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PJC > SEC Filings for PJC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for PIPER JAFFRAY COMPANIES

Form 10-Q for PIPER JAFFRAY COMPANIES


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following information should be read in conjunction with the accompanying unaudited consolidated financial statements and related notes and exhibits included elsewhere in this report. Certain statements in this report may be considered forward-looking. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These forward looking statements include, among other things, statements other than historical information or statements of current condition and may relate to our future plans and objectives and results, and also may include our belief regarding the effect of various legal proceedings, as set forth under "Legal Proceedings" in Part I, Item 3 of our Annual Report on Form 10-K for the year ended December 31, 2011 and in our subsequent reports filed with the SEC. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including those factors discussed below under "External Factors Impacting Our Business" as well as the factors identified under "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011, as updated in our subsequent reports filed with the SEC. These reports are available at our Web site at www.piperjaffray.com and at the SEC Web site at www.sec.gov. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events.

Executive Overview

Our continuing operations are principally engaged in providing investment banking, institutional brokerage, asset management and related financial services to corporations, private equity groups, public entities, non-profit entities and institutional investors in the United States and Europe. We operate through two reportable business segments:

Capital Markets - The Capital Markets segment provides institutional sales, trading and research services and investment banking services. Institutional sales, trading and research services focus on the trading of equity and fixed income products with institutions, government and non-profit entities. Revenues are generated through commissions and sales credits earned on equity and fixed income institutional sales activities, net interest revenues on trading securities held in inventory, and profits and losses from trading these securities. Investment banking services include management of and participation in underwritings, merger and acquisition services and public finance activities. Revenues are generated through the receipt of advisory and financing fees. Also, we generate revenue through strategic trading activities, which focus on proprietary investments in municipal bond securities and structured residential mortgages, and merchant banking activities, which involve proprietary debt or equity investments in late stage private companies. As certain of these efforts have matured and an investment process has been developed, we have created alternative asset management funds in order to invest firm capital as well as seek capital from outside investors. We have created three such funds, one in merchant banking and two in municipal securities. We receive management and performance fees for managing the funds.

As previously disclosed in August 2012, we have made the decision to shut down our Hong Kong capital markets business. As of September 30, 2012, the operations of this business have ceased. As a result of discontinuing the Hong Kong capital markets business, we will realize net cash proceeds of approximately $19.1 million, due principally to a U.S. tax benefit for the realized loss on the investment in our Hong Kong subsidiaries.

The results of our Hong Kong capital markets business, previously reported in the Capital Markets segment, are classified as discontinued operations for all periods presented. See Note 4 to our unaudited financial statements for further discussion of our discontinued operations.

Asset Management - The Asset Management segment provides traditional asset management services with product offerings in equity, master limited partnerships ("MLP") and fixed income securities to institutions and high net worth individuals through proprietary distribution channels. Revenues are generated in the form of management fees and performance fees. The majority of our performance fees, if earned, are generally recognized in the fourth quarter. Revenues are also generated through investments in the private funds or partnerships and registered funds that we manage.

Our business is a human capital business. Accordingly, compensation and benefits comprise the largest component of our expenses, and our performance is dependent upon our ability to attract, develop and retain highly skilled employees who are motivated and committed to providing the highest quality of service and guidance to our clients.


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Results for the three and nine months ended September 30, 2012

For the three months ended September 30, 2012, net income applicable to Piper Jaffray Companies, including continuing and discontinued operations, was $19.7 million, or $1.11 per diluted common share, compared with a net loss of $3.6 million or $0.23 per common share for the year-ago period. Net income applicable to Piper Jaffray Companies from continuing operations for the third quarter of 2012 was $12.9 million, or $0.72 per diluted common share, compared with net income applicable to Piper Jaffray Companies from continuing operations of $3.6 million, or $0.22 per diluted common share, for the prior-year period. Net revenues from continuing operations for the three months ended September 30, 2012 were $133.0 million, an increase of 38.7 percent from $95.9 million reported in the year-ago period, driven primarily by increased fixed income institutional brokerage revenues particularly related to strategic trading of non-agency mortgage-backed securities. For the three months ended September 30, 2012, non-compensation expenses from continuing operations increased 4.2 percent to $31.5 million, compared to $30.2 million in the third quarter of 2011, due to an increase in legal fees and litigation-related expenses.

