Piper Jaffray Companies — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. The filing is for Piper Jaffray Companies, before its later name change to Piper Sandler. The firm reported one segment, Capital Markets, providing investment banking and institutional securities services. ARI, its traditional asset management business, is presented as discontinued operations.
Financial performance
- Third quarter: Continuing-operations net revenue was $200.7 million, down 2.5% year over year. Pre-tax income was $21.0 million versus $27.8 million; pre-tax margin was 10.5%, down from 13.5%. Continuing-operations income attributable to the company was $17.2 million, or $1.20 diluted EPS, compared with $20.6 million, or $1.34.
- Reported Q3 earnings: Net income attributable to the company was $43.2 million and diluted EPS was $3.01, including $26.1 million, or $1.82 per diluted share, from discontinued operations. That discontinued-operations result included a $33.0 million after-tax gain on the ARI sales. Adjusted diluted EPS, a non-GAAP measure, was $1.64 versus $1.70.
- First nine months: Continuing-operations net revenue was $555.7 million, up 5.6%; pre-tax income was $65.1 million versus $40.8 million, and pre-tax margin improved to 11.7% from 7.8%. Continuing-operations income attributable to the company was $49.3 million, or $3.37 diluted EPS. Reported net income attributable to the company was $73.1 million, or $5.01 diluted EPS, including $23.8 million from discontinued operations. Adjusted diluted EPS was $4.47 versus $3.83.
- Revenue mix: Q3 investment banking revenue fell 9.2% to $151.2 million, as lower advisory and equity financing were partly offset by higher debt financing. Institutional brokerage rose 47.5% to $46.8 million, reflecting stronger equity and fixed-income activity and the Weeden acquisition. For the nine months, institutional brokerage rose 23.1% to $114.0 million; investment banking was essentially flat at $411.0 million.
- Expenses and taxes: Q3 compensation expense decreased 4.9% to $126.9 million, while non-interest expense rose 0.9% to $179.7 million, including $6.1 million of restructuring and integration costs. Nine-month non-interest expense increased 1.1% to $490.6 million, including $12.5 million of those costs. The nine-month continuing-operations tax provision was $10.7 million and included a $5.1 million benefit from stock-based compensation vesting.
- Cash flow: Operating cash flow for the first nine months was $18.2 million, compared with $360.4 million a year earlier. Investing activities provided $29.3 million, including $52.9 million of ARI sale proceeds, partly offset by $18.6 million for acquisitions. Financing activities used $73.4 million, including $30.4 million of dividends and $50.3 million of share purchases, principally employee tax-withholding repurchases. Cash ended at $24.0 million, down from $50.4 million at year-end 2018.
- Balance sheet and liquidity: At September 30, assets were $1.344 billion, liabilities $581.7 million, and total equity $762.1 million. Short-term financing was $50.0 million; the company also reported $182.4 million of Pershing financing and $103.4 million under prime-broker arrangements. It had no advances against its $175 million committed revolving credit facility. Regulatory net capital was $179.9 million, $178.9 million above the SEC minimum. Leverage ratio was 1.8 and adjusted leverage ratio 1.9.
- Dividends: The company declared $1.125 per share in quarterly dividends and a $1.01 per-share special dividend during the first nine months. A further $0.375 per-share dividend was declared October 30, payable December 13, 2019.
Material changes and significant events
- The company completed the sale of ARI in two transactions in September for $52.9 million in cash proceeds. Potential additional consideration includes an MLP earnout of up to $35.7 million, a further payment tied to certain sub-advised accounts, and equity-strategy revenue-based payments of up to $10.0 million over four years. The estimated fair value of the latter earnout was $2.2 million.
- Weeden & Co. was acquired on August 2, 2019, adding equity trading and execution capabilities. The stated economic value was approximately $42.0 million; the company recorded $6.4 million of goodwill and $15.2 million of acquired intangible assets. Up to $31.5 million of additional compensation may be payable subject to a revenue target and service conditions.
- The company agreed to acquire Sandler O’Neill for total consideration of $485 million, including $350 million cash and $135 million of restricted consideration, and agreed to provide $115 million of additional restricted retention awards. Closing was expected in early Q1 2020, subject to approvals and customary conditions.
- On October 15, 2019, after quarter-end, the company issued $175 million of unsecured senior notes: $50 million at 4.74% due in 2021 and $125 million at 5.20% due in 2023. Proceeds were intended to fund part of the Sandler O’Neill cash consideration. The notes include financial and regulatory covenants and cannot be prepaid.
- Operating lease accounting was adopted January 1, 2019, adding a $41.7 million right-of-use asset and $59.2 million lease liability at quarter-end. The filing says adoption did not change rent expense or Piper Jaffray’s net capital position.
Outlook, risks and contingencies
- Management expected moderate U.S. economic growth near term, while highlighting trade-policy uncertainty, Brexit negotiations, global deceleration, market volatility, and interest-rate and credit-spread movements. It did not provide earnings or revenue guidance.
- Management said its advisory pipeline remained strong and expected advisory and public finance activity to perform well for the rest of 2019. It noted that deal timing can cause quarterly volatility; equity capital raising had been affected by market volatility and weak IPO after-market performance. Low-touch execution and separately purchased research continued to affect equity brokerage seasonality.
- Management expected further restructuring and integration costs in Q4 2019 and the first half of 2020. The new senior notes were expected to add financing expense beginning in Q4. The committed credit facility was due December 13, 2019; management anticipated renewal for another year.
- Risks include market and liquidity volatility, reliance on secured or discretionary funding from clearing and prime-broker counterparties, potential inventory illiquidity, and counterparty credit exposure. Uncollateralized derivative credit exposure was $22.0 million, including $18.5 million with one counterparty. Trading losses exceeded the one-day VaR measure on five occasions in the first nine months; reported VaR does not cap potential losses.
- The company reported pending legal and regulatory matters and said reasonably possible losses in excess of accruals were not material. Management believed currently known matters would not have a material adverse effect, while cautioning that outcomes and estimates remain uncertain. Disclosure controls were assessed as effective; no material Q3 change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Separate recurring continuing-operations performance from reported earnings boosted by the ARI sale gain; review the company’s non-GAAP reconciliations alongside GAAP results.
- Track whether the ARI earnouts are achieved and the cash proceeds realized, and whether Weeden delivers expected revenue and integration benefits.
- Verify Sandler O’Neill closing, final consideration and financing needs, including the effect of the $175 million notes, covenants, and resulting interest expense.
- Monitor operating cash flow, seasonal compensation payments, liquidity sources and renewals, and broker-dealer capital headroom against facility and clearing covenants.
- Assess exposure to market volatility, illiquid inventory, derivative counterparties, legal matters, and additional integration costs; review future results against management’s stated pipeline and market commentary.