PIPER JAFFRAY COMPANIES
SELECTED FINANCIAL DATA
The following table presents our selected consolidated financial data for the
periods and dates indicated. The information set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and notes
thereto.
<Table>
<Caption>
YEAR ENDED DECEMBER 31
(Dollars and Shares in Thousands, Except Per Share Data) 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------
REVENUES
Commissions and fees $ 256,747 $ 275,682 $ 302,289 $ 374,611 $ 337,171
Principal transactions 215,191 171,957 181,469 232,426 183,942
Investment banking 229,945 208,740 247,929 342,104 224,778
Interest 45,276 59,685 95,436 144,308 71,369
Other income 59,082 47,303 52,865 53,006 43,993
- ------------------------------------------------------------------------------------------------------------------------
Total revenues 806,241 763,367 879,988 1,146,455 861,253
Interest expense 19,511 34,315 79,216 128,177 61,129
- ------------------------------------------------------------------------------------------------------------------------
Net revenues 786,730 729,052 800,772 1,018,278 800,124
- ------------------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES
Compensation and benefits 482,397 449,329 513,623 662,592 516,431
Cash award program 24,000 - - - -
Regulatory settlement - 32,500 - - -
Amortization of acquisition-related compensation and
goodwill - - 17,641 30,108 33,554
Merger and restructuring - 7,976 65,697 8,889 8,316
Royalty fee 3,911 7,482 55,753 47,750 -
Other non-compensation and benefits 234,588 225,804 220,863 228,663 185,666
- ------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 744,896 723,091 873,577 978,002 743,967
- ------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAX EXPENSE (BENEFIT) 41,834 5,961 (72,805) 40,276 56,157
Income tax expense (benefit) 15,835 5,855 (22,754) 19,568 24,981
- ------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 25,999 $ 106 $ (50,051) $ 20,708 $ 31,176
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Basic $ 1.35 $ 0.01 $ (2.60) $ 1.09 $ 1.63
Diluted $ 1.35 $ 0.01 $ (2.60) $ 1.09 $ 1.63
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Basic 19,237 19,160 19,279 19,060 19,078
Diluted 19,237 19,160 19,279 19,060 19,078
OTHER DATA
Total assets $2,380,647 $2,041,945 $2,734,370 $2,735,918 $2,606,482
Long-term debt $ 180,000 $ 215,000 $ 475,000 $ 475,000 $ 375,000
Shareholders' equity $ 669,795 $ 609,857 $ 378,724 $ 362,331 $ 352,023
Total employees 2,991 3,227 3,255 3,845 3,443
Total Private Client Services offices 96 103 107 112 107
</Table>
22 PIPER JAFFRAY ANNUAL REPORT 2003
PIPER JAFFRAY COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the accompanying
consolidated financial statements and related notes included elsewhere in this
report. This information includes forward-looking statements. Forward-looking
statements include all statements that are not historical facts. These
statements involve risks, uncertainties and assumptions, including the risk
factors described in Exhibit 99.1 to our Form 10-K, as filed with the Securities
and Exchange Commission, which you should carefully review. As a result of these
risks, uncertainties and assumptions, our actual results may differ materially
from those expressed in, or implied by, forward-looking statements. Accordingly,
we caution you not to rely on any of these forward-looking statements, which
speak only as of the date made. We do not have any intention or obligation to
update forward-looking statements after the date of this report.
OUR SEPARATION FROM U.S. BANCORP
On February 19, 2003, U.S. Bancorp announced its intention to organize its
capital markets business unit into a new company and to effect a tax-free
distribution of its shares in that company to U.S. Bancorp's shareholders. On
April 28, 2003, Piper Jaffray Companies was incorporated in Delaware as a
subsidiary of U.S. Bancorp for the purpose of effecting the proposed
distribution.
On December 31, 2003, after receiving regulatory approval, U.S. Bancorp
distributed to its shareholders all of its interest in our new company. On that
date, 19,334,261 shares of Piper Jaffray Companies common stock were issued to
U.S. Bancorp shareholders based on a distribution ratio of one share of Piper
Jaffray Companies common stock for every 100 shares of U.S. Bancorp common stock
owned. In lieu of receiving fractional shares of Piper Jaffray Companies common
stock, shareholders received cash from U.S. Bancorp for their fractional
interest.
As part of the separation from U.S. Bancorp, we entered into a variety of
agreements with U.S. Bancorp to govern each of our responsibilities related to
the distribution. Included in the agreements we entered into were a separation
and distribution agreement, a tax sharing agreement, an employee benefits
agreement, an insurance matters agreement and a business alliance agreement. In
addition to those agreements listed above, we have a $180 million unsecured
subordinated debt agreement maturing in 2008 with a subsidiary of U.S. Bancorp.
Pursuant to the separation and distribution agreement, U.S. Bancorp was
generally responsible for all expenses directly incurred in connection with the
distribution.
In connection with the distribution, we implemented a cash award program
consisting of cash payments to a broad-based group of our employees. The award
program is intended to aid in retention of employees and to compensate for the
value of U.S. Bancorp stock options and restricted stock lost by our employees
as a result of our spin off from U.S. Bancorp. The cash award program has an
aggregate value of approximately $47.0 million. We incurred a $24.0 million
charge at the time of the spin off from U.S. Bancorp. The remaining $23.0
million will be paid out over the next four years, which will result in an
annual charge of approximately $5.9 million over the next three years and $5.3
million in the fourth year.
As an independent company focused solely on our business, we believe that we
have enhanced strategic and operational flexibility and, as a result, are better
positioned to serve our clients and grow our business. The distribution has
presented a focused investment opportunity in Piper Jaffray for investors whose
objectives align more closely with our business than with other businesses
operated by U.S. Bancorp. Finally, our incentive compensation will be more
closely tied to our performance, since stock-based awards will be based on our
common stock rather than U.S. Bancorp common stock, and we believe that this
more direct link with our performance will enhance the value of these incentives
to our employees and consequently to our shareholders.
Business Environment
IMPACT OF ECONOMIC AND MARKET CONDITIONS
Performance in the financial services industry in which we operate is highly
correlated to the overall strength of economic conditions and market activity.
Our profitability is sensitive to a variety of factors, including the volume and
value of trading in securities, the volatility of the equity and fixed income
PIPER JAFFRAY ANNUAL REPORT 2003 23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
markets, the level and shape of various yield curves and the demand for
investment banking services as reflected by the number and size of public
offerings and merger and acquisition transactions, particularly in our focus
industries and sectors. For example, our investment banking revenue, in the form
of underwriting discounts and financial advisory fees, is directly related to
the volume and value of the transactions in which we are involved. Uncertain or
unfavorable market or economic conditions adversely affect our business. In such
environments, the volume and size of capital-raising transactions and
acquisitions and divestitures of corporations typically decrease, thereby
reducing the demand for our investment banking services and increasing price
competition among financial services companies seeking such engagements. In
addition, a downturn in the financial markets may result in a decline in the
volume and value of trading transactions and, therefore, may lead to a decline
in the revenue we receive from commissions on the execution of trading
transactions and, in respect of our market-making activities, in a reduction in
the value of our trading positions and commissions and spreads.
Additionally, overall market conditions have been and may continue to be
impacted by political events, legislative and regulatory developments and
investor sentiments most recently caused by uncertainties about terrorist acts,
geo-political events and corporate accounting restatements. Because many of
these factors are unpredictable and beyond our control, our earnings may
fluctuate significantly from period to period.
RECENT TRENDS
Challenging investment and economic conditions prevailed during 2001, 2002 and
the first part of 2003, which negatively impacted the financial markets. The
Federal Reserve Board moved aggressively to improve economic conditions with
multiple interest rate reductions throughout the past three years, decreasing
the Federal Funds target rate from 6.50 percent at December 31, 2000 to 1.75
percent, 1.25 percent and 1.00 percent by December 31, 2001, 2002 and 2003,
respectively. Despite these interest rate reductions, the economy continued to
show signs of weakness and recession through 2002 and into early 2003, driven by
softness in corporate earnings, uncertainty caused by world political events and
reduced confidence in the integrity of reported financial information by several
high-profile corporations. The impact of these economic conditions from 2001
through the first part of 2003 caused significant declines in equity returns for
investors and a substantially lower number of investment banking transactions as
well as a decline in the volume and value of trading transactions.
As 2003 began, the U.S. economy continued to struggle due in part to lower
consumer confidence, higher unemployment, reduced spending in the business
sector and economic uncertainty created by the pending war in Iraq. However,
these conditions began to improve during the second quarter of 2003 and into the
second half of 2003. The economic stimulus provided by low interest rates and
tax cuts, combined with the initial military success in Iraq, has eased some of
the uncertainties in the U.S. and global economies. Capital expenditures began
to increase and the major indices, fueled partly by a sharp rise in corporate
profits, increased significantly. In 2003, the Dow Jones Industrial Average
increased 25 percent, while the Nasdaq Composite Index increased 50 percent.
While the improvement in the equity markets in the second half of 2003 has had a
positive impact on the broker dealer industry, the recent performance is not
necessarily indicative of continued strong performance. Concerns remain about
the U.S. economy with growing budget and trade deficits and the decline in the
value of the dollar relative to other major foreign currencies.
Results of Operations
BASIS OF PRESENTATION
Our consolidated financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America and include the
adjustments necessary to reflect our operations as if the organizational changes
resulting from our spin off had been consummated prior to the distribution. The
consolidated financial statements have been derived from the financial
statements and accounting records of U.S. Bancorp using the historical results
of operations and historical basis of the assets and liabilities of our
business. However, the consolidated financial statements included herein may not
necessarily be indicative of our results of operations, financial position and
cash flows in the future or what our results of operations, financial position
and cash flows would have been had we operated as a stand-alone company during
the periods presented.
Generally, the consolidated results include revenues generated and expenses
incurred based on customer
24 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
relationships and related business activities. In certain situations, affiliated
entities of U.S. Bancorp may have provided services to us. These services
primarily relate to providing employee-related services and benefits, technology
and data processing services, and corporate functions including audit, tax and
real estate management services. Costs included in the consolidated financial
statements for shared services were determined based on actual costs to U.S.
Bancorp and allocated to us based on our proportionate usage of those services.
Proportionate usage was determined based on the number of our employees, actual
hours used, square footage of office space or other similar methodologies. Our
management believes the assumptions underlying the consolidated financial
statements are reasonable.
In the consolidated financial statements, income taxes were determined on a
separate return basis as if we had not been eligible to be included in the
consolidated income tax return of U.S. Bancorp and its affiliates. However, U.S.
Bancorp was managing its tax position for the benefit of its entire portfolio of
businesses, and its tax strategies are not necessarily reflective of the tax
strategies that we would have followed or will follow as a stand-alone entity.
FINANCIAL SUMMARY
The overall trends and conditions of the financial markets, particularly within
the United States, can materially affect our results of operations and financial
position. Given the variability of the capital markets and securities business,
results of any individual period should not be considered indicative of future
results. In addition, we provide services to certain focus industries and
sectors, the performance of which may not correlate to the overall market. Our
Capital Markets business focuses primarily on the consumer, financial
institutions, health care and technology industries within the corporate sector
and health care, higher education, housing, and state and local government
entities within the government/non-profit sector. Such industries may experience
growth or downturns independently of general economic and market conditions, or
may face market conditions that are disproportionately better or worse than
those impacting the economy and markets generally, which may affect our business
differently than overall market trends. Moreover, our Private Client Services
business primarily operates in the Midwest, Mountain and West Coast states. An
economic growth spurt or downturn that disproportionately impacts one or all of
these regions may disproportionately affect our business compared with companies
operating in other regions or more nationally or globally. This may make our
results differ from the overall trends and conditions of the financial markets.
The following tables provide a summary of market data, the results of our
operations and the results of our operations as a percentage of net revenues for
the periods indicated.
MARKET DATA
<Table>
<Caption>
2003 2002
YEAR ENDED DECEMBER 31 2003 2002 2001 V 2002 V 2001
- ---------------------------------------------------------------------------------------------------------
Dow Jones Industrials (a) 10,454 8,342 10,022 25.3% (16.8)%
NASDAQ (a) 2,003 1,336 1,950 49.9 (31.5)
NYSE Average Daily Value Traded ($ BILLIONS) $ 38.5 $ 40.9 $ 42.3 (5.9) (3.3)
NASDAQ Average Daily Value Traded ($ BILLIONS) $ 28.0 $ 28.8 $ 44.1 (2.8) (34.7)
Mergers and Acquisitions (NUMBER OF TRANSACTIONS) (b) 7,091 6,451 6,998 9.9 (7.8)
Public Equity Offerings (NUMBER OF TRANSACTIONS) (c)
(d) 831 608 764 36.7 (20.4)
Initial Public Offerings (NUMBER OF TRANSACTIONS) (c) 77 75 83 2.7 (9.6)
Managed Municipal Underwritings (NUMBER OF
TRANSACTIONS) (e) 14,695 14,056 13,346 4.5 5.3
10-Year Treasuries Average Rate (a) 4.02% 4.61% 5.02% (12.8) (8.2)
- ---------------------------------------------------------------------------------------------------------
</Table>
(a) Data provided is at period end.
(b) Source: Securities Data Corporation.
(c) Source: Dealogic (offerings with market reported value greater than $10
million).
(d) Number of transactions includes convertible offerings.
(e) Source: Thomson Financial.
PIPER JAFFRAY ANNUAL REPORT 2003 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
<Table>
<Caption>
AS A PERCENTAGE OF
YEAR ENDED DECEMBER 31 2003 2002 NET REVENUES
(Dollars in Thousands) 2003 2002 2001 v 2002 v 2001 2003 2002 2001
- ------------------------------------------------------------------------------------- -------------------------
REVENUES
Commissions and fees $256,747 $275,682 $302,289 (6.9)% (8.8)% 32.6% 37.8% 37.7%
Principal transactions 215,191 171,957 181,469 25.1 (5.2) 27.4 23.6 22.7
Investment banking 229,945 208,740 247,929 10.2 (15.8) 29.2 28.6 31.0
Interest 45,276 59,685 95,436 (24.1) (37.5) 5.8 8.2 11.9
Other income 59,082 47,303 52,865 24.9 (10.5) 7.5 6.5 6.6
- ----------------------------------------------------------------- ---------------------------
Total revenues 806,241 763,367 879,988 5.6 (13.3) 102.5 104.7 109.9
Interest expense 19,511 34,315 79,216 (43.1) (56.7) 2.5 4.7 9.9
- ----------------------------------------------------------------- ---------------------------
Net revenues 786,730 729,052 800,772 7.9 (9.0) 100.0 100.0 100.0
- ----------------------------------------------------------------- ---------------------------
NON-INTEREST EXPENSES
Compensation and benefits 482,397 449,329 513,623 7.4 (12.5) 61.3 61.6 64.1
Occupancy and equipment 58,025 55,549 60,121 4.5 (7.6) 7.4 7.6 7.5
Communications 37,599 36,316 41,082 3.5 (11.6) 4.8 5.0 5.1
Floor brokerage and clearance 22,755 26,040 22,092 (12.6) 17.9 2.9 3.6 2.8
Marketing and business
development 39,030 44,115 49,706 (11.5) (11.2) 5.0 6.0 6.2
Outside services 34,219 32,717 22,285 4.6 46.8 4.3 4.5 2.8
Cash award program 24,000 - - 100.0 - 3.1 - -
Regulatory settlement - 32,500 - (100.0) 100.0 - 4.5 -
Amortization of
acquisition-related
compensation and goodwill - - 17,641 - (100.0) - - 2.2
Merger and restructuring - 7,976 65,697 (100.0) (87.9) - 1.1 8.2
Royalty fee 3,911 7,482 55,753 (47.7) (86.6) .5 1.0 7.0
Other operating expenses 42,960 31,067 25,577 38.3 21.5 5.5 4.3 3.2
- ----------------------------------------------------------------- ---------------------------
Total non-interest expenses 744,896 723,091 873,577 3.0 (17.2) 94.7 99.2 109.1
- ----------------------------------------------------------------- ---------------------------
INCOME (LOSS) BEFORE TAXES 41,834 5,961 (72,805) 601.8 108.2 5.3 .8 (9.1)
Income tax expense (benefit) 15,835 5,855 (22,754) 170.5 (125.7) 2.0 .8 (2.8)
- ----------------------------------------------------------------- ---------------------------
NET INCOME (LOSS) $25,999 $ 106 $(50,051) NM 100.2% 3.3% 0.0% (6.3)%
- ----------------------------------------------------------------- ---------------------------
- ----------------------------------------------------------------- ---------------------------
NM - Not Meaningful
</Table>
Net income increased to $26.0 million in 2003 up from $0.1 million in 2002
reflecting the improved economy and market performance during the last six
months of 2003. Net revenues increased to $786.7 million in 2003, up 7.9 percent
over prior year net revenues of $729.1 million. The largest component of our
revenue stream was commissions and fees at $256.7 million, down 6.9 percent from
the prior year. Commissions and fees declined due to lower transaction volumes
in equities and equity-related products such as mutual funds in the first half
of 2003. In addition, commission revenues were impacted from continued attrition
of financial advisors in our Private Client Services business. Profits on
principal transactions grew 25.1 percent for the year, largely due to strong
fixed income sales and trading. Fixed income products continued to be a key
driver of our revenue throughout the year, particularly corporates and
mortgages, two growth focuses of ours. Investment banking revenue increased 10.2
percent for the year, primarily due to improved equity underwriting activity.
This increase was aided by the first full year results of the convertibles team
that joined us at the end of 2002. Other income grew 24.9 percent, primarily due
to our new agreement with U.S. Bancorp Asset Management for the provision of
cash sweep products to our clients. Non-interest expenses increased to $744.9
million in 2003 from $723.1 million for the prior year. Contributing to the
increase in
26 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
non-interest expenses for 2003 were higher incentive compensation resulting from
improved financial performance, increased litigation-related expenses and
additions to employee loan loss reserves for transition to our new Private
Client Services compensation plan. In addition, 2003 non-interest expenses
include the $24.0 million charge related to the cash award program. Non-interest
expenses in 2002 included a $32.5 million charge resulting from the settlement
we entered into in connection with the regulatory investigation of equity
research and its relationship to investment banking. For more details regarding
the regulatory settlement, see "consolidated non-interest expenses -- regulatory
settlement" below.
