Summary of KBW, INC. - Yahoo! Finance

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes included elsewhere in this report.
Cautionary Statement Regarding Forward-Looking Statements We have made statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in other sections of this report that are forward-looking statements. In some cases, you can identify these statements by forward-looking words such as "may," "might," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential" or "continue," the negative of these terms and other comparable terminology. These forward-looking statements, which are based on various underlying assumptions and expectations and are subject to risks, uncertainties and other unknown factors, may include projections of our future financial performance based on our growth strategies and anticipated trends in our business. These statements are only predictions based on our current expectations and projections about future events. There are or may be important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the historical or future results, level of activity, performance or achievements expressed or implied by such forward-looking statements. These factors include, but are not limited to, those discussed in the section entitled "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008.
Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy or completeness of any of these forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. We are under no duty to update any of these forward-looking statements after the date of filing of this report to conform such statements to actual results or revised expectations. Overview
We are a leading full service investment bank specializing in the financial services industry. Our principal activities are: (i) investment banking, including mergers and acquisitions ("M&A") and other strategic advisory services, equity and fixed income securities offerings, and mutual thrift conversions, (ii) equity and fixed income sales and trading, (iii) research that provides fundamental, objective analysis that identifies investment opportunities and helps our investor customers make better investment decisions, and (iv) asset management, including investment management and other advisory services to institutional clients and private high net worth clients and various investment vehicles.
Within our full service business model, our focus includes bank and thrift holding companies, banking companies, thrift institutions, insurance companies, broker-dealers, mortgage banks, asset management companies, mortgage and equity real estate investment trusts, consumer and specialty finance firms, financial processing companies and securities exchanges. We emphasize serving investment banking clients in the small and mid cap segments of the financial services industry although our clients also include many large-cap companies. Our sales customers are primarily institutional investors.
Most revenues with respect to our services provided are primarily determined as a result of active competition in the marketplace. Our revenues are primarily generated through advisory, underwriting and private placement fees earned through our investment banking activities, commissions earned on equity sales and trading activities, interest and dividends earned on our securities' inventories and profit and losses from trading activities related to the securities' inventories.
Our largest expense is compensation and benefits. Our performance is dependant on our ability to attract, develop and retain highly skilled employees who are motivated to provide quality service and guidance to our clients.
Many external factors affect our revenues and profitability. Such factors include equity and fixed income trading prices and volumes, the volatility of these markets, the level and shape of the yield curve, political events and regulatory developments, including recent government participation in providing capital to financial institutions, and competition. These factors influence our investment banking operations in that such factors affect the number and timing of equity and fixed income securities issuances and M&A activity within the financial services industry. These same factors also affect our sales and trading business by impacting equity and fixed income trading prices and volumes and valuations in secondary financial markets. Commission rates, market volatility and other factors also affect our sales and trading revenues. These market forces may cause our revenues and earnings to fluctuate significantly from period to period and the results of any one period should not be considered indicative of future results. See "-Business Environment." A significant portion of our expense base is variable, including employee compensation and benefits, brokerage and clearance, communication and data processing and business development expenses. Our remaining costs generally do not directly relate to the service revenues earned.

