Piper Jaffray Companies Annual Report 2003

Plain-text annual report

annual report 2003 What guides us piper jaffray companies 2003 milestones – Completed our spin-off from U.S. Bancorp, becoming an independent, publicly held securities ﬁrm. – Earned net income of $26.0 million for the year ended Dec. 31, 2003. – Recorded net revenue of $786.7 million for the year ended Dec. 31, 2003, a 7.9 percent increase over 2002. – Renewed our commitment to the communities in which we live and work by pledging 5 percent of pre-tax earnings to charity in the form of employee time and expertise, and ﬁnancial resources. Piper Jaffray Companies (NYSE: PJC) is a focused securities ﬁrm and comprises two principal revenue segments: Capital Markets and Private Client Services. Clients of both segments are supported by Investment Research. The ﬁrm provides a full range of investment products and services to individuals, institutions and businesses. The ﬁrm has more than 100 ofﬁces in 23 states across the country and has headquarters in Minneapolis. Copyright © 2004 Piper Jaffray & Co. All Rights Reserved. Dear Shareholders, I am proud to introduce you to the new Piper Jaffray—a company with a 109-year heritage, more than 2,900 engaged employees and a sharp business focus. There is much to share about our capabilities and the market opportunity, but I must start at the beginning — with the culture that emerges strong and renewed as Piper Jaffray enters 2004 as a new public company. This annual report is dedicated to telling you who we are. THE PIPER JAFFRAY CULTURE To achieve enduring success in the ﬁnancial services industry, a company must build its foundation on strong values. At Piper Jaffray, we have committed to a set of Guiding Principles, a framework for daily decision making throughout the organization. Every employee understands that we must place our clients’ interests ﬁrst. As advisors and agents we are wholly committed to understanding client objectives and striving to help achieve them. We also recognize that our company must have the best people providing the best solutions to succeed in becoming the primary advisor for each of our clients. We have built our expertise in speciﬁc areas that provide distinctive value for the clients we serve. The knowledge and integrity of our employees have enabled Piper Jaffray to build strong national franchises in the capital markets and a formidable regional franchise serving private clients. Our success has not come without some shortcomings. In the past, there were some lapses in adhering to our Guiding Principles. In those instances, we have taken appropriate action to address any issues that have adversely impacted our clients and to provide a stronger business model as we move forward. We recognize that the value of the ﬁrm lies in the reputation we have built and the integrity with which we conduct ourselves. They are the reason our great people want to remain at Piper Jaffray. They are also the reason we are able to attract the highest quality talent. THE MARKET OPPORTUNITY As is often the case when industries consolidate, a number of companies achieve the beneﬁt of scale. Equally as often, opportunity is created as some market sectors become underserved. Our opportunity is to become the leading securities ﬁrm for the underserved middle market— nationally for capital markets clients and regionally for the middle of the afﬂuent private client segment. We will consistently concentrate our resources in these areas—using our expertise and execution to capitalize on this opportunity. We believe a securities ﬁrm, focused solely on raising and investing capital for its clients, will outperform aggregated companies bent on cross-selling. Our results in 2003 partly reﬂected this opportunity, as we transitioned from our merger with U.S. Bancorp. Net revenues increased 7.9 percent in 2003 to $786.7 million, consistent with the improved economy and better market performance during the last six months of the year. The increase in revenue was due primarily to strong ﬁxed-income sales and trading and increased equity underwriting activity. Net income increased to $26.0 million. We are beginning to hit our stride, with productivity improvements in a number of areas. We will continue to focus on improving margins and productivity as we grow. EMPLOYEE OWNERS As we return to the public market, we intend to grow employee ownership. As part of a focused securities ﬁrm, our employees will see the direct impact of their efforts on the valuation of the company. Our employees have a clear understanding of our strategy. They are engaged in their roles and committed to the success of our company. COMMUNITY PARTNERSHIPS Finally, we proudly rejoin the Minnesota Keystone Program, which includes among its members those companies who donate 5 percent of pre-tax earnings to charity through direct contributions and employee volunteerism. Piper Jaffray has had a long-standing commitment to sharing our resources and success with the communities in which we live and work, and we are pleased to renew that commitment. Indeed, a proud new chapter for our 109-year-old ﬁrm begins. Sincerely, Andrew S. Duff Chairman and Chief Executive Ofﬁcer On every journey, there are important milestones: landmark events, deﬁning moments and historic achievements. For a company to reach a signiﬁcant milestone, it takes skill and strategy. Energy and expertise. Determination and drive. But most of all, it requires a shared vision. An understanding of the values that guide, motivate and inspire the organization. At Piper Jaffray, we’re driven by sound prin- ciples and a strong sense of purpose. We’re committed to helping our clients deﬁne and achieve their objectives — and to delivering value for our shareholders. We’re dedicated to creating opportunities for our employees— and to giving back to our communities. Whether you’re a client, a shareholder, an employee or a community member, we share your goals. At Piper Jaffray, what guides us is you. piper jaffray annual report 2003 1 What guides us: our clients Never losing sight of the reason for the journey. At Piper Jaffray, we’ve been guiding clients to success for more than a century. Creating innovative solutions. Discovering new opportunities. Providing superior service. All with our clients’ needs at the forefront. By putting the client ﬁrst, all our stakeholders beneﬁt. That’s a philosophy shared by everyone in our company—from ﬁnancial advisors to investment bankers to traders to support staff. When we say we’re “client-focused,” it’s a reminder of the reason we’re in business. When our clients succeed, we all succeed. At Piper Jaffray, that’s the bottom line. 2 piper jaffray annual report 2003 piper jaffray annual report 2003 3 What guides us: our strategic focus Keeping our focus on the ultimate destination. Staying focused. On any journey, it’s essential. In any business, it’s critical. 4 piper jaffray annual report 2003 At Piper Jaffray, our focus is clear. Our mission is distinct. And our strategy is well-deﬁned. piper jaffray annual report 2003 5 our strategic focus continued We are a focused securities ﬁrm. 6 piper jaffray annual report 2003 We have identiﬁed speciﬁc opportunities that offer the greatest potential for our business, and that’s where we focus our attention. Our Capital Markets teams concentrate on middle-market companies and debt issuers, and the institutional clients that invest in them. Similarly, our Private Client Services business is specialized— targeting client segments and geographic markets that represent signiﬁcant growth opportunities for us. We believe that the acquisitions of securities ﬁrms by large ﬁnancial institutions over the past several years—as well as the decision by many competitors to focus on their largest clients —have resulted in signiﬁcant opportunities in the middle-market space. As always, our focus is on providing levels of expertise, execution, advice and service that are superior to our competitors. At Piper Jaffray, we never take our eyes off the ultimate destination: the continued success of our clients, our shareholders and our company. our strategic focus continued Capital Markets Our Capital Markets business assists clients in raising and investing capital and provides ﬁnancial advisory services to public and private corporations, public entities, non-proﬁt clients and institutional investors. capital markets locations: 23 ofﬁces in the United States and London, England Equities and Investment Banking INVESTMENT BANKING Investment Banking professionals provide ﬁnancial advisory and capital-raising services predominantly to middle-market clients. These typically consist of companies with an enterprise value between $100 million and $5 billion. Investment Banking focuses its efforts primarily on four speciﬁc industries— consumer, ﬁnancial insti- tutions, health care and technology. Accordingly, the area is organized by industry coverage groups, enabling individual investment bankers to develop speciﬁc expertise in particular industries and markets. In addition, we have built a dedicated middle-mar- kets mergers and acquisitions group that provides ﬁnancial advisory services primarily to private equity groups and private companies. SALES AND TRADING This group provides sales coverage and trading execution services for institutional investors. We also provide distribution for our public equity and equity- linked underwriting transactions. We serve more than 500 institutional accounts in the United States and Europe. The group acts as a market maker for more than 500 common stocks traded on Nasdaq. We currently act as a principal in the trading of approximately 250 listed stocks. GROWTH INITIATIVES – Convertible securities. We are working to grow our convertible securities business, which includes origination, restructuring, sales and trading capabilities. In 2003 we completed 15 transactions, raising $2.8 billion in capital. – Middle-market institutional sales coverage. We are working to expand coverage through dedicated salespersons focused on mid-sized institutional accounts. piper jaffray annual report 2003 7 our strategic focus continued Fixed Income PUBLIC FINANCE Our Public Finance bankers underwrite debt issuance and provide ﬁnancial advisory, risk management and other related investment services to govern- ment and non-proﬁt entities. Government clients include cities and counties, school and special districts, and states and state agencies. Not-for-proﬁt clients include health care, higher education and housing organizations. In each of the last ﬁve years we have ranked in the top ﬁve underwriters of tax-exempt issues nationally, when ranked by number of senior- managed issues. Based on revenue, government clients represent the largest overall portion of our public ﬁnance business. DEBT CAPITAL MARKETS Our Debt Capital Markets team advises corporate clients on ﬁnancing strategies in raising debt capital, including bonds, medium-term notes, project debt and commercial paper. Primary clients include medium to large corporations with a desire to access the bond and/or commercial paper markets. SALES AND TRADING In Fixed Income Sales, we seek to differentiate ourselves from competitors through a specialization strategy. Each Fixed Income salesperson focuses on a speciﬁc set of products (such as corporate bonds, mortgage securities, municipal securities) or speciﬁc types of clients (such as corporations, ﬁnancial institutions, public entities). Our Fixed Income Trading professionals underwrite and trade debt or preferred securities for corporations, municipalities, governments and government agencies. GROWTH INITIATIVES – Mortgage securities. We are working to grow our mortgage securities sales force and focus on secondary trading of collateralized mortgage obligations and speciﬁed mortgage pools. – Derivatives. We are working to expand our platform to act as a principal in derivatives transactions, primarily involving municipal hedging products. capital markets 2003 milestones – Raised approximately $8.3 billion for clients through 60 equity ﬁnancing transactions. – Completed 506 Public Finance ﬁxed-income issues nationwide with a total par amount of $5.9 billion. – Ranked #1 in tax-exempt bond underwriting in the upper Midwest four of the last ﬁve years.* – Advised clients on 38 mergers and acquisitions (M&A) transactions with total transaction value of $5.1 billion. – Expanded our convertible securities sales and trading capabilities and our originating and restructuring capabilities. – Established a leading brand in the aircraft sector of the corporate bond market. * Source: Thomson Financial 8 piper jaffray annual report 2003 our strategic focus continued Private Client Services Our Private Client Services business has more than 800 registered ﬁnancial advisors in nearly 100 retail ofﬁces in 18 Midwest, Mountain and West Coast states. We provide ﬁnancial and investment advice through a disciplined advisory process to offer solutions customized to our clients’ unique needs. Our ﬁnancial advisors use a suite of ﬁnancial plan- ning, portfolio performance reporting and ﬁxed- income portfolio management software — allowing them to thoroughly evaluate their clients’ resources, needs and objectives. We offer guidance in retirement and estate planning, education funding, wealth management, investment selection, asset allocation and insurance protection. STRATEGY Our goal is to become the primary ﬁnancial advisor for our clients. We have identiﬁed ﬁve key strategies that are critical to achieving this goal. – Retain, attract and develop highly skilled ﬁnancial advisors. The quality of our employees drives the success of our business. We believe our ﬁrm’s 109-year history, partnership culture, competitive product capabilities and employee value proposition make Piper Jaffray a desirable place to work. – Further our commitment to client relationships. Our talented people strive to build strong multifaceted wealth management relationships by gaining the clients’ trust and focusing on their long-term goals. piper jaffray annual report 2003 9 our strategic focus continued – Provide a broad range of investment products. Sufﬁcient and competitive products and an open architecture approach allow us to meet the diverse investment needs of our clients. – Focus on client relationship planning. We enhance client relationships through a disciplined process of personalized annual account planning and reviews. – Build a distinctive brand image. We have launched a new branding and marketing campaign high- lighting our “Guides for the Journey” theme. GROWTH INITIATIVES – Increase our presence within our existing geographic areas. We believe the regions in which we already operate offer signiﬁcant growth opportunities. private client services 2003 milestones – Launched Journey Plan,® a ﬁnancial planning tool designed to help clients discuss their resources, needs and objectives with their ﬁnancial advisor. – Introduced PASSPORT,SM a ﬁxed-income portfolio management software tool that helps clients better understand and make decisions about their investments. – Increase assets under management. We believe we will achieve this objective by building deeper relationships with existing clients and by focusing on attracting new affluent clients. – Implemented a revised ﬁnancial advisor compensation plan better structured to reward our people competitively and appropriately. – Leverage Capital Markets’ proprietary products. We will expand the training of our ﬁnancial advisors about these products and provide enhanced access to both equity and debt new- issue securities. – Substantially reduced the number of small and inactive accounts in our branch ofﬁces, which will enable us to focus on becoming a primary advisor to our target clients. 10 piper jaffray annual report 2003 our strategic focus continued Investment Research Independent, high-quality research is critical to serving the needs of our clients. It also helps differentiate us in the market- place. Using their deep expertise in the sectors they cover, our investment research teams provide analysis and investment ideas that beneﬁt both our institutional and individual clients. Our Investment Research function reports directly to the CEO. EQUITY RESEARCH This team of more than 70 professionals produces proprietary and fundamental equity research on more than 470 public companies. We focus on four speciﬁc sectors: consumer, ﬁnancial institu- tions, health care and technology. Our analysts have full autonomy in preparing their research. They are encouraged to explore a wide range of sources in developing their analysis framework. FIXED INCOME RESEARCH Our Fixed Income Research focuses on two areas — structured products research and sector research. Our structured products research provides deep expertise in the enhanced equipment trust certiﬁcate (eetc) market, the aircraft asset-backed securities (abs) market as well as the real estate investment trust (reit) market. In our sector research, we currently cover electric and gas utilities and airlines. PRIVATE CLIENT RESEARCH Private Client Research comprises professionals who provide market commentary, equity and ﬁxed-income strategies and asset allocation plans. The information we provide is supported by ideas and perspectives of our equity, ﬁxed-income, fundamental and technical analysts as well as those of our national research correspondents. Piper Jaffray Ventures and Private Capital Piper Jaffray Ventures manages four venture capital funds that invest in emerging growth companies in three segments of the health care industry—medical technologies, biotechnology and health care services. Through our Private Capital business, we manage two funds that invest in alternative asset categories for institutional and high net-worth investors. The company has an investment in one of these funds: Discovery Equity Partners (a broadly positioned buyout and growth fund). piper jaffray annual report 2003 11 What guides us: our spirit of partnership Working together to travel farther. 12 piper jaffray annual report 2003 The spirit of partnership. At Piper Jaffray, we work in partnership with each other — and with our clients. That’s one of our greatest competitive advantages. We know our talent is our most valuable asset. We work hard to recruit and retain exceptional employees. And we believe employee ownership has a direct client beneﬁt: consistency in relationships and better overall client service. Our full potential is realized through our combined efforts. By working together, we can travel farther than ever. piper jaffray annual report 2003 13 What guides us: our values Following the right path. 14 piper jaffray annual report 2003 How do we know we’re headed in the right direction? At Piper Jaffray, our Guiding Principles embody our commitment to the highest standards of ethics, integrity and client service. They guide our actions and reflect our philosophy. They influence our decisions and shape our strategies. They are an assurance to our clients and an inspiration to our employees. our guiding principles – We create and implement superior ﬁnancial solutions for our clients. Serving clients is our fundamental purpose. – We earn our clients’ trust by delivering the best guidance and service. – Great people are our competitive advantage. – As we serve, we are committed to these core values: - Always place our clients’ interests ﬁrst. - Conduct ourselves with integrity and treat others with respect. - Work in partnership with our clients and each other. - Maintain a high-quality environment that attracts, retains and develops the best people. - Contribute our talents and resources to serve the communities in which we live and work. piper jaffray annual report 2003 15 What guides us: our commitment to community Sharing the rewards of a successful journey. Corporate citizenship. It’s one of our company’s greatest legacies. For the past 109 years, Piper Jaffray has been integrally involved in the communities it serves — offering our time, talent and ﬁnancial resources. We believe that strong businesses have a responsibility to help build strong communities. Having become an independent, public company once again, we are strengthening our commitment to collaborative philanthropy. We are dedicated to sharing the time and expertise of our employees—in addition to our ﬁnancial support —with non-proﬁt organizations that can make a difference. OUR FOCUS AREAS – Building strong communities. We will partner with community development and affordable housing organizations to improve the lives of people in our local communities. – Building vibrant culture. We will support organizations that provide access to the arts, offer cultural enrichment and address issues related to diversity for our youth. – Building strong youth. We will join forces with local schools and related organizations to tear down barriers that stand between children and education. 