Net revenues declined to $729.1 million in 2002, down 9.0 percent from $800.8
million in 2001, reflecting poor equity market conditions. Non-interest expenses
declined to $723.1 million in 2002 from $873.6 million in the prior year, or
down 17.2 percent, driven by lower variable compensation associated with
declining net revenues, the effect of adopting a new accounting principle which
eliminated the amortization of goodwill, lower royalty fees paid to U.S. Bancorp
for the use of tradenames and lower restructuring charges relative to 2001.
These declines were offset in part by the $32.5 million settlement charge in
connection with an industry-wide regulatory investigation of equity research and
its relationship to investment banking.
CONSOLIDATED NON-INTEREST EXPENSES
COMPENSATION AND BENEFITS - Compensation and benefits increased to $482.4
million in 2003 from $449.3 million for the prior year, or up 7.4 percent. A
substantial portion of compensation expense represents variable incentive
arrangements and commissions, the amounts of which fluctuate in proportion to
the level of business activity. Other compensation costs, primarily base
salaries and benefits, are more fixed in nature. The increase in compensation
and benefits expense is due primarily to increases in the variable portion of
our compensation as a result of increased revenue and operating profits. In
addition, $9.5 million was allocated in 2003 to our employer discretionary
profit sharing plan based on our 2003 profitability. In 2002 we did not make an
allocation to our employer discretionary profit sharing plan.
Compensation and benefits decreased to $449.3 million in 2002 from $513.6
million in 2001 and was 61.6 percent and 64.1 percent of net revenues in each
year, respectively. The decrease in compensation is primarily attributable to
lower variable compensation as a result of reduced revenue. In addition,
reductions in headcount and the impact of restructuring certain administrative
and support functions in 2001 to improve our operating efficiencies resulted in
a decrease in compensation expense of approximately $18.7 million in 2002. The
other significant contributor to the decline included our decision to no longer
participate in the U.S. Bancorp pension plan effective January 1, 2002. An
employer discretionary profit sharing plan replaced the U.S. Bancorp pension
plan to more closely align retirement benefits for our employees with
performance of the business. In 2002, no contribution was made to the profit
sharing plan, based on our operating results. In 2001, the expense related to
the U.S. Bancorp pension plan was $21.0 million.
OCCUPANCY AND EQUIPMENT - Occupancy and equipment expenses were $58.0 million in
2003 compared with $55.5 million for the prior year. This increase was due
primarily to a $4.1 million write-off of internally developed software in
conjunction with the implementation of a new fixed income trading system, offset
partially by reduced depreciation on furniture and equipment.
Occupancy and equipment expenses were $55.5 million in 2002 compared with $60.1
million in 2001. The 7.6 percent decline in 2002 resulted from savings from
restructuring our distribution network and closing and consolidating sales
offices in 2001.
COMMUNICATIONS - Communication expenses include costs for telecommunication and
data communication, primarily from third-party market information providers.
Communication expenses were $37.6 million in 2003 compared with $36.3 million
for the prior year. This increase was due primarily to higher market data
services expenses as a result of increased business activity.
Communication expenses were $36.3 million in 2002 compared with $41.1 million in
2001. Restructuring activities in 2001 as well as cost containment efforts drove
the 11.6 percent decline in 2002.
FLOOR BROKERAGE AND CLEARANCE - Floor brokerage and clearance expenses were
$22.8 million in 2003 compared with $26.0 million for the prior year. This
decrease is due to our efforts to reduce fees for accessing electronic
communication networks. As a result of our efforts, floor brokerage and
clearance
PIPER JAFFRAY ANNUAL REPORT 2003 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
expense as a percentage of net revenues was reduced to 2.9 percent in 2003 from
3.6 percent in the prior year.
Floor brokerage and clearance expenses increased to $26.0 million in 2002
compared with $22.1 million in 2001. As a percentage of net revenues, floor
brokerage and clearance expenses were 3.6 percent and 2.8 percent in 2002 and
2001, respectively. The increase in these costs primarily reflects increased
usage of electronic communication networks to obtain trade execution.
MARKETING AND BUSINESS DEVELOPMENT - Marketing and business development expenses
include travel and entertainment, postage, supplies and promotional and
advertising costs. Marketing and business development expenses were $39.0
million for 2003 compared with $44.1 million for the prior year, a decline of
11.5 percent. The decrease in these costs is primarily attributable to our
continued efforts to reduce discretionary spending on travel and advertising.
Despite increased net revenues, travel, advertising and supplies expenses
decreased by $0.2 million, $1.3 million, and $2.4 million, respectively.
Marketing and business development expenses were $44.1 million in 2002 compared
with $49.7 million in 2001, a decline of 11.2 percent. The decrease in these
costs is primarily attributable to our efforts to reduce discretionary spending
on travel and advertising as business activity declined. As a result, travel
expenses declined by $3.1 million and advertising expenses declined by $0.6
million.
OUTSIDE SERVICES - Outside services expenses include securities processing
expenses, outsourced technology functions and other professional fees. Outside
services expenses increased to $34.2 million in 2003 compared with $32.7 million
for the prior year, or up 4.6 percent. This increase primarily reflects the
costs for outsourcing our mainframe and network processing to a third-party
vendor and increased outside legal fees. These increases were partially offset
by lower computer consulting expenses incurred during 2003 due to the completion
in early 2002 of our project to outsource certain securities processing
activities.
Outside services expenses increased to $32.7 million in 2002 compared with $22.3
million in 2001. The 46.8 percent increase in outside services in 2002 is
primarily due to investments in and changes to technology we made during 2001 to
support future growth in the business, which included outsourcing certain
securities back office processing activities. The outsourced securities
processing charges include a fixed component plus a variable component based on
trade volumes. As a percentage of net revenues, the cost of outside services
increased from 2.8 percent in 2001 to 4.5 percent in 2002 due, in part, to the
fixed nature of a portion of these costs.
CASH AWARD PROGRAM - A broad group of employees have been granted cash awards
pursuant to a program that we established in connection with our spin off from
U.S. Bancorp. The award program is intended to aid in retention of employees and
to compensate employees for the value of U.S. Bancorp stock options and
restricted stock lost as a result of our spin off from U.S. Bancorp. The cash
award program has an aggregate value of approximately $47.0 million. We incurred
a $24.0 million charge in connection with this program at the time of the spin
off from U.S. Bancorp, which is included in our 2003 results of operations. The
remaining $23.0 million will be paid out over the next four years, which will
result in an annual charge of approximately $5.9 million over the next three
years and $5.3 million in the fourth year.
REGULATORY SETTLEMENT - In connection with an industry-wide investigation of
equity research and its relationship to investment banking, we recognized a
$32.5 million settlement charge in 2002. The charge was predicated on a
settlement with certain federal, state and industry regulatory agencies of $12.5
million for fines and penalties, $12.5 million for a distribution fund primarily
representing the disgorgement of profits and $7.5 million for funding
independent research to be provided to investors. The terms of this settlement
were finalized effective April 28, 2003.
In connection with the research settlement, we have made a number of changes to
our business designed to redefine the role of equity research and its
relationship to investment banking and to separate our research group from our
investment banking group. We have combined our equity, fixed income and private
client research groups into a single Investment Research group and have hired
additional staff who will be dedicated to oversight of this group. The
determination of the budget for our Investment Research group, as well as
compensation of our research analysts, will be made without regard to specific
Investment Banking revenues or results and without input from Investment
Banking. Moreover, with respect to research analyst compensation, we have
developed and implemented a performance matrix to evaluate and compensate
28 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
research analysts. We have formed a research oversight committee, which will
provide oversight and ratification for all fundamental research coverage
initiations and discontinuances, as well as fundamental research opinion
changes. We have significantly revised our policies and procedures to require a
compliance group chaperone for otherwise permissible meetings or communications
between Investment Banking and Investment Research. We also have significantly
revised our policies and procedures to ensure generally the independence of our
research analysts. Finally, we have implemented appropriate firewalls to block
communications (e.g., e-mail) and shared network directory access between
Investment Research and Investment Banking.
The ongoing costs associated with the other changes we are making to our
business in connection with the regulatory settlement will be reflected in our
results of operations in future periods and are not currently determinable.
AMORTIZATION OF ACQUISITION-RELATED COMPENSATION AND GOODWILL - Amortization of
acquisition-related compensation and goodwill expenses in 2001 consisted of
deferred compensation for certain employees and goodwill directly related to the
1998 acquisition of Piper Jaffray Companies Inc. and its subsidiaries by U.S.
Bancorp.
On January 1, 2002, we adopted Statement of Financial Accounting Standards No.
142 (SFAS 142), entitled "Goodwill and Other Intangible Assets." SFAS 142
addresses the accounting for goodwill and intangibles subsequent to their
acquisition. The most significant changes made by SFAS 142 are that goodwill and
indefinite-lived assets are no longer amortized and are tested for impairment at
least annually. As of January 1, 2002, we discontinued the amortization of
goodwill. Prior to the adoption of SFAS 142, goodwill amortization was $14.4
million in 2001. The remaining $3.2 million of expense included in amortization
in 2001 relates to deferred compensation costs established at the time of the
acquisition in 1998 of Piper Jaffray Companies Inc. and its subsidiaries by U.S.
Bancorp. These deferred compensation costs were fully vested and amortized by
May of 2001.
MERGER AND RESTRUCTURING - Merger and restructuring related charges were $8.0
million in 2002 compared with $65.7 million in 2001. In 2002, restructuring
charges were taken in response to continued weakness in the equity market and
included $5.3 million for severance, other benefits and outplacement costs
associated with the termination of employees and $0.5 million for asset
write-downs and lease terminations for branch closings. In addition, we incurred
$2.2 million of charges related to integrating the fixed income division of U.S.
Bancorp Investments, Inc. into our business in connection with the integration
plan associated with the 2001 merger of U.S. Bancorp and Firstar Corporation.
In 2001, merger and restructuring-related charges included costs associated with
the restructuring of our business of $50.8 million and costs associated with the
U.S. Bancorp and Firstar Corporation merger of $14.9 million. In response to
significant changes in the securities markets, including increased volatility,
declines in equity valuations, lower sales volumes and an increasingly
competitive environment, we implemented a restructuring plan to realign our
distribution network and improve business processes. The business restructuring
charges included $29.3 million in severance, other benefits and outplacement
costs associated with the termination of approximately 300 employees.
Approximately $12.4 million of charges were taken for asset write-downs and
lease terminations related to redundant office space and branches that were
vacated as part of the restructuring plan. The remaining $9.1 million of
business restructuring charges in 2001 was primarily from the write-down of
intangibles related to the 1999 acquisition of the investment banking division
of The John Nuveen Company that were impaired as a direct result of decisions to
terminate certain employees and close offices in connection with the overall
restructuring plan. Costs associated with the U.S. Bancorp and Firstar
Corporation merger included approximately $14.0 million in accelerated vesting
of restricted stock that occurred at the time of that merger.
ROYALTY FEE - In connection with the 1998 acquisition of Piper Jaffray Companies
Inc. and its subsidiaries by U.S. Bancorp, tradenames and trademarks were
established for use by us. The amount of the royalty fees was established as a
percentage of net revenues and determined based on analysis of comparable
royalty fee arrangements of other companies. In 2000, we began making royalty
payments to U.S. Bancorp. The royalty rate was adjusted periodically to reflect
changes in the expected benefits from the use of the tradenames and trademarks.
The U.S. Bancorp Piper Jaffray tradename and trademark will no longer be used
and, accordingly, these charges were discontinued at the time of the spin off
from U.S. Bancorp.
PIPER JAFFRAY ANNUAL REPORT 2003 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OTHER OPERATING EXPENSES - Other operating expenses include reserves for
employee loan losses, litigation-related costs, license and registration fees,
service charges from U.S. Bancorp and its affiliates for corporate support, and
other miscellaneous expenses. Other operating expenses increased to $43.0
million in 2003, compared with $31.1 million for the prior year. This increase
relates primarily to a $7.4 million increase in our loan loss allowance related
to loans made to certain revenue-producing employees. These loans are typically
made in connection with recruitment and are forgivable based on continued
employment. We amortize the loans using the straight-line method over the terms
of the loans, which generally range from three to five years. Loan recipients
who leave us prior to full forgiveness of their loan balance are obligated to
repay remaining balances. However, historical collection efforts have been
difficult. Given these facts, an employee loan loss reserve is established when
employees with remaining balances terminate and it is probable that the loans
are not collectible. During the first and second quarters of 2003, we
communicated to employees certain changes to our production-based compensation
plans that were effective in the third quarter of 2003. These compensation
changes reflect a shift from a product-based payout to a production-based
payout. This change more closely aligns our new compensation plan to the
compensation plans of our competitors. Subsequent to these communications, we
have experienced attrition with respect to impacted revenue-producing employees.
We expect this trend to continue and, based on historical collection efforts, to
result in employee loan losses. Accordingly, we increased our allowance for our
exposure to employee loan losses. Also contributing to the increase in other
operating expenses is an increase in litigation-related expenses incurred in
2003 as compared with 2002. Litigation-related expenses were $16.1 million for
2003 as compared with $10.9 million in 2002.
Other operating expenses were $31.1 million in 2002 compared with $25.6 million
in 2001. The increase of $5.5 million, or 21.5 percent, in 2002 compared with
2001 relates primarily to allocated costs from U.S. Bancorp for
technology-related support and from litigation-related expenses.
INCOME TAXES - The provision for income taxes was $15.8 million, an effective
tax rate of 37.9 percent, for the year ended December 31, 2003 compared with
$5.9 million, an effective tax rate of 98.2 percent, and an income tax benefit
of $22.8 million, an effective tax rate of 31.3 percent, for the years ended
December 31, 2002 and 2001, respectively. The non-deductibility of the
regulatory fine in 2002 associated with the equity research practices described
above was the primary factor in the increase in the effective tax rate in 2002,
offset somewhat by the impact of new accounting principles for the amortization
of goodwill. For further information on income taxes, see Note 21 to the
consolidated financial statements.
SEGMENT PERFORMANCE
We measure financial performance by business segment, including Capital Markets,
Private Client Services, and Corporate Support and Other. The business segments
are determined based upon factors such as the type of customers, the nature of
products and services provided and the distribution channels used to provide
those products and services. Segment pre-tax operating income or loss and
segment operating margin is 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. Segment pre-tax operating income or
loss is derived from our business unit profitability reporting systems by
specifically attributing customer relationships and their related revenues and
expenses. Expenses directly managed by the business unit are accounted for
within each segment's pre-tax operating income or loss. Investment research,
operations, technology and compliance related costs are allocated based on each
segment's use of these functions to support its business. General and
administrative expenses incurred by centrally managed corporate support
functions are included within Corporate Support and Other. To enhance the
comparability of business segment results, goodwill amortization for periods
prior to the adoption of SFAS 142 is not included in segment pre-tax operating
income or loss. Also, merger and restructuring-related charges, royalty fees
assessed by U.S. Bancorp, retention cash awards granted to employees in
connection with our separation from U.S. Bancorp, and certain infrequent
regulatory settlement costs are not included in segment pre-tax operating income
or loss. Designations, assignments and allocations may change from time to time
as financial reporting systems are enhanced and methods of evaluating
performance change or business segments are realigned to better serve our
customer base. The presentation reflects our current management structure and,
accordingly, all periods are presented on a comparable basis.
30 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Our primary revenue-producing segments, Capital Markets and Private Client
Services, have different compensation plans and non-compensation cost structures
that impact the operating margins of the two segments differently during periods
of increasing or decreasing business activity and revenue. Compensation expense
for Capital Markets is driven primarily by pre-tax operating profit of the
segment, whereas compensation expense for Private Client Services is driven
primarily by net revenues. In addition, Capital Markets has a higher proportion
of variable non-compensation expenses than does Private Client Services. These
differences in compensation plans and cost structures result in a more stable
operating margin for Capital Markets and greater variability in operating margin
for Private Client Services.
The following table provides our segment performance for the periods presented:
SEGMENT PERFORMANCE
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2003 2002
(Dollars in Thousands) 2003 2002 2001 v 2002 v 2001
- ---------------------------------------------------------------------------------------------------------
NET REVENUES
Capital Markets $430,355 $376,074 $422,235 14.4% (10.9)%
Private Client Services 352,113 357,155 392,447 (1.4) (9.0)
Corporate Support and Other 4,262 (4,177) (13,910) 202.0 70.0
- -------------------------------------------------------------------------------------
Total $786,730 $729,052 $800,772 7.9 (9.0)
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
PRE-TAX OPERATING INCOME (LOSS) BEFORE UNALLOCATED
CHARGES (a)
Capital Markets $ 77,946 $ 65,655 $ 76,534 18.7% (14.2)%
Private Client Services 28,482 29,902 39,013 (4.7) (23.4)
Corporate Support and Other (36,683) (41,638) (49,261) 11.9 15.5
- -------------------------------------------------------------------------------------
Total $ 69,745 $ 53,919 $ 66,286 29.4 (18.7)
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
PRE-TAX OPERATING MARGIN BEFORE UNALLOCATED CHARGES
Capital Markets 18.1% 17.5% 18.1%
Private Client Services 8.1% 8.4% 9.9%
Total 8.9% 7.4% 8.3%
- -------------------------------------------------------------------------------------
</Table>
(a) See Reconciliation to pre-tax operating income (loss) including unallocated
charges for detail on expenses excluded from segment performance.
<Table>
RECONCILIATION TO PRE-TAX OPERATING INCOME (LOSS)
INCLUDING UNALLOCATED CHARGES
Pre-tax operating income (loss) before
unallocated charges $ 69,745 $ 53,919 $ 66,286
Cash award plan 24,000 - -
Regulatory settlement - 32,500 -
Amortization of acquisition-related compensation
and goodwill - - 17,641
Merger and restructuring - 7,976 65,697
Royalty fee 3,911 7,482 55,753
- -------------------------------------------------------------------------------------
Consolidated income (loss) before income tax
expense (benefit) $ 41,834 $ 5,961 $(72,805)
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
</Table>
PIPER JAFFRAY ANNUAL REPORT 2003 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CAPITAL MARKETS
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2003 2002
(DOLLARS IN THOUSANDS) 2003 2002 2001 V 2002 V 2001
- ---------------------------------------------------------------------------------------------------------
NET REVENUES
Commissions and principal transactions $208,741 $170,362 $177,689 22.5% (4.1)%
Investment banking 198,221 181,529 220,390 9.2 (17.6)
Net interest 19,668 20,827 23,392 (5.6) (11.0)
Other income 3,725 3,356 764 11.0 339.3
- -------------------------------------------------------------------------------------
Total net revenues $430,355 $376,074 $422,235 14.4 (10.9)
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
Pre-tax operating income before unallocated charges $ 77,946 $ 65,655 $ 76,534 18.7% (14.2)%
Pre-tax operating margin 18.1% 17.5% 18.1%
- -------------------------------------------------------------------------------------
</Table>
Capital Markets net revenues increased 14.4 percent to $430.4 million in 2003
from $376.1 million for the prior year. Commissions and trading revenue
increased 22.5 percent to $208.7 million in 2003 compared with $170.4 million
for the prior year, primarily due to higher institutional trading volumes,
particularly in fixed income products. In addition, equity institutional revenue
grew despite lower trading volumes as we reduced trading losses incurred from
facilitating customer transactions. Investment banking revenue increased to
$198.2 million for 2003 compared with $181.5 million for the prior year, due
primarily to increased equity underwriting activity, aided by the first full
year results of the convertibles team that joined our firm at the end of 2002.