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Certain data processing systems that support equity and fixed income trading, research, payroll, human resources and employee benefits are service bureau based and are operated in the vendors' data centers. We believe that this stabilizes our fixed costs associated with data processing. We also license vendor information databases to support investment banking, sales and trading and research. Vendors may, at the end of contractual terms, terminate our rights or modify or significantly alter product and service offerings or related fees, which may affect our ongoing business activities or related costs. Business Environment
Our business activities focus on the financial services sector, the landscape of which, in the U.S. and globally, has continued to evolve since the global financial crisis began in 2007. The financial services sector in the third quarter of 2009 reflected a continuation of the trend that began in the first half, with some stabilization and return of market confidence and active capital markets transactions reflecting the recapitalization of selected companies. In particular there have been significant improvements in the equity and credit markets for securities of financial services companies. The Company continued to be very active in capital markets transactions, participating in 28 public capital raises during the third quarter of 2009. However, the sector remains under stress and the market stability and continuation of current trends is not certain. The valuation of certain classes of assets remains uncertain and loss reserves have been increasing reflecting continuing concerns in the credit quality of commercial real estate and personal lending and securitization markets have not broadly reopened. U.S. unemployment remains high and lenders have not widely reopened consumer and commercial credit.
In the U.S., the financial services sector remains highly fragmented. There are approximately 1,050 publicly traded banks and thrifts and approximately 8,200 different banking entities in the U.S. Because of our focus, we are particularly impacted by economic and market conditions affecting this sector. Although many larger financial institutions have succeeded in recapitalizing and have repaid government assistance, there continues to be bank failures among smaller institutions. Trends in the global economy and domestic and international financial markets have a significant impact on the outlook for financial services, including the market prices for our securities and the securities of other companies in the sector. During the third quarter of 2009, in the U.S., select small and mid size financial institutions have sought to recapitalize and we have participated in many offerings for companies in the bank and REIT segments of the financial services sector.
Globally, actions by various government agencies and central banks have been implemented with a view to restoring capital, creating market liquidity and opening credit sources. While certain financial institutions have accessed additional capital, there is likely to be continued stress in many of these markets.
It is difficult to predict how long these conditions will continue or whether additional deteriorations in asset quality, further credit market dislocations or sustained market downturns may exacerbate the impact of these factors on our overall revenues. Even with the market stabilization in recent quarters, there has not been a significant return of M&A activity. During the third quarter of 2009, many financial institutions have reported operating profitability, although others reported significant losses, in particular resulting from increases to loan loss reserves. There have been no further failures of large financial institutions in the US. It is likely that there will be significant changes imposed in the regulation of financial institutions in the U.S. in the future, including the emergence of new regulatory entities with broader oversight and more stringent capital requirements. We believe that we are well capitalized and remain well positioned to assist in capital markets and M&A transactions for the financial services industry in both the U.S. and Europe.

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Results of Operations
Three Months Ended September 30, 2009 Compared with Three Months Ended September 30, 2008
Overview
Total revenues increased $69.0 million, or 128.7%, to $122.6 million for the three months ended September 30, 2009 compared with $53.6 million for the three months ended September 30, 2008. The increase was primarily due to revenue of $23.7 million in principal transactions, net in 2009, a substantial improvement compared to negative revenues of $53.8 million in 2008, and an increase in investment banking revenues of $11.7 million, partially offset by a decrease in commissions revenue of $17.9 million.
Total expenses were $101.1 million for the three months ended September 30, 2009 compared with $91.8 million for the three months ended September 30, 2008. The increase was due to a $13.5 million increase in compensation and benefits expense, partially offset by a $4.2 million decrease in non-compensation expenses.
We recorded net income of $11.9 million, or $0.33 per diluted share, for the three months ended September 30, 2009 compared with a net loss of $23.0 million, or $0.75 per diluted share, for the third quarter of 2008. After adjusting for the 2006 one-time restricted stock awards granted to employees in connection with our initial public offering ("IPO"), our non-GAAP operating net income was $13.4 million, or $0.37 per diluted share, for the three months ended September 30, 2009, compared with a net loss of $21.3 million, or $0.69 per diluted share, for the same period in 2008. See "-Three Month Non-GAAP Financial Measures" for a reconciliation of our non-GAAP measures to their corresponding GAAP amounts. The following table provides a comparison of our revenues and expenses for the periods presented (dollars in thousands):

                                          Three Months Ended
                                             September 30,              Period-to-Period
                                          2009          2008        $ Change       % Change
                                                            (unaudited)
  Revenues:
  Investment banking                    $  57,785     $  46,042     $  11,743           25.5 %
  Commissions                              36,595        54,527       (17,932 )        (32.9 )
  Principal transactions, net              23,675       (53,836 )      77,511            N/M
  Interest and dividend income              2,655         5,891        (3,236 )        (54.9 )
  Investment advisory fees                    341           222           119           53.6
  Other                                     1,588           789           799          101.3

