Piper Jaffray Companies — Form 10-Q summary
Business context and period: The filing is by Piper Jaffray Companies, the issuer named in the 2011 report; it is not identified in the filing as Piper Sandler. The report covers the quarter and nine months ended September 30, 2011. The company operated Capital Markets and Asset Management businesses, providing investment banking, institutional brokerage and asset management services.
Financial performance and position
- Third quarter: Net revenues were $98.2 million, down 15.7% year over year. The company recorded a $3.6 million net loss attributable to Piper Jaffray Companies, or $0.23 per common share, versus $7.1 million of income a year earlier. Pre-tax income was $0.3 million; non-interest expenses were $97.9 million. Compensation and benefits equaled 66.5% of net revenues, versus 56.7% in the prior-year quarter.
- First nine months: Net revenues were $358.9 million, up 1.5%; net income attributable to Piper Jaffray Companies was $14.3 million, down 4.0%, and diluted EPS was $0.74 versus $0.75. Pre-tax income was $29.0 million, down 15.1%. The effective tax rate was 47.6%, compared with 57.5%.
- Revenue mix: Q3 investment banking revenue fell 20.5% to $44.7 million and institutional brokerage fell 22.0% to $31.5 million; asset management revenue declined 9.6% to $15.2 million. For the nine months, asset management revenue rose 26.1% to $52.8 million, mainly reflecting a full-period contribution from the 2010 ARI acquisition; investment banking and institutional brokerage fell 7.5% and 3.8%, respectively.
- Segments: Q3 Capital Markets generated $84.5 million of net revenue and a $0.4 million pre-tax loss (negative 0.4% margin); Asset Management generated $13.7 million of net revenue and $0.7 million of pre-tax income (4.9% margin). Nine-month pre-tax income was $19.1 million for Capital Markets and $9.9 million for Asset Management. Consolidated nine-month pre-tax margin was 8.1%, versus 9.6%.
- Cash flow: Operating activities used $120.4 million in the first nine months, versus $6.1 million provided a year earlier. The filing attributes major working-capital movements to inventory and related operating balances; net financial instruments and inventory positions used $267.6 million. Investing activities used $6.6 million, while financing activities provided $119.4 million, including increased repurchase-agreement funding. Cash and cash equivalents ended at $42.8 million, down $7.8 million from year-end 2010.
- Liquidity and debt: At September 30, cash and cash equivalents were $42.8 million, plus $9.0 million segregated for regulatory purposes. Short-term financing was $195.8 million and bank syndicated financing was $117.5 million; securities sold under repurchase agreements totaled $362.5 million. The company reported a $250 million committed secured revolving facility, with $68 million drawn, maturing December 30, 2011, and $128 million of secured commercial paper outstanding. It expected to renew the committed facility in Q4 2011. The company reported compliance with credit-agreement covenants and broker-dealer net capital of $207.7 million.
- Balance sheet: Total assets were $2.14 billion and total shareholders’ equity was $870.8 million. Management reported a 2.5x leverage ratio, calculated as total assets divided by total common shareholders’ equity.
Material changes and management commentary
- Management said uncertain macroeconomic conditions and increased volatility weighed on capital markets. It expected a challenging remainder of 2011, citing European sovereign-debt concerns, a slower U.S. recovery, weak equity issuance, difficult municipal underwriting, and pressure on asset-management fees if equity prices remained low.
- Q3 volatility lifted equity sales-and-trading volumes but curtailed equity financing, especially IPO activity in the U.S. and Hong Kong. The company completed 9 equity financings totaling $895 million, compared with 17 totaling $2.6 billion a year earlier. Municipal public-finance activity was also weak; management expected that market to remain difficult.
- Q3 advisory revenue rose 32.5% to $27.3 million, but lower financing and fixed-income brokerage revenue reduced Capital Markets results. Management warned that the business mix and operating environment could continue to pressure Capital Markets margins.
- Assets under management declined to $11.2 billion at September 30 from $12.3 billion at year-end 2010, reflecting $574 million of net outflows and $512 million of market depreciation over the nine months. Management reported that key strategies outperformed their benchmarks over that period.
- The European business was refocused in late 2010 on distributing U.S. and Asian securities and M&A advisory; management said it returned to profitability in the first nine months of 2011.
- Q3 tax expense included a $2.3 million valuation allowance against the Hong Kong subsidiary’s deferred tax asset, partly offset by a $1.1 million reversal of a U.K. valuation allowance. Management estimated about $4.9 million of tax expense in Q1 2012 related to shares expected to vest below grant-date value, based on the share price at September 30; the amount depends on the price at vesting.
Risks, contingencies and unusual items
- The DOJ, SEC and state attorneys general were investigating numerous firms, including Piper Jaffray, concerning municipal derivatives and guaranteed investment contracts; related class actions were pending. Management considered a material loss reasonably possible, but said no loss or range could be estimated and recorded no contingency.
- The company disclosed $35.0 million of uncollateralized derivative counterparty credit exposure, including $17.7 million with one counterparty. It noted that collateralization and hedging do not eliminate counterparty or market risk.
- Level III fair-value assets were $107.7 million at September 30, including $67.2 million of asset-backed securities; these valuations rely in part on unobservable inputs and management judgment. The filing also noted that market conditions and declining profitability could create future goodwill impairment risk; no impairment was reported.
- Q3 2010 included a $6.6 million compensation-expense reversal for performance-based awards, complicating year-over-year comparisons of compensation ratios. The 2010 period also included a $5.6 million deferred-tax-asset write-off that contributed to its higher nine-month effective tax rate.
- The company described market, liquidity, credit, operational, legal, regulatory and reputational risks. Its one-day 95% confidence VaR was $1.1 million at September 30, 2011; trading losses exceeded one-day VaR on nine occasions in the first nine months. Management cautioned that actual losses can exceed VaR.
Most important facts for investors to verify
- Whether the committed $250 million secured facility was renewed or refinanced before its December 30, 2011 maturity, and on what terms.
- Subsequent quarterly trends in underwriting, advisory and brokerage revenues, Capital Markets profitability, and compensation as a share of revenue.
- Changes in assets under management, client outflows, market depreciation and resulting management-fee revenue.
- Developments in the municipal-derivatives investigations and litigation, including whether a loss becomes estimable or probable.
- Changes in derivative counterparty exposures, Level III valuations, and any goodwill impairment indicators.
- The eventual tax impact of restricted-stock vesting and the recoverability of foreign deferred tax assets.