16 piper jaffray annual report 2003 2003 milestones – Minnesota Keystone Program. Announced the renewal of our commitment to this landmark program. It was founded by 20 companies, including Piper Jaffray, more than 25 years ago to promote corporate support for communities. – National Teach Children to Save Day. Supported a program that illustrated the power of saving and investing to fourth and ﬁfth graders in 25 cities across 12 states. – Savvy Girls. Taught girls and their mothers the ﬁnancial skills they need to make their dreams come true. – Workplace Tutoring. Provided weekly sessions for Minneapolis eighth graders to help them prepare for standardized testing. piper jaffray annual report 2003 17 What guides us: our leadership Board of Directors Top row Andrew S. Duff Chairman and Chief Executive Ofﬁcer, Piper Jaffray Companies Addison L. (Tad) Piper Vice Chairman, Piper Jaffray Companies Michael R. Francis 2, 3 Executive Vice President of Marketing, Target Corporation B. Kristine Johnson 1, 3 President, Afﬁnity Capital Management 1 Audit Committee 2 Compensation Committee 3 Nominating and Governance Committee Bottom row Samuel L. Kaplan 3 Partner and Founding Member, Kaplan, Strangis and Kaplan, P.A. Frank L. Sims 1, 2 Corporate Vice President, Transportation and Product Assurance, Cargill, Inc. Richard A. Zona 1, 2 Chairman and Chief Executive Ofﬁcer, Zona Financial LLC 18 piper jaffray annual report 2003 Executive Leadership Andrew S. Duff Chairman and Chief Executive Ofﬁcer Addison L. (Tad) Piper Vice Chairman James L. Chosy General Counsel and Secretary Michael D. Duffy Chief Information Ofﬁcer Robert W. Peterson Head of Investment Research R. Todd Firebaugh Head of Corporate Planning and Communication Thomas P. Schnettler Head of Equities and Investment Banking Paul D. Grangaard Head of Private Client Services Sandra G. Sponem Chief Financial Ofﬁcer Pamela L. Clayton Head of Human Resources Barry J. Nordstrand Head of Fixed Income piper jaffray annual report 2003 19 Piper Jaffray Locations Equities and Investment Banking Chicago London Menlo Park Minneapolis New York San Francisco Fixed Income Chicago Cleveland Denver Des Moines Great Falls Hermosa Beach Houston Kansas City Las Vegas Lincoln Milwaukee Minneapolis New York Phoenix Portland San Francisco Seattle Spokane St. Louis Kansas Lawrence Leawood Topeka Minnesota Alexandria Austin Bloomington Brainerd Duluth Edina Fergus Falls Mankato Minneapolis Rochester St. Cloud St. Paul Stillwater Walker Wayzata Missouri Lee’s Summit Montana Billings Bozeman Butte Great Falls Missoula Nebraska Lincoln Omaha North Dakota Bismarck Fargo Grand Forks Private Client Services Arizona Phoenix Scottsdale Sun City California Fresno La Jolla La Jolla Village Marysville Palo Alto Sacramento San Francisco Sonoma Walnut Creek Colorado Boulder Denver Durango Evergreen Glenwood Springs Park Meadows Pueblo Idaho Boise Idaho Falls Pocatello Illinois Chicago Iowa Ames Davenport Des Moines Mason City Sioux City Storm Lake Waterloo West Des Moines Oregon Eugene Lake Oswego Medford Portland Salem The Dalles South Dakota Mitchell Pierre Rapid City Sioux Falls Utah Salt Lake City Washington Aberdeen Bellevue Bellingham Everett Lynden Poulsbo Seattle Spokane Tacoma Tri Cities Walla Walla Wenatchee Wisconsin Appleton Eau Claire Delaﬁeld Green Bay La Crosse Madison Milwaukee Sheboygan Wausau Wyoming Casper Sheridan 20 piper jaffray annual report 2003 Financials Piper Jaffray Companies management’s discussion and analysis and financial statements For the period ended December 31, 2003 piper jaffray annual report 2003 21 P I P E R J A F F R AY C O M P A N I E S S E L E C T E D F I N A N C I A L D ATA The following table presents our selected consoli- dated ﬁnancial data for the periods and dates indi- cated. The information set forth below should be read in conjunction with ‘‘Management’s Discus- sion and Analysis of Financial Condition and Re- sults of Operations’’ and our consolidated ﬁnancial statements and notes thereto. YEAR ENDED DECEMBER 31 (Dollars and Shares in Thousands, Except Per Share Data) 2003 2002 2001 2000 1999 Revenues Commissions and fees Principal transactions Investment banking Interest Other income Total revenues Interest expense Net revenues Non-interest expenses Compensation and beneﬁts Cash award program Regulatory settlement Amortization of acquisition-related compensation and goodwill Merger and restructuring Royalty fee $ 256,747 $ 275,682 $ 302,289 $ 374,611 $ 337,171 215,191 229,945 45,276 59,082 806,241 19,511 171,957 208,740 59,685 47,303 763,367 34,315 181,469 247,929 95,436 52,865 232,426 342,104 144,308 53,006 879,988 1,146,455 79,216 128,177 183,942 224,778 71,369 43,993 861,253 61,129 786,730 729,052 800,772 1,018,278 800,124 482,397 24,000 – – – 3,911 449,329 513,623 662,592 516,431 – 32,500 – 7,976 7,482 – – – – – – 17,641 65,697 55,753 30,108 8,889 47,750 33,554 8,316 – 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) Income tax expense (beneﬁt) 41,834 15,835 5,961 5,855 (72,805) (22,754) 40,276 19,568 56,157 24,981 Net income (loss) $ 25,999 $ 106 $ (50,051) $ 20,708 $ 31,176 Earnings per common share Basic Diluted Weighted average number of common shares Basic Diluted Other data Total assets Long-term debt Shareholders’ equity Total employees Total Private Client Services ofﬁces $ $ 1.35 $ 1.35 $ 0.01 $ 0.01 $ (2.60) $ (2.60) $ 1.09 $ 1.09 $ 1.63 1.63 19,237 19,237 19,160 19,160 19,279 19,279 19,060 19,060 19,078 19,078 $ 2,380,647 $2,041,945 $2,734,370 $2,735,918 $2,606,482 $ 180,000 $ 215,000 $ 475,000 $ 475,000 $ 375,000 $ 669,795 $ 609,857 $ 378,724 $ 362,331 $ 352,023 2,991 96 3,227 103 3,255 107 3,845 112 3,443 107 2 2 P I P E R J A F F R AY A N N U A L R E P O R T 2003 P I P E R J A F F R AY C O M P A N I E S M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S OUR SEPARATION FROM U.S. BANCORP agreements listed above, we have a $180 million un- secured subordinated debt agreement maturing in 2008 with a subsidiary of U.S. Bancorp. Pursuant to the separation and distribution agree- ment, U.S. Bancorp was generally responsible for all expenses directly incurred in connection with the distribution. The following information should be read in con- junction with the accompanying consolidated ﬁnan- cial statements and related notes included elsewhere in this report. This information includes forward- looking statements. Forward-looking statements in- clude all statements that are not historical facts. These statements involve risks, uncertainties and as- sumptions, including the risk factors described in In connection with the distribution, we imple- Exhibit 99.1 to our Form 10-K, as ﬁled with the Securities and Exchange Commission, which you mented a cash award program consisting of cash payments to a broad-based group of our employees. should carefully review. As a result of these risks, The award program is intended to aid in retention uncertainties and assumptions, our actual results of employees and to compensate for the value of may differ materially from those expressed in, or implied by, forward-looking statements. Accord- U.S. Bancorp stock options and restricted stock lost ingly, we caution you not to rely on any of these by our employees as a result of our spin off from forward-looking statements, which speak only as of U.S. Bancorp. The cash award program has an ag- gregate value of approximately $47.0 million. We the date made. We do not have any intention or incurred a $24.0 million charge at the time of the obligation to update forward-looking statements af- spin off from U.S. Bancorp. The remaining ter the date of this report. $23.0 million will be paid out over the next four years, which will result in an annual charge of ap- proximately $5.9 million over the next three years and $5.3 million in the fourth year. 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 As an independent company focused solely on our business, we believe that we have enhanced strategic distribution of its shares in that company to and operational flexibility and, as a result, are better U.S. Bancorp’s shareholders. On April 28, 2003, positioned to serve our clients and grow our business. Piper Jaffray Companies was incorporated in Dela- The distribution has presented a focused investment ware as a subsidiary of U.S. Bancorp for the pur- opportunity in Piper Jaffray for investors whose objec- pose of effecting the proposed distribution. tives 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. On December 31, 2003, after receiving regulatory approval, U.S. Bancorp distributed to its sharehold- ers 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 share- holders 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. Business Environment 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 ben- efits agreement, an insurance matters agreement and a business alliance agreement. In addition to those 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 securi- ties, the volatility of the equity and fixed income P I P E R J A F F R AY A N N U A L R E P O R T 2003 23 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S the volume and value of trading transactions. caused signiﬁcant declines in equity returns for in- markets, the level and shape of various yield curves and the demand for investment banking services as vestors and a substantially lower number of invest- reﬂected by the number and size of public offerings ment banking transactions as well as a decline in and merger and acquisition transactions, particularly in our focus industries and sectors. For example, our investment banking revenue, in the form of under- writing discounts and ﬁnancial advisory fees, is di- rectly related to the volume and value of the transactions in which we are involved. Uncertain or unfavorable market or economic conditions ad- versely affect our business. In such environments, the volume and size of capital-raising transactions and acquisitions and divestitures of corporations typi- cally 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, there- fore, may lead to a decline in the revenue we receive from commissions on the execution of trading trans- actions and, in respect of our market-making activi- While the improvement in the equity markets in the second half of 2003 has had a positive impact on ties, in a reduction in the value of our trading the broker dealer industry, the recent performance positions and commissions and spreads. is not necessarily indicative of continued strong per- formance. Concerns remain about the U.S. econ- omy with growing budget and trade deﬁcits and the decline in the value of the dollar relative to other major foreign currencies. As 2003 began, the U.S. economy continued to struggle due in part to lower consumer conﬁdence, higher unemployment, reduced spending in the bus- iness 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 eco- nomic 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 Av- erage increased 25 percent, while the Nasdaq Com- posite Index increased 50 percent. 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 uncer- tainties about terrorist acts, geo-political events and corporate accounting restatements. Because many of these factors are unpredictable and beyond our Results of Operations control, our earnings may ﬂuctuate signiﬁcantly from period to period. BASIS OF PRESENTATION RECENT TRENDS Challenging investment and economic conditions prevailed during 2001, 2002 and the ﬁrst part of 2003, which negatively impacted the ﬁnancial mar- kets. The Federal Reserve Board moved aggressively to improve economic conditions with multiple in- terest 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-pro- ﬁle corporations. The impact of these economic Generally, the consolidated results include revenues generated and expenses incurred based on customer conditions from 2001 through the ﬁrst part of 2003 Our consolidated ﬁnancial statements are prepared in conformity with accounting principles generally accepted in the United States of America and in- clude the adjustments necessary to reﬂect our oper- ations as if the organizational changes resulting from our spin off had been consummated prior to the distribution. The consolidated ﬁnancial state- ments have been derived from the ﬁnancial state- ments and accounting records of U.S. Bancorp using the historical results of operations and histori- cal 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 oper- ations, ﬁnancial position and cash ﬂows would have been had we operated as a stand-alone company during the periods presented. 2 4 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S relationships and related business activities. In cer- markets and securities business, results of any indi- vidual period should not be considered indicative of tain situations, afﬁliated entities of U.S. Bancorp future results. In addition, we provide services to may have provided services to us. These services certain focus industries and sectors, the perform- primarily relate to providing employee-related ser- ance of which may not correlate to the overall mar- vices and beneﬁts, technology and data processing ket. Our Capital Markets business focuses primarily services, and corporate functions including audit, on the consumer, ﬁnancial institutions, health care tax and real estate management services. Costs in- and technology industries within the corporate sec- cluded in the consolidated ﬁnancial statements for tor and health care, higher education, housing, and shared services were determined based on actual state and local government entities within the gov- costs to U.S. Bancorp and allocated to us based on ernment/non-proﬁt sector. Such industries may ex- our proportionate usage of those services. Propor- perience growth or downturns independently of tionate usage was determined based on the number general economic and market conditions, or may of our employees, actual hours used, square footage face market conditions that are disproportionately of ofﬁce space or other similar methodologies. Our better or worse than those impacting the economy management believes the assumptions underlying the and markets generally, which may affect our busi- consolidated ﬁnancial statements are reasonable. ness differently than overall market trends. More- over, 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 com- pared 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. 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 necessa- rily 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 ﬁnan- cial position. Given the variability of the capital 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 YEAR ENDED DECEMBER 31 2003 2002 2001 2003 v 2002 2002 v 2001 Dow Jones Industrials (a) NASDAQ (a) NYSE Average Daily Value Traded ($ BILLIONS) NASDAQ Average Daily Value Traded ($ BILLIONS) Mergers and Acquisitions (NUMBER OF TRANSACTIONS) (b) Public Equity Offerings (NUMBER OF TRANSACTIONS) (c) (d) Initial Public Offerings (NUMBER OF TRANSACTIONS) (c) Managed Municipal Underwritings (NUMBER OF TRANSACTIONS) (e) 10-Year Treasuries Average Rate (a) (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. 10,454 2,003 $ 38.5 $ 28.0 7,091 831 77 8,342 1,336 $ 40.9 $ 28.8 6,451 608 75 10,022 1,950 $ 42.3 $ 44.1 6,998 764 83 14,695 14,056 13,346 25.3% (16.8)% 49.9 (5.9) (2.8) 9.9 36.7 2.7 4.5 (31.5) (3.3) (34.7) (7.8) (20.4) (9.6) 5.3 (8.2) 4.02% 4.61% 5.02% (12.8) P I P E R J A F F R AY A N N U A L R E P O R T 2003 25 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31 (Dollars in Thousands) Revenues Commissions and fees Principal transactions Investment banking Interest Other income Total revenues Interest expense Net revenues Non-interest expenses 2003 2002 2001 2003 v 2002 2002 v 2001 AS A PERCENTAGE OF NET REVENUES 2003 2002 2001 $256,747 $275,682 $302,289 (6.9)% (8.8)% 32.6% 37.8% 37.7% 215,191 229,945 45,276 59,082 171,957 181,469 208,740 247,929 59,685 47,303 95,436 52,865 25.1 10.2 (5.2) (15.8) (24.1) (37.5) 24.9 (10.5) 27.4 29.2 5.8 7.5 806,241 763,367 879,988 5.6 (13.3) 102.5 19,511 34,315 79,216 (43.1) (56.7) 2.5 23.6 28.6 8.2 6.5 104.7 4.7 22.7 31.0 11.9 6.6 109.9 9.9 786,730 729,052 800,772 7.9 (9.0) 100.0 100.0 100.0 Compensation and beneﬁts 482,397 449,329 513,623 Occupancy and equipment Communications Floor brokerage and clearance Marketing and business development Outside services Cash award program Regulatory settlement Amortization of acquisition-related compensation and goodwill Merger and restructuring Royalty fee Other operating expenses 58,025 37,599 22,755 39,030 34,219 24,000 – – – 3,911 42,960 55,549 36,316 26,040 44,115 32,717 – 32,500 – 7,976 7,482 31,067 60,121 41,082 22,092 49,706 22,285 7.4 4.5 3.5 (12.5) (7.6) (11.6) (12.6) 17.9 (11.5) (11.2) 4.6 46.8 – – 100.0 – (100.0) 100.0 17,641 65,697 55,753 25,577 – (100.0) (100.0) (87.9) (47.7) (86.6) 38.3 21.5 61.3 61.6 64.1 7.4 4.8 2.9 5.0 4.3 3.1 – – – .5 5.5 7.6 5.0 3.6 6.0 4.5 – 4.5 – 1.1 1.0 4.3 7.5 5.1 2.8 6.2 2.8 – – 2.2 8.2 7.0 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 Income tax expense (beneﬁt) 41,834 15,835 5,961 5,855 (72,805) (22,754) 601.8 108.2 170.5 (125.7) 5.3 2.0 .8 .8 (9.1) (2.8) Net income (loss) $ 25,999 $ 106 $ (50,051) NM 100.2% 3.3% 0.0% (6.3)% NM – Not Meaningful for the year, largely due to strong ﬁxed income sales Net income increased to $26.0 million in 2003 up and trading. Fixed income products continued to be from $0.1 million in 2002 reﬂecting the improved a key driver of our revenue throughout the year, economy and market performance during the last particularly corporates and mortgages, two growth six months of 2003. Net revenues increased to focuses of ours. Investment banking revenue in- $786.7 million in 2003, up 7.9 percent over prior creased 10.2 percent for the year, primarily due to year net revenues of $729.1 million. The largest component of our revenue stream was commissions improved equity underwriting activity. This in- and fees at $256.7 million, down 6.9 percent from crease was aided by the ﬁrst full year results of the the prior year. Commissions and fees declined due convertibles team that joined us at the end of 2002. to lower transaction volumes in equities and equity- Other income grew 24.9 percent, primarily due to related products such as mutual funds in the ﬁrst our new agreement with U.S. Bancorp Asset half of 2003. In addition, commission revenues Management for the provision of cash sweep prod- ucts to our clients. Non-interest expenses increased were impacted from continued attrition of financial to $744.9 million in 2003 from $723.1 million for advisors in our Private Client Services business. the prior year. Contributing to the increase in Proﬁts on principal transactions grew 25.1 percent 2 6 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S in to no increased longer participate non-interest expenses for 2003 were higher incen- revenues in each year, respectively. The decrease in tive compensation resulting from improved ﬁnan- compensation is primarily attributable to lower va- cial performance, litigation-related riable compensation as a result of reduced revenue. expenses and additions to employee loan loss In addition, reductions in headcount and the impact reserves for transition to our new Private Client of restructuring certain administrative and support Services compensation plan. In addition, 2003 non- functions in 2001 to improve our operating efﬁcien- interest expenses include the $24.0 million charge cies resulted in a decrease in compensation expense related to the cash award program. Non-interest of approximately $18.7 million in 2002. The other expenses in 2002 included a $32.5 million charge signiﬁcant contributor to the decline included our the resulting from the settlement we entered into in decision connection with the regulatory investigation of eq- U.S. Bancorp pension plan effective January 1, 2002. An employer discretionary proﬁt sharing uity research and its relationship to investment banking. For more details regarding the regulatory plan replaced the U.S. Bancorp pension plan to ‘‘consolidated non-interest ex- more closely align retirement beneﬁts for our em- settlement, see ployees with performance of the business. In 2002, penses — regulatory settlement’’ below. 