just the level of volatility in the gap and in a couple of products.
We have been largely interest-rate neutral. We have hedged out reasonable portion of the credit exposure, but you literally had some gapping in areas of hundreds of basis points in matter of 10, 15 days. That shows up in our P&L. I guess I wouldn't quantify to the dollar to say that another profitable quarter, but significantly impacted by the volatility and the lack of opportunity. We tend to bring capital into that business when we see opportunities and what we saw was volatility, so little less capital in the business in the quarter.
Got it. But overall you did state the trading P&L was roughly neutral?
Yes, throughout our fixed income.
Got it. Okay. And then moving on to the investment income and I know that you guys made an investment into MLP strategy a couple quarters ago. Is there been any change in the size of that investment some of you guys able to shrink that it all?
Yes, we moderated it fairly meaningfully and have a strategy now that did consistently appreciating again, we intend to keep moderating it, but the asset is substantially moderated.
Got it. And once that completely wound down I mean is that your intention to look for ways to lever the balance sheet in a similar manner or do you sort of that way from that strategy?
So that was outsized for us, what we’d typically do with our asset management products is putting a more modest investment might to help see their product that to help build the track record and then attract other assets, and any other occasionally - clients are very drawn to a fact that the former employees put capital in our own strategies. This was outsized. Is the convergence of a number of things?
There were some additional institutional interests that’s really been developing in MLPs, and they were interested if the firm saw that same opportunity and we had excess capital waiting to go into the Simmons investment. We did not get the timing right, but it was relatively unusual for us to do. So the short answer would be that would be unlikely, prospectively. We have more modest, quite diversified investments unlikely to do that.
Understood. And last one for me sort of a housekeeping item, but maybe I missed a bit did you guys breakout the end of period AUM between the MLP in the equity strategies? And if you Deb, could you?
Yes, we did not, but I have - so end of the period total AUM of $7.5 billion versus $3.5 billion in MLP, and $4 billion in value strategies.
Got it. Thank you very much. That’s it for me.
All right. Thank you.
And at this time, we have no further questions. I will turn the conference back over to you for closing remarks.
Thank you very much for joining us today.
Once again, we’d like to thank you for your participation on today’s conference call. You may now disconnect.
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