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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED JUNE 27, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM _____TO ______
Commission file number 0-19483
SOUTHWEST SECURITIES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2040825
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 ELM STREET, SUITE 3500, DALLAS, TEXAS 75270
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 651-1800
Securities registered pursuant to Section 12 (b) of the Act: None
----
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $0.10 per share
---------------------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
---
As of September 15, 1997, there were 9,245,475 shares of the Registrant's common
stock, $.10 par value, outstanding. The aggregate market value of Common Stock
held by non-affiliates was approximately $135,354,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be used in connection with the
solicitation of proxies to be voted at the registrant's annual meeting of
shareholders to be held November 5, 1997, which will be filed with the
Commission pursuant to Regulations 240.14a (6)(c) prior to October 25, 1997, are
incorporated by reference into Part I and Part III of the Report on Form 10-K.
PART I
Item 1. Business
GENERAL
Southwest Securities Group, Inc. and subsidiaries (Registrant),
collectively the "Company" is a Delaware corporation incorporated in 1972 and
through its principal subsidiary, Southwest Securities, Inc. (Southwest),
provides securities transaction processing and other related services and
operates a full-service brokerage, investment banking and asset management firm.
Its primary business is delivering a broad range of securities transaction
processing services to correspondent broker/dealers ("Correspondents").
Transaction processing services include cost-effective integrated trade
execution, clearing, client account processing and other customized services
("Transaction Processing"). Southwest also provides services that are directly
related to Transaction Processing, including margin lending and stock loan
services.
Southwest's Transaction Processing services are currently provided on a
fully disclosed basis to 239 Correspondents. These Correspondents are located
in 34 states, two foreign countries and one U.S. Territory.
The Company also provides securities brokerage and investment services
primarily to individuals, provides investment banking services to municipal and
corporate clients and trades fixed income and equity securities. In addition,
through Brokers Transaction Services ("BTS"), a wholly owned subsidiary of the
Company and a National Association of Securities Dealers ("NASD") registered
broker/dealer, the Company contracts with independent registered representatives
for the administration of their securities business. The Company offers
discount brokerage services through its wholly owned subsidiary Sovereign
Securities, Inc. ("Sovereign"), which began operations in 1997. Sovereign is an
NASD registered broker/dealer. Equity Securities Trading Company, Inc.
("ESTC"), an NASD registered broker/dealer based in Minneapolis, specializes in
regional clearing services.
The Company offers asset management and trust services through Westwood
Management Corporation ("Westwood") and Trust Company of Texas ("Trust
Company"). The Company also offers an investment program called the Local
Government Investment Cooperative, or LOGIC, for cities, counties, schools and
other local governments across Texas. LOGIC is operated by a subsidiary of the
Company, SW Capital Corporation ("Capital"). In addition to providing revenues
to the Company, the Company also believes that many of these activities
complement the Transaction Processing business by providing additional products
and services which are utilized by its Correspondents. SWST Computer
Corporation ("Computer Corp.") provides computer processing and programming
services to affiliates as well as to third parties.
Over the five fiscal years ended June 27, 1997, the Company's revenues grew
from $91.1 million in fiscal 1993 to $218.4 million in fiscal 1997 and its net
income grew from $10.7 million in fiscal 1993 to $17 million in fiscal 1997.
The primary factors responsible for the Company's growth have been an increase
in the number of transactions processed for existing Correspondents, the
addition of new Correspondents, and the expansion of related services and
products including margin loans, stock loans and investment products. The
Company's retail brokerage, investment banking and trading activities have also
contributed to its growth.
Headquartered in Dallas, Texas, Southwest operates 13 retail brokerage
offices in Texas, New Mexico, Oklahoma and California. As of June 27, 1997, the
Company had 689 full-time employees, including 147 account executives employed
by Southwest. In addition, BTS had contracts with 536 independent registered
representatives in 36 states.
Southwest is a member firm of the New York Stock Exchange, Inc. ("NYSE"),
the American Stock Exchange, Inc., and the Chicago Stock Exchange, Inc. It is
also a member of the NASD, the Securities Investor Protection Corporation
("SIPC"), and other regulatory and trade organizations. SIPC provides
protection for clients up to $500,000 each with a limitation of $100,000 for
claims for cash balances. Southwest purchases
1
insurance which, when combined with the SIPC insurance, provides total coverage
in certain circumstances of up to $25.0 million per client for securities held
in clients' accounts with no aggregate limit.
BUSINESS STRATEGY
The Company's strategy is to capitalize on the expanding market for the
outsourcing of Transaction Processing by providing high quality service to
broker/dealers, including brokerage affiliates of commercial banks. The Company
has also expanded into other areas of operations which complement Transaction
Processing by providing additional products and services to its Correspondents.
These areas include margin loans, stock loans, investment banking services for
municipal and corporate clients, trading fixed income and equity securities,
asset management and trust services. In addition, Southwest operates its own
retail brokerage operation in order to attract account executives who prefer to
be employees of Southwest rather than independent contractors or Correspondents.
The Company's business strategy addresses certain important changes
affecting the securities industry. In recent years, individual account
executives have been leaving their employers to form their own broker/dealer
firms. Many of these broker/dealers choose to outsource their Transaction
Processing to a third party, such as Southwest.
Rapid technology changes in both software and hardware are causing many
brokerage firms and banks to change the way they view potential investments in
maintaining up-to-date systems capabilities. An outsourcing arrangement with a
transaction processor allows a broker/dealer to eliminate much of the risk and
difficulty of managing technology and receive Transaction Processing and related
services for a known variable cost.
In order to address the foregoing changes and take advantage of the
opportunities afforded thereby, the Company has adopted a business strategy
which includes the following major elements:
Focus on Independent and Bank-Affiliated Broker/Dealers. Southwest markets
its Transaction Processing services to broker/dealers and bank-affiliated
broker/dealers who elect to have a third party process their securities
transactions for a number of reasons including: (i) the complex nature of the
Transaction Processing business; (ii) the desire to have variable rather than
fixed overhead costs associated with a variable flow of transactions; and (iii)
a prohibitively high level of capital needed to support the processing of
securities transactions. Many of Southwest's Correspondents are smaller
broker/dealers. Southwest and BTS also recruit and train registered
representatives and provide marketing services for small and medium-sized banks
entering the securities business.
Offer a Broad Range of Services. While the Company's primary business
focus is to provide Transaction Processing and related services, the Company
also provides complementary products and services, including investment banking
services for municipal and corporate clients, fixed income and equity trading,
asset management and trust services. The Company believes that many of these
activities complement the Transaction Processing business by providing
additional products and services to its Correspondents. The Company continually
seeks to find new ways to support and enhance more effectively the business of
its Correspondents.
Provide Sophisticated Data Processing Technology. Electronic data
processing is an integral part of Southwest's Transaction Processing
capabilities. Southwest operates sophisticated data processing hardware and
software to execute and process securities transactions and is engaged in
continuing software development and regular up-grades on its computer hardware.
The Company's data center features two six processor Himalaya computers and a
sophisticated telecommunications network supporting over 2,500 terminals. While
Southwest's software is licensed from Securities Industry Software Corporation,
it employs in-house programmers to develop proprietary enhancements and to
maintain its system. The "on-line, real-time" system makes it possible for a
broker to input a desired transaction and immediately have the transaction
posted to the Correspondent's account and a confirmation of the transaction
printed. This system differs from the "batch" system, which does not provide
for immediate posting, confirmation and printing of a transaction. Southwest
provides brokerage accounting, order
2
entry and market data in a local area network/wide area network environment as
well as through other traditional communication environments.
In 1996, Southwest formed Computer Corp. to provide computer processing and
programming to affiliates as well as third parties. WebSite Productions, a
division of Computer Corp., assists companies of all sizes in creating websites
on the Internet as well as building corporate intranets.
Southwest intends to continue to make significant technology investments
including participation in a joint venture with several other broker/dealers.
The joint venture, Comprehensive Software Systems, Ltd., ("CSS") is developing
the next generation of software for the securities industry capable of
accommodating a variety of hardware platforms and operating systems with a large
degree of customization at each location. The CSS system will automate both
front- and back-office brokerage processes from contract and order management to
clearance and settlement. The system is expected to be completed in 1997.
PROCESSING OPERATIONS
Southwest provides Transaction Processing on a fully disclosed basis. In
a fully disclosed clearing transaction, the identity of the Correspondent's
client is known to Southwest, and Southwest physically maintains the client's
account and performs a variety of services as agent for the Correspondent.
The execution and clearing process requires the performance of a series of
complex steps, many of which are accomplished with data processing equipment.
The execution process begins when the Correspondent accepts its client's order
for the purchase or sale of securities and electronically transmits the order to
Southwest's data center for processing. Southwest, in turn, routes the order to
the market in which it believes it can effect the best execution. In the
execution of some listed and some over-the-counter transactions, Southwest
receives payment for that order flow. After execution, a written confirmation
containing the details of each transaction is automatically produced and
delivered to the Correspondent's client and posted to their client's account.
Southwest clears the transaction by taking possession of the cash of the
Correspondent's client, if securities are being purchased, or certificates, if
any, if securities are being sold, and by delivering cash or certificates to the
broker for the other party to the transaction. Southwest collects from the
Correspondent's client the money due on the transaction, including the
commission charged by the Correspondent, deducts from the commission the charge
for execution and clearing and any other amounts due Southwest, and remits the
net commission to the Correspondent on a monthly basis. Cash or certificates
received by Southwest for the Correspondent's client are either held in the
account or delivered to the customer. Southwest sends the client a monthly or
quarterly statement of the client's account. The actual clearing functions for
multiple transactions involving many brokerage firms are much more complex than
is described above. Instead of matching each buyer and seller in a transaction
and making delivery to and receiving payment from each of them, the securities
industry has established a netting process whereby securities and money are
delivered or received between brokerage firms through central clearing houses.