Segment pre-tax operating margin for Capital Markets increased to 18.1 percent
for 2003 compared with 17.5 percent for the prior year. The increase in pre-tax
operating margin is due primarily to the increase in net revenues and the
leveraging of fixed expenses such as marketing and business development,
occupancy and salary costs.
Capital Markets net revenues decreased to $376.1 million in 2002 from $422.2
million in 2001 primarily due to weak equity market conditions. Commissions and
trading revenue decreased to $170.4 million in 2002 from $177.7 million in 2001
due primarily to higher trading losses incurred from facilitating customer
transactions in our equity institutional business, offset partially by higher
equity institutional trading volumes. Investment banking revenue decreased to
$181.5 million in 2002 from $220.4 million in 2001 due primarily to reduced
equity underwritings and merger and acquisition advisory fees, offset partially
by increased municipal bond underwriting revenue as issuers took advantage of
the declining interest rate environment. Net interest revenue declined due to
changes in interest rates and inventory levels.
Segment pre-tax operating margin for Capital Markets decreased to 17.5 percent
in 2002 from 18.1 percent in 2001. This decline is primarily attributable to
increases in outside services related to the outsourcing of securities
processing activities and higher litigation-related expenses. Also contributing
to the decline was increased floor brokerage and clearance expense due to
increased use of electronic communication networks to obtain trade execution.
Partially offsetting these additional expenses was the reduction in certain
costs resulting from the restructuring activities taken in 2001 and our decision
to no longer participate in the U.S. Bancorp Cash Balance Pension Plan during
2002. An employer discretionary profit sharing plan replaced participation in
the U.S. Bancorp plan to more closely align retirement benefits for our
employees with performance of the business. In 2002, no contribution was made to
the profit sharing plan, based on our operating results.
32 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
PRIVATE CLIENT SERVICES
<Table>
<Caption>
YEAR ENDED DECEMBER 31 2003 2002
(DOLLARS IN THOUSANDS) 2003 2002 2001 V 2002 V 2001
- ---------------------------------------------------------------------------------------------------------
NET REVENUES
Commissions and fees $340,001 $344,643 $378,925 (1.3)% (9.0)%
Net interest 12,112 12,512 13,522 (3.2) (7.5)
- -------------------------------------------------------------------------------------
Total net revenues $352,113 $357,155 $392,447 (1.4) (9.0)
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
Pre-tax operating income before unallocated charges $ 28,482 $ 29,902 $ 39,013 (4.7)% (23.4)%
Pre-tax operating margin 8.1% 8.4% 9.9%
Number of financial advisors (period end) 830 975 1,061 (14.9)% (8.1)%
- -------------------------------------------------------------------------------------
</Table>
Private Client Services net revenues decreased to $352.1 million in 2003
compared with $357.2 million for the prior year, due primarily to reduced mutual
fund commissions of $8.8 million, lower account fees of $3.9 million and reduced
investment management account fees of $3.8 million. These reductions were offset
partially by increased revenue of $8.5 million related to our new agreement with
U.S. Bancorp Asset Management for the provision of cash sweep products to our
clients. We implemented a new compensation plan in mid-2003, which contributed
significantly to attrition among lower-end producers. Changes to the new
compensation plan reflected a shift from a product-based payout to a
production-based payout, and more closely aligns our compensation plan to those
of our competitors at all levels of production.
Segment pre-tax operating margin for Private Client Services decreased to 8.1
percent in 2003 compared with 8.4 percent for 2002. This decline is primarily
attributable to increased employee loan losses related to forgivable loans made
to our financial advisors. Also contributing to this decline in operating margin
were increased litigation-related expenses in 2003 as compared with 2002
reflecting an increase in the number of complaints, legal actions,
investigations and regulatory proceedings. Mostly offsetting these additional
expenses were reductions in fixed and variable compensation expense for 2003 due
to our previous restructuring efforts.
Net revenues for Private Client Services decreased to $357.2 million in 2002
from $392.4 million in 2001, primarily due to reduced equity commissions of
$22.0 million, reduced mutual fund commissions of $3.7 million and reduced
annuity commissions of $5.7 million, offset partially by increased fixed income
commissions of $3.4 million due to higher trading volumes. Net interest revenue
decreased as customer margin balances declined, offset in part by competitive
pricing changes. Contributing to the lower revenues were planned reductions in
under-performing financial advisors in connection with our restructuring
activities, as well as unplanned attrition of financial advisors. The number of
financial advisors decreased 8.1 percent between December 31, 2001 and December
31, 2002.
Segment pre-tax operating margin for Private Client Services decreased to 8.4
percent in 2002 from 9.9 percent in 2001. This decline is primarily attributable
to Private Client Services' fixed costs, such as occupancy and communication,
which negatively impacted pre-tax operating margin as net revenues declined due
to market conditions. The impact of these fixed costs on pre-tax operating
margin in 2002 was mitigated somewhat by our restructuring activities taken in
2001 and cost control initiatives undertaken related to discretionary expenses.
Also contributing to the decline in pre-tax operating margin was the increase in
outside services related to outsourcing certain securities processing activities
and litigation-related expenses. Although a significant portion of compensation
is variable, certain components are relatively fixed, such as salaries and
benefits, which have a negative impact on our pre-tax operating margin during
periods of declining revenue. Partially offsetting these fixed components of
compensation was the reduction of other costs resulting from the restructuring
activities taken in 2001 and our decision to no longer participate in the U.S.
Bancorp pension plan effective January 1, 2002. An employer discretionary profit
sharing plan replaced participation in the U.S. Bancorp plan to more closely
align retirement benefits for our employees with performance of the business. In
2002, no contribution was made to the profit sharing plan, based on our
operating results.
PIPER JAFFRAY ANNUAL REPORT 2003 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CORPORATE SUPPORT AND OTHER - Corporate Support and Other includes certain
revenues not attributable to the Capital Markets or Private Client Services
business segments. These revenues are primarily attributable to our venture
capital subsidiary and our investments in limited partnerships that invest in
venture capital funds. The Corporate Support and Other segment also includes
interest expense on subordinated debt, which is recorded in net revenues. Net
revenues increased to $4.3 million in 2003 compared with a loss of $4.2 million
for the prior year. This change was due primarily to a reduction in interest
expense on our subordinated debt and increased management fees from our venture
capital subsidiary.
Net revenues improved to a loss of $4.2 million in 2002 from a loss of $13.9
million in 2001. This change was due primarily to a reduction in interest
expense on subordinated debt due to U.S. Bancorp recapitalizing Piper Jaffray in
July of 2002, by contributing capital and reducing subordinated debt borrowings.
Outlook
We believe that the following are some of the key items that will impact our
future operations:
- - We will no longer incur expenses related to royalty fees paid to U.S. Bancorp
for the use of trade names. In 2003 these fees were approximately $3.9
million.
- - Based on current market conditions, increased claims activity for insurance
carriers and our decreased purchasing power resulting from our spin off from
U.S. Bancorp, we expect insurance premiums are likely to continue to increase.
- - In connection with the market downturn that began in 2000, the number of
complaints, legal actions, investigations and regulatory proceedings has
increased in recent years. We expect that this trend may continue, and we may
continue to see increased litigation-related expenses.
- - Based on current estimates, we expect to incur approximately $5.2 million of
expense on an annual basis as a result of being a public company, including
audit and tax services, investor relations, compliance with SEC and NYSE
rules, board of directors costs and directors and officers insurance costs.
- - We expect to incur an annual pre-tax charge of approximately $5.9 million
through 2006 and approximately $5.3 million in 2007 related to the employee
cash award program established in connection with our spin off from U.S.
Bancorp. We expect to fund these cash awards using cash flow from operations.
- - We joined the Minnesota Keystone Program, a voluntary program, co-founded by
Piper Jaffray 25 years ago, for corporations that commit a portion of their
pre-tax earnings to non-profit organizations. We plan on participating at the
5 percent giving level, meaning that we will contribute up to 5 percent of our
pre-tax earnings. Contributions may consist of a combination of cash, in-kind
services and employee volunteer hours.
- - We do not intend to pay cash dividends on our common stock for the foreseeable
future. We expect to retain all available funds and any future earnings for
use in the operation and expansion of our business.
- - On February 12, 2004 the Company granted approximately 500,000 shares of Piper
Jaffray Companies restricted stock and approximately 290,000 options on Piper
Jaffray Companies common stock to employees, executive officers and directors.
These awards will vest 100 percent on February 12, 2007.
Recent Accounting Developments
Recent accounting pronouncements are set forth in Note 3 to the consolidated
financial statements and are incorporated herein by reference.
Critical Accounting Policies
Our accounting and reporting policies comply with accounting principles
generally accepted in the United States of America and conform to practices
within the securities industry. The preparation of financial statements requires
management to make estimates and assumptions that could materially affect
reported amounts in the consolidated financial statements. Critical accounting
policies are those policies that management believes are the most important to
the portrayal of our financial condition and results of operations, and require
management to make estimates that are difficult, subjective or complex. Most
accounting policies are not considered by management to be critical accounting
policies. Several factors are considered in determining whether or not a policy
is critical, including, among others, whether the estimates are significant to
the consolidated
34 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
financial statements taken as a whole, the nature of the estimates, the ability
to readily validate the estimates with other information including third parties
or independent pricing sources, the sensitivity of the estimates to changes in
economic conditions and whether alternative accounting methods may be used under
accounting principles generally accepted in the United States of America.
Significant accounting policies are discussed in Note 2 to the consolidated
financial statements. We believe that of our significant policies, the following
are our critical accounting policies.
VALUATION OF FINANCIAL INSTRUMENTS
Substantially all of our financial instruments are recorded at fair value or
contract amounts which approximate fair value. Financial instruments carried at
contract amounts which approximate fair value, either have short-term maturities
(one year or less), are repriced frequently, or bear market interest rates and,
accordingly, are carried at amounts approximating fair value. Financial
instruments carried at contract amount on the consolidated statements of
financial condition include receivables from and payables to brokers, dealers
and clearing organizations, securities purchased under agreements to resell,
securities sold under agreements to repurchase, receivables from and payables to
customers, short-term financing and subordinated debt. Unrealized gains and
losses related to these financial instruments are reflected in the consolidated
statements of operations. Where available, we use prices from independent
sources such as listed market prices or dealer price quotations.
For investments in illiquid or privately held securities that do not have
readily determinable fair values, the determination of fair value requires
management to estimate the value of the securities using the best information
available. Among the factors considered by management in determining the fair
value of financial instruments are the cost, terms and liquidity of the
investment, the financial condition and operating results of the issuer, the
quoted market price of publicly traded securities with similar quality and yield
and other factors generally pertinent to the valuation of investments. In
instances where a security is subject to transfer restrictions, the value of the
security is based primarily on the quoted price of a similar security without
restriction but may be reduced by an amount estimated to reflect such
restrictions. In addition, even where the value of a security is derived from an
independent source, certain assumptions may be required to determine the
security's fair value. For instance, we generally assume that the size of
positions in securities that we hold would not be large enough to affect the
quoted price of the securities if we sell them, and that any such sale would
happen in an orderly manner. The actual value realized upon disposition could be
different from the currently estimated fair value.
GOODWILL
We record all assets and liabilities acquired in purchase acquisitions,
including goodwill, at fair value as required by Statement of Financial
Accounting Standards No. 141, entitled "Business Combinations." At December 31,
2003, we had goodwill of $305.6 million as a result of the 1998 acquisition of
Piper Jaffray Companies Inc. and its subsidiaries by U.S. Bancorp. We had no
recorded indefinite-lived assets or other intangibles as of that date.
The initial recognition of goodwill and other intangible assets and subsequent
impairment analysis require management to make subjective judgments concerning
estimates of how the acquired assets or businesses will perform in the future
using valuation methods including discounted cash flow analysis. Additionally,
estimated cash flows may extend beyond ten years and, by their nature, are
difficult to determine over an extended timeframe. Events and factors that may
significantly affect the estimates include, among others, competitive forces,
changes in revenue growth trends, cost structures and technology, changes in
discount rates and market conditions. In determining the reasonableness of cash
flow estimates, management reviews historical performance of the underlying
assets or similar assets in an effort to assess and validate assumptions used in
its estimates.
In assessing the fair value of our operating segments, the volatile nature of
the securities markets and our industry requires our management to consider the
business and market cycle and assess the stage of the cycle in estimating the
timing and extent of future cash flows. In addition to estimating the fair value
of an operating segment based on discounted cash flows, management considers
other information to validate the reasonableness of its valuations including
public market comparables, multiples of recent mergers and acquisitions of
similar businesses and third-party assessments. Valuation multiples may be based
on revenues, price-to-earnings and tangible capital ratios of comparable public
companies and business segments. These multiples may be adjusted to consider
PIPER JAFFRAY ANNUAL REPORT 2003 35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
competitive differences including size, operating leverage, and other factors.
We determine the carrying amount of an operating segment based on the capital
required to support the segment's activities including its tangible and
intangible assets. The determination of a segment's capital allocation requires
management judgment and considers many factors, including the regulatory capital
requirements and tangible capital ratios of comparable public companies in
relevant industry sectors. In certain circumstances, management may engage a
third party to validate independently its assessment of the fair value of its
operating segments. If during any future period it is determined that an
impairment exists, the results of operations in that period could be materially
affected.
STOCK-BASED COMPENSATION
As part of our compensation of employees, we may use stock-based compensation,
including stock options, restricted stock and other stock-based awards. These
awards may be for key employees or in connection with sales and production-based
incentives. Compensation related to restricted stock is amortized over the
vesting period of the award, which is generally three to five years, and is
included in our results of operations as compensation. Accounting principles
generally accepted in the United States allow alternative methods of accounting
for stock options, including an "intrinsic value" method and a "fair value"
method. The intrinsic value method is intended to reflect the impact of stock
options on stockholders based on the appreciation in the stock option over time,
generally driven by financial performance. The fair value method requires an
estimate of the value of stock options to be recognized as compensation over the
vesting period of the awards. Historically, we have used the intrinsic value
method and did not recognize the impact of these awards as compensation expense.
Accordingly, we provided disclosure of the impact of the estimated fair value of
stock options on our compensation and reported income in the notes to the
consolidated financial statements. In determining the estimated fair value of
stock options, we used the Black-Scholes option-pricing model, which requires
judgment regarding certain assumptions, including the expected life of the
options granted, dividend yields and stock volatility. Certain of these
assumptions were based on the stock performance of U.S. Bancorp and may not
reflect assumptions that would be used by us as a stand-alone entity. Also,
employee stock options have characteristics that are significantly different
from those of traded options, including vesting provisions and trading
limitations that impact their liquidity. Therefore, the existing option-pricing
models, including Black-Scholes, do not necessarily provide a reliable measure
of the fair value of employee stock options.
Effective January 1, 2004, we elected to account on a prospective basis for
stock-based employee compensation under the fair value method, as prescribed by
Statement of Financial Accounting Standards No. 123, "Accounting and Disclosure
of Stock-Based Compensation" as amended by Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure."
CONTINGENCIES
We are involved in various pending and potential complaints, arbitrations, legal
actions, investigations and proceedings related to our business. Some of these
matters involve claims for substantial amounts, including claims for punitive
and other special damages. The number of these complaints, legal actions,
investigations and regulatory proceedings has been increasing in recent years.
We have, after consultation with outside counsel and consideration of facts
currently known by management, recorded estimated losses in accordance with
Statement of Financial Accounting Standards No. 5, "Accounting for
Contingencies," to the extent that claims are probable of loss and the amount of
the loss can be reasonably estimated. The determination of these reserve amounts
requires significant judgment on the part of management. In making these
determinations, management considers many factors, including, but not limited
to, the loss and damages sought by the plaintiff or claimant, the basis and
validity of the claim, the likelihood of successful defense against the claim,
and the potential for, and magnitude of, damages or settlements from such
pending and potential complaints, legal actions, arbitrations, investigations
and proceedings, and fines and penalties or orders from regulatory agencies.
Under the terms of our separation and distribution agreement with U.S. Bancorp
and ancillary agreements, we will generally be responsible for all liabilities
relating to our business, including those liabilities relating to our business
while it was operated as a segment of U.S. Bancorp under the supervision of its
management and board of directors and while our employees were employees of U.S.
Bancorp servicing our business. Similarly, U.S. Bancorp will generally be
responsible for all liabilities relating to the businesses U.S. Bancorp
36 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
retained. However, in addition to our established reserves, U.S. Bancorp has
agreed to indemnify us in an amount of up to $17.5 million for losses that
result from third-party claims relating to research analyst independence,
regulatory investigations regarding the allocation of IPO shares to directors
and officers of investment banking clients, and regulatory investigations into
our mutual fund practices. U.S. Bancorp has the right to terminate this
indemnification obligation in the event of a change in control of our company.
Subject to the foregoing, we believe, based on current knowledge, after
consultation with counsel and after taking into account our established reserves
and the U.S. Bancorp indemnity agreement, that pending legal actions,
investigations and proceedings will be resolved with no material adverse effect
on our financial condition. However, if, during any period, a potential adverse
contingency should become probable or resolved for an amount in excess of the
established reserves and indemnification, the results of operations in that
period could be materially affected.
Liquidity and Capital Resources
We have a liquid balance sheet. Most of our assets consist of cash and assets
readily convertible into cash. Securities inventories are stated at fair value
and are generally readily marketable. Customers' margin loans are collateralized
by securities and have floating interest rates. Other receivables and payables
with customers and other brokers and dealers usually settle within a few days.