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. 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-in- terest expenses declined to $723.1 million in 2002 from $873.6 million in the prior year, or down Occupancy and Equipment – Occupancy and equip- 17.2 percent, driven by lower variable compensa- ment expenses were $58.0 million in 2003 com- pared with $55.5 million for the prior year. This tion associated with declining net revenues, the ef- increase was due primarily to a $4.1 million write- fect of adopting a new accounting principle which eliminated the amortization of goodwill, lower roy- off of internally developed software in conjunction alty fees paid to U.S. Bancorp for the use of with the implementation of a new ﬁxed income trading system, offset partially by reduced deprecia- tradenames and lower restructuring charges relative to 2001. These declines were offset in part by the tion on furniture and equipment. $32.5 million settlement charge in connection with an industry-wide regulatory investigation of equity research and its relationship to investment banking. Occupancy and expenses were equipment $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 communica- tion, primarily from third-party market information providers. Communication expenses were $37.6 mil- lion 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. Compensation and Benefits – Compensation and ben- eﬁts 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 rep- resents variable incentive arrangements and com- in missions, the amounts of which ﬂuctuate 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 compen- Communication expenses were $36.3 million in 2002 compared with $41.1 million in 2001. Restruc- sation as a result of increased revenue and operat- turing activities in 2001 as well as cost containment ing proﬁts. In addition, $9.5 million was allocated efforts drove the 11.6 percent decline in 2002. in 2003 to our employer discretionary proﬁt shar- ing plan based on our 2003 proﬁtability. In 2002 we did not make an allocation to our employer discretionary proﬁt sharing plan. 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 and beneﬁts decreased to Compensation $449.3 million in 2002 from $513.6 million in 2001 and was 61.6 percent and 64.1 percent of net CONSOLIDATED NON-INTEREST EXPENSES P I P E R J A F F R AY A N N U A L R E P O R T 2003 27 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S expense as a percentage of net revenues was re- duced 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 mil- lion 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 ob- tain trade execution. Marketing and Business Development – Marketing and business development expenses include travel and en- tertainment, postage, supplies and promotional and advertising costs. Marketing and business develop- ment 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 discre- tionary 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 adver- tising as business activity declined. As a result, travel expenses declined by $3.1 million and adver- tising expenses declined by $0.6 million. 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. for employees Cash Award Program – A broad group of employees have been granted cash awards pursuant to a pro- gram 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 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 ap- proximately $47.0 million. We incurred a $24.0 million charge in connection with this pro- gram 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 indus- try-wide investigation of equity research and its re- lationship 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 fund- ing independent research to be provided to inves- tors. The terms of this settlement were ﬁnalized effective April 28, 2003. Outside Services – Outside services expenses include securities processing expenses, outsourced technol- ogy 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 off- set by lower computer consulting expenses incurred during 2003 due to the completion in early 2002 of our project to outsource certain securities process- ing activities. 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 rela- tionship 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 Invest- ment 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 compensa- Outside services expenses increased to $32.7 million tion of our research analysts, will be made without in 2002 compared with $22.3 million in 2001. The regard to speciﬁc Investment Banking revenues or 46.8 percent increase in outside services in 2002 is primarily due to investments in and changes to tech- results and without input from Investment Banking. nology we made during 2001 to support future Moreover, with respect to research analyst compen- sation, we have developed and implemented a per- growth in the business, which included outsourcing formance matrix to evaluate and compensate certain securities back office processing activities. The 2 8 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S Investment Banking and The ongoing costs associated with the other changes we are making to our business in connec- tion with the regulatory settlement will be reﬂected in our results of operations in future periods and are not currently determinable. associated with the termination of employees and research analysts. We have formed a research over- $0.5 million for asset write-downs and lease termi- sight committee, which will provide oversight and nations for branch closings. In addition, we in- ratiﬁcation for all fundamental research coverage curred $2.2 million of charges related to integrating initiations and discontinuances, as well as funda- the ﬁxed income division of U.S. Bancorp Invest- mental research opinion changes. We have signiﬁ- cantly revised our policies and procedures to ments, Inc. into our business in connection with the require a compliance group chaperone for other- integration plan associated with the 2001 merger of wise permissible meetings or communications be- U.S. Bancorp and Firstar Corporation. tween Investment Research. We also have signiﬁcantly revised our policies and procedures to ensure generally the in- dependence 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. 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 in- creased 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. Ap- proximately $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 re- maining $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 On January 1, 2002, we adopted Statement of Fi- nancial Accounting Standards No. 142 (SFAS 142), Company that were impaired as a direct result of decisions to terminate certain employees and close entitled ‘‘Goodwill and Other Intangible Assets.’’ ofﬁces in connection with the overall restructuring SFAS 142 addresses the accounting for goodwill plan. Costs associated with the U.S. Bancorp and and intangibles subsequent to their acquisition. The Firstar Corporation merger included approximately most signiﬁcant changes made by SFAS 142 are that $14.0 million in accelerated vesting of restricted goodwill and indeﬁnite-lived assets are no longer amortized and are tested for impairment at least stock that occurred at the time of that merger. annually. As of January 1, 2002, we discontinued the amortization of goodwill. Prior to the adoption of SFAS 142, goodwill amortization was $14.4 mil- lion 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. Amortization of Acquisition-related Compensation and Goodwill – Amortization of acquisition-related com- pensation 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. Royalty Fee – In connection with the 1998 acquisi- tion of Piper Jaffray Companies Inc. and its subsidi- aries 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 com- parable royalty fee arrangements of other compa- nies. In 2000, we began making royalty payments to U.S. Bancorp. The royalty rate was adjusted peri- odically 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. 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 weak- ness in the equity market and included $5.3 million for severance, other beneﬁts and outplacement costs P I P E R J A F F R AY A N N U A L R E P O R T 2003 29 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S ded December 31, 2002 and 2001, respectively. The non-deductibility of the regulatory ﬁne in 2002 associated with the equity research practices de- scribed 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 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 cor- porate support, and other miscellaneous expenses. Other operating expenses increased to $43.0 mil- lion 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 con- nection 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 col- lection 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 communi- cated to employees certain changes to our produc- tion-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 at- trition 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-re- lated 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. We measure ﬁnancial performance by business seg- ment, including Capital Markets, Private Client Ser- vices, and Corporate Support and Other. The business segments are determined based upon fac- tors such as the type of customers, the nature of products and services provided and the distribution channels used to provide those products and ser- vices. 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 competi- tors. Segment pre-tax operating income or loss is derived from our business unit proﬁtability report- ing systems by speciﬁcally attributing customer rela- tionships and their related revenues and expenses. Expenses directly managed by the business unit are accounted for within each segment’s pre-tax operat- ing income or loss. Investment research, operations, technology and compliance related costs are allo- cated based on each segment’s use of these func- tions to support its business. General and administrative expenses incurred by centrally man- aged corporate support functions are included within Corporate Support and Other. To enhance the comparability of business segment results, good- will amortization for periods prior to the adoption of SFAS 142 is not included in segment pre-tax operating income or loss. Also, merger and restruc- turing-related charges, royalty fees assessed by Other operating expenses were $31.1 million in U.S. Bancorp, retention cash awards granted to em- 2002 compared with $25.6 million in 2001. The ployees in connection with our separation from increase of $5.5 million, or 21.5 percent, in 2002 U.S. Bancorp, and certain infrequent regulatory set- tlement costs are not included in segment pre-tax compared with 2001 relates primarily to allocated operating income or loss. Designations, assignments costs from U.S. Bancorp for technology-related sup- and allocations may change from time to time as port and from litigation-related expenses. ﬁnancial reporting systems are enhanced and meth- ods of evaluating performance change or business segments are realigned to better serve our customer base. The presentation reﬂects our current manage- ment structure and, accordingly, all periods are presented on a comparable basis. 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 per- cent, and an income tax beneﬁt of $22.8 million, an effective tax rate of 31.3 percent, for the years en- 3 0 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S In addition, Capital Markets has a higher propor- Our primary revenue-producing segments, Capital tion of variable non-compensation expenses than Markets and Private Client Services, have different does Private Client Services. These differences in compensation plans and non-compensation cost structures that impact the operating margins of the compensation plans and cost structures result in a two segments differently during periods of increas- more stable operating margin for Capital Markets and greater variability in operating margin for Pri- ing or decreasing business activity and revenue. Compensation expense for Capital Markets is vate Client Services. driven primarily by pre-tax operating proﬁt of the segment, whereas compensation expense for Private Client Services is driven primarily by net revenues. The following table provides our segment perform- ance for the periods presented: SEGMENT PERFORMANCE YEAR ENDED DECEMBER 31 (Dollars in Thousands) Net revenues Capital Markets Private Client Services Corporate Support and Other 2003 2002 2001 2003 v 2002 2002 v 2001 $ 430,355 $376,074 $422,235 14.4% (10.9)% 352,113 4,262 357,155 392,447 (1.4) (4,177) (13,910) 202.0 (9.0) 70.0 (9.0) Total $ 786,730 $729,052 $800,772 7.9 Pre-tax operating income (loss) before unallocated charges (a) Capital Markets Private Client Services Corporate Support and Other $ 77,946 $ 65,655 $ 76,534 18.7% (14.2)% 28,482 (36,683) 29,902 39,013 (41,638) (49,261) (4.7) 11.9 (23.4) 15.5 Total $ 69,745 $ 53,919 $ 66,286 29.4 (18.7) Pre-tax operating margin before unallocated charges Capital Markets Private Client Services Total 18.1% 8.1% 8.9% 17.5% 8.4% 7.4% 18.1% 9.9% 8.3% (a) See Reconciliation to pre-tax operating income (loss) including unallocated charges for detail on expenses excluded from segment performance. Reconciliation to pre-tax operating income (loss) including unallocated charges Pre-tax operating income (loss) before unallocated charges Cash award plan Regulatory settlement Amortization of acquisition-related compensation and goodwill Merger and restructuring Royalty fee $ 69,745 $ 53,919 $ 66,286 24,000 – – – 3,911 – 32,500 – 7,976 7,482 – – 17,641 65,697 55,753 Consolidated income (loss) before income tax expense (beneﬁt) $ 41,834 $ 5,961 $ (72,805) P I P E R J A F F R AY A N N U A L R E P O R T 2003 31 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S CAPITAL MARKETS YEAR ENDED DECEMBER 31 (Dollars in Thousands) Net revenues 2003 2002 2001 2003 v 2002 2002 v 2001 Commissions and principal transactions $ 208,741 $170,362 $177,689 22.5% (4.1)% Investment banking Net interest Other income Total net revenues 198,221 181,529 19,668 3,725 20,827 3,356 220,390 23,392 764 9.2 (5.6) 11.0 (17.6) (11.0) 339.3 $ 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% uity institutional business, offset partially by higher Capital Markets net revenues increased 14.4 per- equity institutional trading volumes. Investment cent to $430.4 million in 2003 from $376.1 million banking revenue decreased to $181.5 million in for the prior year. Commissions and trading reve- 2002 from $220.4 million in 2001 due primarily to nue increased 22.5 percent to $208.7 million in reduced equity underwritings and merger and ac- 2003 compared with $170.4 million for the prior year, primarily due to higher institutional trading quisition advisory fees, offset partially by increased volumes, particularly in ﬁxed income products. In municipal bond underwriting revenue as issuers took advantage of the declining interest rate envi- addition, equity institutional revenue grew despite ronment. Net interest revenue declined due to lower trading volumes as we reduced trading losses incurred from facilitating customer transactions. In- changes in interest rates and inventory levels. vestment banking revenue increased to $198.2 mil- lion for 2003 compared with $181.5 million for the prior year, due primarily to increased equity under- writing 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 Mar- kets decreased to 17.5 percent in 2002 from 18.1 percent in 2001. This decline is primarily at- tributable to increases in outside services related to the outsourcing of securities processing activities and higher litigation-related expenses. Also contrib- uting to the decline was increased ﬂoor brokerage and clearance expense due to increased use of elec- tronic communication networks to obtain trade ex- these additional ecution. Partially offsetting 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 shar- ing plan, based on our operating results. Segment pre-tax operating margin for Capital Mar- kets 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 develop- ment, 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 condi- tions. 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 eq- 3 2 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S PRIVATE CLIENT SERVICES YEAR ENDED DECEMBER 31 (Dollars in Thousands) Net revenues Commissions and fees Net interest Total net revenues 2003 2002 2001 2003 v 2002 2002 v 2001 $340,001 $344,643 $378,925 (1.3)% (9.0)% 12,112 12,512 13,522 $352,113 $357,155 $392,447 (3.2) (1.4) (7.5) (9.0) Pre-tax operating income before unallocated charges $ 28,482 $ 29,902 $ 39,013 (4.7)% (23.4)% Pre-tax operating margin Number of ﬁnancial advisors (period end) 8.1% 830 8.4% 975 9.9% 1,061 (14.9)% (8.1)% 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 ﬁnan- cial advisors decreased 8.1 percent between Decem- ber 31, 2001 and December 31, 2002. Private Client Services net revenues decreased to $352.1 million in 2003 compared with $357.2 mil- lion 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 reve- nue of $8.5 million related to our new agreement with U.S. Bancorp Asset Management for the provi- sion of cash sweep products to our clients. We im- plemented a new compensation plan in mid-2003, which contributed signiﬁcantly to attrition among lower-end producers. Changes to the new compen- sation 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 8.4 percent in 2002 from 9.9 percent in 2001. This decline is primarily attrib- utable 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 Segment pre-tax operating margin for Private Client undertaken related to discretionary expenses. Also Services decreased to 8.1 percent in 2003 compared with 8.4 percent for 2002. This decline is primarily contributing to the decline in pre-tax operating attributable to increased employee loan losses re- margin was the increase in outside services related to outsourcing certain securities processing activi- lated to forgivable loans made to our ﬁnancial advi- ties and litigation-related expenses. Although a sig- sors. Also contributing to this decline in operating niﬁcant portion of compensation is variable, certain margin were increased litigation-related expenses in components are relatively ﬁxed, such as salaries and 2003 as compared with 2002 reﬂecting an increase beneﬁts, which have a negative impact on our pre- in the number of complaints, legal actions, investi- tax operating margin during periods of declining gations and regulatory proceedings. Mostly offset- revenue. Partially offsetting these ﬁxed components ting these additional expenses were reductions in of compensation was the reduction of other costs ﬁxed and variable compensation expense for 2003 resulting from the restructuring activities taken in due to our previous restructuring efforts. 