The following table sets forth, for each of the last three fiscal years,
certain information relating to the number of client transactions processed and
the number of Correspondents at the end of each year:
Fiscal 1997 Fiscal 1996 Fiscal 1995
---------------- --------------- ---------------
Tickets for Correspondents (except BTS) 3,050,930 1,831,455 670,495
Tickets for BTS 114,733 80,258 57,228
Tickets for Southwest account executives 155,896 128,487 97,042
---------------- --------------- ---------------
Total Tickets 3,321,559 2,040,200 824,765
================ =============== ===============
Number of Correspondents* 239 228 205
================ =============== ===============
* Number at fiscal year end. BTS is included as one Correspondent. See
Brokers Transaction Services, Inc. below
3
LENDING ACTIVITIES AND OTHER SOURCES OF INTEREST INCOME
Southwest derives interest revenue in connection with extending credit to
its own clients and clients of its Correspondents to enable those clients to
purchase securities on margin. Southwest also extends credit directly to
Correspondents to the extent the Correspondents hold securities positions for
their own accounts. Other sources of interest income include investing excess
credit balances for its own clients and clients of its Correspondents, interest
generated by trading portfolios of fixed income securities and securities
lending activities.
Client Financing. Transactions in securities are effected on either a cash
or margin basis. In margin transactions, Southwest extends credit for a portion
of the purchase price, which is collateralized by securities and cash in the
client's account, and receives income from interest charged on such extension of
credit. The amount of the loan is subject to the margin regulations
("Regulation T") of the Board of Governors of the Federal Reserve System, NYSE
margin requirements, and Southwest's internal policies, which in many instances
are more stringent than Regulation T or NYSE requirements. In most
transactions, Regulation T limits the amount loaned to a customer for the
purchase of a particular security to 50% of the purchase price. Furthermore, in
the event of a decline in the value of the collateral, the NYSE regulates the
percentage of client cash or securities that must be on deposit at all times as
collateral for the loans. Southwest is subject to the risk of a market decline,
which could reduce the value of its collateral below the client's indebtedness
before the collateral could be sold. Agreements with margin account clients
permit Southwest to liquidate clients' securities with or without prior notice
in the event of an insufficient amount of margin collateral. Despite those
agreements, Southwest may be unable to liquidate clients' securities for various
reasons including the fact that the pledged securities may not be actively
traded, there is an undue concentration of certain securities pledged, or a stop
order is issued with regard to pledged securities.
Interest is charged to clients on the amount borrowed to finance margin
transactions. The financing of margin purchases is an important source of
revenue to Southwest since the interest rate paid by the client on funds loaned
by Southwest exceeds Southwest's cost of short-term funds. The interest rate
charged to clients on such loans is based on the brokers' call rate (the rate
paid to banks by brokers on loans collateralized by securities). Interest
earned on client margin transactions represented approximately 25% of total
interest income during the most recent fiscal year. At June 27, 1997, margin
receivables were approximately $491,092,000.
The primary source of funds to finance clients' margin account balances has
been credit balances in clients' accounts. As of June 27, 1997, clients' credit
balances available to Southwest were approximately $688,418,000. Southwest pays
interest to clients on most of the funds at a rate determined periodically. SEC
regulations restrict the use of client's funds to the financing of clients'
activities including margin account balances and, to the extent not so used,
such funds are required to be deposited in a special account for the benefit of
clients. Interest income earned by the Company on these deposits totaled
approximately 13% of interest income in fiscal 1997.
Securities Lending Activities. Southwest performs securities lending
services for its own clients, clients of Correspondents and Correspondents
themselves as well as for other broker/dealers and lending institutions.
Southwest's securities borrowing and lending activities involve borrowing
securities to cover short sales and to complete transactions in which clients
have failed to deliver securities by the required settlement date, and lending
securities to other broker/dealers for similar purposes. When borrowing
securities, Southwest is required to deposit cash or other collateral, or to
post a letter of credit with the lender and Southwest generally receives a
rebate (based on the amount of cash deposited) or a fee calculated to yield a
negotiated rate of return. When lending securities, Southwest receives cash or
similar collateral and generally pays a rebate (based on the amount of cash
deposited) to the other party to the transaction. Southwest earns interest on
the cash or similar collateral received. Securities borrowing and lending
transactions are generally executed pursuant to written agreements that require
that the securities borrowed and loaned be marked to market on a daily basis and
that excess collateral be refunded or that additional collateral be furnished as
a result of changes in the market value of the securities. Margin adjustments
are usually made on a daily basis through the facilities of various clearing
houses. Southwest is a principal in these securities borrowing and lending
transactions and becomes liable for losses in the event of a failure of any
other party to honor its contractual obligation. See Note 3 to the Company's
Consolidated Financial Statements. Southwest's securities borrowing and lending
activities are primarily conducted from its New York office, where
4
some of Southwest's operations and clerical activities are also performed.
Interest earned from securities borrowing activities accounted for approximately
56% of interest income in fiscal 1997.
Other. Other sources of interest revenue for Southwest include interest
charged directly to Correspondents to finance securities held for their accounts
and interest generated by trading portfolios of fixed income securities. These
items, and others, accounted for approximately 6% of interest income in fiscal
1997.
BROKERAGE
The Company conducts its retail brokerage business through four wholly
owned subsidiaries, Southwest, BTS, Sovereign, and ESTC. The following table
sets forth the dollar amount in thousands and the percentage (before deducting
commissions payable to Southwest's account executives and BTS's registered
representatives) of securities commissions by product, as well as other
information:
Fiscal Year Ended
(dollars in thousands)
---------------------------------------------------------------
June 27, June 28, June 30,
1997 % 1996 % 1995 %
-------- ----- -------- ----- -------- -----
Securities Commissions:
Listed equities $ 9,729 25% $ 9,550 26% $ 7,305 27%
Over-the-counter equities 9,658 25% 10,146 27% 6,184 23%
Corporate bonds 1,906 5% 1,015 3% 547 2%
Government bonds 1,970 5% 2,754 7% 2,273 9%
Municipal bonds 4,026 10% 3,903 11% 3,182 12%
Options 1,205 3% 814 2% 614 2%
Mutual funds 9,013 23% 7,433 20% 5,372 20%
Other 1,375 4% 1,281 4% 1,140 5%
------- ------- -------
Total $38,882 $36,896 $26,617
======= ======= =======
Account executives at year-end 147 118 115
Brokerage offices at year-end 16 13 15
BTS representatives at year-end 536 462 361
Southwest. As of June 27, 1997, Southwest had 13 retail brokerage offices,
four located in Dallas, Texas and one each in Georgetown, Longview, Lufkin,
Nacogdoches, and San Antonio, Texas; Albuquerque and Santa Fe, New Mexico;
Tulsa, Oklahoma; and Beverly Hills, California. In addition, Southwest has bond
brokerage offices in Dallas, Texas and Chicago, Illinois; and an institutional
sales office in Dallas, Texas.
Southwest generates commission revenues when it acts as a broker, on an
agency basis, or as a dealer, on a principal basis, to effect securities
transactions for individual and institutional investors. Southwest processes
both listed and over-the-counter agency transactions for clients. Southwest
also processes transactions in puts and calls on options exchanges as agent for
its clients. In addition, Southwest sells a number of professionally managed
mutual funds and maintains dealer-sales agreements with most major distributors
of mutual fund shares sold through broker/dealers. Some account executives
employed by Southwest maintain a license to sell certain insurance products.
Southwest is registered with the Commodity Futures Trading Commission as a non-
guaranteed introducing broker and is a member of the National Futures
Association. Southwest is a fully disclosed client of one of the largest
futures commodity merchants in the United States.
Brokers Transaction Services, Inc. BTS is an NASD member broker/dealer
that contracts with individual registered representatives who are NASD licensed
salespersons for the conduct of their securities business. BTS is a
Correspondent of Southwest. While these registered representatives must conduct
all of their securities business
5
through BTS, their contracts permit them to conduct insurance, real estate
brokerage or other business for others or for their own accounts. The registered
representatives are responsible for all of their direct expenses and are paid
higher commission rates than Southwest's account executives to compensate them
for their added expenses.
Sovereign Securities, Inc. Sovereign, which began operations in 1997,
is an NASD member broker/dealer specializing in deep discount brokerage
services. Sovereign has positioned itself as a brokerage firm that discounts
commissions without sacrificing customer service. Although Sovereign's brokers
do not provide investment advice or recommendations, they do offer clients the
information needed, including quotes, market news, and trends, to make informed
investment decisions. Sovereign's brokers work on a salary, rather than
commission. Sovereign is preparing to offer on-line trading via the Internet in
the near future.
Equity Securities Trading Company. Acquired on May 1, 1997, ESTC is an
NASD member broker/dealer based in Minneapolis, specializing in regional
clearing services. Founded in 1976, Equity has earned a reputation in the
Midwest as a reliable, service-oriented clearing firm. Like Southwest, Equity
is known for introducing fully automated clearing operations and will also be
integrating the new CSS software to benefit its customers.
INVESTMENT BANKING
Municipal Finance. The Fixed Income Division of Southwest is
headquartered in Dallas. It is comprised of a public finance department and a
sales and underwriting department. The public finance department, which is
staffed by 25 professionals, provides professional financial advisory services
to public entities across Texas and the Southwest and maintains branch offices
in San Antonio, Longview, Austin and Houston, Texas, and Albuquerque, New
Mexico. The municipal bond sales and underwriting division, which is staffed by
27 professionals, participates in underwriting and selling both negotiated and
competitive bid municipal bond offerings.
The following table sets forth, for the last three fiscal years, the number
and dollar amounts, using the full credit to the co-manager method, of municipal
bond offerings managed or co-managed by Southwest.
Aggregate
Fiscal Number of Amount of
Years Issues Offerings
------ --------- --------------
1997 165 $2,444,316,713
1996 168 $3,892,244,000
1995 102 $1,169,881,000
Corporate Finance. Southwest's Corporate Finance Department is staffed by
12 professionals who provide financial advisory and capital raising services,
primarily to corporate clients. Financial advisory services involve advising
clients in mergers and acquisitions and their related financings and in various
types of corporate valuations. Most financial advisory clients are privately
held companies. Capital raising services involve public and private offerings.