  Total revenues                          122,639        53,635        69,004          128.7


  Expenses:
  Compensation and benefits                73,819        60,318        13,501           22.4

  Non-compensation expenses:
  Occupancy and equipment                   5,567         5,297           270            5.1
  Communications and data processing        7,399         7,290           109            1.5
  Brokerage and clearance                   4,939         6,039        (1,100 )        (18.2 )
  Business development                      4,427         5,054          (627 )        (12.4 )
  Interest                                    135           871          (736 )        (84.5 )
  Other                                     4,829         6,902        (2,073 )        (30.0 )

  Non-compensation expenses                27,296        31,453        (4,157 )        (13.2 )

  Total expenses                          101,115        91,771         9,344           10.2

  Income / (loss) before income taxes      21,524       (38,136 )      59,660            N/M
  Income tax expense / (benefit)            9,630       (15,136 )      24,766            N/M

  Net income / (loss)                   $  11,894     $ (23,000 )   $  34,894            N/M %

N/M = Not Meaningful

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Three Month Non-GAAP Financial Measures
Compensation cost for stock-based awards are measured at fair value on the date of grant and recognized as compensation expense over the requisite service period, net of estimated forfeitures.
We reported our compensation and benefits expense, income / (loss) before income taxes, income tax expense / (benefit), net income / (loss), compensation ratio and basic and diluted earnings per share on a non-GAAP basis for the three and nine months ended September 30, 2009 and 2008 in our October 29, 2009 press release. The non-GAAP amounts excludes compensation expense related to the amortization of IPO restricted stock awards granted in November 2006.
Our management has utilized such non-GAAP calculations as an additional device to aid in understanding and analyzing our financial results for the period ended September 30, 2009. Specifically, our management believes that these non-GAAP measures provide useful information by excluding certain items that may not be indicative of our core operating results and business outlook. Our management believes that these non-GAAP measures will allow for a better evaluation of the operating performance of our business and facilitate meaningful comparison of our results in the current period to those in prior and future periods. Such periods did not in the past, and likely will not in the future include substantial grants of restricted stock awards to employees such as the Company-wide IPO restricted stock awards. Our reference to these non-GAAP measures should not be considered as a substitute for results that are presented in a manner consistent with GAAP. These non-GAAP measures are provided to enhance investors' overall understanding of our current financial performance.
A limitation of utilizing these non-GAAP measures is that the determination of these amounts in accordance with GAAP reflects the underlying financial results of our business. These effects should not be ignored in evaluating and analyzing our financial results. Therefore, management believes that, with respect to the items set forth in the table below, both our GAAP and respective non-GAAP measures should be considered together.
The following table provides details with respect to reconciling compensation and benefits expense, income / (loss) before income taxes, income tax expense / (benefit), net income / (loss), compensation ratio and basic and diluted earnings per share on a non-GAAP basis for the three months ended September 30, 2009 and 2008.

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                                                            GAAP              Reconciliation Amount              Non-GAAP
                                                               (dollars in thousands, except per share information)
Three months ended September 30, 2009:
Compensation and benefits expense                       $      73,819        $               (2,689) (a)       $     71,130

Income before income taxes                              $      21,524        $                 2,689 (a)       $     24,213
Income tax expense                                      $       9,630        $                 1,136 (b)       $     10,766

Net income                                              $      11,894        $                 1,553 (c)       $     13,447

Compensation ratio (d):                                          60.2 %                                                58.0 %

Earnings per share (e):
Basic                                                   $        0.33        $                  0.04           $       0.37
Diluted                                                 $        0.33        $                  0.04           $       0.37