Our assets are financed by our equity capital, bank lines of credit,
subordinated debt, proceeds from securities lending and securities sold under
agreements to repurchase, in addition to non-interest bearing liabilities, such
as checks and drafts payable, payables to customers and employee compensation
payable. The fluctuations in cash flows from financing activities are directly
related to daily operating activities from our various businesses.
CASH FLOWS FOR THE YEAR ENDED DECEMBER 2003
Cash and cash equivalents increased $51.8 million in 2003 to $84.4 million at
December 31, 2003. Operating activities provided cash of $159.0 million. Cash of
$15.1 million was used for investing activities. Cash of $92.1 million was used
for financing activities, including the net reduction of short-term borrowings
of $91.0 million and subordinated debt of $35.0 million, net of $33.9 million in
capital contributions from U.S. Bancorp.
CASH FLOWS FOR THE YEAR ENDED DECEMBER 2002
Cash and cash equivalents increased $4.9 million in 2002 to $32.6 million at
December 31, 2002. Operating activities provided cash of $297.3 million. Cash of
$5.8 million was used for investing activities. Cash of $286.6 million was used
for financing activities, including the reduction of short-term borrowings of
$257.6 million and subordinated debt of $260.0 million, net of $231.0 million in
capital contributions from U.S. Bancorp.
CASH FLOWS FOR THE YEAR ENDED DECEMBER 2001
Cash and cash equivalents decreased $50.0 million to $27.7 million at December
31, 2001. Operating activities provided cash of $11.6 million. Cash of $41.0
million was used for investing activities. Cash of $20.6 million was used for
financing activities, including the reduction of short-term borrowings of $87.1
million and a capital distribution of $8.5 million to U.S. Bancorp, offset
partially by a $75.0 million capital contribution from U.S. Bancorp to ensure
adequate levels of capital through significant system conversions.
FUNDING SOURCES
As of December 31, 2003, we had uncommitted credit agreements with banks
totaling $550 million, comprising $450 million in discretionary secured lines
and $100 million in discretionary unsecured lines. In addition, we have
established an arrangement to obtain financing using our securities held by our
clearing bank at the end of each day as collateral. In addition, we will use
repurchase agreements and securities lending as additional sources of funding.
In addition to the $550 million of financing commitments described above, our
broker dealer subsidiary is party to a $180 million subordinated debt facility
with an affiliate of U.S. Bancorp, which has been approved by the NYSE for
regulatory net capital purposes as allowable in our broker dealer subsidiary's
net capital computation. The interest on the subordinated debt facility is based
on the three-month London Interbank Offer Rate and the entire amount outstanding
matures in 2008.
PIPER JAFFRAY ANNUAL REPORT 2003 37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CASH REQUIREMENTS
The following table provides a summary of our contractual obligations as of
December 31, 2003:
<Table>
<Caption>
2005 2007 2009
Through Through and
(Dollars in Millions) 2004 2006 2008 Thereafter Total
- ------------------------------------------------------------------------------------------------------------
Long-term borrowings $ - $ - $ 180.0 $ - $180.0
Operating leases 28.3 43.8 36.2 84.2 192.5
Venture fund commitments (a) - - - - 1.7
Technology contracts 9.9 15.7 12.5 - 38.1
Cash award program 24.0 11.8 11.2 - 47.0
- ------------------------------------------------------------------------------------------------------------
Total $62.2 $ 71.3 $ 239.9 $ 84.2 $459.3
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
</Table>
(a) The venture fund commitments have no specified call dates. The timing of
capital calls is based on market conditions and investment opportunities.
As of December 31, 2003, our long-term borrowings were $180.0 million, all due
in 2008. Our minimum lease commitments for noncancelable office space and
equipment leases were $192.5 million. Certain leases have renewal options and
clauses for escalation and operating cost adjustments. We have commitments to
invest an additional $1.7 million in venture capital funds and commitments for
technology contracts of $38.1 million.
CAPITAL REQUIREMENTS
As a registered broker dealer and member firm of the NYSE, our broker dealer
subsidiary is subject to the uniform net capital rule of the SEC and the net
capital rule of the NYSE. We have elected to use the alternative method
permitted by the uniform net capital rule, which requires that we maintain
minimum net capital of the greater of $1.0 million or 2 percent of aggregate
debit balances arising from customer transactions, as this is defined in the
rule. The NYSE may prohibit a member firm from expanding its business or paying
dividends if resulting net capital would be less than 5 percent of aggregate
debit balances. Advances to affiliates, repayment of subordinated liabilities,
dividend payments and other equity withdrawals are subject to certain
notification and other provisions of the uniform net capital rule and the net
capital rule of the NYSE. We expect these provisions will not impact our ability
to meet current and future obligations. In addition, we are subject to certain
notification requirements related to withdrawals of excess net capital from our
broker dealer subsidiary. Our broker dealer subsidiary is also registered with
the Commodity Futures Trading Commission and therefore is subject to CFTC
regulations. Piper Jaffray Ltd., our registered United Kingdom broker dealer
subsidiary, is subject to the capital requirements of the U.K. Financial
Services Authority.
Off-balance Sheet Arrangements
Our off-balance sheet arrangements are described in Note 19 to the consolidated
financial statements and are incorporated herein by reference.
Enterprise Risk Management
Risk is an inherent part of our business. Market risk, credit risk, operational
risk and legal, regulatory and compliance risk are the principal risks in our
business activities, and we seek to identify, assess and monitor each risk in
accordance with defined policies and procedures. The extent to which we properly
and effectively manage each of the various types of risk involved in our
activities is critical to our financial condition and profitability.
With respect to market risk and credit risk, the cornerstone of our risk
management process is daily communication between traders, trading department
management and senior management concerning our inventory positions and overall
market risk profile. Our enterprise risk management department supplements this
communication process by providing its independent perspective on our market and
credit risk profile on a daily basis through a series of reports. The broader
goals of our enterprise risk management department are to understand the market
risk profile of each trading area, to consolidate risk monitoring company-wide,
to articulate large trading or position risks to senior management, to provide
traders with perspectives on their positions and to ensure accurate mark-to-
market pricing.
38 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In addition to supporting daily risk management processes on the trading desks,
our enterprise risk management department supports the market risk and
institutional credit risk committees. The committees oversee risk management
practices, including defining acceptable risk tolerances and approving risk
management policies.
The following discussion of our risk management procedures for our principal
risks and the estimated amounts of our market risk exposure generated by our
statistical analyses contains forward-looking statements. The analyses used to
assess such risks are not predictions of future events, and actual results may
vary significantly from such analyses due to events in the markets in which we
operate and certain other factors as described herein.
MARKET RISK
Market risk represents the risk of financial loss that may result from the
change in value of a financial instrument due to fluctuations in its market
price. Market risk can be exacerbated in times of trading illiquidity when
market participants refrain from transacting in normal quantities and/or at
normal bid-offer spreads. Our exposure to market risk is directly related to our
role as a financial intermediary in customer trading and to our market-making
activities. Market risk is inherent to both cash and derivative financial
instruments. The scope of our market risk management policies and procedures
includes all market-sensitive financial instruments.
We use a variety of risk management techniques and hedging strategies, including
establishing position limits by product type and industry sector, closely
monitoring inventory turnover, maintaining long and short positions in related
securities, and using interest rate swaps, exchange-traded interest rate futures
and options, exchange-traded equity options and other derivative instruments for
hedging. However, we do not use derivatives for speculative purposes.
Trading desk management, senior management and risk management also review the
age and composition of inventory accounts and review risk reports appropriate to
the risk profile of each trading activity. Typically, market conditions are
evaluated, certain transactions are reviewed and quantitative methods, such as
value-at-risk are employed. These activities seek to ensure that trading
strategies are within acceptable risk tolerance parameters. We also believe that
an understanding of how our positions generate profit or loss on a daily basis
is crucial to managing risk.
INTEREST RATE RISK
Interest rate risk represents the potential loss from adverse changes in market
interest rates. We are exposed to interest rate risk arising from changes in the
level and volatility of interest rates, changes in the shape of the yield curve,
changes in credit spreads, and the rate of mortgage prepayment. Interest rate
risk is managed through the use of short positions in U.S. government and
corporate debt securities, interest rate swaps, options, futures and forward
contracts. We utilize interest rate swap contracts to hedge a portion of our
fixed income inventory and to hedge residual cash flows from our tender option
bond program. These interest rate swap contracts are recorded at fair value with
the changes in fair value recognized in earnings.
EQUITY PRICE RISK
Equity price risk represents the potential loss in value due to adverse changes
in the level or volatility of equity prices. We are exposed to equity price risk
through our trading activities in both listed and over-the-counter equity
markets. We attempt to reduce the risk of loss inherent in our inventory of
equity securities by establishing position limits and managing net position
levels with those limits, monitoring inventory turnover and entering into hedge
transactions designed to mitigate our market risk profile.
VALUE-AT-RISK
Value-at-risk is the maximum expected loss, for a given level of confidence,
which could occur over a specified time period for a portfolio of securities.
For our value-at-risk calculations, we use a 99 percent confidence level over a
10-day holding period, adjusted for liquidity considerations but excluding most
diversification benefits. Interest rate and credit spread risk are modeled by
mapping positions to their 10-year equivalent values and then applying a 2.326
standard deviation (that is, a 99 percent confidence level) "shock" to the
curve.
We perform a daily value-at-risk analysis of substantially all our trading
positions, including fixed income, equities, convertible bonds and all
associated hedges. We use a value-at-risk model because it provides a common
metric for assessing market risk. We regularly evaluate our value-at-risk model
in an effort to more accurately measure the risk of loss.
PIPER JAFFRAY ANNUAL REPORT 2003 39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The modeling of the risk characteristics of our trading positions involves a
number of assumptions and approximations. While we believe that these
assumptions and approximations are reasonable, there is no uniform industry
methodology for estimating value-at-risk, and different assumptions and
approximations could produce different value-at-risk estimates.
Value-at-risk has inherent limitations, including reliance on historical data,
which may not accurately predict future market risk, and the quantitative risk
information generated is limited by the parameters established in creating the
models. There can be no assurance that actual losses occurring over any 10-day
period arising from changes in market conditions will not exceed the
value-at-risk amounts shown below or that such losses will not occur more than
once in one hundred 10-day periods. However, we believe value-at-risk models are
an appropriate methodology for comparing risk profiles across different risk
types, different business lines, and different companies in the financial
services industry.
The following table provides a quantification of the estimated value-at-risk for
each component of market risk for the periods presented:
<Table>
<Caption>
AT DECEMBER 31
(DOLLARS IN THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------
Interest Rate Risk $3,705 $2,961 $3,580
Equity Price Risk 796 880 853
- --------------------------------------------------------------------------------------
Aggregate Value-at-Risk $4,501 $3,841 $4,433
- --------------------------------------------------------------------------------------
</Table>
The table below illustrates the high, low and average value-at-risk calculated
on a daily basis for each component of market risk during calendar years 2003,
2002 and 2001. The increase in average equity price risk from 2002 to 2003 is
the result of our addition of a convertible business in November 2002:
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31, 2003
(Dollars in Thousands) High Low Average
- ---------------------------------------------------------------------------------------
Interest Rate Risk $5,336 $2,433 $3,892
Equity Price Risk 3,810 561 1,617
Aggregate Value-at-Risk 7,903 3,733 5,509
- ---------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31, 2002 High Low Average
- ---------------------------------------------------------------------------------------
Interest Rate Risk $5,088 $1,848 $3,857
Equity Price Risk 1,092 564 781
Aggregate Value-at-Risk 5,961 2,466 4,638
- ---------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31, 2001 High Low Average
- ---------------------------------------------------------------------------------------
Interest Rate Risk $4,643 $2,049 $3,077
Equity Price Risk 1,891 181 641
Aggregate Value-at-Risk 5,262 2,422 3,718
- ---------------------------------------------------------------------------------------
</Table>
CREDIT RISK
Credit risk in our Capital Markets business arises from potential
non-performance by counterparties, customers, borrowers or debt security
issuers. We are exposed to credit risk in our role as a trading counterparty to
dealers and customers, as a holder of securities and as a member of exchanges
and clearing organizations. Our client activities involve the execution,
settlement and financing of various transactions. Client activities are
transacted on a cash, delivery versus payment or margin basis. Our credit
exposure to institutional client business is mitigated by the use of industry
standard delivery versus payment through depositories and clearing banks.
40 PIPER JAFFRAY ANNUAL REPORT 2003
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Credit exposure associated with our Private Client Services business consists
primarily of customer margin accounts, which are monitored daily and are
collateralized. The treasury and credit services department, in conjunction with
our credit committee, establishes and reviews appropriate credit limits for our
Private Client Services customers.
Our institutional credit committee reviews risk associated with institutional
counterparties with whom we hold repurchase and resale agreement facilities,
stock borrow or loan facilities and other documented institutional counterparty
agreements that may give rise to credit exposure. Counterparty levels are
established relative to the level of counterparty capital and ratings.
We are subject to credit concentration risk if we hold large individual
securities positions, execute large transactions with individual counterparties
or groups of related counterparties, extend large loans to individual borrowers
or make substantial underwriting commitments. Concentration risk can occur by
industry, geographic area or type of client. Client receivables and payables and
stock borrowing and lending activities are conducted with a large number of
clients and counterparties. Potential credit concentration risk is carefully
monitored and is managed through the use of policies and limits.
We are also exposed to the risk of loss related to changes in the credit spreads
of debt instruments. Credit spread risk arises from potential changes in an
issuer's credit rating or the market's perception of the issuer's credit
worthiness. Credit spread risk is managed through offsetting long or short
positions in various related securities.
OPERATIONAL RISK
Operational risk refers to the risk of direct or indirect loss resulting from
inadequate or failed internal processes, people and systems or from external
events. We rely on the ability of our employees, our internal systems and
processes and systems at computer centers operated by third parties to process a
large number of transactions. These transactions may cross multiple markets. In
the event of a breakdown or improper operation of our systems or processes or
improper action by our employees or third-party vendors, we could suffer
financial loss, regulatory sanctions and damage to our reputation. We have
disaster recovery plans in place that we believe will cover critical systems on
a company-wide basis, and redundancies are built into the systems as we have
deemed appropriate. We also use periodic self-assessments and internal audit
reviews as a further check on operational risk.
In order to mitigate and control operational risk, we have developed and
continue to enhance specific policies and procedures that are designed to
identify, measure, control and manage operational risk at levels we believe are
appropriate throughout the organization and within such departments as
accounting, operations, technology, legal and compliance. These control
mechanisms attempt to ensure that operations policies and procedures are being
followed and that our various businesses are operating within established
corporate policies and limits.
LEGAL, REGULATORY AND COMPLIANCE RISK
Legal, regulatory and compliance risk includes the risk of non-compliance with
applicable legal and regulatory requirements and the risk that a counterparty's
performance obligations will be unenforceable. We are generally subject to
extensive regulation in the various jurisdictions in which we conduct our
business. We have established procedures that are designed to ensure compliance
with applicable statutory and regulatory requirements, including those relating
to, among others, regulatory net capital requirements, sales and trading
practices, use and safekeeping of customer funds and securities, credit
extension, money-laundering, privacy and record-keeping. We have established
internal policies relating to business conduct, ethics and compliance with
applicable requirements, as well as procedures designed to ensure that these
policies are followed.
Effects of Inflation
Because our assets are liquid in nature, they are not significantly affected by
inflation. However, the rate of inflation affects our expenses, such as employee
compensation, office space leasing costs and communications charges, which may
not be readily recoverable in the price of services offered by us. To the extent
inflation results in rising interest rates and has other adverse effects upon
the securities markets, it may adversely affect our financial position and
results of operations.
PIPER JAFFRAY ANNUAL REPORT 2003 41
PIPER JAFFRAY COMPANIES
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
<Table>
<Caption>
Page
- ------------------------------------------------------------------
Report of Independent Auditors 44
Report of Independent Accountants 45
Consolidated Financial Statements
Consolidated Statements of Financial Condition 46
Consolidated Statements of Operations 47
Consolidated Statements of Changes in Shareholders' Equity 48
Consolidated Statements of Cash Flows 49
Notes to Consolidated Financial Statements 50
- ------------------------------------------------------------------
</Table>
42 PIPER JAFFRAY ANNUAL REPORT 2003
RESPONSIBILITY FOR FINANCIAL STATEMENTS
OF PIPER JAFFRAY COMPANIES
Responsibility for financial statements and other information presented
throughout the Annual Report rests with the management of Piper Jaffray
Companies (the "Company"). The Company believes that the consolidated financial
statements have been prepared in conformity with accounting principles generally
accepted in the United States and present fairly the substance of transactions
based on the circumstances and management's best estimates and judgment. All
financial information throughout the Annual Report is consistent with that in
the financial statements.
In meeting its responsibilities for the reliability of the financial statements,
the Company depends on its system of internal controls. The system is designed
to provide reasonable assurance that assets are safeguarded and transactions are
executed in accordance with the appropriate corporate authorization and recorded
properly to permit the preparation of the financial statements. To test
compliance, the Company carries out an extensive audit program. This program
includes a review for compliance with written policies and procedures and a
comprehensive review of the adequacy and effectiveness of the internal control
systems. Although control procedures are designed and tested, it must be
recognized that there are limits inherent in all systems of internal accounting
control and, as such, errors and irregularities may nevertheless occur. Also,
estimates and judgments are required to assess and balance the relative cost and
expected benefits of the controls. The Company believes that its system of
internal controls provides reasonable assurance that errors or irregularities
that could be material to the financial statements are prevented or would be
detected within a timely period by employees in the normal course of performing
their assigned functions.
The Board of Directors of the Company has an Audit Committee composed of
directors who are not officers or employees of Piper Jaffray Companies. The
committee meets periodically with management, the internal auditors and the
independent accountants to consider audit results to discuss internal accounting
control, auditing and financial reporting matters.
The Company's independent accountants, Ernst & Young LLP, have been engaged to
render an independent professional opinion on the financial statements. Their
opinion on the financial statements is based on procedures conducted in
accordance with auditing standards generally accepted in the United States and
forms the basis for their report as to the fair presentation, in the financial
statements, of the Company's financial condition and results of operations.
<Table>
/s/ Andrew S. Duff /s/ Sandra G. Sponem
Andrew S. Duff Sandra G. Sponem
Chairman and Chief Executive Officer Chief Financial Officer
</Table>
PIPER JAFFRAY ANNUAL REPORT 2003 43
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders
of Piper Jaffray Companies:
We have audited the accompanying consolidated statement of financial condition
of Piper Jaffray Companies (the "Company") as of December 31, 2003, and the
related consolidated statements of operations, changes in shareholders' equity,
and cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Piper Jaffray
Companies at December 31, 2003, and the consolidated results of their operations
and their cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States.