Syndicate. Southwest's Special Products/Syndicate Department, staffed by
six professionals, manages the Company's participation in national syndicates of
underwriters. Southwest acts as an underwriter, dealer, and selling group
member for tax-free municipal unit trusts, taxable government and corporate bond
unit trusts and equity unit trusts. During fiscal 1997, Southwest underwrote
and sold in excess of $5,800,000 of unit trust securities. Southwest
participates in equity syndicate offerings either as a member of the
underwriting group or the selling group. During fiscal 1997, Southwest
participated in 51 equity offerings in which its underwriting commitments were
approximately $72,000,000 in the aggregate. Southwest also acts as a dealer in
syndicates of underwriters of certificates of deposit and distributes money
market and other mutual fund shares.
6
PRINCIPAL TRANSACTIONS
Trading securities in the over-the-counter markets involves the purchase of
securities from and the sale of securities to other dealers who may be
purchasing or selling securities for their own account or acting as agent for
their clients. Profits and losses are derived from the spread between bid and
asked prices, as well as market increases or decreases for the individual
security during the holding period. Southwest makes markets in corporate
equities and trades in municipal bonds and various government securities. As of
June 27, 1997, Southwest made markets in 216 common stocks traded in the over-
the-counter market. Southwest's over-the-counter common stock inventory
positions at the end of each quarter during fiscal 1997 ranged from
approximately $1,767,000 to $2,811,000 and averaged approximately $2,333,000.
The number of fixed income securities traded varies widely. Southwest's fixed
income securities positions at the end of each quarter during fiscal 1997,
ranged from $14,920,000 to $26,371,000 and averaged $20,475,000.
Southwest also acts as agent in the execution of over-the-counter orders
for its clients and as such transacts trades with other dealers. When Southwest
receives a client order in a security in which it makes a market, it may act as
principal so long as it matches the best price in the dealer market, plus or
minus a mark-up or mark-down equivalent to an agency commission price.
ASSET MANAGEMENT AND TRUST SERVICES
The Company offers asset management and trust services through Westwood,
Trust Company and SW Capital Corporation.
Westwood is a registered investment advisor founded in 1983 by Susan M.
Byrne, who continues to serve as its President and Chief Executive Officer. The
firm, which has offices in Dallas and New York, manages equity, fixed income,
cash and balanced accounts for a diverse clientele, including corporate plan
sponsors, charitable institutions, educational endowments and public funds. In
addition, Westwood manages the Westwood Family of Mutual Funds which is
available to both taxable and non-taxable investors.
Trust Company was established in 1974 and provides trust, custodial and
other management services to estates, charitable and other trusts and retirement
plans established by high net worth individuals and corporations throughout
Texas and the Southwest. Trust Company is chartered and regulated by the Texas
Department of Banking.
SW Capital Corporation was established in 1994 and administers the Local
Government Investment Cooperative program, or LOGIC. The LOGIC program is
targeted to the needs of cities, counties, schools and other local governments
across Texas. This program allows participants to pool their available funds,
resulting in increased economies of scale, which allow higher returns while
maintaining a high degree of safety and liquidity.
COMPETITION
All aspects of the business of the Company are highly competitive. The
Company competes with numerous other securities firms, commercial banks,
investment banking firms, life insurance companies, asset management firms,
trust companies and others. Many of the Company's competitors have
substantially greater capital and other resources than the Company. Competition
among financial services firms also exists for experienced technical and other
personnel as well as for account executives.
The Transaction Processing business has become considerably more
competitive over the past few years as numerous highly visible, large, well-
financed securities firms either have begun offering Transaction Processing
services or have attempted to increase their share of the market. This
competition is centered around offering enhanced computer software capabilities
to improve services for retail clients. Despite the Company's efforts to
7
maintain state-of-the-art technology, there is no assurance that its
Correspondents will continue to use its services. In addition, there has been
consolidation within the securities industry by companies having financial
resources far greater than the Company. These developments have increased
competition from firms with greater capital resources and possibly greater
operating efficiencies than those of the Company.
The securities industry has experienced substantial commission discounting
by broker/dealers competing for institutional and individual brokerage business.
In addition, an increasing number of specialized firms now focus their services
to the individual client. These firms generally effect transactions for their
clients on a discounted commission basis without offering other services such as
portfolio valuation, investment recommendations and research.
Commercial banks and other financial institutions have become a competitive
factor by offering their clients certain corporate and individual financial
services traditionally provided by securities firms. The current trend toward
consolidation in the commercial banking industry could further increase
competition in all aspects of the Company's business and could affect the
opportunities for the Company to expand its Transaction Processing business.
The Federal Reserve Board has approved applications of several leading
commercial banks to underwrite certain types of securities which commercial
banks have previously not been permitted to underwrite. While it is not possible
to predict the type and extent of competitive services which commercial banks
and other financial institutions ultimately may offer or whether administrative
or legislative barriers will be repealed or modified, securities firms such as
the Company may be adversely affected.
EMPLOYEES
As of June 27, 1997, the Company employed 689 full-time employees. The
Company believes its relations with its employees are good.
8
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G(3) of Form 10-K, the following list is
included as an unnumbered Item in Part I of this report in lieu of being
included in the Proxy Statement for the Annual meeting of Stockholders to be
held November 5, 1997.
Name Age Position
- --------------------- --- ------------------------------------------------
David Glatstein /(1)/ 48 Director, Chief Executive Officer and President
of the Company
Richard H. Litton 50 Senior Executive Vice President of the Company
William. D. Felder 39 Senior Executive Vice President of the Company
W. Norman Thompson 41 Senior Executive Vice President and Chief
Information Officer of the Company
Kenneth R. Hanks 43 Senior Executive Vice President and Chief
Financial Officer of the Company
- -------------------
/(1)/ Executive Committee
9
DAVID GLATSTEIN was elected Chief Executive Officer in May 1996 and has
served as President and a director of the Company and President and Chief
Operating Officer of Southwest since May 1995. Mr. Glatstein was President of
Barre & Company from its founding in 1980 until its acquisition by Southwest in
1995; First Vice President of the Securities Division of Lehman Brothers Kuhn
Loeb, Inc. from 1978 to 1980 and securities broker with White, Weld & Company,
Inc. from 1973 to 1978. Mr. Glatstein is a past Chairman of the District 6
Business Conduct Committee of the NASD.
RICHARD H. LITTON has served as Senior Executive Vice President of the
Company and Senior Executive Vice President in charge of the Public Finance
Division of Southwest since July 1995. Mr. Litton headed the Municipal
Securities Group in Dallas for BA Securities, Inc. from 1993 to 1995. Mr.
Litton was President with First Southwest Company, a regional investment bank
from 1987 to 1993; Vice President and Regional Manager of Merrill Lynch Capital
Markets Municipal Group from 1977 to 1987 and a securities broker with White,
Weld & Company, Inc. from 1976 to 1977. Mr. Litton served on the Advisory
Committee on the Recovery of Real Estate Finance for the Texas House of
Representatives' Financial Institutions Committee. Mr. Litton is past member
and director of the Municipal Advisory Council of Texas and past member of the
Marketing Committee of the Public Securities Association.
WILLIAM D. FELDER has served as Senior Executive Vice President of the
Company since December 1995, as Senior Vice President of the Company since
August 1993, and as Senior Vice President in charge of Clearing Services of
Southwest since 1988. Mr. Felder has been associated with Southwest in various
capacities since 1980. Mr. Felder is a past chairman of the District Business
Conduct Committee, District 6, of the NASD.
W. NORMAN THOMPSON has served as Senior Executive Vice President and Chief
Information Officer of the Company since January 1995. Mr. Thompson was
associated with Kenneth Leventhal & Co. in various capacities ranging from Audit
Manager to Senior Consulting Manager from 1987 to 1994. Previously, Mr.
Thompson was an Audit Manager with KPMG Peat Marwick from 1981 to 1987. In the
capacities he held with both Kenneth Leventhal & Co. and KPMG Peat Marwick, he
was heavily involved in EDP auditing and consulting.
KENNETH R. HANKS has served as Senior Executive Vice President and Chief
Financial Officer since June 1996. Mr. Hanks served in various executive
capacities of Rauscher Pierce Refsnes, Inc. From 1981 to 1996, including
Executive Vice President and Chief Financial Officer. He serves as an
arbitrator with the NASD and formerly served as a member of the NASD's District
6 Business Conduct Committee.
10
The Company has an Executive Committee, an Audit Committee and a
Compensation Committee, all of which were established in September 1991 and a
Stock Option Committee established in September 1996. The Executive Committee
of the Board of Directors of the Company has the authority, between meetings of
the Board of Directors, to take all actions with respect to the management of
the Company's business that require action by the Board of Directors, except
with respect to certain specified matters that by law must be approved by the
entire Board. The Audit Committee is responsible for (i) reviewing the results
and scope of, and the fees for, the annual audit, (ii) reviewing with the
independent auditors the corporate accounting practices and policies and
recommending to whom reports should be submitted within the Company, (iii)
reviewing with the independent auditors their final report, (iv) reviewing with
internal and independent auditors overall accounting and financial controls, and
(v) being available to the independent auditors during the year for consultation
purposes. The Compensation Committee determines the salaries of the officers of
the Company, assists the officers in determining the salaries of other
personnel, and performs other similar functions. The Stock Option Committee
administers the grant of awards under the Stock Option Plan.
All Directors are elected for a one-year term of office or until their
respective successors are duly elected and qualified. Officers are elected by
and serve at the discretion of the Board of Directors.
Members of the Board of Directors who are not officers or employees of the
Company receive a fee of $1,500 per quarter plus $500 for each directors'
meeting they attend. Directors are reimbursed for expenses relating to
attendance at meetings.