For the nine months ended September 30, 2012, net income applicable to Piper Jaffray Companies, including continuing and discontinued operations, was $29.4 million, or $1.60 per diluted common share, up from $14.3 million or $0.74 per diluted common share for the year-ago period. Net income applicable to Piper Jaffray Companies from continuing operations for the nine months ended September 30, 2012 was $29.5 million, or $1.60 per diluted common share, compared with net income applicable to Piper Jaffray Companies from continuing operations of $24.8 million, or $1.29 per diluted common share, for the prior-year period. Net revenues from continuing operations for the nine months ended September 30, 2012 were $352.3 million, up 2.4 percent from $344.0 million reported in the year-ago period. Higher fixed income institutional brokerage revenues were offset in part by lower gains recorded on our merchant banking activities. For the nine months ended September 30, 2012, non-compensation expenses from continuing operations decreased to $97.2 million, compared with $98.9 million for the nine months ended September 30, 2011.

External Factors Impacting Our Business

Performance in the financial services industry in which we operate is highly correlated to the overall strength of economic conditions and financial market activity. Overall market conditions are a product of many factors, which are beyond our control and mostly unpredictable. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors, including the demand for investment banking services as reflected by the number and size of equity and debt financings and merger and acquisition transactions, the volatility of the equity and fixed income markets, changes in interest rates (especially rapid and extreme changes), the level and shape of various yield curves, the volume and value of trading in securities, and the demand for asset management services as reflected by the amount of assets under management.

Factors that differentiate our business within the financial services industry also may affect our financial results. For example, our business focuses on a middle-market clientele in specific industry sectors. If the business environment for our focus sectors is impacted disproportionately as compared to the economy as a whole, or does not recover on pace with other sectors of the economy, our business and results of operations will be negatively impacted. In addition, our business could be affected differently than overall market trends. Given the variability of the capital markets and securities businesses, our earnings may fluctuate significantly from period to period, and results for any individual period should not be considered indicative of future results.

As a participant in the financial services industry, we are subject to complex and extensive regulation of our business. In recent years and following the credit crisis of 2008, legislators and regulators increased their focus on the regulation of the financial services industry, resulting in fundamental changes to the manner in which the industry is regulated and increased regulation in a number of areas. For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in 2010 bringing sweeping change to financial services regulation in the U.S. Changes in the regulatory environment in which we operate could affect our business and the competitive environment, potentially adversely.

Outlook for the remainder of 2012

We anticipate that a challenging economic environment will continue through the remainder of 2012 and into 2013. A number of uncertainties impacting global growth continue to persist, including the European debt crisis, the outlook for global economic growth, concerns about the U.S. budget deficit and the "fiscal cliff" of increasing tax rates and federal spending cuts. However, equity market volatility remains near a five-year low and the equity markets have posted significant positive year-to-date results, which may result in increased U.S. capital markets activity as compared to 2011. This level of activity can change rapidly as economic and market indicators fluctuate. The low interest rate environment has increased the number of issuers refinancing existing debt, which has aided our tax-exempt financing revenues in the first nine months of 2012. We anticipate that interest rates will remain at historically low levels throughout the remainder of 2012 and 2013 as uncertainties continue to persist around the


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U.S. economic recovery, the European debt crisis and global growth. We generated robust fixed income institutional brokerage revenue in the third quarter of 2012, particularly related to strategic trading activity in non-agency mortgage-backed securities. In 2011, we added a mortgage-backed securities strategy to capitalize on pricing inefficiencies within structured mortgage products. In early 2012, we identified an additional opportunity in the mortgage market which proved to be successful during the third quarter of 2012. We believe we have largely captured the revenues related to this opportunity and do not expect this level of fixed income institutional brokerage revenues to continue. Our strategic trading revenues, such as those generated from trading non-agency mortgage bonds, can vary significantly from quarter to quarter. Lastly, our asset management performance will continue to be dependent upon equity valuations and our investment performance, which can impact the amount of client inflows and outflows of assets under management.