ERNST & YOUNG LLP LOGO
Minneapolis, Minnesota
January 27, 2004,
except for Note 17, as to which the date is
February 12, 2004
44 PIPER JAFFRAY ANNUAL REPORT 2003
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Piper Jaffray Companies:
In our opinion, the accompanying consolidated statement of financial condition
as of December 31, 2002 and the related consolidated statements of operations,
changes in shareholders' equity, and cash flows for each of the two years in the
period ended December 31, 2002 present fairly, in all material respects, the
financial position of Piper Jaffray Companies and its subsidiaries (the
"Company") at December 31, 2002, and the results of their operations and their
cash flows for each of the two years in the period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 2 of the notes to the consolidated financial statements, in
2002, the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
PRICEWATERHOUSECOOPERS LLP LOGO
Minneapolis, Minnesota
April 30, 2003
PIPER JAFFRAY ANNUAL REPORT 2003 45
PIPER JAFFRAY COMPANIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<Table>
<Caption>
AT DECEMBER 31
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) 2003 2002
- --------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 84,436 $ 32,615
Cash and cash equivalents segregated for regulatory
purposes 66,000 -
Receivables:
Customers (net of allowance of $1,993 and $1,593,
respectively) 463,557 474,002
Brokers, dealers and clearing organizations 238,393 217,457
Deposits with clearing organizations 66,570 46,075
Securities purchased under agreements to resell 306,987 240,014
Trading securities owned 342,994 80,129
Trading securities owned and pledged as collateral 314,618 393,555
------------------------
Total trading securities owned 657,612 473,684
Fixed assets (net of accumulated depreciation and
amortization of $103,573 and $88,969, respectively) 60,757 69,059
Goodwill 305,635 305,635
Other receivables 38,553 72,012
Other assets 92,147 111,392
- --------------------------------------------------------------------------------------
Total assets $2,380,647 $2,041,945
- --------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term financing $ 159,000 $ 250,040
Payables:
Customers 226,163 143,580
Checks and drafts 64,438 57,919
Brokers, dealers and clearing organizations 224,208 216,675
Securities sold under agreements to repurchase 178,716 115,791
Trading securities sold, but not yet purchased 386,281 171,999
Accrued compensation 194,583 140,972
Other liabilities and accrued expenses 97,463 120,112
- --------------------------------------------------------------------------------------
Total liabilities 1,530,852 1,217,088
Subordinated debt 180,000 215,000
Shareholders' equity:
Invested capital - 609,857
Common stock, $0.01 par value; 100,000,000 shares
authorized, 19,334,261 issued and outstanding 193 -
Additional paid-in capital 669,602 -
- --------------------------------------------------------------------------------------
Total shareholders' equity 669,795 609,857
- --------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $2,380,647 $2,041,945
- --------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
</Table>
See Notes to Consolidated Financial Statements
46 PIPER JAFFRAY ANNUAL REPORT 2003
PIPER JAFFRAY COMPANIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001
- -------------------------------------------------------------------------------------------------
REVENUES
Commissions and fees $ 256,747 $ 275,682 $ 302,289
Principal transactions 215,191 171,957 181,469
Investment banking 229,945 208,740 247,929
Interest 45,276 59,685 95,436
Other income 59,082 47,303 52,865
- -------------------------------------------------------------------------------------------------
Total revenues 806,241 763,367 879,988
Interest expense 19,511 34,315 79,216
- -------------------------------------------------------------------------------------------------
Net revenues 786,730 729,052 800,772
- -------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES
Compensation and benefits 482,397 449,329 513,623
Occupancy and equipment 58,025 55,549 60,121
Communications 37,599 36,316 41,082
Floor brokerage and clearance 22,755 26,040 22,092
Marketing and business development 39,030 44,115 49,706
Outside services 34,219 32,717 22,285
Cash award program 24,000 - -
Regulatory settlement - 32,500 -
Amortization of acquisition-related compensation and
goodwill - - 17,641
Merger and restructuring - 7,976 65,697
Royalty fee 3,911 7,482 55,753
Other operating expenses 42,960 31,067 25,577
- -------------------------------------------------------------------------------------------------
Total non-interest expenses 744,896 723,091 873,577
- -------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAX EXPENSE (BENEFIT) 41,834 5,961 (72,805)
Income tax expense (benefit) 15,835 5,855 (22,754)
- -------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 25,999 $ 106 $ (50,051)
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Basic $ 1.35 $ 0.01 $ (2.60)
Diluted $ 1.35 $ 0.01 $ (2.60)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Basic 19,237 19,160 19,279
Diluted 19,237 19,160 19,279
</Table>
See Notes to Consolidated Financial Statements
PIPER JAFFRAY ANNUAL REPORT 2003 47
PIPER JAFFRAY COMPANIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<Table>
<Caption>
Common Additional Total
Shares Common Paid-In Invested Shareholders'
(Amounts in thousands, except share data) Outstanding Stock Capital Capital Equity
- ----------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 - $ - $ - $ 362,331 $ -
Capital contribution from U.S. Bancorp - - - 75,000 -
Distribution to U.S. Bancorp - - - (8,556) -
Net loss - - - (50,051) -
- ----------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 - $ - $ - $ 378,724 $ -
Capital contribution from U.S. Bancorp - - - 250,000 -
Distribution to U.S. Bancorp - - - (18,973) -
Net income - - - 106 -
- ----------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 - $ - $ - $ 609,857 $ -
Capital contribution from U.S. Bancorp - - - 37,500 -
Distribution to U.S. Bancorp - - - (3,561) -
Net income - - - 25,999 -
Recapitalization upon spin off from U.S.
Bancorp 19,334,261 193 669,602 (669,795) 669,795
- ----------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2003 19,334,261 $ 193 $ 669,602 $ - $ 669,795
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
</Table>
See Notes to Consolidated Financial Statements
48 PIPER JAFFRAY ANNUAL REPORT 2003
PIPER JAFFRAY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
(DOLLARS IN THOUSANDS) 2003 2002 2001
- -----------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $25,999 $ 106 $ (50,051)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 19,031 20,787 20,428
Deferred income taxes (6,491) (11,386) 783
Loss on disposal of fixed assets 4,380 83 116
Restricted stock amortization 3,859 3,861 14,903
Goodwill amortization and impairment charges - - 23,542
Decrease (increase) in operating assets:
Cash and cash equivalents segregated for regulatory
purposes (66,000) - -
Receivables:
Customers 10,445 187,350 256,393
Brokers, dealers and clearing organizations (20,936) 223,017 (257,969)
Deposits with clearing organizations (20,495) (31,417) 46,277
Securities purchased under agreements to resell (66,973) 132,123 (22,851)
Net trading securities owned 30,354 31,043 35,514
Other receivables 33,459 34,986 (43,385)
Other assets 21,877 99,253 (21,632)
Increase (decrease) in operating liabilities:
Payables:
Customers 82,583 (113,427) 53,621
Checks and drafts 6,519 (37,004) (7,203)
Brokers, dealers and clearing organizations 7,533 (91,397) 33,277
Securities sold under agreements to repurchase 62,925 (87,422) (63,127)
Accrued compensation 53,611 (15,066) (102,669)
Other liabilities and accrued expenses (22,649) (48,159) 95,645
- -----------------------------------------------------------------------------------------------
Net cash provided by operating activities 159,031 297,331 11,612
- -----------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of fixed assets, net (15,109) (5,800) (40,963)
- -----------------------------------------------------------------------------------------------
Net cash used in investing activities (15,109) (5,800) (40,963)
- -----------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Decrease in short-term financing, net (91,040) (257,652) (87,092)
Capital contribution from U.S. Bancorp 37,500 250,000 75,000
Capital distribution to U.S. Bancorp (3,561) (18,973) (8,556)
Net decrease in subordinated debt (35,000) (260,000) -
- -----------------------------------------------------------------------------------------------
Net cash used in financing activities (92,101) (286,625) (20,648)
- -----------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 51,821 4,906 (49,999)
Cash and cash equivalents at beginning of year 32,615 27,709 77,708
- -----------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $84,436 $ 32,615 $ 27,709
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information -
Cash paid (received) during the year for:
Interest $19,427 $ 36,001 $ 82,977
Income taxes $(1,937) $ 1,311 $ (4,190)
</Table>
See Notes to Consolidated Financial Statements
PIPER JAFFRAY ANNUAL REPORT 2003 49
PIPER JAFFRAY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 Background and Basis of Presentation
BACKGROUND
Piper Jaffray Companies is the parent company of Piper Jaffray & Co. ("Piper
Jaffray"), a securities broker dealer and investment banking firm; Piper Jaffray
Ventures Inc. ("Piper Jaffray Ventures"), a private equity venture capital firm
managing investments in emerging growth companies; Piper Jaffray Ltd., a firm
providing securities brokerage and investment banking services in Europe through
an office located in London, England; and Piper Jaffray Financial Products Inc.
and Piper Jaffray Financial Products II Inc., two entities that facilitate Piper
Jaffray Companies customer derivative transactions.
On April 28, 2003, Piper Jaffray Companies was incorporated in Delaware as a
subsidiary of U.S. Bancorp ("USB") to effect the spin off of USB's capital
markets business to its shareholders. On December 31, 2003, after receiving
regulatory approval, USB distributed to its shareholders all of its interest in
Piper Jaffray Companies and its subsidiaries (collectively, the "Company"). On
that date, 19,334,261 shares of Piper Jaffray Companies common stock were issued
to USB shareholders (the "Distribution") based on a distribution ratio of one
share of Piper Jaffray Companies common stock for every 100 shares of USB common
stock owned (the "Distribution Ratio"). In lieu of receiving fractional shares
of Piper Jaffray Companies common stock, shareholders received cash from USB for
their fractional interest.
The consolidated financial statements include the accounts and historical
operations of the Company as well as certain assets, liabilities, and related
operations transferred to Piper Jaffray Companies (the "Contribution") from USB
immediately prior to the Distribution. Because prior to the Distribution no
direct ownership relationship existed among all the various units comprising the
Company, USB and its subsidiaries' interest in the Company is shown as invested
capital in the consolidated financial statements prior to the Distribution.
BASIS OF PRESENTATION
The consolidated financial statements of the Company are prepared in conformity
with accounting principles generally accepted in the United States of America
and include the adjustments necessary to reflect the Company's operations as if
its organizational changes had been consummated prior to the Distribution. The
consolidated financial statements prior to the Distribution have been derived
from the financial statements and accounting records of USB using the historical
results of operations and historical basis of the assets and liabilities of the
Company's business. However, the consolidated financial statements included
herein may not necessarily be indicative of the Company's results of operations,
financial position and cash flows in the future or what its results of
operations, financial position and cash flows would have been had the Company
been a stand-alone company during the periods presented.
Generally, the consolidated results include revenues generated and expenses
incurred based on customer relationships and related business activities. In
certain situations, affiliated entities of USB may have provided services to and
thus charged expense to the Company. These expenses primarily relate to
providing employee-related services and benefits, technology and data processing
services, and corporate functions including audit, tax and real estate
management services. Costs included on the consolidated financial statements for
shared services were determined based on actual costs to USB and allocated based
on the Company's proportionate usage of those services. Proportionate usage was
determined based on the number of employees, actual hours used, square footage
of office space or other similar methodologies. Management believes the
assumptions underlying the consolidated financial statements are reasonable.
On the consolidated financial statements, income taxes were determined on a
separate return basis as if the Company had not been eligible to be included in
the consolidated income tax return of USB and its affiliates. However, USB was
managing its tax position for the benefit of its entire portfolio of businesses,
and its tax strategies are not necessarily reflective of the tax strategies that
the Company would have followed or will follow as a stand-alone entity.
50 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 Summary of Significant Accounting Policies
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Piper Jaffray
Companies and its subsidiaries. All material intercompany accounts and
transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments with
maturities of 90 days or less at the date of purchase.
In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Piper
Jaffray, as a registered broker dealer carrying customer accounts, is subject to
requirements related to maintaining cash or qualified securities in a segregated
reserve account for the exclusive benefit of its customers.
COLLATERALIZED SECURITIES TRANSACTIONS
Securities purchased under agreements to resell and securities sold under
agreements to repurchase are carried at the contractual amounts at which the
securities will be subsequently resold or repurchased, including accrued
interest. It is the Company's policy to take possession or control of securities
purchased under agreements to resell at the time these agreements are entered
into. Counterparties are principally primary dealers of U.S. Government
securities and major financial institutions. Collateral is valued daily and
additional collateral is obtained from or refunded to counterparties, when
appropriate.
Securities borrowed and loaned result from transactions with other brokers and
dealers or financial institutions and are recorded at the amount of cash
collateral advanced or received. These amounts are included in receivable from
and payable to brokers, dealers and clearing organizations on the Consolidated
Statements of Financial Condition. Securities borrowed transactions require the
Company to deposit cash or other collateral with the lender. Securities loaned
transactions require the borrower to deposit cash with the Company. The Company
monitors the market value of securities borrowed and loaned on a daily basis,
with additional collateral obtained or refunded as necessary. Interest is
accrued on securities borrowed and loaned transactions and is included in other
assets and other liabilities and accrued expenses on the Consolidated Statements
of Financial Condition and the respective interest balances on the Consolidated
Statements of Operations.
CUSTOMER TRANSACTIONS
Customer securities transactions are recorded on a settlement date basis while
the related commission revenues and expenses are recorded on a trade date basis.
Customer receivables and payables include amounts related to both cash and
margin transactions. Securities owned by customers, including those that
collateralize margin or other similar transactions, are not reflected on the
Consolidated Statements of Financial Condition.
INVESTMENT BANKING
Investment banking revenues, which include underwriting fees, management fees
and advisory fees, are recorded when services for the transactions are
substantially completed under the terms of each engagement. Expenses associated
with such transactions are deferred until the related revenue is recognized or
the engagement is otherwise concluded. Investment banking revenues are
presented net of related expenses.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Management estimates an allowance for doubtful accounts to reserve for probable
losses from unsecured and partially secured customer accounts. Management is
continually evaluating its receivables from customers for collectibility and
possible write-off by examining the facts and circumstances surrounding each
customer where a loss is deemed possible.
TRADING SECURITIES OWNED AND TRADING SECURITIES SOLD, BUT NOT YET PURCHASED
Trading securities owned and trading securities sold, but not yet purchased are
recorded on a trade date basis and are stated at market or fair value.
Unrealized gains and losses related to these financial instruments are reflected
in principal transactions on the Consolidated Statements of Operations. The
Company's valuation policy is to use quoted market
PIPER JAFFRAY ANNUAL REPORT 2003 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
or dealer prices from independent sources where they are available and reliable.
The fair value of trading securities, for which a quoted market or dealer price
is not available, is based on management's estimate, using the best information
available, of amounts that could be realized under current market conditions.
Among the factors considered by management in determining the fair value of
these securities are the cost, terms and liquidity of the investment, the
financial condition and operating results of the issuer, quoted market price of
securities with similar quality and yield that are publicly traded, and other
factors generally pertinent to the valuation of investments.
FIXED ASSETS
Fixed assets include office equipment, software and leasehold improvements.
Depreciation of office equipment and software is provided using the
straight-line method over estimated useful lives of three to ten years.
Leasehold improvements are amortized over their estimated useful life or the
life of the lease, whichever is shorter. Additionally, certain costs incurred in
connection with internal-use software projects are capitalized and amortized
over the expected useful life of the asset, generally three to seven years.
GOODWILL
The Company adopted Statement of Financial Accounting Standards No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets," on January 1, 2002. SFAS 142
addresses the accounting for goodwill and intangible assets subsequent to their
acquisition. The most significant changes made by SFAS 142 are that goodwill and
indefinite-lived intangible assets are no longer amortized and are to be tested
for impairment at least annually. Prior to the adoption of SFAS 142, the Company
amortized goodwill using the straight-line method over a maximum period of 25
years.
The recoverability of goodwill is evaluated annually, at a minimum, or on an
interim basis if events or circumstances indicate a possible inability to
realize the carrying amount. The evaluation includes assessing the estimated
fair value of the goodwill based on market prices for similar assets, where
available, and the present value of the estimated future cash flows associated
with the goodwill. Because 100 percent of goodwill is treated as a non-
allowable asset for regulatory purposes, the impact of any impairment on Piper
Jaffray net capital would not be significant, but could adversely impact the
Company's results of operations.
OTHER RECEIVABLES
Included in other receivables are loans made to investment executives and other
revenue-producing employees, typically in connection with their recruitment.
These loans are forgiven based on continued employment and are amortized to
compensation and benefits using the straight-line method over the terms of the
loans, which generally range from three to five years.
In conjunction with these loans, management estimates an allowance for loan
losses. This allowance is established for recipients who leave the Company prior
to full forgiveness of their loan balance and the Company is subsequently not
able to recover the remaining balances. The Company determines adequacy of the
allowance based upon the collectibility of unforgiven balances of departed
employees, evaluation of the loan portfolio, recent experience related to
attrition of certain revenue-producing employees and other pertinent factors.
OTHER ASSETS
Included in other assets are investments that the Company makes to fund deferred
compensation liabilities for certain employees. The Company fully funds its
deferred compensation liabilities by investing in venture capital stage
companies or by investing in partnerships which invest in venture capital stage
companies. Future payments, if any, to deferred compensation plan participants
are directly linked to the performance of these investments. Also included in
other assets are investments the Company has made in various other venture
capital investments. Investments are carried at estimated fair value based on
valuations received from statements obtained from the underlying fund manager or
based on published market quotes, with the resulting gains and losses recognized
in other income on the Consolidated Statements of Operations. In the event a
security is thinly traded or the market price is not readily available for an
investment, management estimates fair value using other valuation methods
depending on the type of security and related market.
Net deferred tax assets are also included in other assets. Refer to Note 21 for
additional information related to income taxes.
52 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's financial instruments are recorded at fair
value or contract amounts on the Company's Consolidated Statements of Financial
Condition. Financial instruments recorded at fair value include trading
securities owned and trading securities sold, but not yet purchased.
Financial instruments carried at contract amounts which approximate fair value,
either have short-term maturities (one year or less), are repriced frequently,
or bear market interest rates and, accordingly, are carried at amounts
approximating fair value. Financial instruments carried at contract amounts on
the Consolidated Statements of Financial Condition include receivables from and
payables to brokers, dealers and clearing organizations, securities purchased
under agreements to resell, securities sold under agreements to repurchase,
receivables from and payables to customers, short-term financing and
subordinated debt.