Item 2. Properties
The Company presently leases all of its office space. The Company conducts its
Clearing Operations primarily in its principal office in Dallas, Texas and its
office in New York. It has 13 retail brokerage offices, four located in Dallas,
Texas and one each in Georgetown, Longview, Lufkin, Nacogdoches, and San
Antonio, Texas; Albuquerque and Santa Fe, New Mexico; Tulsa, Oklahoma; and
Beverly Hills, California. The Company opened public finance offices in Austin
and Houston in 1997. During 1996, the Company leased space in North Dallas for
an off-site disaster recovery center. The Company's present facilities and
equipment are adequate for current and planned operations.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Shareholders
None.
11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The registrant's common stock is traded principally on the NASDAQ National
Market System; however, the Company has made application to list its shares on
the New York Stock Exchange, Inc. At June 27, 1997, there were approximately
2,200 holders of record of common stock. The following table sets forth for the
periods indicated the high and low market prices for the common stock and the
cash dividend declared per common share.
1997 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
--------------- --------------- ---------------- ---------------
Cash dividend declared per common share /(3)/ $ .045 $ .045 $ .045 $ .045
Stock Price Range
High $12.25 $14.38 $18.25 $17.94
Low $10.75 $11.50 $14.25 $14.88
1996 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
--------------- --------------- ---------------- ---------------
Cash dividend declared per common share /(3)/ $ .036 $ .036 $ .036 $ .036
Stock Price Range
High $10.38 $10.63 $11.75 $11.75
Low $ 8.25 $ 8.75 $10.75 $11.00
Item 6. Selected Financial Data
SELECTED FINANCIAL DATA
(In thousands, except per share amounts)
Year Ended
------------------------------------------------------------------------------
June 27, June 28, June 30, June 24, June 25,
1997 1996 1995 1994 1993
------------------------------------------------------------------------------
Operating Results:
Revenues $ 218,404 $ 181,808 $ 120,181 $ 113,755 $ 91,191
Net Income $ 16,983 $ 14,040 $ 5,668 $ 8,192 $ 10,692
Earnings per share /(3)/ $ 1.75 $ 1.45 $ .63 $ .90 $ 1.37
Weighted average shares outstanding
/(1) (3)/ 9,727 9,669 8,998 9,133 7,801
Cash dividend declared per common
share /(3)/ $ .18 $ .14 $ .13 $ .11 $ .07
Financial Condition:
Total assets $3,276,392 $2,196,397 $1,535,979 $1,271,556 $1,093,884
Long-term debt $ -- $ -- $ -- $ 723 $ 1,550
Stockholders' equity $ 106,928 $ 84,449 $ 71,541 $ 63,866 $ 46,267
Shares outstanding /(1) (3)/ 10,152 9,662 9,639 9,073 8,044
Tangible book value per common share
/(1) (2) (3)/ $ 9.74 $ 8.43 $ 7.12 $ 6.68 $ 5.32
(1) Adjusted to reflect the three-for-two stock split granted to shareholders
of record date June 15, 1993, issued July 1, 1993.
(2) Adjusted to consider goodwill of $8,002 at June 27, 1997, $2,976 at June
28, 1996, $2,940 at June 30, 1995, $3,225 at June 24, 1994, and $3,452 at
June 25, 1993.
(3) Adjusted to reflect a ten percent stock dividend declared on August 28,
1997 and payable on October 1, 1997 to shareholders of record on September
15, 1997.
12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
GENERAL
Southwest Securities Group, Inc. and subsidiaries (the "Company"), through
its principal subsidiary, Southwest Securities, Inc. ("Southwest"), provides
securities transaction processing and other related services and operates a
full-service brokerage, investment banking and asset management firm. Its
primary business is delivering a broad range of securities transaction
processing services to broker/dealers. Transaction processing services include
cost-effective integrated trade execution, clearing, client account processing
and other customized services ("Transaction Processing"). Southwest provides
services that are directly related to Transaction Processing, including margin
lending and stock loan services. The Company also provides securities brokerage
and investment services to individuals and institutions, provides investment
banking services to municipal and corporate clients and trades fixed income and
equity securities. Brokers Transaction Services, Inc. ("BTS"), a wholly owned
subsidiary of the Company, and a National Association of Securities Dealers
("NASD") registered broker/dealer, contracts with independent registered
representatives for the administration of their securities business. Sovereign
Securities, Inc. ("Sovereign"), a discount brokerage firm and NASD
broker/dealer, began operations in 1997.
Effective May 1, 1997, Equity Securities Trading Company, Inc. ("ESTC")
became a wholly owned subsidiary of the Company through the issuance of 445,845
shares of common stock. The acquisition was accounted for under the purchase
method of accounting and, accordingly, assets and liabilities were recorded at
their fair market values on the date of the acquisition. Goodwill relating to
this acquisition of approximately $5,113,000 is recorded in other assets in the
consolidated statements of financial condition. Based in Minneapolis, ESTC is
an NASD broker/dealer which operates a regional securities clearing business.
SW Capital Corporation, a wholly owned subsidiary of the Company, houses
the Local Government Investment Cooperative ("LOGIC") program. The LOGIC
program is targeted to the needs of cities, counties, schools and other local
governments across Texas. This program allows participants to pool their
available funds, resulting in increased economies of scale, and allows higher
returns while maintaining a high degree of safety and liquidity. In addition,
the Company offers asset management and trust services through its wholly owned
subsidiaries, Westwood Management Corporation ("Westwood") and The Trust Company
of Texas ("Trust Company"). Southwest Investment Advisors, Inc. ("Advisors"), a
wholly owned subsidiary of the Company is a registered investment advisor.
Advisors has been inactive since April 11, 1994. The Company formed SWST
Computer Corporation ("Computer Corp.") in 1996 to provide computer processing
and programming to affiliates as well as third parties.
Effective May 26, 1995, the Company acquired Barre & Company, Inc.
("Barre"), a Dallas-based brokerage firm, through the issuance of 740,702 shares
of common stock. The acquisition was accounted for under the purchase method of
accounting and, accordingly, assets and liabilities were recorded at their fair
market values on the date of the acquisition. Simultaneous with the
acquisition, the assets and liabilities of Barre were merged with Southwest, and
Barre was dissolved. Goodwill relating to this acquisition of approximately
$270,000 is recorded in other assets in the consolidated statements of financial
condition. Subsequent to the acquisition, David Glatstein, Chief Executive
Officer of Barre, became President and a Director of the Company as well as
President of Southwest. Effective May 2, 1996, Mr. Glatstein was elected Chief
Executive Officer of the Company.
During fiscal 1994, the Company's Board of Directors authorized the
repurchase of up to 1,000,000 shares of the Company's common stock in the open
market. The Company's Board granted management the authority to repurchase the
Company's common stock from time to time at its discretion as market conditions
permit. A total of 710,527 shares were purchased at a total cost of $4,776,000.
A total of 61,122 of these shares were issued for the Employee Stock Purchase
Plan. The remainder were issued for the acquisition of Barre.
13
In August 1994, the Company authorized an employee stock purchase plan
available to eligible employees. The shares available for purchase were those
purchased in the Company's recent series of treasury stock acquisitions. A
total of 61,122 shares were sold under the terms of the Plan, resulting in loans
to employees of $421,000. As of June 27, 1997, $137,000 was outstanding under
these notes.
One of the most important facets of the Company's operations is
Transactions Processing and related services. Substantially all of the revenues
from Transaction Processing are shown on the Company's Consolidated Statements
of Income as net revenues from clearing operations. Increased Transaction
Processing and related services have resulted in increases in certain revenues,
including net revenues from clearing operations, interest revenue from margin
loans to clients of Southwest's Correspondents and to Correspondents for their
own security inventory positions and money market administrative fees. The
resultant increases in retained earnings have increased the capital of the
Company which in turn has permitted the Company to expand all areas of its
operations.
Other major sources of revenues are commissions from Southwest's client
transactions and interest from margin loans to its own clients, stock loan
transactions and other interest-bearing assets. Investment banking, advisory
and administrative fees include revenues derived from the underwriting and
distribution of corporate and municipal securities, unit trusts and money market
and other mutual funds. The major expenses incurred by the Company relate to
payment of commissions, overall compensation and benefits for both sales and
administrative personnel and the costs of funds to finance the Company's
securities operations, including short-term borrowings, securities lending
transactions and other interest-bearing obligations.
FISCAL 1997 COMPARED TO FISCAL 1996
The Company's total revenues increased $36,596,000, or 20%, to
$218,404,000, compared with fiscal 1996 revenues of $181,808,000, due to
increases in all facets of the Company. Improved market conditions, combined
with the addition of Correspondents, resulted in increased revenues from
Transaction Processing of $4,796,000, an increase of 27% in fiscal 1997 over
fiscal 1996. The number of Correspondents increased to 239 in 1997 from 228 in
1996. Commissions generated by Southwest brokers increased $1,986,000 to
$38,882,000, an increase of 5% when compared with the previous year revenue of
$36,896,000, due to an increase in the number of account executives. Investment
banking, advisory and administrative fees increased to $16,031,000 for the year
ended June 27, 1997, an increase of $3,498,000, or 28%, when compared to the
same period last year, due to increased deal flow. Other income in fiscal 1997
was comparable to other income in fiscal 1996.
Interest income increased $23,220,000 to $119,176,000, or 24%, over fiscal
1996 while interest expense increased 20%, or $14,146,000, to $83,238,000 from
$69,092,000 in fiscal 1996. This resulted in an increase in net interest
revenue of $9,074,000, or 34%. The increase in net interest revenue was due to
higher average balances in securities lending and customer margin accounts.
Southwest actively participates in the borrowing and lending of securities other
than those of its clients. The amounts receivable and payable relating to open
positions for securities borrowed and loaned as of June 27, 1997 were
$2,159,204,000 and $2,102,972,000, respectively. As of June 28, 1996 these
amounts were $1,341,788,000 and $1,286,199,000, respectively.
Total expenses for fiscal 1997 increased $32,610,000 to $192,661,000, or
20%, when compared to fiscal 1996 expenses of $160,051,000 primarily, as a
result of increased occupancy expenses and increased commission and employee
compensation expense, as well as increased interest expense as discussed above.