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Results of Operations

Financial Summary for the Three Months Ended September 30, 2012 and
September 30, 2011

The following table provides a summary of the results of our operations and the
results of our operations as a percentage of net revenues for the periods
indicated.
                                                                            As a Percentage of
                                        Three Months Ended                 Net Revenues for the
                                           September 30,                    Three Months Ended
                                                             2012              September 30,
(Dollars in thousands)           2012          2011          v2011          2012           2011
Revenues:

Investment banking            $  51,083     $  44,031         16.0  %       38.4 %          45.9  %
Institutional brokerage          58,719        28,689        104.7          44.2            29.9
Asset management                 17,588        15,205         15.7          13.2            15.9
Interest                         12,457        15,116        (17.6 )         9.4            15.8
Other income                        235         1,710        (86.3 )         0.2             1.8

Total revenues                  140,082       104,751         33.7         105.4           109.3

Interest expense                  7,125         8,894        (19.9 )         5.4             9.3

Net revenues                    132,957        95,857         38.7         100.0           100.0

Non-interest expenses:

Compensation and benefits        78,738        60,505         30.1          59.2            63.1
Occupancy and equipment           6,232         6,638         (6.1 )         4.7             6.9
Communications                    5,374         5,595         (3.9 )         4.0             5.8
Floor brokerage and clearance     1,827         2,143        (14.7 )         1.4             2.2
Marketing and business
development                       4,285         5,059        (15.3 )         3.2             5.3
Outside services                  7,557         6,263         20.7           5.7             6.5
Intangible asset amortization
expense                           1,917         2,069         (7.3 )         1.4             2.2
Other operating expenses          4,313         2,457         75.5           3.2             2.6

Total non-interest expenses     110,243        90,729         21.5          82.9            94.7

Income from continuing
operations before income tax
expense                          22,714         5,128        342.9          17.1             5.3

Income tax expense                9,188         1,361        575.1           6.9             1.4

Income from continuing
operations                       13,526         3,767        259.1          10.2             3.9

Discontinued operations:
Income/(loss) from
discontinued operations, net
of tax                            6,803        (7,143 )        N/M           5.1            (7.5 )

Net income/(loss)                20,329        (3,376 )        N/M          15.3            (3.5 )

Net income applicable to
noncontrolling interests            665           207        221.3  %        0.5             0.2

Net income/(loss) applicable
to Piper Jaffray Companies    $  19,664     $  (3,583 )        N/M          14.8 %          (3.7 )%

N/M - Not meaningful

For the three months ended September 30, 2012, we recorded net income applicable to Piper Jaffray Companies, including continuing and discontinued operations, of $19.7 million. Net revenues from continuing operations for the three months ended September 30, 2012 were $133.0 million, a 38.7 percent increase from the year-ago period. In the third quarter of 2012, investment banking revenues were $51.1 million, compared with $44.0 million in the prior-year period. The increase in investment banking revenues was driven by higher equity and debt financing revenues resulting from improved equity capital markets in the third


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quarter of 2012 and increased public finance underwriting revenues, offset in part by lower advisory service revenues. For the three months ended September 30, 2012, institutional brokerage revenues increased 104.7 percent to $58.7 million, compared with $28.7 million in the corresponding period of the prior year, driven by fixed income institutional brokerage revenues, particularly strategic trading of non-agency mortgage-backed securities. For the three months ended September 30, 2012, asset management fees increased 15.7 percent to $17.6 million, compared with $15.2 million in the third quarter of 2011, due to higher management fees and gains recorded on our investments in registered funds or partnerships that we manage. In the third quarter of 2012, net interest income was $5.3 million, a 14.3 percent decrease compared with $6.2 million in the prior-year period. The decrease primarily resulted from a strategy to further diversify away from overnight funding sources to more short term funding sources with extended terms. These short term funding sources with extended terms typically have higher interest costs than overnight financing obtained from repurchase obligations or overnight bank financing. The change in net interest income is also partly attributable to a decline of our average long inventory balances. For the three months ended September 30, 2012, other income was $0.2 million, compared with $1.7 million in the corresponding period of the prior year. The decline was due to lower investment gains recorded on our merchant banking activities. Non-interest expenses from continuing operations increased to $110.2 million for the three months ended September 30, 2012, from $90.7 million in the corresponding period of the prior year, primarily driven by an increase in compensation and benefits expenses, due to higher net revenues and operating profits.