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 shar- ing plan, based on our operating results. 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 in- come commissions of $3.4 million due to higher trading volumes. Net interest revenue decreased as P I P E R J A F F R AY A N N U A L R E P O R T 2003 33 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S Corporate Support and Other – Corporate Support and Other includes certain revenues not attributable to the Capital Markets or Private Client Services busi- ness segments. These revenues are primarily attribu- table 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 reve- nues. 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 re- duction in interest expense on our subordinated debt and increased management fees from our ven- ture 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 con- tributing 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 roy- approximately $5.3 million in 2007 related to the employee cash award program established in con- nection 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 por- tion of their pre-tax earnings to non-profit organi- zations. 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 ser- vices and employee volunteer hours. ) We do not intend to pay cash dividends on our common stock for the foreseeable future. We ex- pect 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. alty fees paid to U.S. Bancorp for the use of trade Recent Accounting Developments names. In 2003 these fees were approximately $3.9 million. Recent accounting pronouncements are set forth in Note 3 to the consolidated ﬁnancial statements and are incorporated herein by reference. ) Based on current market conditions, increased claims activity for insurance carriers and our de- creased purchasing power resulting from our spin Critical Accounting Policies off from U.S. Bancorp, we expect insurance pre- miums are likely to continue to increase. ) In connection with the market downturn that be- gan in 2000, the number of complaints, legal ac- tions, 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. 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 fi- nancial statements requires management to make es- timates and assumptions that could materially affect reported amounts in the consolidated financial state- ments. Critical accounting policies are those policies ) Based on current estimates, we expect to incur that management believes are the most important to approximately $5.2 million of expense on an an- the portrayal of our financial condition and results of operations, and require management to make esti- nual basis as a result of being a public company, including audit and tax services, investor rela- mates that are difficult, subjective or complex. Most tions, compliance with SEC and NYSE rules, accounting policies are not considered by manage- board of directors costs and directors and ofﬁcers ment to be critical accounting policies. Several fac- tors are considered in determining whether or not a insurance costs. policy is critical, including, among others, whether the estimates are significant to the consolidated ) We expect to incur an annual pre-tax charge of approximately $5.9 million through 2006 and 3 4 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S independent source, certain assumptions may be re- ﬁnancial statements taken as a whole, the nature of quired to determine the security’s fair value. For the estimates, the ability to readily validate the instance, we generally assume that the size of posi- estimates with other information including third par- tions in securities that we hold would not be large ties or independent pricing sources, the sensitivity of enough to affect the quoted price of the securities if the estimates to changes in economic conditions and whether alternative accounting methods may be used we sell them, and that any such sale would happen in an orderly manner. The actual value realized under accounting principles generally accepted in the upon disposition could be different from the cur- United States of America. rently estimated fair value. 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. GOODWILL VALUATION OF FINANCIAL INSTRUMENTS We record all assets and liabilities acquired in purchase acquisitions, including goodwill, at fair value as required by Statement of Financial Account- ing Standards No. 141, entitled ‘‘Business Combina- tions.’’ 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. Substantially all of our ﬁnancial instruments are recorded at fair value or contract amounts which approximate fair value. Financial instruments car- ried at contract amounts which approximate fair value, either have short-term maturities (one year or less), are repriced frequently, or bear market inter- The initial recognition of goodwill and other intan- est rates and, accordingly, are carried at amounts gible assets and subsequent impairment analysis approximating fair value. Financial instruments require management to make subjective judgments carried at contract amount on the consolidated concerning estimates of how the acquired assets or statements of ﬁnancial condition include receivables businesses will perform in the future using valuation from and payables to brokers, dealers and clearing organizations, securities purchased under agree- methods including discounted cash flow analysis. Ad- ditionally, estimated cash flows may extend beyond ments to resell, securities sold under agreements to repurchase, receivables from and payables to cus- ten years and, by their nature, are difficult to deter- tomers, short-term ﬁnancing and subordinated mine over an extended timeframe. Events and factors that may significantly affect the estimates include, debt. Unrealized gains and losses related to these among others, competitive forces, changes in revenue ﬁnancial instruments are reﬂected in the consoli- growth trends, cost structures and technology, dated statements of operations. Where available, we changes in discount rates and market conditions. In use prices from independent sources such as listed determining the reasonableness of cash flow estimates, market prices or dealer price quotations. management reviews historical performance of the un- derlying assets or similar assets in an effort to assess and validate assumptions used in its estimates. For investments in illiquid or privately held securi- ties that do not have readily determinable fair val- ues, the determination of fair value requires In assessing the fair value of our operating segments, management to estimate the value of the securities the volatile nature of the securities markets and our using the best information available. Among the industry requires our management to consider the factors considered by management in determining business and market cycle and assess the stage of the the fair value of ﬁnancial instruments are the cost, cycle in estimating the timing and extent of future terms and liquidity of the investment, the ﬁnancial cash flows. In addition to estimating the fair value of condition and operating results of the issuer, the quoted market price of publicly traded securities an operating segment based on discounted cash flows, with similar quality and yield and other factors gen- management considers other information to validate the reasonableness of its valuations including public erally pertinent to the valuation of investments. In instances where a security is subject to transfer re- market comparables, multiples of recent mergers and acquisitions of similar businesses and third-party as- strictions, the value of the security is based prima- sessments. Valuation multiples may be based on reve- rily on the quoted price of a similar security without nues, price-to-earnings and tangible capital ratios of restriction but may be reduced by an amount esti- comparable public companies and business segments. mated to reﬂect such restrictions. In addition, even These multiples may be adjusted to consider where the value of a security is derived from an P I P E R J A F F R AY A N N U A L R E P O R T 2003 35 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S competitive differences including size, operating lever- age, 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 in- dustry 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 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 mea- sure of the fair value of employee stock options. Effective January 1, 2004, we elected to account on a prospective basis for stock-based employee compensa- tion 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 dam- ages. The number of these complaints, legal actions, investigations and regulatory proceedings has been increasing in recent years. We have, after consulta- tion with outside counsel and consideration of facts currently known by management, recorded esti- mated losses in accordance with Statement of Finan- cial Accounting Standards No. 5, ‘‘Accounting for Contingencies,’’ to the extent that claims are proba- ble of loss and the amount of the loss can be reason- ably estimated. The determination of these reserve amounts requires significant judgment on the part of management. In making these determinations, man- agement considers many factors, including, but not limited to, the loss and damages sought by the plain- tiff 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 com- plaints, legal actions, arbitrations, investigations and proceedings, and fines and penalties or orders from regulatory agencies. As part of our compensation of employees, we may use stock-based compensation, including stock op- tions, restricted stock and other stock-based awards. These awards may be for key employees or in connection with sales and production-based in- centives. Compensation related to restricted stock is amortized over the vesting period of the award, which is generally three to ﬁve years, and is in- cluded in our results of operations as compensation. Accounting principles generally accepted in the United States allow alternative methods of account- ing 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 appreci- ation 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 pe- riod 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 determin- Under the terms of our separation and distribution ing the estimated fair value of stock options, we agreement with U.S. Bancorp and ancillary agree- used the Black-Scholes option-pricing model, which ments, we will generally be responsible for all liabil- ities relating to our business, including those requires judgment regarding certain assumptions, liabilities relating to our business while it was oper- including the expected life of the options granted, ated as a segment of U.S. Bancorp under the super- dividend yields and stock volatility. Certain of these vision of its management and board of directors assumptions were based on the stock performance of U.S. Bancorp and may not reﬂect assumptions and while our employees were employees of that would be used by us as a stand-alone entity. U.S. Bancorp servicing our business. Similarly, Also, employee stock options have characteristics U.S. Bancorp will generally be responsible for all liabilities relating to the businesses U.S. Bancorp that are signiﬁcantly different from those of traded 3 6 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S 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 re- garding the allocation of IPO shares to directors and ofﬁcers of investment banking clients, and reg- ulatory investigations into our mutual fund prac- tices. 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 cur- rent 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 proceed- ings will be resolved with no material adverse effect on our ﬁnancial condition. However, if, during any period, a potential adverse contingency should be- come probable or resolved for an amount in excess of the established reserves and indemniﬁcation, the results of operations in that period could be materi- ally affected. Liquidity and Capital Resources short-term borrowings of $91.0 million and subor- dinated 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. Oper- ating activities provided cash of $297.3 million. Cash of $5.8 million was used for investing activi- ties. Cash of $286.6 million was used for ﬁnancing activities, including the reduction of short-term bor- rowings 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 mil- lion to U.S. Bancorp, offset partially by a $75.0 mil- lion capital contribution from U.S. Bancorp to ensure adequate levels of capital through signiﬁcant system conversions. FUNDING SOURCES 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 As of December 31, 2003, we had uncommitted credit agreements with banks totaling $550 million, dealers usually settle within a few days. Our assets comprising $450 million in discretionary secured are ﬁnanced by our equity capital, bank lines of lines and $100 million in discretionary unsecured credit, subordinated debt, proceeds from securities lending and securities sold under agreements to re- lines. In addition, we have established an arrange- purchase, in addition to non-interest bearing liabili- ment to obtain ﬁnancing using our securities held by our clearing bank at the end of each day as ties, such as checks and drafts payable, payables to customers and employee compensation payable. collateral. In addition, we will use repurchase agree- The ﬂuctuations in cash ﬂows from ﬁnancing activi- ments and securities lending as additional sources ties are directly related to daily operating activities from our various businesses. of funding. 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 mil- lion. Cash of $15.1 million was used for investing activities. Cash of $92.1 million was used for ﬁ- nancing activities, including the net reduction of In addition to the $550 million of ﬁnancing com- mitments described above, our broker dealer sub- sidiary 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. P I P E R J A F F R AY A N N U A L R E P O R T 2003 37 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S CASH REQUIREMENTS The following table provides a summary of our con- tractual obligations as of December 31, 2003: (Dollars in Millions) Long-term borrowings Operating leases Venture fund commitments (a) Technology contracts Cash award program 2005 Through 2006 $ – 43.8 – 15.7 11.8 2007 Through 2008 $180.0 36.2 – 12.5 11.2 2009 and Thereafter $ – 84.2 – – – Total $180.0 192.5 1.7 38.1 47.0 2004 $ – 28.3 – 9.9 24.0 Total $62.2 $71.3 $239.9 $84.2 $459.3 (a) The venture fund commitments have no speciﬁed call dates. The timing of capital calls is based on market conditions and investment opportunities. dealer subsidiary, is subject to the capital require- As of December 31, 2003, our long-term borrow- ings were $180.0 million, all due in 2008. Our min- ments of the U.K. Financial Services Authority. imum lease commitments for noncancelable ofﬁce space and equipment leases were $192.5 million. Off-balance Sheet Arrangements Certain leases have renewal options and clauses for escalation and operating cost adjustments. We have Our off-balance sheet arrangements are described in commitments to invest an additional $1.7 million in Note 19 to the consolidated ﬁnancial statements venture capital funds and commitments for technol- ogy contracts of $38.1 million. and are incorporated herein by reference. CAPITAL REQUIREMENTS Enterprise Risk Management Risk is an inherent part of our business. Market risk, credit risk, operational risk and legal, regula- tory and compliance risk are the principal risks in our business activities, and we seek to identify, as- sess and monitor each risk in accordance with de- ﬁned policies and procedures. The extent to which we properly and effectively manage each of the vari- ous types of risk involved in our activities is critical to our ﬁnancial condition and proﬁtability. 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 mini- mum 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 ex- With respect to market risk and credit risk, the cornerstone of our risk management process is daily panding its business or paying dividends if resulting net capital would be less than 5 percent of aggre- communication between traders, trading depart- gate debit balances. Advances to afﬁliates, repay- ment management and senior management con- cerning our inventory positions and overall market ment of subordinated liabilities, dividend payments risk proﬁle. Our enterprise risk management de- and other equity withdrawals are subject to certain partment supplements this communication process notiﬁcation and other provisions of the uniform net capital rule and the net capital rule of the NYSE. by providing its independent perspective on our We expect these provisions will not impact our abil- market and credit risk proﬁle on a daily basis through a series of reports. The broader goals of ity to meet current and future obligations. In addi- our enterprise risk management department are to tion, we are subject to certain notiﬁcation understand the market risk proﬁle of each trading requirements related to withdrawals of excess net area, to consolidate risk monitoring company-wide, capital from our broker dealer subsidiary. Our bro- to articulate large trading or position risks to senior ker dealer subsidiary is also registered with the Commodity Futures Trading Commission and management, to provide traders with perspectives therefore is subject to CFTC regulations. Piper Jaf- on their positions and to ensure accurate mark-to- fray Ltd., our registered United Kingdom broker market pricing. 