The carrying amount of subordinated debt closely approximates fair value based
upon market rates of interest available to the Company at December 31, 2003.
INCOME TAXES
Income tax expense (benefit) is provided for using the asset and liability
method. Deferred tax assets and liabilities are recognized for the expected
future tax consequences attributable to temporary differences between amounts
reported for income tax purposes and financial statement purposes, using current
tax rates. A valuation allowance is recognized if it is anticipated that some or
all of a deferred tax asset will not be realized.
CONSOLIDATION OF SPECIAL PURPOSE ENTITIES
Special purpose entities ("SPEs") are trusts, partnerships or corporations
established for a particular limited purpose. The Company follows the accounting
guidance in Statement of Financial Accounting Standards No. 140 ("SFAS 140"),
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities," to determine whether or not such SPEs are required to be
consolidated. The Company engages in transactions with SPEs to securitize fixed
rate municipal bonds which meet the SFAS 140 definition of a qualifying special
purpose entity ("QSPE"). A QSPE can generally be described as an entity with
significantly limited powers which are intended to limit it to passively holding
financial assets and distributing cash flows based upon predetermined criteria.
Based upon the guidance in SFAS 140, the Company does not consolidate such
QSPEs. The Company accounts for its involvement with such QSPEs under a
financial components approach in which the Company recognizes only its retained
residual interest in the QSPE. The Company accounts for such retained interests
at fair value.
STOCK-BASED COMPENSATION
Prior to the Distribution, certain employees of the Company were eligible to
participate in USB employee incentive plans consisting of stock options,
restricted stock or other deferred compensation that are described more fully in
Note 17. The Company accounted for these stock option grants under the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock Issued to Employees" and, accordingly, recognized no
compensation expense for the stock option grants as all options granted under
those plans had an exercise price equal to the market value of the underlying
common stock on the date of grant.
Effective January 1, 2004, the Company adopted the fair value based method of
accounting for future grants of stock-based compensation, as prescribed by
Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting
and Disclosure of Stock-Based Compensation," as amended by Statement of
Financial Accounting Standards No. 148 ("SFAS 148"),"Accounting for Stock-Based
Compensation -Transition and Disclosure."
EARNINGS PER SHARE
Basic earnings per common share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding for the year. Since the
Company's common stock was not issued until December 31, 2003, the date of
Distribution, the weighted average number of common shares outstanding for each
year presented was calculated by applying the Distribution Ratio against the
historical USB weighted average number of common shares outstanding for the same
period presented. Diluted earnings per common share are calculated by adjusting
weighted average outstanding shares, assuming conversion of all potentially
dilutive stock options.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the current
year presentation.
PIPER JAFFRAY ANNUAL REPORT 2003 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 Recent Accounting Pronouncements
ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY
In May 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 150 ("SFAS 150"), "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity,"
which establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equities.
SFAS 150 is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatorily redeemable
financial instruments of nonpublic entities. The adoption of SFAS 150 did not
have a material impact on the Company's financial statements.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In April 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 149 ("SFAS 149"), "Amendment of Statement 133
on Derivative Instruments and Hedging Activities," which amends and clarifies
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under Statement of Financial Accounting Standards No. 133. In particular, SFAS
149 clarifies under what circumstances a contract with an initial net investment
meets the characteristic of a derivative and clarifies when a derivative
contains financing components. SFAS 149 is generally effective for contracts
entered into or modified after June 30, 2003. The Company's adoption of SFAS 149
did not have a material impact on its financial statements.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities"
("VIEs"), an interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to improve financial reporting of special
purpose and other entities. In accordance with this interpretation, business
enterprises that represent the primary beneficiary of another entity by
retaining a controlling financial interest in that entity's assets, liabilities
and results of operating activities must consolidate the entity in its financial
statements. Prior to the issuance of FIN 46, consolidation generally occurred
when an enterprise controlled another entity through voting interests. Certain
VIEs that are QSPEs subject to the reporting requirements of SFAS 140 are not
required to be consolidated under the provisions of FIN 46.
VIEs created after January 31, 2003, but prior to January 1, 2004, may be
accounted for based on either the original interpretation or the revised
interpretations. VIEs created after January 1, 2004 must be accounted for under
the revised interpretations. If the revised interpretations were applied,
transition rules allow the restatement of financial statements or prospective
application with a cumulative effect adjustment. In addition, FIN 46 expands the
disclosure requirements for the primary beneficiary of a significant portion or
a majority of the variable interests to provide information regarding the
nature, purpose and financial characteristics of the entities.
The Company has investments in and advances to approximately 30 limited
partnerships established for the purpose of investing in emerging growth
companies. The Company has investments in or acts as the managing general
partner of these partnerships. As managing general partner of or through
investments in the limited partnerships, the Company may have the ability to
exercise control over major operating and financial policies. These partnerships
are funded with capital contributed by or financing from related parties and
third parties. The Company accounts for these investments on the equity method
of accounting or consolidates the entire partnership based upon the Company's
ability to exercise control over major operating and financial policies.
At December 31, 2003, the Company's aggregate net investment in these
partnerships totaled $11.3 million and its remaining commitment to these
partnerships was $1.7 million. These amounts represent the Company's maximum
exposure to loss at December 31, 2003 as a result of its current and future
investment in these limited partnerships. There has been no material impact to
the Company's financial statements from potential VIEs entered into after
January 31, 2003 and there is no expected impact from the adoption of the
deferred provisions in the first quarter of fiscal year 2004.
54 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Also, the Company engages in transactions with QSPEs to securitize fixed rate
municipal bonds. These securitizations do not require consolidation in the
Company's financial statements. Refer to Note 19 for additional information on
securitizations.
NOTE 4 Derivatives
Derivative contracts are financial instruments such as forwards, futures, swaps
or option contracts that derive their value from underlying assets, reference
rates, indices or a combination of these factors. A derivative contract
generally represents future commitments to purchase or sell financial
instruments at specified terms on a specified date or to exchange currency or
interest payment streams based on the contract or notional amount.
Derivative contracts exclude certain cash instruments, such as mortgage-backed
securities, interest-only and principal-only obligations and indexed debt
instruments that derive their values or contractually required cash flows from
the price of some other security or index.
Derivatives are often referred to as off-balance sheet instruments since neither
their notional amounts nor the underlying instruments are reflected as assets or
liabilities of the Company. Instead, the market or fair values related to the
derivative contract transactions are reported on the Consolidated Statements of
Financial Condition and any unrealized gain or loss is recognized on the
Consolidated Statements of Operations. The Company uses derivatives to
facilitate customer transactions and as a means to manage the Company's interest
rate and market value risk associated with its security positions. As of
December 31, 2003 and 2002, the fair value of these open derivative contracts
was not material.
As discussed in Note 19, the Company also enters into interest rate swap
agreements to minimize interest rate risk associated with holding residual
interest securities from its tender option bond program. The fair value of such
contracts is included in other liabilities and accrued expenses on the
Consolidated Statements of Financial Condition and was approximately $5.7
million and $3.7 million as of December 31, 2003 and 2002, respectively.
NOTE 5 Receivables from and Payables to Brokers,
Dealers and Clearing Organizations
Amounts receivable from brokers, dealers and clearing organizations at December
31 included:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ----------------------------------------------------
Receivable arising from
unsettled securities
transactions, net $106,187 $160,662
Deposits paid for securities
borrowed 72,751 16,588
Receivable from clearing
organizations 10,577 3,838
Securities failed to deliver 34,277 33,914
Other 14,601 2,455
- ----------------------------------------------------
Total receivables $238,393 $217,457
- ----------------------------------------------------
- ----------------------------------------------------
</Table>
Amounts payable to brokers, dealers and clearing organizations at December 31
included:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ---------------------------------------------------
Deposits received for
securities loaned $181,166 $174,700
Payable to clearing
organizations 4,258 25,968
Securities failed to receive 31,926 13,263
Other 6,858 2,744
- ---------------------------------------------------
Total payables $224,208 $216,675
- ---------------------------------------------------
- ---------------------------------------------------
</Table>
Securities failed to deliver and receive represent the contract value of
securities that have not been delivered or received by the Company on settlement
date. Deposits paid for securities borrowed and deposits received for securities
loaned approximate the market value of the related securities.
PIPER JAFFRAY ANNUAL REPORT 2003 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 Receivables from and Payables to Customers
Amounts receivable from customers at December 31 included:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ----------------------------------------------------
Cash accounts $ 81,853 $ 77,801
Margin accounts 381,704 396,201
- ----------------------------------------------------
Total receivables $463,557 $474,002
- ----------------------------------------------------
- ----------------------------------------------------
</Table>
Amounts payable to customers at December 31 included:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ----------------------------------------------------
Cash accounts $168,901 $118,983
Margin accounts 57,262 24,597
- ----------------------------------------------------
Total receivables $226,163 $143,580
- ----------------------------------------------------
- ----------------------------------------------------
</Table>
Securities owned by customers are held as collateral for margin receivables.
Such collateral is not reflected on the consolidated financial statements.
Margin loan receivables earn interest at floating interest rates based on broker
call rates.
Payables to customers primarily consist of customer funds pending completion of
securities transactions and customer funds on deposit. Except for customer short
sales, all amounts payable to customers are subject to withdrawal upon customer
request.
NOTE 7 Trading Securities Owned and Trading Securities Sold,
but Not Yet Purchased
At December 31, trading securities owned and trading securities sold, but not
yet purchased were as follows:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ----------------------------------------------------
Owned:
Corporate securities:
Equity securities $ 15,903 $ 15,446
Convertible securities 78,474 42,534
Fixed income securities 90,459 87,009
Mortgage-backed securities 92,292 98,950
U.S. government securities 240,248 95,041
Municipal securities 140,236 134,704
- ----------------------------------------------------
$657,612 $473,684
- ----------------------------------------------------
- ----------------------------------------------------
Sold, but not yet purchased:
Corporate securities:
Equity securities $ 46,700 $ 17,285
Convertible securities 1,137 -
Fixed income securities 14,316 40,996
Mortgage-backed securities 47,114 15,573
U.S. government securities 276,750 96,749
Municipal securities 264 1,396
- ----------------------------------------------------
$386,281 $171,999
- ----------------------------------------------------
- ----------------------------------------------------
</Table>
At December 31, 2003 and 2002, trading securities owned in the amounts of $314.6
million and $393.6 million, respectively, have been pledged as collateral.
Securities sold, but not yet purchased represent obligations of the Company to
deliver the specified security at the contracted price, thereby creating a
liability to purchase the security in the market at prevailing prices. The
Company is obligated to acquire the securities sold short at prevailing market
prices, which may exceed the amount reflected on the Consolidated Statements of
Financial Condition.
56 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 Fixed Assets
The following is a summary of fixed assets as of December 31, 2003 and 2002:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ---------------------------------------------------
Furniture and equipment $93,323 $ 91,718
Leasehold improvements 27,999 25,620
Software 40,823 30,645
Projects in process 2,185 10,045
- ---------------------------------------------------
Total 164,330 158,028
Less accumulated depreciation
and amortization 103,573 88,969
- ---------------------------------------------------
$60,757 $ 69,059
- ---------------------------------------------------
- ---------------------------------------------------
</Table>
For the years ended December 31, 2003, 2002 and 2001, depreciation and
amortization of office equipment, software and leasehold improvements totaled
$19.0 million, $20.8 million and $20.4 million, respectively, and is included in
occupancy and equipment on the Consolidated Statements of Operations.
NOTE 9 Goodwill
The Company adopted SFAS 142 on January 1, 2002. The most significant changes
made by SFAS 142 are that goodwill and other indefinite-lived intangibles are no
longer amortized and will be tested for impairment at least annually. At
December 31, 2003 and 2002, goodwill of $305.6 million was recorded on the
Consolidated Statements of Financial Condition. All of the Company's goodwill
resulted from the 1998 acquisition of the Company's former parent company, U.S.
Bancorp Piper Jaffray Companies Inc. ("Former Parent"), and its subsidiaries by
USB. The following table reflects the consolidated results of operations
adjusted as if the adoption of SFAS 142 occurred as of January 1, 2001:
<Table>
<Caption>
YEAR ENDED DECEMBER 31
(DOLLARS IN THOUSANDS) 2003 2002 2001
- ---------------------------------------------------------------------------------------------
Net Earnings:
As reported $25,999 $ 106 $(50,051)
Goodwill amortization, net of tax - - 14,439
- ---------------------------------------------------------------------------------------------
As adjusted $25,999 $ 106 $(35,612)
- ---------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
</Table>
As reflected in the following table, there were no changes in the carrying value
of goodwill by reportable segments for the year ended December 31, 2003:
<Table>
<Caption>
Private Corporate
Capital Client Support Consolidated
(Dollars in thousands) Markets Services and Other Company
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $220,035 $85,600 $ - $ 305,635
Goodwill acquired - - - -
Impairment losses - - - -
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 $220,035 $85,600 $ - $ 305,635
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
</Table>
Management completed an estimate of the fair value of its business segments as
of December 31, 2003 and validated its determination through an independent
third party. Based upon this assessment,
management concluded that no impairment existed at December 31, 2003.
The Company had no indefinite-lived or other intangible assets at December 31,
2003 or 2002.
PIPER JAFFRAY ANNUAL REPORT 2003 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 Borrowings
The Company has uncommitted credit agreements with banks and former affiliated
entities totaling $550 million at December 31, 2003, composed of $450 million in
discretionary secured lines and $100 million in discretionary unsecured lines.
In addition, the Company has established an arrangement to obtain financing
using the Company's securities held by its clearing bank at the end of each day
as collateral. The following table provides a breakdown of borrowings
outstanding at December 31:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ---------------------------------------------------
Unsecured borrowings $ - $ 50,040
Secured borrowings 159,000 200,000
- ---------------------------------------------------
$159,000 $250,040
- ---------------------------------------------------
- ---------------------------------------------------
</Table>
The secured borrowings were collateralized with $169.4 million and $276.1
million of trading securities owned at December 31, 2003 and 2002, respectively.
During 2003, Piper Jaffray repaid its outstanding subordinated debt of $215
million to its Former Parent and executed a $180 million subordinated debt
agreement with an affiliate of USB, which satisfies provisions of Appendix D of
Securities and Exchange Commission ("SEC") Rule 15c3-1 and has been approved by
the New York Stock Exchange, Inc. ("NYSE") and is therefore allowable in Piper
Jaffray's net capital computation. The entire amount of the subordinated debt
will mature in 2008.
The Company's outstanding borrowings bear interest at rates based on the London
Interbank Offered Rate ("LIBOR") or federal funds rates. At December 31, 2003
and 2002, the weighted average interest rate on borrowings was 2.07 percent and
2.40 percent, respectively. At December 31, 2003 and 2002, no formal
compensating balance agreements existed, and the Company was in compliance with
all debt covenants related to these facilities. The Company recognized and paid
to USB and affiliates $9.0 million, $15.9 million and $42.0 million of interest
expense related to borrowings for the years ended December 31, 2003, 2002 and
2001, respectively.
NOTE 11 Commitments and Contingent Liabilities
LEASE COMMITMENTS
The Company leases office space and equipment under various noncancelable
leases. Certain leases have renewal options and clauses for escalation and
operating cost adjustments. Aggregate minimum lease commitments under operating
leases and various other contractual commitments as of December 31, 2003 are as
follows:
<Table>
<Caption>
(Dollars in thousands)
- ---------------------------------------------------
2004 $ 28,257
2005 24,198
2006 19,609
2007 18,431
2008 17,759
Thereafter 84,247
- ---------------------------------------------------
$192,501
- ---------------------------------------------------
- ---------------------------------------------------
</Table>
Rental expense, including operating costs and real estate taxes, charged to
operations was $27.5 million, $30.8 million and $30.6 million for the years
ended December 31, 2003, 2002 and 2001, respectively.
Additionally, in 2003 the Company entered into a five-year contract with an
outside vendor to support the Company's data center and network management
technology needs. Aggregate minimum contract commitments for data center and
remote network services per the contract as of December 31, 2003 are as follows:
<Table>
<Caption>
(Dollars in thousands)
- ---------------------------------------------------
2004 $ 9,912
2005 8,698
2006 7,029
2007 7,109
2008 5,383
- ---------------------------------------------------
$ 38,131
- ---------------------------------------------------
- ---------------------------------------------------
</Table>
Network and data center service expense related to this contract that was
charged to operations in 2003 was $2.7 million.
58 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
VENTURE CAPITAL COMMITMENTS
As of December 31, 2003, the Company had commitments to invest approximately
$1.7 million in limited partnerships that make private equity investments. The
commitments will be funded, if called, through the end of the respective
investment periods ranging from 2006 to 2013.
LITIGATION
The Company has been the subject of customer complaints and has also been named
as a defendant in various legal actions arising primarily from securities
brokerage and investment banking activities, including certain class actions
which primarily allege violations of securities laws and seek unspecified
damages, which could be substantial. Also, the Company is involved from time to
time in investigations and proceedings by governmental agencies and
self-regulatory organizations. Included among these was an industry-wide
investigation by the SEC, the National Association of Securities Dealers
("NASD"), the NYSE, the New York Attorney General and other state securities
regulators of research practices of certain brokerage firms, including Piper
Jaffray. In April 2003, Piper Jaffray entered into a final settlement agreement
with these regulatory agencies to resolve the investigation concerning research
practices. The agreement required, among other things, that Piper Jaffray pay
$12.5 million as a penalty, contribute $12.5 million to a distribution fund for
the benefit of investors and pay $7.5 million for the procurement of independent
research. The charges are included separately as regulatory settlement on the
Company's 2002 Consolidated Statement of Operations.
The Company has established reserves for potential losses that are probable and
reasonably estimable that may result from pending and potential complaints,
legal actions, investigations and proceedings, including private litigation
related to the matters that were the subject of the final settlement referred to
above. The Company's reserves totaled $49.2 and $62.9 million at December 31,
2003 and 2002, respectively, and are included within other liabilities and
accrued expenses on the Consolidated Statements of Financial Condition. These
reserves include $9.6 million and $32.5 million at December 31, 2003 and 2002,
respectively, to be paid as part of the industry-wide regulatory settlement
related to research practices. In addition to the established reserves, USB has
agreed to indemnify the Company in an amount up to $17.5 million for certain
matters.