Consolidated Non-Interest Expenses From Continuing Operations

Compensation and Benefits - Compensation and benefits expenses, which are the largest component of our expenses, include salaries, incentive compensation, benefits, stock-based compensation, employment taxes, income associated with the forfeiture of stock-based compensation and other employee costs. A portion of compensation expense is comprised of variable incentive arrangements, including discretionary incentive compensation, the amount of which fluctuates in proportion to the level of business activity, increasing with higher revenues and operating profits. Other compensation costs, primarily base salaries and benefits, are more fixed in nature. The timing of incentive compensation payments, which generally occur in February, has a greater impact on our cash position and liquidity than is reflected on our consolidated statements of operations.

For the three months ended September 30, 2012, compensation and benefits expenses increased 30.1 percent to $78.7 million from $60.5 million in the corresponding period in 2011, due to increased variable compensation expense driven by higher net revenues and operating profits. Compensation and benefits expenses as a percentage of net revenues were 59.2 percent for the third quarter of 2012, compared with 63.1 percent for the third quarter of 2011. The reduced compensation ratio was driven by the significant increase in fixed income strategic trading revenues during the third quarter of 2012, which has a lower compensation payout.

Occupancy and Equipment - In the third quarter of 2012, occupancy and equipment expenses decreased 6.1 percent to $6.2 million, compared with $6.6 million in the corresponding period in 2011. The decrease was primarily attributable to cost saving initiatives.

Communications - Communication expenses include costs for telecommunication and data communication, primarily consisting of expenses for obtaining third-party market data information. For the three months ended September 30, 2012, communication expenses were $5.4 million, essentially flat compared with the third quarter of 2011.

Floor Brokerage and Clearance - For the three months ended September 30, 2012, floor brokerage and clearance expenses decreased 14.7 percent to $1.8 million, compared with $2.1 million for the three months ended September 30, 2011. The decline was due to lower trading fees resulting from lower U.S. equity client volumes.

Marketing and Business Development - Marketing and business development expenses include travel and entertainment and promotional and advertising costs. For the three months ended September 30, 2012, marketing and business development expenses decreased 15.3 percent to $4.3 million, compared with $5.1 million for the three months ended September 30, 2011 due to reduced travel expenses.

Outside Services - Outside services expenses include securities processing expenses, outsourced technology functions, outside legal fees and other professional fees. Outside services expenses increased 20.7 percent to $7.6 million in the third quarter of 2012, compared with $6.3 million in the corresponding period in 2011, primarily due to increased legal fees.

Intangible Asset Amortization Expense - Intangible asset amortization expense includes the amortization of definite-lived intangible assets consisting of asset management contractual relationships and certain trade names and trademarks. For the three months ended September 30, 2012, intangible asset amortization expense was $1.9 million, essentially flat compared with the three months ended September 30, 2011.


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Other Operating Expenses - Other operating expenses include insurance costs, license and registration fees, expenses related to our charitable giving program and litigation-related expenses, which consist of the amounts we reserve and/or pay out related to legal and regulatory matters. Other operating expenses increased to $4.3 million in the third quarter of 2012, compared with $2.5 million in the prior-year period, primarily due to increased litigation-related expenses.