3 8 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S 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 re- sults 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 tions generate proﬁt or loss on a daily basis is cru- cial 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. In- terest 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 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 Equity price risk represents the potential loss in value illiquidity when market participants refrain from due to adverse changes in the level or volatility of equity prices. We are exposed to equity price risk transacting in normal quantities and/or at normal through our trading activities in both listed and over- bid-offer spreads. Our exposure to market risk is the-counter equity markets. We attempt to reduce directly related to our role as a ﬁnancial intermedi- the risk of loss inherent in our inventory of equity ary in customer trading and to our market-making securities by establishing position limits and manag- activities. Market risk is inherent to both cash and ing net position levels with those limits, monitoring derivative ﬁnancial instruments. The scope of our inventory turnover and entering into hedge transac- market risk management policies and procedures tions designed to mitigate our market risk profile. includes all market-sensitive ﬁnancial instruments. VALUE-AT-RISK We use a variety of risk management techniques and hedging strategies, including establishing posi- tion limits by product type and industry sector, Value-at-risk is the maximum expected loss, for a given level of conﬁdence, which could occur over a closely monitoring inventory turnover, maintaining speciﬁed time period for a portfolio of securities. long and short positions in related securities, and For our value-at-risk calculations, we use a 99 per- using interest rate swaps, exchange-traded interest cent conﬁdence level over a 10-day holding period, rate futures and options, exchange-traded equity options and other derivative instruments for hedg- adjusted for liquidity considerations but excluding ing. However, we do not use derivatives for specu- most diversiﬁcation beneﬁts. Interest rate and credit spread risk are modeled by mapping positions to lative purposes. their 10-year equivalent values and then applying a 2.326 standard deviation (that is, a 99 percent con- ﬁdence level) ‘‘shock’’ to the curve. Trading desk management, senior management and risk management also review the age and composi- tion of inventory accounts and review risk reports appropriate to the risk proﬁle of each trading activ- We perform a daily value-at-risk analysis of substan- tially all our trading positions, including fixed in- ity. Typically, market conditions are evaluated, cer- come, equities, convertible bonds and all associated tain transactions are reviewed and quantitative hedges. We use a value-at-risk model because it pro- methods, such as value-at-risk are employed. These vides a common metric for assessing market risk. We activities seek to ensure that trading strategies are regularly evaluate our value-at-risk model in an ef- within acceptable risk tolerance parameters. We fort to more accurately measure the risk of loss. also believe that an understanding of how our posi- P I P E R J A F F R AY A N N U A L R E P O R T 2003 39 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S assurance that actual losses occurring over any The modeling of the risk characteristics of our trad- 10-day period arising from changes in market condi- ing positions involves a number of assumptions and tions will not exceed the value-at-risk amounts approximations. While we believe that these assump- shown below or that such losses will not occur more tions and approximations are reasonable, there is no than once in one hundred 10-day periods. However, uniform industry methodology for estimating value- at-risk, and different assumptions and approxima- we believe value-at-risk models are an appropriate tions could produce different value-at-risk estimates. methodology for comparing risk profiles across dif- ferent risk types, different business lines, and differ- ent companies in the financial services industry. Value-at-risk has inherent limitations, including reli- ance 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 The following table provides a quantiﬁcation of the estimated value-at-risk for each component of mar- ket risk for the periods presented: 2003 2002 2001 $ 3,705 $2,961 $3,580 796 880 853 $ 4,501 $3,841 $4,433 AT DECEMBER 31 (Dollars in Thousands) Interest Rate Risk Equity Price Risk Aggregate Value-at-Risk The table below illustrates the high, low and aver- age 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 eq- uity price risk from 2002 to 2003 is the result of our addition of a convertible business in November 2002: FOR THE YEAR ENDED DECEMBER 31, 2003 (Dollars in Thousands) Interest Rate Risk Equity Price Risk Aggregate Value-at-Risk FOR THE YEAR ENDED DECEMBER 31, 2002 Interest Rate Risk Equity Price Risk Aggregate Value-at-Risk FOR THE YEAR ENDED DECEMBER 31, 2001 Interest Rate Risk Equity Price Risk Aggregate Value-at-Risk CREDIT RISK High Low Average $5,336 $2,433 $3,892 3,810 7,903 561 3,733 1,617 5,509 High Low Average $5,088 $1,848 $3,857 1,092 5,961 564 781 2,466 4,638 High Low Average $4,643 $2,049 $3,077 1,891 5,262 181 641 2,422 3,718 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 ment through depositories and clearing banks. organizations. Our client activities involve the execu- tion, settlement and financing of various transac- tions. 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 pay- 40 P I P E R J A F F R AY A N N U A L R E P O R T 2003 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U LT S O F O P E R AT I O N S believe will cover critical systems on a company- Credit exposure associated with our Private Client Services business consists primarily of customer wide basis, and redundancies are built into the sys- tems as we have deemed appropriate. We also use margin accounts, which are monitored daily and periodic self-assessments and internal audit reviews are collateralized. The treasury and credit services as a further check on operational risk. department, in conjunction with our credit commit- tee, establishes and reviews appropriate credit limits for our Private Client Services customers. Our institutional credit committee reviews risk as- institutional counterparties with sociated 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 under- writing commitments. Concentration risk can occur by industry, geographic area or type of client. Cli- ent 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 posi- tions in various related securities. 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 iden- tify, measure, control and manage operational risk at levels we believe are appropriate throughout the organization and within such departments as ac- counting, operations, technology, legal and compli- ance. These control mechanisms attempt to ensure that operations policies and procedures are being followed and that our various businesses are oper- ating 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 un- enforceable. We are generally subject to extensive regulation in the various jurisdictions in which we conduct our business. We have established proce- dures that are designed to ensure compliance with applicable statutory and regulatory requirements, including those relating to, among others, regula- tory 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. Operational risk refers to the risk of direct or indi- rect loss resulting from inadequate or failed internal Effects of Inflation processes, people and systems or from external Because our assets are liquid in nature, they are not events. We rely on the ability of our employees, our signiﬁcantly affected by inﬂation. However, the rate internal systems and processes and systems at com- of inﬂation affects our expenses, such as employee puter centers operated by third parties to process a large number of transactions. These transactions compensation, ofﬁce space leasing costs and com- may cross multiple markets. In the event of a break- munications charges, which may not be readily re- coverable in the price of services offered by us. To down or improper operation of our systems or the extent inﬂation results in rising interest rates processes or improper action by our employees or third-party vendors, we could suffer ﬁnancial loss, and has other adverse effects upon the securities regulatory sanctions and damage to our reputation. markets, it may adversely affect our ﬁnancial posi- We have disaster recovery plans in place that we tion and results of operations. P I P E R J A F F R AY A N N U A L R E P O R T 2003 41 P I P E R J A F F R AY C O M P A N I E S I N D E X T O A U D I T E D C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S Report of Independent Auditors Report of Independent Accountants Consolidated Financial Statements Consolidated Statements of Financial Condition Consolidated Statements of Operations Consolidated Statements of Changes in Shareholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Page 44 45 46 47 48 49 50 42 P I P E R J A F F R AY A N N U A L R E P O R T 2003 R E S P O N S I B I L I T Y F O R F I N A N C I A L S TAT E M E N T S O F P I P E R J A F F R A Y C O M P A N I E S 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 safe- guarded 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 indepen- dent 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. Andrew S. Duff Chairman and Chief Executive Ofﬁcer Sandra G. Sponem Chief Financial Ofﬁcer P I P E R J A F F R AY A N N U A L R E P O R T 2003 43 R E P O R T O F I N D E P E N D E N T A U D I T O R S To the Board of Directors and Shareholders of Piper Jaffray Companies: We have audited the accompanying consolidated statement of ﬁnancial condition of Piper Jaffray Compa- nies (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 evaluat- ing 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. Minneapolis, Minnesota January 27, 2004, except for Note 17, as to which the date is February 12, 2004 44 P I P E R J A F F R AY A N N U A L R E P O R T 2003 R E P O R T O F I N D E P E N D E N T A C C O U N TA N T S 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 responsibil- ity 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 state- ment 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.’’ Minneapolis, Minnesota April 30, 2003 P I P E R J A F F R AY A N N U A L R E P O R T 2003 45 P I P E R J A F F R AY C O M P A N I E S C O N S O L I D AT E D S TAT E M E N T S O F F I N A N C I A L C O N D I T I O N AT DECEMBER 31 (Amounts in thousands, except share data) Assets Cash and cash equivalents Cash and cash equivalents segregated for regulatory purposes Receivables: Customers (net of allowance of $1,993 and $1,593, respectively) Brokers, dealers and clearing organizations Deposits with clearing organizations Securities purchased under agreements to resell Trading securities owned Trading securities owned and pledged as collateral Total trading securities owned Fixed assets (net of accumulated depreciation and amortization of $103,573 and $88,969, respectively) Goodwill Other receivables Other assets Total assets Liabilities and Shareholders’ Equity Short-term ﬁnancing Payables: Customers Checks and drafts Brokers, dealers and clearing organizations Securities sold under agreements to repurchase Trading securities sold, but not yet purchased Accrued compensation Other liabilities and accrued expenses Total liabilities Subordinated debt Shareholders’ equity: Invested capital Common stock, $0.01 par value; 100,000,000 shares authorized, 19,334,261 issued and outstanding Additional paid-in capital Total shareholders’ equity 2003 2002 $ 84,436 $ 32,615 66,000 – 463,557 238,393 66,570 306,987 342,994 314,618 474,002 217,457 46,075 240,014 80,129 393,555 657,612 473,684 60,757 305,635 38,553 92,147 69,059 305,635 72,012 111,392 $ 2,380,647 $2,041,945 $ 159,000 $ 250,040 226,163 64,438 224,208 178,716 386,281 194,583 97,463 143,580 57,919 216,675 115,791 171,999 140,972 120,112 1,530,852 180,000 1,217,088 215,000 – 609,857 193 669,602 – – 669,795 609,857 Total liabilities and shareholders’ equity $ 2,380,647 $2,041,945 See Notes to Consolidated Financial Statements 46 P I P E R J A F F R AY A N N U A L R E P O R T 2003 P I P E R J A F F R AY C O M P A N I E S C O N S O L I D AT E D S TAT E M E N T S O F O P E R AT I O N S YEAR ENDED DECEMBER 31 (Amounts in thousands, except per share data) Revenues Commissions and fees Principal transactions Investment banking Interest Other income Total revenues Interest expense Net revenues Non-interest expenses Compensation and beneﬁts Occupancy and equipment Communications Floor brokerage and clearance Marketing and business development Outside services Cash award program Regulatory settlement Amortization of acquisition-related compensation and goodwill Merger and restructuring Royalty fee Other operating expenses 2003 2002 2001 $ 256,747 $ 275,682 $ 302,289 215,191 229,945 45,276 59,082 806,241 19,511 171,957 208,740 59,685 47,303 763,367 34,315 181,469 247,929 95,436 52,865 879,988 79,216 786,730 729,052 800,772 482,397 449,329 513,623 58,025 37,599 22,755 39,030 34,219 24,000 – – – 3,911 42,960 55,549 36,316 26,040 44,115 32,717 – 32,500 – 7,976 7,482 31,067 60,121 41,082 22,092 49,706 22,285 – – 17,641 65,697 55,753 25,577 Total non-interest expenses 744,896 723,091 873,577 Income (loss) before income tax expense (beneﬁt) Income tax expense (beneﬁt) Net income (loss) Earnings per common share Basic Diluted Weighted average number of common shares Basic Diluted See Notes to Consolidated Financial Statements 41,834 15,835 $ 25,999 $ $ 1.35 1.35 $ $ $ 5,961 5,855 (72,805) (22,754) 106 $ (50,051) 0.01 0.01 $ $ (2.60) (2.60) 19,237 19,237 19,160 19,160 19,279 19,279 P I P E R J A F F R AY A N N U A L R E P O R T 2003 47 P I P E R J A F F R AY C O M P A N I E S C O N S O L I D AT E D S TAT E M E N T S O F C H A N G E S I N S H A R E H O L D E R S ’ E Q U I T Y (Amounts in thousands, except share data) Balance at December 31, 2000 Capital contribution from U.S. Bancorp Distribution to U.S. Bancorp Net loss Balance at December 31, 2001 Capital contribution from U.S. Bancorp Distribution to U.S. Bancorp Net income Balance at December 31, 2002 Capital contribution from U.S. Bancorp Distribution to U.S. Bancorp Net income Recapitalization upon spin off from Common Shares Outstanding Common Stock Additional Paid-In Capital Invested Capital Total Shareholders’ Equity $ $ $ – – – – – – – – – – – – $ $ $ – – – – – – – – – – – – – – – – – – – – – – – – $ 362,331 $ 75,000 (8,556) (50,051) $ 378,724 $ 250,000 (18,973) 106 $ 609,857 $ 37,500 (3,561) 25,999 – – – – – – – – – – – – 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 See Notes to Consolidated Financial Statements 48 P I P E R J A F F R AY A N N U A L R E P O R T 2003 P I P E R J A F F R AY C O M P A N I E S C O N S O L I D AT E D S TAT E M E N T S O F C A S H F L O W S YEAR ENDED DECEMBER 31 (Dollars in thousands) Operating Activities Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization Deferred income taxes Loss on disposal of ﬁxed assets Restricted stock amortization Goodwill amortization and impairment charges Decrease (increase) in operating assets: Cash and cash equivalents segregated for regulatory purposes Receivables: Customers Brokers, dealers and clearing organizations Deposits with clearing organizations Securities purchased under agreements to resell Net trading securities owned Other receivables Other assets Increase (decrease) in operating liabilities: Payables: Customers Checks and drafts Brokers, dealers and clearing organizations Securities sold under agreements to repurchase Accrued compensation Other liabilities and accrued expenses 2003 2002 2001 $ 25,999 $ 106 $ (50,051) 19,031 (6,491) 4,380 3,859 – (66,000) 10,445 (20,936) (20,495) (66,973) 30,354 33,459 21,877 82,583 6,519 7,533 62,925 53,611 (22,649) 20,787 (11,386) 83 3,861 – – 187,350 223,017 (31,417) 132,123 31,043 34,986 99,253 (113,427) (37,004) (91,397) (87,422) (15,066) (48,159) 20,428 783 116 14,903 23,542 – 256,393 (257,969) 46,277 (22,851) 35,514 (43,385) (21,632) 53,621 (7,203) 33,277 (63,127) (102,669) 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 Capital contribution from U.S. Bancorp Capital distribution to U.S. Bancorp Net decrease in subordinated debt (91,040) (257,652) 37,500 (3,561) 250,000 (18,973) (35,000) (260,000) (87,092) 75,000 (8,556) – Net cash used in ﬁnancing activities (92,101) (286,625) (20,648) Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year 51,821 32,615 4,906 27,709 (49,999) 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 Income taxes See Notes to Consolidated Financial Statements $ 19,427 $ 36,001 $ 82,977 $ (1,937) $ 1,311 $ (4,190) P I P E R J A F F R AY A N N U A L R E P O R T 2003 49 P I P E R J A F F R AY C O M P A N I E S N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 1 Background and Basis of Presentation BACKGROUND Piper Jaffray Companies is the parent company of America and include the adjustments necessary to reﬂect the Company’s operations as if its organiza- Piper Jaffray & Co. (‘‘Piper Jaffray’’), a securities broker dealer and investment banking firm; Piper tional changes had been consummated prior to the Jaffray Ventures Inc. (‘‘Piper Jaffray Ventures’’), Distribution. The consolidated ﬁnancial statements prior to the Distribution have been derived from the a private equity venture capital firm managing ﬁnancial statements and accounting records of USB investments in emerging growth companies; Piper using the historical results of operations and histori- Jaffray Ltd., a firm providing securities brokerage cal basis of the assets and liabilities of the Com- and investment banking services in Europe through pany’s business. However, an office located in London, England; and Piper Jaf- the consolidated ﬁnancial statements included herein may not neces- fray Financial Products Inc. and Piper Jaffray Finan- sarily be indicative of the Company’s results of op- cial Products II Inc., two entities that facilitate Piper erations, ﬁnancial position and cash ﬂows in the Jaffray Companies customer derivative transactions. 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. 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 De- cember 31, 2003, after receiving regulatory ap- Generally, the consolidated results include revenues generated and expenses incurred based on customer proval, USB distributed to its shareholders all of its relationships and related business activities. In cer- interest in Piper Jaffray Companies and its subsidi- tain situations, afﬁliated entities of USB may have aries (collectively, the ‘‘Company’’). On that date, provided services to and thus charged expense to 19,334,261 shares of Piper Jaffray Companies com- the Company. These expenses primarily relate to mon stock were issued to USB shareholders (the providing employee-related services and beneﬁts, ‘‘Distribution’’) based on a distribution ratio of one technology and data processing services, and corpo- share of Piper Jaffray Companies common stock for every 100 shares of USB common stock owned (the rate functions including audit, tax and real estate ‘‘Distribution Ratio’’). In lieu of receiving fractional management services. Costs included on the consol- idated ﬁnancial statements for shared services were shares of Piper Jaffray Companies common stock, determined based on actual costs to USB and allo- shareholders received cash from USB for their frac- cated based on the Company’s proportionate usage tional interest. of those services. Proportionate usage was deter- mined based on the number of employees, actual hours used, square footage of ofﬁce space or other similar methodologies. Management believes the as- sumptions underlying the consolidated ﬁnancial statements are reasonable. The consolidated ﬁnancial statements include the accounts and historical operations of the Company as well as certain assets, liabilities, and related oper- ations 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 On the consolidated ﬁnancial statements, income taxes were determined on a separate return basis as various units comprising the Company, USB and its if the Company had not been eligible to be included subsidiaries’ interest in the Company is shown as in the consolidated income tax return of USB and invested capital in the consolidated ﬁnancial state- its afﬁliates. However, USB was managing its tax ments prior to the Distribution. position for the beneﬁt of its entire portfolio of businesses, and its tax strategies are not necessarily BASIS OF PRESENTATION The consolidated ﬁnancial statements of the Com- reﬂective of the tax strategies that the Company pany are prepared in conformity with accounting would have followed or will follow as a stand-alone principles generally accepted in the United States of entity. 5 0 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 2 Summary of Signiﬁcant Accounting Policies PRINCIPLES OF CONSOLIDATION The consolidated ﬁnancial statements include the deposit cash with the Company. The Company accounts of Piper Jaffray Companies and its subsid- monitors the market value of securities borrowed and loaned on a daily basis, with additional collat- iaries. All material intercompany accounts and eral obtained or refunded as necessary. Interest is transactions have been eliminated. accrued on securities borrowed and loaned transac- tions and is included in other assets and other liabil- ities and accrued expenses on the Consolidated Statements of Financial Condition and the respec- tive interest balances on the Consolidated State- USE OF ESTIMATES The preparation of ﬁnancial statements and related disclosures in conformity with accounting princi- ples generally accepted in the United States of America requires management to make estimates ments of Operations. and assumptions that affect the reported amounts of assets and liabilities at the date of the ﬁnancial statements and the reported amounts of revenues Customer securities transactions are recorded on a settlement date basis while the related commission and expenses during the reporting period. Actual revenues and expenses are recorded on a trade date results could differ from those estimates. basis. Customer receivables and payables include amounts related to both cash and margin transac- tions. Securities owned by customers, including those that collateralize margin or other similar transactions, are not reﬂected on the Consolidated Statements of Financial Condition. 