Given the uncertainties of the commencement, timing, size, volume and outcome of
pending and potential litigation and other factors, the reserve is difficult to
determine and of necessity subject to future revisions. Subject to the
foregoing, management of the Company believes, based on its current knowledge,
after consultation with counsel and after taking into account its established
reserves and the USB indemnity agreement, that pending legal actions,
investigations and proceedings will be resolved with no material adverse effect
on the financial condition of the Company. However, if during any period a
potential adverse contingency should become probable or resolved for an amount
in excess of the established reserves and indemnification, the results of
operations in that period could be materially affected.
Litigation-related expenses charged to operations included within other
operating expenses was $16.1 million, $10.9 million, and $8.6 million for the
years ended December 31, 2003, 2002 and 2001, respectively.
GUARANTEES
The Company participates in securities lending activities as a funding source
for the Company by using customer margin securities. The Company indemnifies
customers for the difference between the market value of the securities lent and
the market value of the collateral received. Cash collateralizes these
transactions. At December 31, 2003, future payments guaranteed by the Company
under these arrangements were approximately $175.4 million and represent the
market value of the customer securities lent to third parties. At December 31,
2003, the Company held cash of $179.0 million as collateral for these
arrangements and included it within payables to brokers, dealers and clearing
organizations on the Consolidated Statements of Financial Condition. At December
31, 2003, the Company had collateral in excess of the market value of the
securities lent and, therefore, no liability is recorded related to potential
future payments made under these guarantees.
OTHER COMMITMENTS
In the normal course of business, the Company enters into underwriting and other
commitments. The ultimate settlement of such transactions open at year-end is
not expected to have a material effect on the financial statements of the
Company.
PIPER JAFFRAY ANNUAL REPORT 2003 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 Merger and Restructuring Items
The Company recorded pre-tax merger and restructuring related charges of $8.0
million and $65.7 million in 2002 and 2001, respectively. In 2002 and 2001,
costs were incurred in connection with the merger of USB and Firstar Corporation
("Firstar"). In both 2002 and 2001, the Company undertook plans to restructure
its operations in response to significant changes in the securities markets,
including increased market volatility, declines in equity valuations and an
increasingly competitive environment for the securities industry. The
restructuring was designed to improve the operating efficiency of the business
by removing excess capacity from the product distribution network and by
implementing more effective business processes.
The components of the charges described above are
shown below:
<Table>
<Caption>
USB/ Piper
(Dollars in thousands) Firstar Restructuring Total
- -----------------------------------------------------------------------------------------------
2002
Severance and employee-related $ - $ 5,314 $ 5,314
Business integration costs 2,161 - 2,161
Asset write-downs and lease terminations - 501 501
- -----------------------------------------------------------------------------------------------
Total $ 2,161 $ 5,815 $ 7,976
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
2001
Severance and employee-related $14,480 $ 29,286 $43,766
Business integration costs 468 - 468
Asset write-downs and lease terminations - 12,360 12,360
Intangible impairments - 9,103 9,103
- -----------------------------------------------------------------------------------------------
Total $14,948 $ 50,749 $65,697
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
</Table>
The Company determined merger and restructuring charges and related accruals
based on specific formulated plans or integration strategies.
Severance and employee-related charges included the cost of severance, other
benefits and outplacement costs associated with the termination of employees due
to the reconfiguration or closure of certain branches and the downsizing and
consolidation of certain back office support functions. The severance amounts
were determined based on the Company's severance pay programs in place at the
time of termination and were paid out over a benefit period up to two years from
the time of termination. Approximately 410 employees were included in severance
and employee-related severance charges for 2002 and 2001. Employee-related
charges in 2001 included approximately $14.0 million in accelerated vesting of
restricted stock due to the merger of USB and Firstar.
Business integration charges primarily pertained to costs incurred to realign
the retail distribution networks and integrate certain components of a USB
affiliate's fixed income division with Piper Jaffray.
Asset write-downs and lease terminations represented costs associated with
redundant office space, branches that were vacated and equipment disposed of as
part of the restructuring plans. Generally, payments related to terminated lease
contracts continue through the original term of the lease.
Intangible impairment charges of $9.1 million in 2001 pertained to the
write-down of goodwill related to the Company's 1999 acquisition of the
investment banking division of The John Nuveen Company. This goodwill impairment
occurred as a result of the loss of key personnel in certain sales offices,
acquired in the John Nuveen acquisition, that were realigned as a result of
restructuring decisions made in 2001.
60 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents a summary of activity with respect to the merger
and restructuring related accruals:
<Table>
<Caption>
USB/ Piper
(Dollars in thousands) Firstar Restructuring Total
- -------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 $ - $ - $ -
Provision charged to operating expense 14,948 50,749 65,697
Cash outlays (468) (22,324) (22,792)
Noncash writedowns and other (14,480) (10,323) (24,803)
- -------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $ - $ 18,102 $ 18,102
Provision charged to operating expense 2,161 5,815 7,976
Cash outlays (853) (13,277) (14,130)
Noncash writedowns and other - (1,617) (1,617)
- -------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 $ 1,308 $ 9,023 $ 10,331
Cash outlays (1,308) (6,547) (7,855)
Noncash writedowns and other - (144) (144)
- -------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2003 $ - $ 2,332 $ 2,332
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
</Table>
The adequacy of the merger and restructuring related liability is reviewed
regularly taking into consideration actual and projected payment liabilities.
Adjustments are made to increase or decrease these accruals as needed. Reversals
of expenses, if any, can reflect a lower use of benefits by affected employees,
changes in initial assumptions as a result of subsequent events and the
alteration of business integration plans.
NOTE 13 Financial Instruments with Off-balance Sheet Risk
In the normal course of business, the Company's customer and trading activities
involve the execution, settlement and financing of various securities
transactions. These activities may expose the Company to off-balance sheet risk
in the event that the other party to the transaction is unable to fulfill its
contractual obligations.
The Company from time to time uses financial futures and interest rate swap
contracts to manage interest rate risk related to fixed income trading
securities against market interest rate fluctuations and the residual cash flows
on the Company's tender option bond program. In addition, the Company uses
exchange-traded options to manage the risk related to market value fluctuations
of convertible inventories. Such contracts are subject to the same controls as
securities owned for the Company's account and are not intended to be entered
into for speculative purposes. Contracts are marked to market with gains or
losses recorded in principal transactions. As of December 31, 2003 and 2002, the
fair value of these contracts was not material.
The Company's financing and customer securities activities involve the Company
using securities as collateral. In the event that the counterparty does not meet
its contractual obligation to return securities used as collateral, or customers
do not deposit additional securities or cash for margin when required, the
Company may be exposed to the risk of reacquiring the securities or selling the
securities at unfavorable market prices in order to satisfy its obligations to
its customers or counterparties. The Company seeks to control this risk by
monitoring the market value of securities pledged or used as collateral on a
daily basis and requiring adjustments in the event of excess market exposure.
In the normal course of business, the Company obtains securities under resale,
securities borrowed and margin agreements on terms which permit it to repledge
or resell the securities to others. The Company obtained securities with a fair
value of approximately $914.5 million and $811.0 million at December 31, 2003
and 2002, respectively, of which $220.5 million and $210.6 million,
respectively, has been either
PIPER JAFFRAY ANNUAL REPORT 2003 61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pledged or otherwise transferred to others in connection with the Company's
financing activities or to satisfy its commitments under proprietary short
sales.
The Company provides investment, capital raising and related services to a
diverse group of domestic and foreign customers, including governments,
corporations, and institutional and individual investors. The Company's exposure
to credit risk associated with the non-performance of customers in fulfilling
their contractual obligations pursuant to securities transactions can be
directly impacted by volatile securities markets, credit markets and regulatory
changes. This exposure is measured on an individual customer basis, as well as
for groups of customers that share similar attributes. To alleviate the
potential for risk concentrations, credit limits are established and continually
monitored in light of changing customer and market conditions. As of December
31, 2003 and 2002, the Company did not have significant concentrations of credit
risk with any one single customer or counterparty, or group of customers or
counterparties.
NOTE 14 Transactions with U.S. Bancorp
Prior to the Distribution, the Company regularly entered into transactions with
USB and its affiliates. These transactions were either charges to or
reimbursements from the Company and included fees for referrals, fees for the
underwriting and selling of USB affiliated mutual funds and costs for occupancy,
technology support and general and administrative services. Royalty fees for the
use of the USB brand name and other trademarks of $3.9 million, $7.5 million and
$55.8 million were incurred to a USB affiliate for the years ended December 31,
2003, 2002 and 2001, respectively. USB or its affiliates will continue to
provide asset management services under a negotiated market-based fee
arrangement.
The Company entered into certain interest rate swap contracts during 2002 with a
USB affiliate as counterparty. During 2003, these swap contracts with USB were
terminated and were subsequently reestablished with other unaffiliated
counterparties.
During 2003, Piper Jaffray repaid its outstanding subordinated debt of $215
million to its Former Parent and entered into a new subordinated debt agreement
of $180 million with an affiliate of USB. The Company received capital
contributions of $37.5 million, $250.0 million and $75.0 million in 2003, 2002
and 2001, respectively, from USB. Additionally, the Company made distributions
of $3.6 million, $19.0 million and $8.6 million to USB in 2003, 2002 and 2001,
respectively.
NOTE 15 Net Capital Requirements and Other Regulatory Matters
As an SEC registered broker dealer and member firm of the NYSE, Piper Jaffray is
subject to the Uniform Net Capital Rule (the "Rule") of the SEC and the net
capital rule of the NYSE. Piper Jaffray has elected to use the alternative
method permitted by the Rule, which requires that it maintain minimum net
capital of the greater of $1.0 million or 2 percent of aggregate debit balances
arising from customer transactions, as such term is defined in the Rule. The
NYSE may prohibit a member firm from expanding its business or paying dividends
if resulting net capital would be less than 5 percent of aggregate debit
balances. In addition, Piper Jaffray is subject to certain notification
requirements related to withdrawals of excess net capital. Piper Jaffray is also
registered with the Commodity Futures Trading Commission ("CFTC") and therefore
is subject to the CFTC regulations.
At December 31, 2003, net capital under the Rule was $216.9 million or 38.8
percent of aggregate debit balances, and $205.7 million in excess of the minimum
required net capital.
Advances to affiliates, repayment of subordinated liabilities, dividend payments
and other equity withdrawals are subject to certain notification and other
provisions of the net capital rule of the SEC and regulatory bodies.
Piper Jaffray Ltd., a registered United Kingdom broker dealer, is subject to the
capital requirements of the Financial Services Authority ("FSA"). As of December
31, 2003, Piper Jaffray Ltd. was in compliance with the requirements of the FSA.
62 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 Employee Benefit Plans
During 2002, the Company implemented a qualified, non-contributory profit
sharing plan covering substantially all employees. Company contributions to the
plan are discretionary within limits to qualify as deductions for income tax
purposes. Employees are fully vested after five years of service. The Company
expensed $9.5 million related to the profit sharing plan in 2003. There was no
such expense in 2002.
In 2001, employees of the Company participated in the USB cash balance pension
plan. Participant cash balance pension accounts ceased receiving further service
credits as of December 31, 2001. Participant balances will continue to receive
investment credits based on participant investment elections. As a result of the
Distribution, employees who were fully vested in the plan are considered
inactive participants similar to other terminated employees of USB and its
affiliates. Employees who were not fully vested on the Distribution date
continue to receive vesting within the USB plan, based on working a minimum of
1,000 hours in a given plan year, provided they remain actively employed by the
Company. Once an employee is fully vested he or she will receive similar
treatment as a fully vested employee, as outlined above. In addition, certain
employees were eligible to participate in an unfunded, non-qualified component
of the USB cash balance pension plan. Because the non-qualified component was
unfunded, the aggregate accumulated benefit obligation exceeds the plan assets.
Similar to the qualified component of the pension plan, service credits for
employees of the Company participating in the non-qualified component were
frozen at December 31, 2001. Effective upon the Distribution, the existing
non-qualified liability of $23.9 million and $21.5 million at December 31, 2003
and 2002, respectively, was separated from the USB cash balance pension plan and
is included within accrued compensation on the Consolidated Statements of
Financial Condition.
Prior to the Distribution, Company employees participated in health and welfare
plans provided by USB. The Company subsidized the cost of coverage for employees
meeting certain work schedule and service requirements. The medical plan
contained other cost-sharing features such as deductibles and coinsurance. Costs
charged to the consolidated financial statements are based on actual employee
participation in the plans. All claims incurred in the health and welfare plans
prior to the Distribution will be paid by USB. The Company has created similar
health and welfare plans for its employees' use on a prospective basis. As such,
all claims incurred subsequent to the Distribution are the responsibility of the
Company.
Additionally, prior to the Distribution the Company provided certain health and
welfare benefits to retired employees through post-retirement benefit plans
offered by USB. Generally, all employees were eligible for retiree health care
benefits by meeting defined age and service requirements. The estimated cost of
these retiree health care benefits is accrued during the employees' active
service. Effective upon the Distribution, the existing post-retirement benefit
plans were separated from the USB post-retirement benefit plan. All active
employees of the Company are eligible for post-retirement health care benefits
and the existing liability for those employees will be the responsibility of the
Company. All retired employees of the Company will be considered terminated
employees of USB and continue to receive the benefits under the USB
post-retirement plan.
Prior to the Distribution, Company employees also participated in a USB defined
contribution retirement savings plan, which allowed qualified employees, at
their option, to make contributions through salary deductions under Section
401(k) of the Internal Revenue Code. Employee contributions were 100 percent
matched by the Company, up to the first 4 percent of an employee's compensation
and were invested, at the employees' direction, among various investment
alternatives. Although the Company's matching contribution vests immediately, a
participant must be employed on December 31 to receive that year's matching
contribution. Although the matching contribution was initially invested in USB
common stock, an employee was allowed to reinvest the matching contributions
among various investment alternatives. Effective upon the Distribution,
employees of the Company became inactive participants in the USB plan similar to
terminated employees. The Company has created a similar defined contribution
retirement savings plan under Section 401(k) of the Internal Revenue Code for
its employees' use beginning in 2004.
During the years ended December 31, 2003, 2002 and 2001, the Company incurred
expenses of $31.3 million, $23.2 million and $51.5 million, respectively,
related to USB employee benefit plans.
PIPER JAFFRAY ANNUAL REPORT 2003 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 Cash Award Program and Stock-Based Compensation
Certain of the Company's employees are eligible to participate in a cash award
program implemented concurrent with the Distribution from USB. The program is
intended to aid in retention of employees and to compensate employees for the
value of USB stock options and restricted stock lost by employees as a result of
the Distribution. The cash award program has an aggregate value of approximately
$47 million. The Company incurred a $24 million charge at the time of the
Distribution from USB. The remaining $23.0 million will be paid out over the
next four years, which will result in an annual charge of approximately $5.9
million over the next three years and $5.3 million in the fourth year.
Prior to the Distribution, certain of the Company's employees were eligible to
participate in the stock incentive plans offered by USB, which include incentive
stock options, restricted stock, and other stock-based awards. While part of
USB, the Company applied APB 25 in accounting for USB employee stock incentive
plans. Because the exercise price of the USB employee stock options equaled the
market price of the underlying stock on the date of the grant, under APB 25, no
compensation expense was recognized at the grant date. Options granted under the
plans are generally exercisable up to ten years from the date of grant and vest
over three to five years. Restricted shares vested over three to five years.
Expense for restricted stock was based on the market price of USB stock at the
time of the grant and amortized on a straight-line basis over the vesting
period. Expense related to restricted stock grants was $3.9 million, $3.9
million and $14.9 million in 2003, 2002 and 2001, respectively.
Prior to the Distribution, many of the Company's employees held options to
purchase USB common stock under a variety of USB option plans and held shares of
unvested USB restricted stock. Grants under the option plans can be summarized
into two categories: USB 90-day options that generally expire 90 days after an
employee terminates from USB and USB term options that generally expire after a
specified period of time. As a result of the Distribution, 90-day options that
were not exercised either expired on the Distribution date or will expire within
90 days of the Distribution date as the Distribution was deemed a termination of
employment of the Company's employees by USB. USB 90-day options held by Company
employees who have reached retiree status did not expire in connection with the
Distribution but rather remained with USB and continue to vest in accordance
with their terms. USB term options remained with USB after the Distribution and
continue to vest in accordance with their terms, as provided in the applicable
USB stock incentive plans.
The total amount of USB restricted stock held by the Company's employees at the
time of Distribution was 148,238 shares. Since the Distribution was deemed to be
a termination of employment of the Company's employees under the terms of the
applicable USB stock incentive plans, approximately 76,325 shares of USB
restricted stock were forfeited in connection with the Distribution. The
remaining shares of USB restricted stock held by the Company's employees at the
time of the Distribution, totaling approximately 71,913 shares, have terms that
permit those shares to continue to vest in accordance with their terms after a
termination of employment such as that occurring in the Distribution.
No Company employees, officers or directors received Piper Jaffray Company
options or restricted stock as part of the Distribution.
64 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes USB stock options and restricted stock
outstanding and exercised under various equity plans of USB while the Company's
employees were employed by USB:
<Table>
<Caption>
Shares of
Weighted Restricted
Options Average Stock
Outstanding Exercise Price Outstanding
- --------------------------------------------------------------------------------------------------------
DECEMBER 31, 2000 18,041,960 $ 22.62 2,277,106
Granted:
Stock options 3,937,315 23.29 -
Restricted stock - - 474,271
Exercised 1,776,404 22.95 -
Canceled options 1,066,451 24.71 -
Canceled/vested restricted stock - - 2,158,141
- --------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001 19,136,420 $ 23.28 593,236
Granted:
Stock options 2,820,104 22.84 -
Restricted stock - - -
Exercised 1,305,813 22.36 -
Canceled options 98,330 27.29 -
Canceled/vested restricted stock - - 193,569
- --------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002 20,552,381 $ 23.47 399,667
Exercised 4,992,438 25.87 -
Canceled options and canceled/vested restricted stock 3,821,652 24.49 327,754
Options/restricted stock remaining with USB 11,738,291 24.19 71,913
- --------------------------------------------------------------------------------------------------------
DECEMBER 31, 2003 - -
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
</Table>
Piper Jaffray Companies had no options or restricted stock outstanding as of
December 31, 2003. On February 12, 2004 the Company granted approximately
500,000 shares of Piper Jaffray Companies restricted stock and approximately
290,000 options on Piper Jaffray Companies common stock to employees, executive
officers and directors. These awards will vest 100 percent on February 12, 2007.