Income Taxes - For the three months ended September 30, 2012, our provision for income taxes was $9.2 million, equating to an effective tax rate of 40.5 percent. For the three months ended September 30, 2011, our provision for income taxes was $1.4 million equating to an effective tax rate of 26.5 percent. Income tax expense recorded in the third quarter of 2011 included a $1.1 million partial reversal of our U.K. subsidiary's deferred tax asset valuation allowance. For more information on deferred tax assets, see "Income Taxes" within our critical accounting policies.

Segment Performance from Continuing Operations

We measure financial performance by business segment. Our two reportable segments are Capital Markets and Asset Management. We determined these segments based upon the nature of the financial products and services provided to customers and the Company's management organization. Segment pre-tax operating income and segment pre-tax operating margin are used to evaluate and measure segment performance by our management team in deciding how to allocate resources and in assessing performance in relation to our competitors. Revenues and expenses directly associated with each respective segment are included in determining segment operating results. Revenues and expenses that are not directly attributable to a particular segment are allocated based upon the Company's allocation methodologies, generally based on each segment's respective net revenues, use of shared resources, headcount or other relevant measures.

The following table provides our segment performance from continuing operations for the periods presented:

                                  Three Months Ended
                                    September 30,
                                                           2012
(Dollars in thousands)            2012          2011       v2011
Net revenues
Capital Markets                $ 115,249     $ 81,398      41.6 %
Asset Management                  17,708       14,459      22.5
Total net revenues             $ 132,957     $ 95,857      38.7 %

Pre-tax operating income
Capital Markets                $  20,578        3,704     455.6 %
Asset Management                   2,136        1,424      50.0
Total pre-tax operating income $  22,714     $  5,128     342.9 %

Pre-tax operating margin
Capital Markets                     17.9 %        4.6 %
Asset Management                    12.1 %        9.8 %
Total pre-tax operating margin      17.1 %        5.3 %


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Capital Markets
Three Months Ended September 30, 2012 (Dollars in thousands) 2012 2011 v2011 Net revenues:
Investment banking
Financing
Equities $ 18,781 $ 6,569 185.9 % Debt 16,573 11,105 49.2 Advisory services 16,317 26,951 (39.5 ) Total investment banking 51,671 44,625 15.8

Institutional sales and trading
Equities 17,927 22,020 (18.6 ) Fixed income 46,690 13,681 241.3 Total institutional sales and trading 64,617 35,701 81.0

Other income/(loss) (1,039 ) 1,072 N/M

Total net revenues $ 115,249 $ 81,398 41.6 %

Pre-tax operating income $ 20,578 $ 3,704 455.6 %

Pre-tax operating margin 17.9 % 4.6 %

N/M - Not meaningful

Capital Markets net revenues increased 41.6 percent to $115.2 million, compared with $81.4 million in the third quarter of 2011, driven by fixed income institutional brokerage revenues, particularly strategic trading of non-agency mortgage-backed securities.

Investment banking revenues comprise all the revenues generated through financing and advisory services activities, including derivative activities that relate to debt financing. To assess the profitability of investment banking, we aggregate investment banking fees with the net interest income or expense associated with these activities.

In the third quarter of 2012, investment banking revenues increased 15.8 percent to $51.7 million compared with $44.6 million in the corresponding period of the prior year, driven by increased equity and debt financing revenues, partially offset by a decline in advisory services revenues. For the three months ended September 30, 2012, equity financing revenues increased to $18.8 million, compared with $6.6 million in the prior-year period as equity capital markets improved and volatility remained low resulting in an increase in capital raised and higher average revenue per transaction. During the third quarter of 2012, we completed 14 equity financings, raising $2.6 billion in capital, compared with 8 equity financings, raising $0.9 billion for the corresponding period in 2011. Debt financing revenues in the third quarter of 2012 increased 49.2 percent to $16.6 million, compared with $11.1 million in the third quarter of 2011, driven by higher average revenue per transaction. During the third quarter of 2012, we completed 113 public finance issues with a total par value of $2.3 billion, compared with 133 public finance issues with a total par value of $1.8 billion during the prior-year period. For the three months ended September 30, 2012, . . .

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