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. CUSTOMER TRANSACTIONS 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 qual- iﬁed 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 car- ried 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 fi- nancial institutions. Collateral is valued daily and ad- ditional collateral is obtained from or refunded to counterparties, when appropriate. INVESTMENT BANKING Investment banking revenues, which include un- derwriting fees, management fees and advisory fees, are recorded when services for the transac- tions 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 other- wise concluded. Investment banking revenues are presented net of related expenses. ALLOWANCE FOR DOUBTFUL ACCOUNTS Management estimates an allowance for doubtful ac- counts to reserve for probable losses from unsecured and partially secured customer accounts. Manage- ment is continually evaluating its receivables from cus- tomers 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 borrowed and loaned result from transac- tions with other brokers and dealers or ﬁnancial institutions and are recorded at the amount of cash SECURITIES SOLD, BUT NOT YET PURCHASED Trading securities owned and trading securities collateral advanced or received. These amounts are sold, but not yet purchased are recorded on a trade included in receivable from and payable to brokers, dealers and clearing organizations on the Consoli- date basis and are stated at market or fair value. dated Statements of Financial Condition. Securities Unrealized gains and losses related to these ﬁnancial instruments are reﬂected in principal transactions borrowed transactions require the Company to de- posit cash or other collateral with the lender. Secu- on the Consolidated Statements of Operations. The rities loaned transactions require the borrower to Company’s valuation policy is to use quoted market P I P E R J A F F R AY A N N U A L R E P O R T 2003 51 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S pact the Company’s results of operations. or dealer prices from independent sources where would not be signiﬁcant, but could adversely im- 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 manage- OTHER RECEIVABLES ment’s estimate, using the best information availa- Included in other receivables are loans made to ble, of amounts that could be realized under current investment executives and other revenue-produc- market conditions. Among the factors considered ing employees, typically in connection with their by management in determining the fair value of recruitment. These loans are forgiven based on these securities are the cost, terms and liquidity of continued employment and are amortized to compensation and benefits using the straight-line the investment, the ﬁnancial condition and operat- ing results of the issuer, quoted market price of method over the terms of the loans, which gener- securities with similar quality and yield that are publicly traded, and other factors generally perti- nent to the valuation of investments. ally range from three to five years. In conjunction with these loans, management esti- mates 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 collec- tibility of unforgiven balances of departed employ- ees, evaluation of the loan portfolio, recent experience related to attrition of certain revenue- producing employees and other pertinent factors. 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 am- ortized 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 Ac- counting Standards No. 142 (‘‘SFAS 142’’), ‘‘Good- will and Other Intangible Assets,’’ on January 1, 2002. SFAS 142 addresses the accounting for good- will and intangible assets subsequent to their acqui- sition. 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 adop- tion of SFAS 142, the Company amortized goodwill using the straight-line method over a maximum pe- riod of 25 years. OTHER ASSETS Included in other assets are investments that the Company makes to fund deferred compensation lia- bilities for certain employees. The Company fully funds its deferred compensation liabilities by invest- ing in venture capital stage companies or by invest- ing in partnerships which invest in venture capital stage companies. Future payments, if any, to de- ferred 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 state- ments obtained from the underlying fund manager or based on published market quotes, with the re- sulting gains and losses recognized in other income on the Consolidated Statements of Operations. In The recoverability of goodwill is evaluated annu- the event a security is thinly traded or the market ally, at a minimum, or on an interim basis if events or circumstances indicate a possible inability to re- price is not readily available for an investment, alize the carrying amount. The evaluation includes management estimates fair value using other valua- tion methods depending on the type of security and assessing the estimated fair value of the goodwill related market. based on market prices for similar assets, where available, and the present value of the estimated future cash ﬂows associated with the goodwill. Be- cause 100 percent of goodwill is treated as a non- allowable asset for regulatory purposes, the impact of any impairment on Piper Jaffray net capital Net deferred tax assets are also included in other assets. Refer to Note 21 for additional information related to income taxes. 5 2 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S guidance in SFAS 140, the Company does not con- FAIR VALUE OF FINANCIAL INSTRUMENTS solidate such QSPEs. The Company accounts for its Substantially all of the Company’s financial instru- involvement with such QSPEs under a ﬁnancial ments are recorded at fair value or contract amounts components approach in which the Company rec- on the Company’s Consolidated Statements of Fi- ognizes only its retained residual interest in the nancial Condition. Financial instruments recorded at fair value include trading securities owned and trad- QSPE. The Company accounts for such retained ing securities sold, but not yet purchased. interests at fair value. Financial instruments carried at contract amounts which approximate fair value, either have short- term maturities (one year or less), are repriced fre- quently, or bear market interest rates and, accord- ingly, are carried at amounts approximating fair value. Financial instruments carried at contract amounts on the Consolidated Statements of Finan- cial Condition include receivables from and pay- ables to brokers, dealers and clearing organizations, securities purchased under agreements to resell, se- curities sold under agreements to repurchase, re- ceivables from and payables to customers, short- term ﬁnancing and subordinated debt. STOCK-BASED COMPENSATION Prior to the Distribution, certain employees of the Company were eligible to participate in USB em- ployee 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 Account- ing 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 The carrying amount of subordinated debt closely market value of the underlying common stock on approximates fair value based upon market rates of interest available to the Company at December 31, 2003. the date of grant. 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 differ- ences between amounts reported for income tax purposes and ﬁnancial statement purposes, using current tax rates. A valuation allowance is recog- nized if it is anticipated that some or all of a de- ferred tax asset will not be realized. CONSOLIDATION OF SPECIAL PURPOSE ENTITIES Special purpose entities (‘‘SPEs’’) are trusts, partner- ships or corporations established for a particular limited purpose. The Company follows the account- ing guidance in Statement of Financial Accounting Standards No. 140 (‘‘SFAS 140’’), ‘‘Accounting for Transfers and Servicing of Financial Assets and Ex- tinguishment 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 pur- pose 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 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 Disclo- sure 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 his- torical 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. P I P E R J A F F R AY A N N U A L R E P O R T 2003 53 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 3 Recent Accounting Pronouncements ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH statements. Prior to the issuance of FIN 46, consoli- dation generally occurred when an enterprise con- trolled another entity through voting interests. LIABILITIES AND EQUITY In May 2003, the Financial Accounting Standards Certain VIEs that are QSPEs subject to the report- ing requirements of SFAS 140 are not required to be Board issued Statement of Financial Accounting Standards No. 150 (‘‘SFAS 150’’), ‘‘Accounting for consolidated under the provisions of FIN 46. 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 im- pact on the Company’s ﬁnancial statements. 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 interpreta- tions. If the revised interpretations were applied, transition rules allow the restatement of ﬁnancial statements or prospective application with a cumu- lative effect adjustment. In addition, FIN 46 ex- pands the disclosure requirements for the primary beneﬁciary of a signiﬁcant portion or a majority of the variable interests to provide information regard- ing the nature, purpose and ﬁnancial characteristics of the entities. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In April 2003, the Financial Accounting Standards The Company has investments in and advances to Board issued Statement of Financial Accounting approximately 30 limited partnerships established Standards No. 149 (‘‘SFAS 149’’), ‘‘Amendment of for the purpose of investing in emerging growth Statement 133 on Derivative Instruments and Hedg- companies. The Company has investments in or ing Activities,’’ which amends and clarifies account- acts as the managing general partner of these part- ing and for derivative nerships. As managing general partner of or instruments, including certain derivative instruments through investments in the limited partnerships, the embedded in other contracts and for hedging activi- ties under Statement of Financial Accounting Stan- Company may have the ability to exercise control over major operating and ﬁnancial policies. These dards No. 133. In particular, SFAS 149 clarifies partnerships are funded with capital contributed by under what circumstances a contract with an initial or ﬁnancing from related parties and third parties. net investment meets the characteristic of a derivative The Company accounts for these investments on and clarifies when a derivative contains financing the equity method of accounting or consolidates the components. SFAS 149 is generally effective for con- entire partnership based upon the Company’s abil- tracts entered into or modified after June 30, 2003. ity to exercise control over major operating and The Company’s adoption of SFAS 149 did not have ﬁnancial policies. a material impact on its financial statements. standards reporting CONSOLIDATION OF VARIABLE INTEREST ENTITIES In January 2003, the Financial Accounting Stan- dards Board issued FASB Interpretation No. 46 (‘‘FIN 46’’), ‘‘Consolidation of Variable Interest En- tities’’ (‘‘VIEs’’), an interpretation of Accounting Re- search Bulletin No. 51, ‘‘Consolidated Financial Statements,’’ to improve financial reporting of spe- cial purpose and other entities. In accordance with this interpretation, business enterprises that repre- sent the primary beneﬁciary of another entity by retaining a controlling ﬁnancial interest in that en- tity’s assets, liabilities and results of operating activ- ities must consolidate the entity in its ﬁnancial investment At December 31, 2003, the Company’s aggregate net 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 Com- pany’s ﬁnancial statements from potential VIEs en- tered 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. 5 4 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S Also, the Company engages in transactions with QSPEs to securitize ﬁxed rate municipal bonds. Note 19 These securitizations do not require consolidation securitizations. in the Company’s ﬁnancial statements. Refer to information on for additional NOTE 4 Derivatives ket or fair values related to the derivative contract Derivative contracts are ﬁnancial instruments such as forwards, futures, swaps or option contracts that transactions are reported on the Consolidated State- derive their value from underlying assets, reference ments of Financial Condition and any unrealized rates, indices or a combination of these factors. A gain or loss is recognized on the Consolidated State- derivative contract generally represents future com- ments of Operations. The Company uses derivatives to facilitate customer transactions and as a means mitments to purchase or sell ﬁnancial instruments to manage the Company’s interest rate and market at speciﬁed terms on a speciﬁed date or to exchange value risk associated with its security positions. As currency or interest payment streams based on the of December 31, 2003 and 2002, the fair value of contract or notional amount. these open derivative contracts was not material. Derivative contracts exclude certain cash instru- ments, such as mortgage-backed securities, interest- As discussed in Note 19, the Company also enters into interest rate swap agreements to minimize only and principal-only obligations and indexed interest rate risk associated with holding residual in- debt instruments that derive their values or contrac- terest securities from its tender option bond pro- tually required cash ﬂows from the price of some gram. The fair value of such contracts is included in other security or index. other liabilities and accrued expenses on the Con- solidated Statements of Financial Condition and was approximately $5.7 million and $3.7 million as of December 31, 2003 and 2002, respectively. Derivatives are often referred to as off-balance sheet instruments since neither their notional amounts nor the underlying instruments are reﬂected as as- sets or liabilities of the Company. Instead, the mar- NOTE 5 Receivables from and Payables to Brokers, Dealers and Clearing Organizations Amounts receivable from brokers, dealers and Amounts payable to brokers, dealers and clearing clearing organizations at December 31 included: organizations at December 31 included: (Dollars in thousands) 2003 2002 (Dollars in thousands) 2003 2002 Receivable arising from unsettled Deposits received for securities securities transactions, net $106,187 $160,662 loaned Deposits paid for securities Payable to clearing organizations borrowed 72,751 16,588 Securities failed to receive $181,166 $174,700 4,258 31,926 6,858 25,968 13,263 2,744 Receivable from clearing organizations Securities failed to deliver Other 10,577 34,277 14,601 3,838 33,914 2,455 Total receivables $238,393 $217,457 Other Total payables $224,208 $216,675 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. P I P E R J A F F R AY A N N U A L R E P O R T 2003 55 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 6 Receivables from and Payables to Customers Securities owned by customers are held as collateral for margin receivables. Such collateral is not re- ﬂected on the consolidated ﬁnancial statements. 2002 Margin loan receivables earn interest at ﬂoating in- terest 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 cus- tomer short sales, all amounts payable to customers are subject to withdrawal upon customer request. Amounts receivable from customers at December 31 included: (Dollars in thousands) Cash accounts Margin accounts 2003 $ 81,853 $ 77,801 381,704 396,201 Total receivables $463,557 $474,002 Amounts payable to customers at December 31 included: (Dollars in thousands) Cash accounts Margin accounts 2003 2002 $168,901 $118,983 57,262 24,597 Total receivables $226,163 $143,580 NOTE 7 Trading Securities Owned and Trading Securities Sold, but Not Yet Purchased At December 31, trading securities owned and trad- At December 31, 2003 and 2002, trading securities owned in the amounts of $314.6 million and ing securities sold, but not yet purchased were as $393.6 million, respectively, have been pledged as follows: collateral. (Dollars in thousands) 2003 2002 $ 15,446 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 pre- vailing prices. The Company is obligated to acquire the securities sold short at prevailing market prices, 87,009 98,950 which may exceed the amount reflected on the Con- solidated Statements of Financial Condition. 95,041 42,534 $ 15,903 78,474 90,459 92,292 240,248 140,236 134,704 $657,612 $473,684 $ 46,700 $ 17,285 1,137 14,316 47,114 276,750 264 – 40,996 15,573 96,749 1,396 $386,281 $171,999 Owned: Corporate securities: Equity securities Convertible securities Fixed income securities Mortgage-backed securities U.S. government securities Municipal securities Sold, but not yet purchased: Corporate securities: Equity securities Convertible securities Fixed income securities Mortgage-backed securities U.S. government securities Municipal securities 5 6 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 8 Fixed Assets The following is a summary of ﬁxed assets as of December 31, 2003 and 2002: (Dollars in thousands) Furniture and equipment Leasehold improvements Software Projects in process Total Less accumulated depreciation and amortization 2003 2002 $ 93,323 27,999 40,823 2,185 $ 91,718 25,620 30,645 10,045 164,330 158,028 103,573 88,969 $ 60,757 $ 69,059 NOTE 9 Goodwill 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 mil- lion, respectively, and is included in occupancy and equipment on the Consolidated Statements of Operations. The Company adopted SFAS 142 on January 1, 2002. Company’s goodwill resulted from the 1998 acquisi- The most significant changes made by SFAS 142 are tion of the Company’s former parent company, that goodwill and other indefinite-lived intangibles are U.S. Bancorp Piper Jaffray Companies Inc. (‘‘Former Parent’’), and its subsidiaries by USB. The following no longer amortized and will be tested for impairment table reflects the consolidated results of operations at least annually. At December 31, 2003 and 2002, adjusted as if the adoption of SFAS 142 occurred as of goodwill of $305.6 million was recorded on the Con- January 1, 2001: solidated Statements of Financial Condition. All of the YEAR ENDED DECEMBER 31 (Dollars in thousands) Net Earnings: As reported Goodwill amortization, net of tax As adjusted As reflected in the following table, there were no changes in the carrying value of goodwill by reporta- ble segments for the year ended December 31, 2003: (Dollars in thousands) Balance at December 31, 2002 Goodwill acquired Impairment losses Balance at December 31, 2003 2003 2002 2001 $25,999 – $ 106 – $(50,051) 14,439 $25,999 $ 106 $(35,612) Capital Markets Private Client Services Corporate Support and Other Consolidated Company $220,035 – – $85,600 – – $ $220,035 $85,600 $ – – – – $305,635 – – $305,635 Management completed an estimate of the fair value management concluded that no impairment existed of its business segments as of December 31, 2003 and validated its determination through an inde- pendent third party. Based upon this assessment, The Company had no indeﬁnite-lived or other intangible assets at December 31, 2003 or 2002. at December 31, 2003. P I P E R J A F F R AY A N N U A L R E P O R T 2003 57 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 10 Borrowings The Company has uncommitted credit agreements During 2003, Piper Jaffray repaid its outstanding subordinated debt of $215 million to its Former Par- with banks and former affiliated entities totaling ent and executed a $180 million subordinated debt $550 million at December 31, 2003, composed of agreement with an affiliate of USB, which satisfies $450 million in discretionary secured lines and $100 million in discretionary unsecured lines. In ad- provisions of Appendix D of Securities and Exchange dition, the Company has established an arrangement Commission (‘‘SEC’’) Rule 15c3-1 and has been ap- proved by the New York Stock Exchange, Inc. to obtain financing using the Company’s securities (‘‘NYSE’’) and is therefore allowable in Piper held by its clearing bank at the end of each day as Jaffray’s net capital computation. The entire amount collateral. The following table provides a breakdown of the subordinated debt will mature in 2008. of borrowings outstanding at December 31: (Dollars in thousands) Unsecured borrowings Secured borrowings 2003 $ – 159,000 $159,000 The secured borrowings were collateralized with $169.4 million and $276.1 million of trading securities owned at December 31, 2003 and 2002, respectively. 