Commissions and other employee compensation increased $11,629,000 to
$65,062,000, an increase of 22%, during fiscal 1997 compared to the same period
last year, due to increased incentive compensation and an increase in the number
of employees. The number of BTS registered representatives at June 27, 1997 was
536, compared to 462 at June 28, 1996. The number of full-time employees
increased to 689 at June 27, 1997, compared to 638 at June 28, 1996. Occupancy,
equipment and computer service costs increased $2,625,000, or 27%, to
$12,216,000 for fiscal 1997 due to an upgrade in computer processing equipment
and increased square footage under lease at the Company's headquarters.
Communications expenses increased 21% to $11,026,000 in fiscal 1997 compared to
fiscal 1996, due to expanding computer networking. Floor brokerage and clearing
organization charges increased $311,000, or 8%, to $4,181,000 in fiscal 1997
compared to $3,870,000 in fiscal 1996. Other expenses increased $1,982,000 to
$16,938,000 for the year ended June 27, 1997, an increase of 13% over the June
28, 1996 expenses of $14,956,000. This increase was due primarily to increases
in expenses associated with trading and underwriting fixed income securities.
14
FISCAL 1996 COMPARED TO FISCAL 1995
The Company's total revenues increased $61,627,000, or 51%, to $181,808,000
compared with fiscal 1995 revenues of $120,181,000, due to increases in all
facets of the Company. Favorable market conditions, combined with the addition
of Correspondents, resulted in increased revenues from Transaction Processing of
$7,079,000, an increase of 65% in fiscal 1996 over fiscal 1995. The number of
Correspondents increased to 228 in 1996 from 205 in 1995. Commissions generated
by Southwest brokers increased $10,297,000 to $36,896,000, an increase of 39%,
compared with the previous year revenue of $26,617,000, due to increased
activity in the securities markets for substantially all of the fiscal year.
Investment banking, advisory and administrative fees increased to $12,533,000
for the year ended June 28, 1996, an increase of $3,426,000, or 38%, when
compared to the same period last year. Other income increased $4,658,000 to
$9,791,000 in fiscal 1996, primarily due to an increase in rebates received from
third market transactions.
Interest income increased $32,327,000 to $95,956,000, or 51%, over fiscal
1995 while interest expense increased 63%, or $26,784,000, to $69,092,000 from
$42,308,000 in fiscal 1995. This resulted in an increase in net interest
revenue of $5,543,000, or 26%. The increase in net interest revenue was due to
higher average balances in the securities lending area as well as a continuing
favorable interest rate environment. Southwest actively participates in the
borrowing and lending of securities other than those of its clients. The
amounts receivable and payable relating to open positions for securities
borrowed and loaned as of June 28, 1996 were $1,341,788,000 and $1,286,199,000,
respectively. As of June 30, 1995 these amounts were $863,648,000 and
$848,722,000, respectively.
Total expenses for fiscal 1996 increased $48,625,000 to $160,051,000, or
44%, when compared to fiscal 1995 expenses of $111,426,000, primarily as a
result of increased commissions and other employee compensation, as well as
interest expense as discussed above. Commissions and other employee
compensation increased $13,017,000 to $53,433,000, an increase of 32%, during
fiscal 1996 compared to the same period last year, due to higher commission
revenue generated by Southwest brokers and an increase in BTS registered
representatives, who are independent contractors and are paid at higher rates
than Southwest's representatives. The number of BTS registered representatives
at June 28, 1996 was 462 compared to 361 at June 30, 1995. The number of
employees increased to 638 at June 28, 1996, compared to 553 at June 30, 1995,
contributing to the increased compensation. Occupancy, equipment and computer
service costs increased $1,014,000, or 12%, to $9,591,000 for fiscal 1996, due
to upgrades of computer equipment and an increase in office space.
Communications expenses increased 35% to $9,109,000 in fiscal 1996 compared to
fiscal 1995, due to expanding computer networking. Floor brokerage and clearing
organization charges increased $489,000, or 14%, to $3,870,000 in fiscal 1996
compared to $3,381,000 in fiscal 1995. Other expenses increased $4,963,000 to
$14,956,000 for the year ended June 28, 1996, an increase of 50% over the June
30, 1995 expenses of $9,993,000. This increase was due primarily to expenses
associated with investment banking services.
LIQUIDITY AND CAPITAL RESOURCES
Approximately 99% of the Company's assets consist of cash, marketable
securities and receivables from clients, clients of Correspondents and
Correspondents themselves (representing borrowings from Southwest to finance the
purchase of securities on margin, which are secured by marketable securities);
broker/dealers; and clearing organizations. All assets are financed by the
Company's equity capital, short-term bank borrowings, interest bearing and non-
interest bearing client credit balances, Correspondent deposits, and other
payables. Southwest maintains an allowance for doubtful accounts which
represents amounts, in the judgment of management, that are necessary to
adequately absorb losses from known and inherent risks in receivables from
clients, clients of Correspondents and Correspondents.
Net cash provided by operating activities during the current year was
$115,935,000. Cash was provided by fluctuations in the receivables from
clients.
Southwest has credit arrangements with commercial banks, which include
broker loan lines up to $207,000,000. These lines of credit are used primarily
to finance securities owned, securities held for correspondent broker/dealer
accounts, and receivables in customers' margin accounts. These credit
arrangements are provided on an "as offered" basis and are not committed lines
of credit. Outstanding balances under these credit arrangements
15
are due on demand, bear interest at rates indexed to the Federal Funds rate, and
are collateralized by securities of Southwest and its clients. There were no
amounts outstanding at June 27, 1997 on these credit arrangements. In the
opinion of management, these credit arrangements are adequate to meet the short-
term operating capital needs of Southwest.
In addition to the broker loan lines, the Company has a $10,000,000
unsecured line of credit which is due on demand and bears interest at rates
indexed to the federal funds rate. The amount outstanding under this unsecured
line of credit was $4,000,000 at June 27, 1997.
Southwest is subject to the requirements of the Securities and Exchange
Commission and the New York Stock Exchange relating to liquidity, capital
standards and the use of client funds and securities. The Company has
historically operated in excess of the minimum net capital requirements.
EFFECTS OF RECENTLY ISSUED ACCOUNTING STANDARDS
On July 1, 1996, the Company adopted Statement of Financial Accounting
Standards No. 123 "Accounting for Stock-Based Compensation" ("FAS 123"). FAS
123 will not have a material impact on the Company's financial position or
results of operations, as the Company does not intend to adopt the value based
measurement concept. The impact of options granted during the fiscal year ended
June 27, 1997 is not material to the financial statements of the Company;
therefore, additional disclosure under FAS 123 is not required.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128 "Earnings per Share" ("FAS
128"). This statement specifies the computation, presentation, and disclosure
requirements for earnings per share ("EPS") for entities with publicly held
common stock or potential common stock. Basic EPS, which replaces primary EPS
but does not include dilutive securities, should increase the Company's per
share amounts under the new standard. Diluted EPS is replacing fully diluted
EPS, although the computation of the two is similar. Both basic and diluted are
required to be presented on the face of the financial statements. FAS 128 is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods; earlier application is not permitted. This
statement requires prior period restatement.
Statement of Financial Accounting Standards No. 130 "Reporting
Comprehensive Income" ("FAS 130") was issued in June 1997 and establishes
standards for reporting and display of comprehensive income and its components
in a set of general-purpose financial statements. FAS 130 is effective for
financial statements issued for periods beginning after December 15, 1997, and
reclassification of financial statements for earlier periods provided for
comparative purposes is required. Initial application of FAS 130 should be as of
the beginning of the fiscal year, but earlier application is permitted. FAS 130
must be applied to all interim periods after initial application.
The FASB issued Statement of Financial Accounting Standards No. 131
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131") in June 1997. This statement establishes standards for the way that a
public business enterprise reports information about operating segments in the
annual financial statements and requires that those enterprises report selected
information about operating segments in interim reports to shareholders. FAS
131 is effective for financial statements issued for periods beginning after
December 15, 1997, and comparative information requires restatement in the
initial year of application.
EFFECTS OF INFLATION
Management does not believe that changes in replacement costs of fixed
assets will materially affect the Company's operations. The rate of inflation,
however, affects the Company's expenses, such as employee compensation, rent and
communications. Increases in these expenses may not be readily recoverable in
the price the Company charges for its services. Inflation can have significant
effects on interest rates which, in turn, can affect prices and activities in
the securities markets. These fluctuations may have an adverse impact on the
Company's operations.
16
Item 8. Financial Statements and Supplementary Data
(a) Financial statements, schedules and exhibits filed under this item are
listed in the index appearing on page F-1 of this report.
(b) QUARTERLY FINANCIAL INFORMATION
(In thousands, except per share amounts)
1997 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
---------------- ---------------- ---------------- ----------------
Revenues $47,704 $51,718 $56,242 $62,740
Income before income taxes $ 6,014 $ 5,947 $ 6,376 $ 7,406
Net income $ 3,928 $ 3,859 $ 4,246 $ 4,950
Earnings per share /(1)/ $ .41 $ .40 $ .44 $ .50
Cash dividend declared per common share /(1)/ $ .045 $ .045 $ .045 $ .045
Stock Price Range
High $ 12.25 $ 14.38 $ 18.25 $ 17.94
Low $ 10.75 $ 11.50 $ 14.25 $ 14.88
1996 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
---------------- ---------------- ---------------- ----------------
Revenues $40,923 $46,313 $44,287 $50,285
Income before income taxes $ 4,021 $ 5,149 $ 5,774 $ 6,813
Net income $ 2,624 $ 3,347 $ 3,724 $ 4,345
Earnings per share /(1)/ $ .27 $ .35 $ .38 $ .45
Cash dividend declared per common share /(1)/ $ .036 $ .036 $ .036 $ .036
Stock Price Range
High $ 10.38 $ 10.63 $ 11.75 $ 11.75
Low $ 8.25 $ 8.75 $ 10.75 $ 11.00
(1) Adjusted to reflect a ten percent stock dividend declared on August 28,
1997 and payable on October 1, 1997 to shareholders of record on September
15, 1997.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
17
PART III
Item 10. Directors and Executive Officers of the Registrant
For information with respect to executive officers of the registrant, see
"Executive Officers of the Registrant" at the end of Part I, Item 1 of this
report.