Pro forma information regarding net income (loss) is required by SFAS No. 123
and has been determined as if the Company had accounted for employee stock
option and stock purchase plans (collectively, the "options") under the fair
value method of SFAS 123. The fair value of the options was estimated at the
grant date using a Black-Scholes option-pricing model. Option valuation models
require the use of highly subjective assumptions. Also, employee stock options
have characteristics that are significantly different from those of traded
options, including vesting provisions and trading limitations that impact their
liquidity. Because employee stock options have differing characteristics and
changes in the subjective input assumptions can materially affect the fair value
estimate, the existing models do not necessarily provide a reliable measure of
the fair value of employee stock options.
The pro forma disclosures include USB options granted to our employees while
employed by USB and will not be representative of future years. In addition, the
value of certain of these options that expired as a result of our separation
from USB were replaced by cash awards to our employees. The estimated fair value
of the options is amortized to expense over the options' vesting period. The
cash award program has an aggregate value of approximately $47 million, of which
$24 million was included in our results of operations for 2003.
PIPER JAFFRAY ANNUAL REPORT 2003 65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table shows pro forma compensation expense and net income (loss)
adjusted for the impact of applying the fair value method of accounting for
stock-based compensation.
<Table>
<Caption>
YEAR ENDED DECEMBER 31
(DOLLARS IN THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------------
Reported compensation expense $482,397 $449,329 $513,623
Stock-based compensation 21,457 27,973 52,504
- --------------------------------------------------------------------------------------------
Pro forma compensation expense $503,854 $477,302 $566,127
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
Reported net income (loss) $ 25,999 $ 106 $(50,051)
Stock-based compensation, net of tax (12,874) (16,784) (31,502)
- --------------------------------------------------------------------------------------------
Pro forma net income (loss) $ 13,125 $(16,678) $(81,553)
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
WEIGHTED AVERAGE ASSUMPTIONS IN USB OPTION VALUATION
Risk-free interest rates N/A 4.90% 4.75%
Dividend yields N/A 3.00% 3.00%
Stock volatility factor N/A 0.38 0.39
Expected life of options (in years) N/A 6.00 6.25
Weighted average fair value of shares granted N/A $ 7.27 $ 7.66
</Table>
Effective January 1, 2004, the Company will account for future stock-based
employee compensation under the fair value based method as prescribed by SFAS
123 as amended by SFAS 148.
NOTE 18 Shareholders' Equity
Piper Jaffray Companies' articles of incorporation provide for the issuance of
up to 100,000,000 shares of common stock with a par value of $0.01 and 5,000,000
shares of undesignated preferred stock also with a par value of $0.01.
COMMON STOCK
The holders of Piper Jaffray Companies common stock are entitled to one vote per
share on all matters to be voted upon by its shareholders. Subject to
preferences that may be applicable to any of Piper Jaffray Companies outstanding
preferred stock, the holders of its common stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by Piper Jaffray
Companies board of directors out of funds legally available for that purpose. In
the event of Piper Jaffray Companies liquidation, dissolution or winding-up, the
holders of its common stock are entitled to share ratably in all assets
remaining after payment of liabilities, subject to prior distribution rights of
Piper Jaffray Companies stock, if any, then outstanding. The holders of common
stock have no preemptive or conversion rights or other subscription rights.
There are no redemption or sinking fund provisions applicable to Piper Jaffray
Companies common stock.
Piper Jaffray Companies does not intend to pay cash dividends on its common
stock for the foreseeable future. Instead, Piper Jaffray Companies intends to
retain all available funds and any future earnings for use in the operation and
expansion of its business. Additionally, as set forth in Note 15, there are
restrictions on its broker dealer subsidiary in paying dividends.
PREFERRED STOCK
Piper Jaffray Companies board of directors has the authority, without action by
its shareholders, to designate and issue preferred stock in one or more series
and to designate the rights, preferences and privileges of each series, which
may be greater than the rights of common stock. It is not possible to state the
actual effect of the issuance of any shares of preferred stock upon the rights
of holders of
66 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
common stock until Piper Jaffray Companies board of directors determines the
specific rights of the holders of preferred stock. However, the effects might
include, among other things, the following: restricting dividends on its common
stock, diluting the voting power of its common stock, impairing the liquidation
rights of its common stock and delaying or preventing a change in control of
Piper Jaffray Companies without further action by its shareholders.
RIGHTS AGREEMENT
Piper Jaffray Companies adopted a rights agreement prior to the Distribution
date. The issuance of a share of Piper Jaffray Companies common stock also
constitutes the issuance of a preferred stock purchase right associated with
such share. These rights are intended to have anti-takeover effects in that the
existence of the rights may deter a potential acquirer from making a takeover
proposal or a tender offer.
EARNINGS PER SHARE
Basic earnings per common share are calculated by dividing net income (loss) by
the weighted average number of common shares outstanding during the year. Since
Piper Jaffray Companies common stock was not issued until December 31, 2003, the
date of the Distribution, the weighted average number of common shares
outstanding during each year presented was calculated by applying the
Distribution Ratio to USB's historical weighted average number of common shares
outstanding for applicable years.
<Table>
<Caption>
YEAR ENDED DECEMBER 31
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001
- ------------------------------------------------------------------------------------------
Earnings per common share
Net income (loss) $25,999 $ 106 $(50,051)
Weighted average number of common shares 19,237 19,160 19,279
- ------------------------------------------------------------------------------------------
Basic earnings per common share $ 1.35 $ .01 $ (2.60)
- ------------------------------------------------------------------------------------------
</Table>
NOTE 19 Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities
The Company, in connection with its tender option bond program, has securitized
$166.2 million of highly-rated fixed rate municipal bonds. Each municipal bond
is sold into a separate trust that is funded by the sale of variable rate
certificates to institutional customers seeking variable rate tax-free
investment products. These variable rate certificates reprice weekly. The
Company retains a residual interest in each structure that is accounted for as a
trading security, recorded at fair value on the Consolidated Statements of
Financial Condition. The fair value of retained interests was $7.4 million at
December 31, 2003 with a weighted average life of 9.6 years. Securitization
transactions are treated as sales with the resulting gain included in principal
transactions on the Consolidated Statements of Operations. Fair value of
retained interests is estimated based on the present value of future cash flows
using management's best estimates of the key assumptions - forward yield curves,
credit losses of 0 percent, and a 15 percent discount rate. The Company receives
a fee to remarket the variable rate certificates derived from the
securitizations. The Company enters into interest rate swaps to minimize any
interest rate risk associated with the retained interests.
At December 31, 2003, the sensitivity of the current fair value of retained
interests to immediate 10 percent and 20 percent adverse changes in the key
economic assumptions was not material.
Certain cash flow activity for the municipal bond securitizations described
above during 2003 includes:
<Table>
Proceeds from new sales $22.6 million
Remarketing fees received $89,000
Cash flows received on
retained interests $4.9 million
</Table>
PIPER JAFFRAY ANNUAL REPORT 2003 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 Business Segments
Within the Company, financial performance is measured by lines of business. The
Company's reportable business segments include Capital Markets, Private Client
Services and Corporate Support and Other. The business segments are determined
based upon factors such as the type of customers, the nature of products and
services provided and the distribution channels used to provide those products
and services. Certain services that the Company offers are provided to clients
through more than one of our business segments. These business segments are
components of the Company about which financial information is available and is
evaluated on a regular basis in deciding how to allocate resources and assess
performance relative to competitors.
BASIS FOR PRESENTATION
Segment results are derived from the Company's financial reporting systems by
specifically attributing customer relationships and their related revenues and
expenses to segments. Revenue-sharing of sales credits associated with
underwritten offerings is based on the distribution channel generating the
sales. Expenses directly managed by the business line, including salaries,
commissions, incentives, employee benefits, occupancy, marketing and business
development and other direct expenses are accounted for within each segment's
financial results in a manner similar to the consolidated financial results.
Research, operations, technology and compliance related costs are allocated
based on the segment's use of these areas to support their businesses. General
and administrative expenses incurred by centrally managed corporate support
functions are not allocated. To enhance the comparability of business segment
results, goodwill amortization for periods prior to the adoption of SFAS 142 is
no longer assigned to each segment. Also, cash award plan charges related to the
Distribution, merger and restructuring related charges, royalty fees assessed by
USB, income taxes and certain infrequent regulatory settlement costs are not
assigned to the business segments. The financial management of assets,
liabilities and capital is performed on an enterprise-wide basis. Revenues from
the Company's non-U.S. operations were $9.2 million, $8.2 million and $6.6
million for the years ended December 31, 2003, 2002 and 2001, respectively,
while long-lived assets were $0.6 million and $0.8 million at December 31, 2003
and 2002, respectively.
Designations, assignments and allocations may change from time to time as
financial reporting systems are enhanced and methods of evaluating performance
change or business segments are realigned to better serve the clients of the
Company. Accordingly, prior periods are reclassified and presented on a
comparable basis.
CAPITAL MARKETS ("CM")
CM includes institutional sales and trading services with an emphasis on the
sale of U.S. equities and fixed income products to institutions. This segment
also includes management of and participation in underwritings, merger and
acquisition services and public finance activities. Additionally, CM includes
earnings on investments acquired in connection with its business activities and
net interest revenues on trading securities held in inventory.
PRIVATE CLIENT SERVICES ("PCS")
PCS principally provides individual investors with financial advice and
investment products and services, including equity and fixed income securities,
mutual funds and annuities. This segment also includes net interest income on
client margin loans. PCS has approximately 830 financial advisers operating in
96 branch offices in 18 Midwest, Mountain and West Coast states.
CORPORATE SUPPORT AND OTHER
Corporate Support and Other consists primarily of the Company's investments in
limited partnerships that invest in venture capital funds and the venture
capital subsidiary. It also includes business activities managed on a corporate
basis, including enterprise-wide administrative support functions.
68 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reportable segment financial results for the respective year ended December 31,
are as follows:
<Table>
<Caption>
Corporate Support Consolidated
Capital Markets Private Client Services and Other Company
(DOLLARS IN THOUSANDS) 2003 2002 2003 2002 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Net revenues $430,355 $376,074 $352,113 $357,155 $ 4,262 $ (4,177) $786,730 $729,052
Direct operating expense 293,106 248,870 288,412 291,156 40,945 37,461 622,463 577,487
- ----------------------------------------------------------------------------------------------------------------------
Direct contribution 137,249 127,204 63,701 65,999 (36,683) (41,638) 164,267 151,565
Support cost 59,303 61,549 35,219 36,097 - - 94,522 97,646
- ----------------------------------------------------------------------------------------------------------------------
Pre-tax operating income
(loss) before
unallocated charges $ 77,946 $ 65,655 $ 28,482 $ 29,902 $(36,683) $(41,638) 69,745 53,919
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
Cash award plan 24,000 -
Regulatory settlement - 32,500
Merger and restructuring - 7,976
Royalty fee 3,911 7,482
-------------------
Consolidated income before
taxes $ 41,834 $ 5,961
-------------------
-------------------
</Table>
<Table>
<Caption>
Corporate Support Consolidated
Capital Markets Private Client Services and Other Company
(Dollars in thousands) 2002 2001 2002 2001 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Net revenues $376,074 $422,235 $357,155 $392,447 $ (4,177) $(13,910) $729,052 $800,772
Direct operating expense 248,870 274,688 291,156 324,470 37,461 35,351 577,487 634,509
- -------------------------------------------------------------------------------------------------------------------------
Direct contribution 127,204 147,547 65,999 67,977 (41,638) (49,261) 151,565 166,263
Support cost 61,549 71,013 36,097 28,964 - - 97,646 99,977
- -------------------------------------------------------------------------------------------------------------------------
Pre-tax operating income
(loss) before unallocated
charges $ 65,655 $ 76,534 $ 29,902 $ 39,013 $(41,638) $(49,261) 53,919 66,286
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
Regulatory settlement 32,500 -
Amortization of goodwill and
acquisition-related
compensation - 17,641
Merger and restructuring 7,976 65,697
Royalty fee 7,482 55,753
-------------------
Consolidated income (loss)
before taxes $ 5,961 $(72,805)
-------------------
-------------------
</Table>
PIPER JAFFRAY ANNUAL REPORT 2003 69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 Income Taxes
On the consolidated financial statements, income taxes were determined on a
separate return basis as if the Company had not been eligible to be included in
the consolidated income tax return of USB and its affiliates.
The components of income tax expense (benefit) were:
<Table>
<Caption>
YEAR ENDED DECEMBER 31
(DOLLARS IN THOUSANDS) 2003 2002 2001
- -------------------------------------------------------------------------------------------
Current:
Federal $17,528 $ 12,809 $(20,876)
State 4,380 4,152 (2,891)
Foreign 418 280 230
- -------------------------------------------------------------------------------------------
22,326 17,241 (23,537)
- -------------------------------------------------------------------------------------------
Deferred:
Federal (5,529) (9,952) 697
State (962) (1,434) 86
- -------------------------------------------------------------------------------------------
(6,491) (11,386) 783
- -------------------------------------------------------------------------------------------
Total tax expense (benefit) $15,835 $ 5,855 $(22,754)
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
</Table>
A reconciliation of the statutory federal income tax rates to the Company's
effective tax rates for the fiscal years ended December 31 was as follows:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002 2001
- -------------------------------------------------------------------------------------------
Federal income tax at statutory rates $14,642 $ 2,087 $(25,482)
Increase (reduction) in taxes resulting from:
State income taxes, net of federal tax benefit 2,270 1,767 (1,823)
Goodwill amortization - - 5,054
Net tax-exempt interest income (2,933) (3,692) (1,525)
Fines and penalties 350 4,953 -
Other, net 1,506 740 1,022
- -------------------------------------------------------------------------------------------
Total tax expense (benefit) $15,835 $ 5,855 $(22,754)
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
</Table>
70 PIPER JAFFRAY ANNUAL REPORT 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income tax assets and liabilities reflect the tax effect of temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for the same items for income tax
reporting purposes.
The net deferred tax asset included in other assets at December 31 on the
Consolidated Statements of Financial Condition consisted of the following items:
<Table>
<Caption>
(DOLLARS IN THOUSANDS) 2003 2002
- ---------------------------------------------------------------
Deferred tax assets:
Liabilities/accruals not
currently deductible $26,254 $28,628
Pension and retirement costs 10,086 8,503
Deferred compensation 14,854 7,651
Other 5,382 5,613
- ---------------------------------------------------------------
56,576 50,395
- ---------------------------------------------------------------
Deferred tax liabilities:
Partnership investments 588 1,700
Fixed assets 3,188 2,180
Other 130 336
- ---------------------------------------------------------------
3,906 4,216
- ---------------------------------------------------------------
Net deferred tax assets $52,670 $46,179
- ---------------------------------------------------------------
- ---------------------------------------------------------------
</Table>
The Company has reviewed the components of the deferred tax assets and has
determined that no valuation allowance is deemed necessary based on management's
expectation of future taxable income.
As part of the Distribution, the Company entered into a tax sharing agreement
with USB that governs each parties' responsibilities, as it relates to income
taxes, going forward. Pursuant to this agreement, USB is generally responsible
for any future liabilities resulting from Internal Revenue Service audits for
those years the Company was part of the USB consolidated income tax return.
PIPER JAFFRAY ANNUAL REPORT 2003 71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUPPLEMENTAL INFORMATION
Quarterly Information (UNAUDITED)
<Table>
<Caption>
2003 FISCAL QUARTER
(Amounts in thousands, except per share data) First Second Third Fourth
- -------------------------------------------------------------------------------------------------------
TOTAL REVENUES $174,634 $210,377 $214,900 $206,330
INTEREST EXPENSE 5,427 5,327 4,225 4,532
NET REVENUES 169,207 205,050 210,675 201,798
NON-INTEREST EXPENSES 162,024 191,380 184,570 206,922
INCOME (LOSS) BEFORE INCOME TAXES 7,183 13,670 26,105 (5,124)
NET INCOME (LOSS) 4,693 8,622 16,030 (3,346)
EARNINGS PER COMMON SHARE
Basic $ 0.24 $ 0.45 $ 0.83 $ (0.17)
Diluted $ 0.24 $ 0.45 $ 0.83 $ (0.17)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Basic 19,190 19,223 19,260 19,273
Diluted 19,190 19,223 19,260 19,273
</Table>
<Table>
<Caption>
2002 FISCAL QUARTER
(Amounts in thousands, except per share data) First Second Third Fourth
- -------------------------------------------------------------------------------------------------------
TOTAL REVENUES $191,405 $215,774 $170,702 $185,486
INTEREST EXPENSE 8,127 13,379 6,630 6,179
NET REVENUES 183,278 202,395 164,072 179,307
NON-INTEREST EXPENSES 168,001 186,509 158,765 209,816
INCOME (LOSS) BEFORE INCOME TAXES 15,277 15,886 5,307 (30,509)
NET INCOME (LOSS) 9,076 9,947 4,308 (23,225)
EARNINGS PER COMMON SHARE
Basic $ 0.47 $ 0.52 $ 0.23 $ (1.21)
Diluted $ 0.47 $ 0.52 $ 0.23 $ (1.21)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Basic 19,198 19,132 19,150 19,162
Diluted 19,198 19,132 19,150 19,162
</Table>
Market for Piper Jaffray Common Stock and Related Shareholder Matters
STOCK PRICE INFORMATION
Our common stock is listed on the New York Stock Exchange under the symbol
"PJC." Our separation from U.S. Bancorp was completed on December 31, 2003 and
our common stock began "regular trading" on the New York Stock Exchange on
January 2, 2004. Consequently, historical quarterly price information is not
available for shares of our common stock. On February 6, 2004, the last reported
sale price of our common stock was $46.75 per share.
SHAREHOLDERS
We had 49,217 shareholders of record and an estimated 217,000 beneficial owners
of our common stock as of February 6, 2004.
DIVIDENDS
We do not intend to pay cash dividends on our common stock for the foreseeable
future. Instead, we currently intend to retain all available funds and any
future earnings for use in the operation and expansion of our business. Our
board of directors is free to change our dividend policy at any time and will
make any such future determination regarding the payment of dividends based upon
various factors then existing, including:
- - our financial condition, operating results and current and anticipated cash
needs,
- - general economic and business conditions,
- - our strategic plans and business prospects,
- - legal, contractual and regulatory restrictions on our ability to pay
dividends, and
- - other factors that our board of directors may consider to be relevant.
Restrictions on our broker dealer subsidiary's ability to pay dividends are
described in Note 15 to the consolidated financial statements.
72 PIPER JAFFRAY ANNUAL REPORT 2003