2002 $250,040 The Company’s outstanding borrowings bear inter- est at rates based on the London Interbank Offered $ 50,040 Rate (‘‘LIBOR’’) or federal funds rates. At Decem- ber 31, 2003 and 2002, the weighted average interest 200,000 rate on borrowings was 2.07 percent and 2.40 per- cent, 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 mil- lion, $15.9 million and $42.0 million of interest ex- pense 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 Additionally, in 2003 the Company entered into a ﬁve-year contract with an outside vendor to support under various noncancelable leases. Certain leases have renewal options and clauses for escalation and the Company’s data center and network manage- operating cost adjustments. Aggregate minimum ment technology needs. Aggregate minimum con- tract commitments for data center and remote lease commitments under operating leases and vari- network services per the contract as of Decem- ous other contractual commitments as of Decem- ber 31, 2003 are as follows: ber 31, 2003 are as follows: (Dollars in thousands) (Dollars in thousands) 2004 2005 2006 2007 2008 Thereafter 2004 2005 2006 2007 2008 $ 28,257 24,198 19,609 18,431 17,759 84,247 $192,501 $ 9,912 8,698 7,029 7,109 5,383 $ 38,131 Rental expense, including operating costs and real es- tate 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. Network and data center service expense related to this contract that was charged to operations in 2003 was $2.7 million. 5 8 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S Litigation-related expenses charged to operations in- cluded within other operating expenses was $16.1 mil- lion, $10.9 million, and $8.6 million for the years ended December 31, 2003, 2002 and 2001, respectively. Given the uncertainties of the commencement, tim- VENTURE CAPITAL COMMITMENTS ing, size, volume and outcome of pending and po- As of December 31, 2003, the Company had com- tential litigation and other factors, the reserve is mitments to invest approximately $1.7 million in difﬁcult to determine and of necessity subject to limited partnerships that make private equity in- future revisions. Subject to the foregoing, manage- vestments. The commitments will be funded, if called, through the end of the respective investment ment of the Company believes, based on its current knowledge, after consultation with counsel and af- periods ranging from 2006 to 2013. ter taking into account its established reserves and the USB indemnity agreement, that pending legal actions, investigations and proceedings will be re- solved with no material adverse effect on the ﬁnan- cial condition of the Company. However, if during any period a potential adverse contingency should become probable or resolved for an amount in ex- cess of the established reserves and indemniﬁcation, the results of operations in that period could be 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 secu- rities brokerage and investment banking activities, including certain class actions which primarily al- lege violations of securities laws and seek unspeci- ﬁed damages, which could be substantial. Also, the Company is involved from time to time in investiga- materially affected. tions 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 re- search practices of certain brokerage ﬁrms, includ- ing Piper Jaffray. In April 2003, Piper Jaffray entered into a ﬁnal settlement agreement with these regulatory agencies to resolve the investigation con- cerning 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 inde- pendent research. The charges are included sepa- rately as regulatory settlement on the Company’s 2002 Consolidated Statement of Operations. GUARANTEES The Company participates in securities lending activi- ties 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 col- lateral received. Cash collateralizes these transactions. At December 31, 2003, future payments guaranteed by the Company under these arrangements were ap- proximately $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 The Company has established reserves for potential losses that are probable and reasonably estimable and clearing organizations on the Consolidated State- that may result from pending and potential com- ments of Financial Condition. At December 31, 2003, the Company had collateral in excess of the market plaints, legal actions, investigations and proceedings, value of the securities lent and, therefore, no liability is including private litigation related to the matters that recorded related to potential future payments made were the subject of the final settlement referred to under these guarantees. above. The Company’s reserves totaled $49.2 and $62.9 million at December 31, 2003 and 2002, re- spectively, and are included within other liabilities OTHER COMMITMENTS and accrued expenses on the Consolidated State- ments 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 re- search 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. 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. P I P E R J A F F R AY A N N U A L R E P O R T 2003 59 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 12 Merger and Restructuring Items The Company recorded pre-tax merger and restruc- turing 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 re- sponse 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 restruc- turing was designed to improve the operating efﬁ- ciency of the business by removing excess capacity from the product distribution network and by im- plementing more effective business processes. The components of the charges described above are shown below: (Dollars in thousands) 2002 Severance and employee-related Business integration costs Asset write-downs and lease terminations Total 2001 Severance and employee-related Business integration costs Asset write-downs and lease terminations Intangible impairments Total The Company determined merger and restructuring charges and related accruals based on speciﬁc for- mulated plans or integration strategies. USB/ Firstar Piper Restructuring Total $ – 2,161 – $ 5,314 $ 5,314 – 501 2,161 501 $ 2,161 $ 5,815 $ 7,976 $14,480 $29,286 $43,766 468 – – – 12,360 9,103 468 12,360 9,103 $14,948 $50,749 $65,697 Business integration charges primarily pertained to costs incurred to realign the retail distribution net- works and integrate certain components of a USB afﬁliate’s ﬁxed income division with Piper Jaffray. Severance and employee-related charges included the cost of severance, other benefits and outplacement Asset write-downs and lease terminations repre- sented costs associated with redundant ofﬁce space, costs associated with the termination of employees branches that were vacated and equipment disposed due to the reconfiguration or closure of certain branches and the downsizing and consolidation of of as part of the restructuring plans. Generally, pay- certain back office support functions. The severance ments related to terminated lease contracts continue amounts were determined based on the Company’s severance pay programs in place at the time of termi- nation and were paid out over a benefit period up to two years from the time of termination. Approxi- mately 410 employees were included in severance and employee-related severance charges for 2002 and 2001. Employee-related charges in 2001 in- cluded approximately $14.0 million in accelerated vesting of restricted stock due to the merger of USB and Firstar. Intangible impairment charges of $9.1 million in 2001 pertained to the write-down of goodwill re- lated to the Company’s 1999 acquisition of the in- vestment 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 deci- sions made in 2001. through the original term of the lease. 60 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S The following table presents a summary of activity with respect to the merger and restructuring related accruals: (Dollars in thousands) Balance at December 31, 2000 Provision charged to operating expense Cash outlays Noncash writedowns and other Balance at December 31, 2001 Provision charged to operating expense Cash outlays Noncash writedowns and other Balance at December 31, 2002 Cash outlays Noncash writedowns and other Balance at December 31, 2003 USB/ Firstar Piper Restructuring Total $ – 14,948 $ – $ – 50,749 65,697 (468) (22,324) (22,792) (14,480) (10,323) (24,803) $ – $ 18,102 $ 18,102 2,161 (853) – 5,815 7,976 (13,277) (14,130) (1,617) (1,617) $ 1,308 $ 9,023 $ 10,331 (1,308) (6,547) (7,855) – – $ (144) (144) $ 2,332 $ 2,332 The adequacy of the merger and restructuring re- lated liability is reviewed regularly taking into con- sideration 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 em- ployees, changes in initial assumptions as a result of subsequent events and the alteration of business in- tegration 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 execu- tion, settlement and ﬁnancing of various securities transactions. These activities may expose the Com- pany to off-balance sheet risk in the event that the other party to the transaction is unable to fulﬁll its contractual obligations. 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 securi- ties used as collateral, or customers do not deposit additional securities or cash for margin when re- quired, 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. The Company from time to time uses ﬁnancial fu- tures 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 Com- pany uses exchange-traded options to manage the In the normal course of business, the Company ob- risk related to market value ﬂuctuations of converti- tains securities under resale, securities borrowed and ble inventories. Such contracts are subject to the same controls as securities owned for the Com- margin agreements on terms which permit it to re- pledge or resell the securities to others. The Company pany’s account and are not intended to be entered obtained securities with a fair value of approximately into for speculative purposes. Contracts are marked $914.5 million and $811.0 million at December 31, to market with gains or losses recorded in principal 2003 and 2002, respectively, of which $220.5 million transactions. As of December 31, 2003 and 2002, and $210.6 million, respectively, has been either the fair value of these contracts was not material. P I P E R J A F F R AY A N N U A L R E P O R T 2003 61 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 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, cor- porations, and institutional and individual inves- tors. 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 allevi- ate the potential for risk concentrations, credit lim- its 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 The Company entered into certain interest rate Prior to the Distribution, the Company regularly en- swap contracts during 2002 with a USB afﬁliate as tered into transactions with USB and its affiliates. These transactions were either charges to or reim- counterparty. During 2003, these swap contracts bursements from the Company and included fees for with USB were terminated and were subsequently referrals, fees for the underwriting and selling of USB reestablished with other unafﬁliated counterparties. 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. 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. Ad- ditionally, 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 At December 31, 2003, net capital under the Rule ﬁrm of the NYSE, Piper Jaffray is subject to the was $216.9 million or 38.8 percent of aggregate Uniform Net Capital Rule (the ‘‘Rule’’) of the SEC debit balances, and $205.7 million in excess of the and the net capital rule of the NYSE. Piper Jaffray minimum required net capital. has elected to use the alternative method permitted by the Rule, which requires that it maintain mini- mum 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 Piper Jaffray Ltd., a registered United Kingdom expanding its business or paying dividends if result- broker dealer, is subject to the capital requirements ing net capital would be less than 5 percent of aggregate debit balances. In addition, Piper Jaffray of the Financial Services Authority (‘‘FSA’’). As of is subject to certain notiﬁcation requirements re- December 31, 2003, Piper Jaffray Ltd. was in com- lated to withdrawals of excess net capital. Piper Jaffray is also registered with the Commodity Fu- tures Trading Commission (‘‘CFTC’’) and therefore is subject to the CFTC regulations. 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. pliance with the requirements of the FSA. 62 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 16 Employee Beneﬁt Plans During 2002, the Company implemented a quali- will be paid by USB. The Company has created similar health and welfare plans for its employees’ ﬁed, non-contributory proﬁt sharing plan covering use on a prospective basis. As such, all claims in- substantially all employees. Company contributions curred subsequent to the Distribution are the re- to the plan are discretionary within limits to qualify as deductions for income tax purposes. Employees sponsibility of the Company. are fully vested after ﬁve years of service. The Com- pany expensed $9.5 million related to the proﬁt sharing plan in 2003. There was no such expense in 2002. Additionally, prior to the Distribution the Com- pany 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 em- ployees of the Company will be considered termi- nated employees of USB and continue to receive the beneﬁts under the USB post-retirement plan. 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 re- sult of the Distribution, employees who were fully vested in the plan are considered inactive partici- pants 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, pro- vided they remain actively employed by the Com- pany. Once an employee is fully vested he or she will receive similar treatment as a fully vested em- ployee, as outlined above. In addition, certain em- ployees 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 De- cember 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 bal- ance pension plan and is included within accrued compensation on the Consolidated Statements of Financial Condition. 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 Rev- enue Code. Employee contributions were 100 per- cent 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 partici- pant 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 rein- vest the matching contributions among various investment alternatives. Effective upon the Distribution, employees of the Company became inactive participants in the USB plan similar to ter- Prior to the Distribution, Company employees par- minated employees. The Company has created a similar deﬁned contribution retirement savings plan ticipated in health and welfare plans provided by under Section 401(k) of the Internal Revenue Code USB. The Company subsidized the cost of coverage for employees meeting certain work schedule and for its employees’ use beginning in 2004. service requirements. The medical plan contained other cost-sharing features such as deductibles and coinsurance. Costs charged to the consolidated ﬁ- nancial statements are based on actual employee participation in the plans. All claims incurred in the health and welfare plans prior to the Distribution 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, re- spectively, related to USB employee beneﬁt plans. P I P E R J A F F R AY A N N U A L R E P O R T 2003 63 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 17 Cash Award Program and Stock-Based Compensation Prior to the Distribution, many of the Company’s Certain of the Company’s employees are eligible to employees held options to purchase USB common participate in a cash award program implemented stock under a variety of USB option plans and held concurrent with the Distribution from USB. The pro- shares of unvested USB restricted stock. Grants under gram is intended to aid in retention of employees and the option plans can be summarized into two catego- to compensate employees for the value of USB stock options and restricted stock lost by employees as a ries: USB 90-day options that generally expire 90 days result of the Distribution. The cash award program after an employee terminates from USB and USB term options that generally expire after a specified period of has an aggregate value of approximately $47 million. time. As a result of the Distribution, 90-day options The Company incurred a $24 million charge at the that were not exercised either expired on the Distribu- time of the Distribution from USB. The remaining tion date or will expire within 90 days of the Distribu- $23.0 million will be paid out over the next four tion date as the Distribution was deemed a years, which will result in an annual charge of ap- termination of employment of the Company’s em- proximately $5.9 million over the next three years and ployees by USB. USB 90-day options held by Com- $5.3 million in the fourth year. pany 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 re- mained with USB after the Distribution and continue to vest in accordance with their terms, as provided in the applicable USB stock incentive plans. Prior to the Distribution, certain of the Company’s employees were eligible to participate in the stock incentive plans offered by USB, which include in- centive stock options, restricted stock, and other stock-based awards. While part of USB, the Com- pany applied APB 25 in accounting for USB em- ployee stock incentive plans. Because the exercise price of the USB employee stock options equaled The total amount of USB restricted stock held by the the market price of the underlying stock on the date Company’s employees at the time of Distribution was 148,238 shares. Since the Distribution was deemed to of the grant, under APB 25, no compensation ex- be a termination of employment of the Company’s pense was recognized at the grant date. Options employees under the terms of the applicable USB granted under the plans are generally exercisable up to ten years from the date of grant and vest over stock incentive plans, approximately 76,325 shares of three to ﬁve years. Restricted shares vested over USB restricted stock were forfeited in connection with the Distribution. The remaining shares of USB re- three to ﬁve years. Expense for restricted stock was stricted stock held by the Company’s employees at the based on the market price of USB stock at the time time of the Distribution, totaling approximately of the grant and amortized on a straight-line basis 71,913 shares, have terms that permit those shares to over the vesting period. Expense related to re- continue to vest in accordance with their terms after a stricted stock grants was $3.9 million, $3.9 million termination of employment such as that occurring in and $14.9 million in 2003, 2002 and 2001, the Distribution. respectively. No Company employees, ofﬁcers or directors re- ceived Piper Jaffray Company options or restricted stock as part of the Distribution. 