Weighted average number of common shares
outstanding (e):
Basic                                                      31,410,337                              - (f)         31,410,337
Diluted                                                    31,410,337                              - (f)         31,410,337

Three months ended September 30, 2008:
Compensation and benefits expense                       $      60,318        $                (2,843 )(a)      $     57,475

(Loss) / income before income taxes                     $     (38,136 )      $                 2,843 (a)       $    (35,293 )
Income tax (benefit) / expense                          $     (15,136 )      $                 1,145 (b)       $    (13,991 )

Net (loss) / income                                     $     (23,000 )      $                 1,698 (c)       $    (21,302 )

Compensation ratio (d):                                         112.5 %                                               107.2 %

Earnings per share (e):
Basic                                                   $       (0.75 )      $                  0.06           $      (0.69 )
Diluted                                                 $       (0.75 )      $                  0.06           $      (0.69 )

Weighted average number of common shares
outstanding (e):
Basic                                                      30,794,738                              - (f)         30,794,738
Diluted                                                    30,794,738                              - (f)         30,794,738

(a) The non-GAAP adjustment represents the pre-tax expense with respect to the amortization of the IPO restricted stock awards granted to employees on November 2006.

(b) The non-GAAP adjustment with respect to income tax expense / (benefit) represents the elimination of the tax expense / (benefit) resulting from the amortization of the IPO restricted stock awards in the period.

(c) The non-GAAP adjustment with respect to net income / (loss) was the after-tax amortization of the IPO restricted stock awards in the period.

(d) The third quarter 2009 and 2008 compensation ratios were calculated by dividing compensation and benefits expense by total revenues of $122,639 and $53,635 respectively.

(e) Basic and diluted common shares outstanding were equal for each respective period under the two-class method.

(f) Both the basic and diluted weighted average number of common shares outstanding were not adjusted.

Our management utilizes these non-GAAP calculations in understanding and analyzing our financial results. Our management believes that the non-GAAP measures provide useful information by excluding certain items that may not be indicative of our core operating results and business outlook. Our management believes that these GAAP measures will allow for a better evaluation of the operating performance of our business and facilitate meaningful comparison of our results in the current period to those in prior periods and future periods. Our reference to these non-GAAP measures should not be considered as a substitute for results that are presented in a manner consistent with GAAP. These non-GAAP measures are provided to enhance investors' overall understanding of our current financial performance.