The information required by this item regarding Directors is incorporated by
reference to pages 2 through 4 of the Company's Proxy Statement dated September
25, 1997 which will be filed with the Commission pursuant to Regulation 240.14a
(6)(c) prior to October 25, 1997.
Item 11. Executive Compensation
The information required by this item regarding Executive Compensation is
incorporated by reference to pages 7 through 9 of the Company's Proxy Statement
dated September 25, 1997 which will be filed with the Commission pursuant to
Regulation 240.14a (6)(c) prior to October 25, 1997.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item regarding security ownership of certain
beneficial owners and management is incorporated by reference to pages 5 and 6
of the Company's Proxy Statement dated September 25, 1997 which will be filed
with the Commission pursuant to Regulation 240.14a (6)(c) prior to October 25,
1997.
Item 13. Certain Relationships and Related Transactions
The information required by this item regarding Directors is incorporated by
reference to pages 2 through 6 of the Company's Proxy Statement dated September
25, 1997 which will be filed with the Commission pursuant to Regulation 240.14a
(6)(c) prior to October 25, 1997.
18
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) List of documents filed as a part of the report:
1. Exhibits required by this Item are either listed in the index
appearing on page F-1 of this report or have been previously filed
with the SEC.
2. The following consolidated financial statement schedules of the
Registrant and its subsidiaries, and Independent Auditors' Report
thereon, are attached hereto as required by Item 14 (d) :
Exhibit Number
--------------
S-1 Schedule I - Condensed Financial Information of
Registrant
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under
the related instructions or are inapplicable, and therefore have been
omitted.
3. The following exhibits of the Registrant and its subsidiaries are
attached hereto as required by Item 14(d):
Exhibit Number
--------------
3.1 Certificate of Incorporation of the Registrant
incorporated by reference to the Registrant's
Registration Statement No. 33-42338 filed August
21, 1991 (File No. 0-19483).
3.2 By-laws of the Registrant incorporated by
reference to Amendment No. 1 to the Registrant's
Registration Statement No. 33-42338 filed
October 7, 1991 (File No. 0-19483).
3.3 Certificate of Amendment of Certificate of
Incorporation, filed September 25, 1997.
10.1 Executive compensation information incorporated
by reference to the Registrant's Proxy Statement
filed September 26, 1996.
10.2 Employees Stock Purchase Plan. Incorporated by
reference to the Registrant's Registration
Statement on Form S-8, filed November 10, 1994.
(Registration No. 33-86234)
10.3 Stock Option Plan. Incorporated by reference to
the Registrant's Proxy Statement filed September
26, 1996.
10.4 Phantom Stock Plan. Incorporated by reference to
the Registrant's Proxy Statement filed September
26, 1996.
22 Registrant's Proxy Statement dated September 25,
1997, filed September 25, 1997.
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule
(b) Reports on Form 8-K:
None.
19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Southwest Securities Group, Inc.
------------------------------------------------
(Registrant)
September 25, 1997 /s/ David Glatstein
- ------------------ ------------------------------------------------
(Date) (Signature)
David Glatstein
Director and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
September 25, 1997 /s/ Don A. Buchholz
- ------------------ ------------------------------------------------
(Date) (Signature)
Don A. Buchholz
Chairman of the Board
September 25, 1997 /s/ Raymond E. Wooldridge
- ------------------ ------------------------------------------------
(Date) (Signature)
Raymond E. Wooldridge
Director and Vice
Chairman of the Board
September 25, 1997 /s/ David Glatstein
- ------------------ ------------------------------------------------
(Date) (Signature)
David Glatstein
Director and Chief
Executive Officer
September 25, 1997 /s/ Susan M. Byrne
- ------------------ ------------------------------------------------
(Date) (Signature)
Susan M. Byrne
Director
September 25, 1997 /s/ Frederick R. Meyer
- ------------------ ------------------------------------------------
(Date) (Signature)
Frederick R. Meyer
Director
September 25, 1997 /s/ Kenneth R. Hanks
- ------------------ ------------------------------------------------
(Date) (Signature)
Kenneth R. Hanks
Chief Financial Officer
20
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS PAGE(S)
Consolidated Statements of Financial Condition F-2
as of June 27 1997 and June 28, 1996
Consolidated Statements of Income F-3
for the years ended June 27, 1997, June 28, 1996 and June 30, 1995
Consolidated Statements of Stockholders' Equity F-4
for the years ended June 27, 1997, June 28, 1996 and June 30, 1995
Consolidated Statements of Cash Flows F-5
for the years ended June 27, 1997, June 28, 1996 and June 30, 1995
Notes to Consolidated Financial Statements F-6-13
Independent Auditors' Report F-14
F-1
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 27, 1997 and June 28, 1996
(In thousands, except par values and share amounts)
1997 1996
-------------------- --------------------
ASSETS
Cash $ 10,745 $ 5,284
Assets segregated for regulatory purposes (Notes 2 and 12) 352,197 204,454
Receivable from brokers, dealers and clearing organizations (Notes 3 and 6) 2,282,304 1,455,645
Receivable from clients, net (Notes 4 and 6) 570,461 475,195
Securities owned, at market value (Notes 5 and 6) 31,921 34,593
Other assets (Note 7) 28,764 21,226
-------------------- --------------------
$3,276,392 $2,196,397
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings (Note 6) $ 4,000 $ 104,984
Payable to brokers, dealers and clearing organizations (Note 3) 2,139,611 1,313,455
Payable to clients (Note 4) 963,552 647,787
Drafts payable 31,036 25,158
Other liabilities 29,865 20,564
-------------------- --------------------
3,168,064 2,111,948
Liabilities subordinated to claims of general creditors (Note 10) 1,400 --
-------------------- --------------------
3,169,464 2,111,948
-------------------- --------------------
Stockholders' equity (Notes 8 and 14):
Preferred stock of $1.00 par value. Authorized 100,000 shares;
none issued -- --
Common stock of $.10 par value. Authorized 20,000,000 shares,
issued 10,161,599 and outstanding 10,152,422 shares in 1997.
Authorized 10,000,000 shares, issued 8,792,807 and outstanding
8,783,630 shares in 1996. 1,016 879
Additional paid-in capital 56,139 27,107
Retained earnings 49,984 56,815
Receivable from employees under the Employee Stock Purchase Plan
(Note 9) (137) (278)
Treasury stock (9,177 shares, at cost) (74) (74)
-------------------- --------------------
Total stockholders' equity 106,928 84,449
-------------------- --------------------
Commitments and contingencies (Notes 6, 9, 11 and 13)
$3,276,392 $2,196,397
==================== ====================
See accompanying Notes to Consolidated Financial Statements.
F-2
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Years ended June 27, 1997, June 28, 1996 and June 30, 1995
(In thousands, except share and per share amounts)
1997 1996 1995
------------ ------------ ------------
Net revenues from clearing operations $ 22,693 $ 17,897 $ 10,818
Commissions 38,882 36,896 26,617
Interest 119,176 95,956 63,629
Investment banking, advisory and administrative fees 16,031 12,533 9,107
Net gains on principal transactions 11,856 8,735 4,877
Other 9,766 9,791 5,133
------------ ------------ ------------
218,404 181,808 120,181
------------ ------------ ------------
Commissions and other employee compensation (Note 9) 65,062 53,433 40,416
Interest 83,238 69,092 42,308
Occupancy, equipment and computer service costs (Note 11) 12,216 9,591 8,577
Communications 11,026 9,109 6,751
Floor brokerage and clearing organization charges 4,181 3,870 3,381
Other 16,938 14,956 9,993
------------ ------------ ------------
192,661 160,051 111,426
------------ ------------ ------------
Income before income taxes 25,743 21,757 8,755
Income taxes (Note 7) 8,760 7,717 3,087
------------ ------------ ------------
Net income $ 16,983 $ 14,040 $ 5,668
============ ============ ============
Earnings per share (Note 14) $ 1.75 $ 1.45 $ .63
============ ============ ============
Weighted average shares outstanding (Note 14) 9,726,538 9,669,081 8,998,218
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
F-3
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended June 27, 1997, June 28, 1996 and June 30, 1995
(In thousands, except share and per share amounts)
Receivable
from
employees
under
Employee
Additional Stock
Common Stock paid-in Retained Purchase Treasury
Shares Amount capital earnings Plan stock Total
-----------------------------------------------------------------------------------
Balance at June 24, 1994 8,248,299 $ 867 $26,224 $ 39,671 $ -- $(2,896) $ 63,866
Purchase of treasury stock (286,727) -- -- -- -- (1,880) (1,880)
Issuance of common stock for
acquisition 740,702 9 636 -- -- 4,355 5,000
Net income -- -- -- 5,668 -- -- 5,668
Dividends ($.13/share)
(Note 14) -- -- -- (1,158) -- -- (1,158)
Issuance of common stock for
Employee Stock Purchase
Plan 61,122 -- -- -- (421) 421 --
Proceeds from employees for
Employee Stock Purchase
Plan -- -- -- -- 45 -- 45
-----------------------------------------------------------------------------------
Balance at June 30, 1995 8,763,396 876 26,860 44,181 (376) -- 71,541
Purchase of treasury stock (9,177) -- -- -- -- (74) (74)
Issuance of common stock 29,411 3 247 -- -- -- 250
Net income -- -- -- 14,040 -- -- 14,040
Dividends ($.14/share)
(Note 14) -- -- -- (1,406) -- -- (1,406)
Proceeds from employees for
Employee Stock Purchase
Plan -- -- -- -- 98 -- 98
-----------------------------------------------------------------------------------
Balance at June 28, 1996 8,783,630 879 27,107 56,815 (278) (74) 84,449
Issuance of common stock for
acquisition 445,845 45 7,089 -- -- -- 7,134
Net income -- -- -- 16,983 -- -- 16,983
Dividends ($.18/share)
(Note 14) -- -- -- (1,779) -- -- (1,779)
Stock dividend declared on
August 28, 1997 (Note 14) 922,947 92 21,943 (22,035) -- -- --
Proceeds from employees for
Employee Stock Purchase
Plan -- -- -- -- 141 -- 141
-----------------------------------------------------------------------------------
Balance at June 27, 1997 10,152,422 $1,016 $56,139 $ 49,984 $ (137) $ (74) $106,928
===================================================================================
See accompanying Notes to the Consolidated Financial Statements.