64 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S The following table summarizes USB stock options and restricted stock outstanding and exercised under various equity plans of USB while the Com- pany’s employees were employed by USB: December 31, 2000 Granted: Stock options Restricted stock Exercised Canceled options Canceled/vested restricted stock December 31, 2001 Granted: Stock options Restricted stock Exercised Canceled options Canceled/vested restricted stock December 31, 2002 Exercised Canceled options and canceled/vested restricted stock Options /restricted stock remaining with USB December 31, 2003 Options Outstanding Weighted Average Exercise Price Shares of Restricted Stock Outstanding 18,041,960 $22.62 2,277,106 3,937,315 23.29 – – 1,776,404 1,066,451 – – 474,271 22.95 24.71 – – – 2,158,141 19,136,420 $23.28 593,236 2,820,104 – 1,305,813 98,330 – 20,552,381 4,992,438 3,821,652 11,738,291 – 22.84 – 22.36 27.29 – – – – – 193,569 $23.47 399,667 25.87 24.49 24.19 – 327,754 71,913 – in the subjective traded options, including vesting provisions and Piper Jaffray Companies had no options or re- trading limitations that impact their liquidity. Be- stricted stock outstanding as of December 31, 2003. cause employee stock options have differing charac- On February 12, 2004 the Company granted ap- input teristics and changes proximately 500,000 shares of Piper Jaffray Com- panies restricted stock and approximately 290,000 assumptions can materially affect the fair value esti- options on Piper Jaffray Companies common stock mate, the existing models do not necessarily provide a reliable measure of the fair value of employee to employees, executive ofﬁcers and directors. These awards will vest 100 percent on February 12, stock options. 2007. The pro forma disclosures include USB options granted to our employees while employed by USB Pro forma information regarding net income (loss) and will not be representative of future years. In is required by SFAS No. 123 and has been deter- addition, the value of certain of these options that mined as if the Company had accounted for em- expired as a result of our separation from USB were ployee stock option and stock purchase plans (collectively, the ‘‘options’’) under the fair value replaced by cash awards to our employees. The esti- method of SFAS 123. The fair value of the options mated fair value of the options is amortized to ex- pense over the options’ vesting period. The cash was estimated at the grant date using a Black- Scholes option-pricing model. Option valuation award program has an aggregate value of approxi- models require the use of highly subjective assump- mately $47 million, of which $24 million was in- tions. Also, employee stock options have character- istics that are signiﬁcantly different from those of cluded in our results of operations for 2003. P I P E R J A F F R AY A N N U A L R E P O R T 2003 65 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S The following table shows pro forma compensation expense and net income (loss) adjusted for the im- pact of applying the fair value method of account- ing for stock-based compensation. YEAR ENDED DECEMBER 31 (Dollars in thousands) Reported compensation expense Stock-based compensation Pro forma compensation expense Reported net income (loss) Stock-based compensation, net of tax Pro forma net income (loss) Weighted average assumptions in USB option valuation Risk-free interest rates Dividend yields Stock volatility factor Expected life of options (in years) Weighted average fair value of shares granted Effective January 1, 2004, the Company will ac- count for future stock-based employee compensa- tion 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 mat- ters 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 Compa- nies liquidation, dissolution or winding-up, the holders of its common stock are entitled to share ratably in all assets remaining after payment of lia- bilities, subject to prior distribution rights of Piper Jaffray Companies stock, if any, then outstanding. The holders of common stock have no preemptive 66 P I P E R J A F F R AY A N N U A L R E P O R T 2003 2003 2002 2001 $ 482,397 $449,329 $513,623 21,457 27,973 52,504 $ 503,854 $477,302 $566,127 $ 25,999 $ 106 $ (50,051) (12,874) (16,784) (31,502) $ 13,125 $ (16,678) $ (81,553) N/A N/A N/A N/A N/A $ 4.90% 3.00% 0.38 6.00 7.27 $ 4.75% 3.00% 0.39 6.25 7.66 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 foresee- able future. Instead, Piper Jaffray Companies in- tends 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 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 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 de- laying or preventing a change in control of Piper Jaffray Companies without further action by its shareholders. RIGHTS AGREEMENT Piper Jaffray Companies adopted a rights agree- ment 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 Distribu- tion Ratio to USB’s historical weighted average number of common shares outstanding for applica- ble years. YEAR ENDED DECEMBER 31 (Amounts in thousands, except per share data) Earnings per common share Net income (loss) Weighted average number of common shares Basic earnings per common share 2003 2002 2001 $ 25,999 $ 106 $(50,051) 19,237 19,160 19,279 $ 1.35 $ .01 $ (2.60) NOTE 19 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities retained interests. losses of 0 percent, and a 15 percent discount rate. The Company, in connection with its tender option The Company receives a fee to remarket the varia- bond program, has securitized $166.2 million of ble rate certiﬁcates derived from the securitizations. highly-rated ﬁxed rate municipal bonds. Each mu- nicipal bond is sold into a separate trust that is The Company enters into interest rate swaps to funded by the sale of variable rate certiﬁcates to minimize any interest rate risk associated with the institutional customers seeking variable rate tax- free investment products. These variable rate certiﬁ- cates 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 Condi- tion. The fair value of retained interests was Certain cash ﬂow activity for the municipal bond securitizations described above during 2003 $7.4 million at December 31, 2003 with a weighted average life of 9.6 years. Securitization transactions includes: are treated as sales with the resulting gain included in principal transactions on the Consolidated State- ments 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 At December 31, 2003, the sensitivity of the current fair value of retained interests to immediate 10 per- cent and 20 percent adverse changes in the key economic assumptions was not material. Remarketing fees received Proceeds from new sales Cash ﬂows received on retained interests $22.6 million $4.9 million $89,000 P I P E R J A F F R AY A N N U A L R E P O R T 2003 67 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S NOTE 20 Business Segments Within the Company, ﬁnancial performance is mea- sured by lines of business. The Company’s reporta- ble 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 prod- ucts and services. Certain services that the Com- pany 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 eval- uated 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 attribut- ing customer relationships and their related reve- nues 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 busi- ness development and other direct expenses are ac- counted for within each segment’s ﬁnancial results in a manner similar to the consolidated ﬁnancial results. Research, operations, technology and com- pliance related costs are allocated based on the seg- ment’s use of these areas to support their businesses. General and administrative expenses in- curred by centrally managed corporate support functions are not allocated. To enhance the compa- rability of business segment results, goodwill amor- tization 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 in- frequent regulatory settlement costs are not as- signed to the business segments. The ﬁnancial management of assets, liabilities and capital is per- formed on an enterprise-wide basis. Revenues from the Company’s non-U.S. operations were $9.2 mil- lion, $8.2 million and $6.6 million for the years ended December 31, 2003, 2002 and 2001, respec- tively, 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 sys- tems are enhanced and methods of evaluating per- formance change or business segments are realigned to better serve the clients of the Company. Accord- ingly, 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 ser- vices, including equity and ﬁxed income securities, mutual funds and annuities. This segment also in- cludes net interest income on client margin loans. PCS has approximately 830 ﬁnancial advisers oper- ating 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 P I P E R J A F F R AY A N N U A L R E P O R T 2003 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S Reportable segment ﬁnancial results for the respec- tive year ended December 31, are as follows: (Dollars in thousands) 2003 2002 2003 2002 2003 2002 2003 2002 Capital Markets Private Client Services Corporate Support and Other Consolidated Company 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 Support cost 137,249 59,303 127,204 61,549 63,701 35,219 65,999 36,097 (36,683) (41,638) 164,267 151,565 – – 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 Regulatory settlement Merger and restructuring Royalty fee Consolidated income before taxes 24,000 – – 3,911 – 32,500 7,976 7,482 $ 41,834 $ 5,961 Capital Markets Private Client Services Corporate Support and Other Consolidated 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 Support cost 127,204 147,547 61,549 71,013 65,999 36,097 67,977 28,964 (41,638) (49,261) 151,565 166,263 – – 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 Amortization of goodwill and acquisition-related compensation Merger and restructuring Royalty fee Consolidated income (loss) before taxes 32,500 – – 7,976 7,482 17,641 65,697 55,753 $ 5,961 $ (72,805) P I P E R J A F F R AY A N N U A L R E P O R T 2003 69 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 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: YEAR ENDED DECEMBER 31 (Dollars in thousands) Current: Federal State Foreign Deferred: Federal State Total tax expense (beneﬁt) 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: (Dollars in thousands) Federal income tax at statutory rates Increase (reduction) in taxes resulting from: State income taxes, net of federal tax beneﬁt Goodwill amortization Net tax-exempt interest income Fines and penalties Other, net Total tax expense (beneﬁt) 7 0 P I P E R J A F F R AY A N N U A L R E P O R T 2003 2003 2002 2001 $17,528 $ 12,809 $(20,876) 4,380 418 4,152 280 (2,891) 230 22,326 17,241 (23,537) (5,529) (962) (9,952) (1,434) (6,491) (11,386) 697 86 783 $15,835 $ 5,855 $(22,754) 2003 2002 2001 $14,642 $ 2,087 $(25,482) 2,270 – 1,767 – (1,823) 5,054 (2,933) (3,692) (1,525) 350 1,506 4,953 740 – 1,022 $15,835 $ 5,855 $(22,754) The Company has reviewed the components of the deferred tax assets and has determined that no valu- ation allowance is deemed necessary based on man- agement’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 con- solidated income tax return. N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S Deferred income tax assets and liabilities reﬂect the tax effect of temporary differences between the car- rying 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: (Dollars in thousands) Deferred tax assets: Liabilities /accruals not currently deductible Pension and retirement costs Deferred compensation Other Deferred tax liabilities: Partnership investments Fixed assets Other 2003 2002 $26,254 $28,628 10,086 14,854 5,382 8,503 7,651 5,613 56,576 50,395 588 3,188 130 1,700 2,180 336 3,906 4,216 Net deferred tax assets $52,670 $46,179 P I P E R J A F F R AY A N N U A L R E P O R T 2003 71 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S S U P P L E M E N TA L I N F O R M AT I O N Quarterly Information (Unaudited) 2003 FISCAL QUARTER (Amounts in thousands, except per share data) Total revenues Interest expense Net revenues Non-interest expenses Income (loss) before income taxes Net income (loss) Earnings per common share Basic Diluted Weighted average number of common shares Basic Diluted 2002 FISCAL QUARTER (Amounts in thousands, except per share data) Total revenues Interest expense Net revenues Non-interest expenses Income (loss) before income taxes Net income (loss) Earnings per common share Basic Diluted Weighted average number of common shares Basic Diluted First Second Third Fourth $174,634 5,427 169,207 162,024 7,183 4,693 $210,377 5,327 205,050 191,380 13,670 8,622 $214,900 4,225 210,675 184,570 26,105 16,030 $206,330 4,532 201,798 206,922 (5,124) (3,346) $ $ 0.24 0.24 $ $ 0.45 0.45 $ $ 0.83 0.83 $ $ (0.17) (0.17) 19,190 19,190 19,223 19,223 19,260 19,260 19,273 19,273 First Second Third Fourth $191,405 8,127 183,278 168,001 15,277 9,076 $215,774 13,379 202,395 186,509 15,886 9,947 $170,702 6,630 164,072 158,765 5,307 4,308 $185,486 6,179 179,307 209,816 (30,509) (23,225) $ $ 0.47 0.47 $ $ 0.52 0.52 $ $ 0.23 0.23 $ $ (1.21) (1.21) 19,198 19,198 19,132 19,132 19,150 19,150 19,162 19,162 Market for Piper Jaffray Common Stock and Related Shareholder Matters any future earnings for use in the operation and STOCK PRICE INFORMATION expansion of our business. Our board of directors is Our common stock is listed on the New York Stock Exchange under the symbol ‘‘PJC.’’ Our separation free to change our dividend policy at any time and from U.S. Bancorp was completed on December 31, will make any such future determination regarding the payment of dividends based upon various fac- 2003 and our common stock began ‘‘regular trad- ing’’ on the New York Stock Exchange on January 2, tors then existing, including: 2004. Consequently, historical quarterly price infor- mation 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. ) our ﬁnancial condition, operating results and cur- rent 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 abil- ity to pay dividends are described in Note 15 to the consolidated ﬁnancial statements. SHAREHOLDERS We had 49,217 shareholders of record and an esti- mated 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 7 2 P I P E R J A F F R AY A N N U A L R E P O R T 2003 Company Information CORPORATE HEADQUARTERS Piper Jaffray Companies 800 Nicollet Mall Minneapolis, MN 55402 612 303-6000 COMPANY WEB SITE www.piperjaffray.com STOCK TRANSFER AGENT AND REGISTRAR Mellon Investor Services LLC acts as transfer agent and registrar for Piper Jaffray Companies and maintains all shareholder records for the company. If you have questions regarding the Piper Jaffray Companies stock you own, stock transfers, address corrections or changes, lost stock certiﬁcates or duplicate mailings, please contact Mellon Investor Services by writing or calling: Mellon Investor Services LLC P.O. Box 3315 South Hackensack, NJ 07606 800 872-4409 Street address for overnight deliveries: 85 Challenger Road Ridgeﬁeld Park, NJ 07660 INDEPENDENT ACCOUNTANTS Ernst & Young LLP COMMON STOCK LISTING New York Stock Exchange (symbol: PJC) INVESTOR INQUIRIES Shareholders, securities analysts and investors seeking more information about the company should contact Jennifer A. Olson-Goude, Director of Communications and Investor Relations, 612 303-6277, jennifer.a.olson-goude@pjc.com, at the corporate headquarters address. WEB SITE ACCESS TO SEC REPORTS Piper Jaffray Companies makes available free of charge on its Web site, www.piperjaffray.com, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports ﬁled or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as well as all other reports ﬁled by Piper Jaffray Companies with the SEC, as soon as reasonably practicable after we electronically ﬁle them with, or furnish them to, the SEC. WEB SITE ACCESS TO CORPORATE GOVERNANCE INFORMATION Piper Jaffray Companies makes available free of charge on its Web site, www.piperjaffray.com, the company’s code of ethics and business conduct, its corporate governance principles and the charters of the audit, compensation, and nominating and governance committees of the board of directors. Upon your request, we will mail printed copies of these materials to you. DIVIDENDS Piper Jaffray Companies does not currently pay cash dividends on its common stock. CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This Annual Report contains forward-looking statements. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These forward-looking statements cover, among other things, the future prospects of Piper Jaffray Companies. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including the following: (1) following our spin-off from U.S. Bancorp, we may experience increased costs resulting from decreased purchasing power and size compared to that provided by our association with U.S. Bancorp prior to the spin-off, (2) we will compete with U.S. Bancorp with respect to clients we both serviced prior to the spin-off and may not be able to retain these clients, (3) the continued ownership of U.S. Bancorp common stock and options by our executive ofﬁcers and some of our directors will create, or will appear to create, conflicts of interest, (4) we have agreed to certain restrictions to preserve the tax treatment of the spin-off, which reduce our strategic and operating flexibility, (5) we have agreed to indemnify U.S. Bancorp for taxes and related losses resulting from any actions we take that cause the spin-off to fail to qualify as a tax-free transaction, (6) developments in market and economic conditions have in the past adversely affected, and may in the future adversely affect, our business and proﬁtability, (7) we may not be able to compete successfully with other companies in the ﬁnancial services industry, (8) our underwriting and market-making activities may place our capital at risk, (9) an inability to readily divest or transfer trading positions may result in ﬁnancial losses to our business, (10) use of derivative instruments as part of our risk management techniques may place our capital at risk, while our risk management techniques themselves may not fully mitigate our market risk exposure, (11) an inability to access capital readily or on terms favorable to us could impair our ability to fund operations and could jeopardize our ﬁnancial condition, (12) our data processing, ﬁnancial and accounting systems are critical components of our operations and the failure of those systems may disrupt our business, cause ﬁnancial loss and constrain our growth, (13) our business is subject to extensive regulation which limits our business activities, and a signiﬁcant regulatory action against our company may have a material adverse ﬁnancial effect or cause signiﬁcant reputational harm, (14) regulatory capital requirements may adversely affect our ability to expand or maintain present levels of our business or impair our ability to meet our ﬁnancial obligations, (15) our exposure to legal liability is signiﬁcant, and could lead to substantial damages and restrictions on our business going forward, (16) we may suffer losses if our reputation is harmed, and (17) other factors identiﬁed in the document entitled “Risk Factors” ﬁled as Exhibit 99.1 to our Annual Report on Form 10-K and in our subsequent reports ﬁled with the SEC. These reports are available at our Web site at www.piperjaffray.com and at the SEC’s Web site at www.sec.gov. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events. The premise of our theme, Guides for the Journey,® is that many of the heroes, inventors and pioneers throughout history achieved their success because of the guides they chose. We see ourselves as guides—trusted advisors who are totally committed to our clients’ success.

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