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A limitation of utilizing these non-GAAP measures is that the GAAP accounting effects of these events do in fact reflect the underlying financial results of our business and these effects should not be ignored in evaluating and analyzing our financial results. Therefore, management believes that our GAAP measures of compensation and benefits expense, income / (loss) before income taxes, income tax expense / (benefit), net income / (loss), and basic and diluted earnings per share and the same respective non-GAAP measures of our financial performance should be considered together.
We expect to grant restricted stock awards and other share-based compensation in the future. We do not expect to make any such substantial grants to employees outside of our regular compensation and hiring process, as we did when we granted IPO restricted stock awards.
Revenues
Investment Banking
Investment banking revenue increased $11.7 million, or 25.5%, to $57.8 million for the three months ended September 30, 2009 compared with $46.0 million for the same period in 2008. Capital markets revenue increased $16.3 million, or 46.0%, to $51.7 million for the three months ended September 30, 2009 compared with $35.4 million for the same period in 2008. The 2009 increase reflects the completion of a record number of equity capital market transactions when 28 capital markets transactions were completed compared with 8 for same period in 2008. M&A and advisory revenue was $6.1 million for the three months ended September 30, 2009 compared with $10.6 million for the same period in 2008. This decrease was primarily due to a decline in completed mergers and acquisitions and the smaller average size of transactions that closed in the third quarter of 2009 compared with the same period in 2008.
Commissions
Commissions revenue was $36.6 million for the three months ended September 30, 2009 compared with $54.5 million for the same period in 2008, a decrease of $17.9 million, or 32.9%. U.S. equity commissions were $25.5 million for the three months ended September 30, 2009 compared with $36.8 million for the same 2008 period, a decrease of $11.3 million, or 30.7%, reflecting lower trading volume due to lower levels of market volatility and a less favorable mix of order flow. European equity commissions were $11.1 million for the three months ended September 30, 2009 compared with $17.7 million for the same period in 2008, a decrease of $6.6 million, or 37.3%, reflecting the lower value of most European financial services stocks on which our European commissions are based and the impact of translating our non-U.S. commissions revenues to U.S. dollars at less favorable exchange rates in 2009 compared to 2008.
Principal Transactions, Net
Principal transactions, net resulted in revenue of $23.7 million for the three months ended September 30, 2009 compared to a net loss of $53.8 million for the same period in 2008. The net gain in the current quarter reflects the absence of significant negative valuation adjustments on certain financial instruments owned, primarily related to trust preferred backed collateralized debt obligations and related securities, and higher revenue from our fixed income customer business. Our fixed income revenue was $16.2 million for the three months ended September 30, 2009 compared to $3.9 million for the same period in 2008, reflecting strong client-driven activity as credit markets continued to improve. Our equity market making activity resulted in a loss of $2.9 million for the three months ended September 30, 2009 compared to a loss of $1.2 million for the same period in 2008. Trading for our own account, including firm investments, resulted in a net gain of $10.4 million for the three months ended September 30, 2009 compared to a net loss of $6.3 million for the same period in 2008, reflecting an improved trading environment. The change in the fair value of our trust preferred backed collateralized debt obligations and related securities owned was nil for the three months ended September 30, 2009 compared to a loss of $50.6 million for the same period in 2008, reflecting improved market conditions and continued stability of issuer credit quality in the third quarter of 2009. At September 30, 2009, our trust preferred backed collateralized debt obligations and related securities owned were carried at an aggregate fair value of approximately $31 million (or 23% of original par value or an unrealized loss of approximately $103 million).
Interest and Dividend Income
Interest and dividend income was $2.7 million for the three months ended September 30, 2009, a decrease of $3.2 million, or 54.9%, compared with $5.9 million for the three months ended September 30, 2008. The decrease was primarily due to significantly reduced interest rates compared with the third quarter of 2008.

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Other
Other revenues increased $0.8 million to $1.6 million for the three months ended September 30, 2009 compared with $0.8 million for the three months ended September 30, 2008. The increase was primarily due to higher loan portfolio sales fees compared with the third quarter of 2008. Expenses
Compensation and Benefits
Compensation and benefits expense was $73.8 million, an increase of $13.5 million, or 22.4% for the three months ended September 30, 2009 compared with $60.3 million for the three months ended September 30, 2008, reflecting higher revenues. Compensation and benefits as a percentage of total revenue, after adjusting for expenses associated with the IPO restricted stock awards, was 58.0% in the third quarter of 2009 compared to 107.2% in the same 2008 period. See "-Three Month Non-GAAP Financial Measures" for a reconciliation of our non-GAAP measures to their corresponding GAAP amounts.
Brokerage and Clearance
Brokerage and clearance expense decreased $1.1 million, or 18.2%, to $4.9 million for the three months ended September 30, 2009 compared with $6.0 million for the three months ended September 30, 2008. This decrease was primarily a result of lower trading volume in the third quarter of 2009 compared with the third quarter of 2008.
Business Development
Business development expense decreased $0.6 million, or 12.4% , to $4.4 million for the three months ended September 30, 2009 compared with $5.1 million for the same 2008 period. The decrease was primarily due to lower travel and entertainment expenses for the third quarter of 2009 relative to 2008.
Interest
Interest expense decreased $0.7 million to $0.1 million for the three months ended September 30, 2009 compared with $0.9 million for the three months ended September 30, 2008. The decrease was primarily due to lower average balances of securities sold under repurchased agreements and short-term borrowings and . . .