Business context and reporting period
Filing entity: Piper Jaffray Companies (the 2010 filing does not identify the registrant as Piper Sandler). This unaudited Form 10-Q covers the quarter and six months ended June 30, 2010. The company operates Capital Markets and Asset Management businesses.
On March 1, 2010, the company acquired Advisory Research Holdings, Inc. (ARI), expanding Asset Management. The acquisition was valued at $212.1 million, including $180.3 million cash and $31.8 million in company shares.
Financial performance and condition
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenues | $135.8 million | $134.3 million | $251.9 million | $220.3 million |
| Net revenues | $127.7 million | $132.3 million | $237.2 million | $216.2 million |
| Income before taxes | $11.8 million | $18.4 million | $21.0 million | $22.0 million |
| Net income | $7.4 million | $11.6 million | $7.9 million | $8.9 million |
| Diluted EPS | $0.36 | $0.59 | $0.39 | $0.45 |
- Revenue mix: Q2 investment banking revenue rose 15.4% to $71.7 million; institutional brokerage fell 47.3% to $32.1 million, principally reflecting weaker fixed-income trading. Asset management revenue rose to $15.9 million from $3.2 million, primarily due to ARI. For the first half, investment banking revenue increased 33.5% and asset management revenue increased 300.5%, while institutional brokerage declined 29.9%.
- Margins and expenses: Q2 pretax margin was 9.3% of net revenues, versus 13.9% a year earlier; first-half pretax margin was 8.8%, versus 10.2%. Non-interest expenses rose 1.7% in Q2 and 11.3% in the first half. Compensation was 60.9% of Q2 net revenues and 60.2% for the first half.
- Taxes: The first-half effective tax rate was 62.4%, including a $5.3 million write-off of a deferred tax asset related to restricted shares vesting below grant-date value. Q2 effective tax rate was 37.7%.
- Cash flow: First-half operating cash flow was negative $15.0 million; investing cash flow was negative $184.8 million, mainly reflecting the ARI acquisition; financing cash flow was positive $203.4 million. Cash and cash equivalents ended June at $46.8 million, up from $43.9 million at year-end.
- Balance sheet and funding: Total assets were $2.00 billion and shareholders’ equity $817.0 million. Short-term financing was $57.1 million; variable-rate senior notes were $120 million, due December 31, 2010, bearing LIBOR plus 4.10%. Repurchase liabilities were $323.1 million. The company reported a 2.5x assets-to-equity leverage ratio and $241.9 million of U.S. broker-dealer net capital, $240.9 million above the regulatory minimum. It was in compliance with financing covenants.
Material changes versus the prior comparable period
- Q2 net revenues declined 3.5%, pretax income declined 35.7%, and net income declined 36.3% year over year. First-half net revenues increased 9.7%, but pretax income declined 4.4% and net income declined 10.9%.
- ARI contributed $15.8 million of net revenues and $3.7 million of net income after acquisition. Goodwill increased to $316.9 million, including $152.3 million recorded for ARI; acquired identifiable intangibles were $55.1 million.
- Assets under management ended June at $11.8 billion, up from $6.9 billion at year-end, mainly from ARI. In Q2, AUM declined $1.0 billion, reflecting $742 million market depreciation and $260 million net outflows.
- First-half repurchases totaled $30.0 million. The prior authorization expired June 30; the board approved a new authorization of up to $75 million on July 28, 2010, expiring September 30, 2012.
Outlook, risks, contingencies, and unusual items
- Management gave no quantified earnings or revenue guidance. It said investment banking backlogs remained strong but required constructive capital markets to convert to revenue. It expected fixed-income market volatility and municipal institutional brokerage pressure to continue through the second half of 2010.
- Management cited a shift toward higher-compensation investment banking revenue as a source of pressure on compensation ratios and Capital Markets margins. It also expected higher occupancy costs from office transitions in New York and Hong Kong.
- Risks include market and trading volatility, credit and liquidity conditions, counterparty exposure, valuation uncertainty in less-liquid assets, and increased financial-industry regulation under Dodd-Frank. Model-based one-day VaR was $1.76 million at June 30; trading losses exceeded VaR on two days in the first half. The filing cautions that actual losses can exceed VaR.
- Uncollateralized derivative credit exposure was $27.3 million, including $13.8 million to one counterparty. Separately, a $5.5 million private-company debt investment was in default; management believed collateral value exceeded the loan and recorded no impairment.
- The company disclosed various legal, arbitration, and regulatory matters, including claims seeking potentially substantial unspecified damages. Management believed, after considering reserves and consulting counsel, that resolution would not materially harm financial condition; excess losses could materially affect results.
- The company had no advances on its $250 million committed secured revolver at quarter-end; the facility was due September 30, 2010. The $120 million senior notes were due December 31, 2010. The company had no credit rating, which management said could constrain funding access or increase borrowing costs.
- ARI’s separate accounting systems represented a material change to internal controls. Management said disclosure controls were effective and planned to complete its review of ARI financial-reporting controls by December 31, 2010.
Important facts for investors to verify
- ARI’s ongoing revenue, earnings contribution, integration, and final purchase accounting, including goodwill and intangible-asset assumptions.
- Repayment or refinancing plans for the $120 million notes due December 2010 and renewal or replacement of the committed revolver due September 2010.
- Whether fixed-income trading weakness and AUM outflows or market depreciation persist, and how these affect segment profitability.
- Potential losses from derivative counterparties, the defaulted private debt investment, Level III valuations, and legal or regulatory matters.
- Completion and results of the ARI internal-control review, and the effect of the new share-repurchase authorization on capital and liquidity.