F-4
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 27, 1997, June 28, 1996 and June 30, 1995
(In thousands)
1997 1996 1995
---------------- -------------- --------------
Cash flows from operating activities:
Net income $ 16,983 $ 14,040 $ 5,668
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization 2,750 2,815 2,860
Provision for doubtful accounts -- 984 663
Deferred income taxes (1,198) (1,208) (91)
Increase in assets segregated for regulatory purposes (128,167) (2,087) (47,957)
Net change in broker, dealer and clearing organization
accounts 1,452 (67,751) (52,373)
Net change in client accounts 203,161 24,472 24,372
Decrease (increase) in securities owned 2,672 1,972 (12,552)
Decrease (increase) in other assets 4,089 5,153 (8,296)
Increase (decrease) in drafts payable 5,878 (201) 6,997
Increase (decrease) in other liabilities 8,315 (8,607) 9,977
---------------- -------------- --------------
Net cash provided by (used in) operating activities 115,935 (30,418) (70,732)
---------------- -------------- --------------
Cash flows from investing activities:
Purchase of fixed assets (7,597) (2,725) (1,757)
Proceeds from sale of fixed assets 96 481 --
---------------- -------------- --------------
Net cash used in investing activities (7,501) (2,244) (1,757)
---------------- -------------- --------------
Cash flows from financing activities:
Net change in short-term borrowings (100,984) 35,445 69,539
Payment of capital lease obligation -- -- (723)
Proceeds from employees for Employee Stock Purchase Plan 141 98 45
Purchase of treasury stock -- (74) (1,880)
Net proceeds from issuance of common stock -- 250 --
Payment of cash dividends on common stock (2,130) (1,362) (1,110)
---------------- -------------- --------------
Net cash provided by (used in) financing activities (102,973) 34,357 65,871
---------------- -------------- --------------
Net increase (decrease) in cash 5,461 1,695 (6,618)
Cash at beginning of year 5,284 3,589 10,207
---------------- -------------- --------------
Cash at end of year $ 10,745 $ 5,284 $ 3,589
================ ============== ==============
See accompanying Notes to Consolidated Financial Statements.
F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
(a) General and Basis of Presentation
The consolidated financial statements include the accounts of
Southwest Securities Group, Inc. ("Parent") and its wholly owned subsidiaries
(collectively "Company"), Southwest Securities, Inc. ("Southwest"), Brokers
Transaction Services, Inc. ("BTS"), Southwest Investment Advisors ("Advisors"),
SW Capital Corporation ("Capital"), Trust Company of Texas ("Trust Company"),
Westwood Management Corporation ("Westwood"), SWST Computer Corporation
("Computer Corp."), Sovereign Securities, Inc. ("Sovereign"), and Equity
Securities Trading Company, Inc. ("ESTC").
Southwest, BTS, Sovereign and ESTC are registered broker/dealers under
the Securities Exchange Act of 1934 ("1934 Act"). Sovereign, a discount
brokerage firm, began operations in 1997. ESTC, a regional securities clearing
firm based in Minneapolis, was acquired May 1, 1997 through the issuance of
445,845 shares of common stock. The acquisition was accounted for under the
purchase method of accounting and, accordingly, assets and liabilities were
recorded at their fair market values on the date of acquisition. Goodwill
relating to this acquisition of approximately $5,113,000 is recorded in other
assets in the accompanying consolidated statements of financial condition.
Westwood and Advisors are registered investment advisors under the
Investment Advisors Act of 1940. Computer Corp., which was formed in 1996,
provides computer processing and programming services to affiliates as well as
third parties. All significant intercompany balances and transactions have been
eliminated.
Effective May 26, 1995, the Company acquired Barre & Company, Inc.
("Barre"), a Dallas-based brokerage firm, through the issuance of 740,702 shares
of common stock. The acquisition was accounted for under the purchase method of
accounting and, accordingly, assets and liabilities were recorded at their fair
market values on the date of acquisition. Simultaneous with the acquisition,
the assets and liabilities of Barre were merged with Southwest, and Barre was
dissolved. Goodwill relating to this acquisition of approximately $270,000 is
recorded in other assets in the accompanying consolidated statements of
financial condition.
The annual consolidated financial statements are prepared as of the
close of business on the last Friday of June. Accordingly, the fiscal years for
1997, 1996, and 1995 ended June 27, 1997, June 28, 1996 and June 30, 1995,
respectively.
(b) Securities Transactions
Securities transactions are recorded on a settlement date basis with
such transactions generally settling three business days after trade date.
Revenues and expenses related to such transactions are also recorded on
settlement date which is not materially different than trade date.
(c) Securities Owned
Marketable securities are carried at quoted market value. The
increase or decrease in net unrealized appreciation or depreciation of
securities owned is credited or charged to operations and is included in net
gains on principal transactions in the consolidated statements of income.
(d) Depreciation and Amortization
Depreciation of furniture, equipment, and leasehold improvements is
provided over the estimated useful lives of the assets (5 or 7 years).
Equipment under capital leases is amortized on a straight-line basis over the
terms of the leases. Goodwill is amortized on a straight-line basis over
periods ranging from twenty-five to forty years.
(e) Drafts Payable
In the normal course of business, Southwest uses drafts to make
payments relating to its brokerage transactions. These drafts are presented for
payment through Southwest's bank and are sent to Southwest daily for review and
acceptance. Upon acceptance, the drafts are paid and charged against cash.
(f) Reverse Repurchase and Repurchase Agreements
Securities purchased under agreements to resell ("Reverse Repurchase
Agreements") and securities sold under agreements to repurchase ("Repurchase
Agreements") are carried at the amounts at which these securities will
F-6
be subsequently resold or reacquired as specified in the respective agreements
(Notes 2 and 6). Management regularly monitors the market value of the
underlying securities relating to outstanding repurchase and reverse repurchase
agreements.
(g) Federal Income Taxes
The Company and its subsidiaries file a consolidated Federal income
tax return.
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(h) Cash Flow Reporting
For the purposes of the consolidated statements of cash flows, the
Company considers cash to include cash on hand and in depository accounts.
Assets segregated for regulatory purposes are not included as cash
equivalents for purposes of the consolidated statements of cash flows because
such assets are segregated for the benefit of customers only.
Cash paid during the year for interest was $82,936,000, $67,616,000
and $41,280,000, in 1997, 1996 and 1995, respectively. Cash paid during the
year for income taxes was $9,235,000, $8,742,000 and $3,587,000 in 1997, 1996
and 1995, respectively.
During 1995, the Company loaned $421,000 to employees under an
Employee Stock Purchase Plan for the purchase of 61,122 shares of Treasury stock
(Note 9). During 1997 and 1995, the Company issued common stock valued at
approximately $7,134,000 and $5,000,000, respectively, related to acquisitions.
(i) Earnings Per Share
Earnings per share are computed by dividing net income by the weighted
average number of common shares and common share equivalents outstanding, after
taking into effect the issuance of common stock and the purchase of Treasury
shares as discussed in (h) and (k), respectively (also see Note 14). Common
share equivalents include shares issuable under stock options and are determined
under the treasury stock method.
(j) Authorization of Common Stock
On November 6, 1996, the shareholders voted to increase the number of
shares of common stock authorized to 20,000,000.
(k) Purchase of Treasury Stock
The Company's Board of Directors authorized the repurchase of up to
1,000,000 shares of the Company's common stock in the open market during fiscal
1994. A total of 710,527 shares were repurchased under this plan in fiscal 1995
and 1994. These shares were issued to employees under the Employee Stock
Purchase Plan and for the acquisition of Barre.
(l) Use of Estimates
The preparation of consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(m) Fair Value of Financial Instruments
Substantially all of the Company's financial assets and liabilities
are carried at market value or at amounts which, because of their short-term
nature, approximate current fair value. The Company's borrowings, if
recalculated based on current interest rates, would not significantly differ
from the amounts recorded at June 27, 1997 and June 28, 1996.
F-7
2. ASSETS SEGREGATED FOR REGULATORY PURPOSES
At June 27, 1997, the Company had cash of $90,000, U.S. Treasury
securities with a market value of $119,984,000 and reverse repurchase agreements
of $232,123,000 segregated in special reserve bank accounts for the exclusive
benefit of customers under Rule 15c3-3 of the 1934 Act, at a subsidiary (Note
12). Under a master repurchase agreement ("Agreement") with Trust Company,
securities purchased under these reverse repurchase agreements are identified
and segregated by Trust Company on its books and records as subject to the
Agreement.
Reverse repurchase agreements are entered into with third parties. The
underlying securities purchased under these reverse repurchase agreements are
delivered to Trust Company by these third parties, versus payment. Reverse
repurchase agreements at June 27, 1997 were collateralized by U.S. Government
securities with market values of approximately $234,372,000.
At June 28, 1996, the Company had U.S. Treasury securities with market
values of $104,362,000 and reverse repurchase agreements of $100,092,000 in
these accounts. The reverse repurchase agreements were collateralized by U.S.
Government securities with market values of approximately $101,013,000 at June
28, 1996.
3. RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
At June 27, 1997 and June 28, 1996, the Company had receivable from
and payable to brokers, dealers and clearing organizations related to the
following (in thousands):
1997 1996
--------------- ---------------
Receivable:
Securities failed to deliver $ 15,213 $ 22,013
Securities borrowed 2,159,204 1,341,788
Correspondent broker/dealers 62,235 72,207
Clearing organizations 7,355 547
Other 38,297 19,090
--------------- ---------------
$2,282,304 $1,455,645
=============== ===============
Payable:
Securities failed to receive $ 17,889 $ 15,138
Securities loaned 2,102,972 1,286,199
Correspondent broker/dealers 9,013 7,293
Other 9,737 4,825
--------------- ---------------
$2,139,611 $1,313,455
=============== ===============
Securities failed to deliver and receive represent the contract value
of securities that have not been delivered or received subsequent to settlement
date. Securities borrowed and loaned represent deposits made to or received from
other broker/dealers relating to these transactions. These deposits approximate
the market value of the underlying securities.
The Company clears securities transactions for correspondent
broker/dealers. Settled securities and related transactions for these
correspondents are included in the receivable from and payable to brokers,
dealers and clearing organizations.
The Company participates in the securities borrowing and lending
business by borrowing and lending securities other than those of its clients.
All open positions are adjusted to market values daily. The amounts receivable
and payable, relating to open positions for the securities borrowed and
securities loaned other than those of the Company's clients, were $2,097,048,000
and $2,087,147,000 at June 27, 1997 and $1,276,337,000 and $1,277,410,000 at
June 28, 1996.
4. RECEIVABLE FROM AND PAYABLE TO CLIENTS
Receivable from and payable to clients include amounts due on cash and
margin transactions. Included in these amounts are receivable from and payable
to noncustomers (as defined by Rule 15c3-3 of the 1934 Act, principally
officers, directors and related accounts), which aggregated approximately
$1,969,000 and $6,825,000 at
F-8
June 27, 1997 and $2,815,000 and $3,093,000 at June 28, 1996. Securities
accounts of noncustomers are subject to the same terms and regulations as those
of customers. Securities owned by customers and noncustomers that collateralize
the receivable are not reflected in the accompanying consolidated financial
statements.
The Company pays interest on certain customer "free credit" balances
available for reinvestment. The aggregate balance of such funds was
approximately $688,418,000 and $494,391,000 at June 27, 1997 and June 28, 1996,
respectively. During fiscal years 1997 and 1996, the interest rates paid on
these balances ranged from 4.5% to 5%. While the Company pays interest on these
funds at varying rates, the rate paid at June 27, 1997 was 4.75%.
The Company maintains an allowance for doubtful accounts which
represents amounts, in the judgment of management, that are necessary to
adequately absorb losses from known and inherent risks in receivables from
customers. Provisions made to this allowance are charged to operations. At June
27, 1997 and June 28, 1996, all unsecured customer receivables had been provided
for in this allowance.
5. SECURITIES OWNED
Securities owned at June 27, 1997 and June 28, 1996, which are carried
at market value, include the following (in thousands):
1997 1996
---------- ----------
Corporate equity securities $ 2,280 $ 2,456
Municipal obligations 13,604 16,318
U.S. Government and Government agency obligations 9,205 8,730
Corporate obligations 3,064 6,703
Commercial paper 2,446 --
Other 1,322 386
---------- ----------
$31,921 $34,593
========== ==========
Certain of the above securities have been pledged to secure short-term
borrowings and as security deposits at clearing organizations for the Company's
clearing business. These pledged securities amounted to $1,583,000 and
$1,914,000 at June 27, 1997 and June 28, 1996, respectively.
6. SHORT-TERM BORROWINGS
The Company has credit arrangements with commercial banks, which
include broker loan lines up to $207,000,000. These lines of credit are used
primarily to finance securities owned, securities held for correspondent
broker/dealer accounts, and receivables in customers' margin accounts. These
lines may also be used to release pledged collateral against day loans. These
credit arrangements are provided on an "as offered" basis and are not committed
lines of credit. These arrangements can be terminated at any time by the lender.
Any outstanding balances under these credit arrangements are due on demand and
bear interest at rates indexed to the federal funds rate (5.56% at June 27, 1997
and 5.25 % at June 28, 1996).
There were no amounts outstanding at June 27, 1997 on these credit
arrangements. The amount outstanding under these secured credit arrangements was
$94,995,000 at June 28, 1996 which was collateralized by marketable securities
owned valued at approximately $17,772,000, securities held for correspondent
broker/dealer accounts valued at approximately $68,193,000, and clients'
securities valued at approximately $57,436,000. The weighted average interest
rate was 5.93% and 6.12% for the years ended June 27, 1997 and June 28, 1996,
respectively.
In addition to the broker loan lines, the Parent has a $10,000,000
unsecured line of credit which is due on demand and bears interest at rates
indexed to the federal funds rate. The amount outstanding under this unsecured
line of credit was $4,000,000 at June 27, 1997.
At June 28, 1996 the Company had a repurchase agreement totaling
$9,989,000 which matured July 3, 1996. The repurchase agreement was
collateralized by certain U.S. Government agency securities, held by a third
party, with a market value of $9,989,000. At June 27, 1997, the Company had no
such repurchase agreements outstanding.
F-9
Additionally, the Company has an irrevocable letter of credit
agreement aggregating $26,600,000 at June 27, 1997 and $12,800,000 at June 28,
1996 pledged to support its open options positions with an options clearing
organization. The letter of credit bears interest at the brokers' call rate, if
drawn, and is renewable annually. This letter of credit is fully collateralized
by marketable securities held in clients' and nonclients' margin accounts with a
value of $29,618,000 and $21,532,000 at June 27, 1997 and June 28, 1996,
respectively.
7. INCOME TAXES
Income tax expense for the fiscal years ended June 27, 1997, June 28,
1996 and June 30, 1995 (effective rate of 34.0% in 1997, 35.5% in 1996 and 35.3%
in 1995) differs from the amount that would otherwise have been calculated by
applying the Federal corporate tax rate (35% in 1997, 1996 and 1995) to income
before income taxes and is comprised of the following (in thousands):
1997 1996 1995
--------- --------- ---------
Income tax expense at the statutory rate $9,010 $7,615 $3,064
Tax exempt interest (321) (274) (117)
Other, net 71 376 140
--------- --------- ---------
$8,760 $7,717 $3,087
========= ========= =========
Income taxes as set forth in the consolidated statements of income
consisted of the following components (in thousands):
1997 1996 1995
--------- -------- --------
Current $ 9,958 $ 8,925 $3,178
Deferred (1,198) (1,208) (91)
--------- -------- --------
Total income taxes $ 8,760 $ 7,717 $3,087
========= ======== ========
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities as of June 27, 1997 and June 28, 1996 are
presented below (in thousands):
1997 1996
--------- ---------
Deferred tax assets:
Expenses for book, not taxable
until paid $2,417 $1,680
Partnership basis in excess of financial
reporting basis 756 649
Management incentive compensation 826 210
Other 79 262
--------- ---------
Total gross deferred tax assets 4,078 2,801
Deferred tax liabilities:
Unrealized gains (15) (44)
Depreciation at rates different for tax
than for financial reporting -- (102)
Other (210) --
--------- ---------
Total gross deferred tax liabilities (225) (146)
--------- ---------
Net deferred tax assets $3,853 $2,655
========= =========
As a result of the Company's history of taxable income and the nature
of the items from which deferred tax assets are derived, management believes
that it is more likely than not that the Company will realize the benefit of the
deferred tax assets.
F-10
8. NET CAPITAL REQUIREMENTS
The broker/dealer subsidiaries are subject to the Securities and
Exchange Commission's Uniform Net Capital Rule (the "Rule"), which requires the
maintenance of minimum net capital. Southwest has elected to use the alternative
method, permitted by the Rule, which requires that it maintain minimum net
capital, as defined in Rule 15c3-1 under the 1934 Act, equal to the greater of
$1,500,000 or 2% of aggregate debit balances, as defined in Rule 15c3-3 under
the 1934 Act. At June 27, 1997, Southwest had net capital of $66,100,000 or
approximately 11% of aggregate debit balances, which is $53,587,000 in excess of
its minimum net capital requirement of $12,513,000 at that date. Additionally,
the net capital rule of the New York Stock Exchange, Inc. (the "Exchange")
provides that equity capital may not be withdrawn or cash dividends paid if
resulting net capital would be less than 5% of aggregate debit items. At June
27, 1997, Southwest had net capital of $34,818,000 in excess of 5% of aggregate
debit items.
ESTC has also elected to use the alternative method, permitted by the
Rule. At June 27, 1997, ESTC had net capital of $5,011,000, or approximately 7%
of aggregate debit balances, which is $3,569,000 in excess of its minimum net
capital requirement of $1,442,000 at that date. Additionally, at June 27, 1997,
ESTC had net capital of $1,407,000 in excess of 5% of aggregate debit items.
BTS follows the primary (aggregate indebtedness) method under Rule
15c3-1, which requires it to maintain minimum net capital of $100,000. BTS had
net capital of $154,000 which is $54,000 in excess of its minimum net capital
requirement at June 27, 1997.
Sovereign also follows the primary (aggregate indebtedness) method
under Rule 15c3-1, which requires it to maintain minimum net capital of $50,000.
At June 27, 1997, Sovereign had net capital of $93,000 which is $43,000 in
excess of its minimum net capital requirement.
Trust Company is subject to the capital requirements of the Texas
Department of Banking, and has a minimum capital requirement of $1,000,000.
Trust Company had total stockholder's equity of $4,632,000, which is $3,632,000
in excess of its minimum capital requirement at June 27, 1997.
9. EMPLOYEE BENEFITS
The Company has a defined contribution profit sharing plan covering
substantially all employees. Profit sharing plan benefits become fully vested
after six years of service by the participant. Costs of the profit sharing plan
are accrued and funded at the Company's discretion. Profit sharing expense for
fiscal years 1997, 1996 and 1995 was approximately $3,338,000, $3,692,000, and
$3,751,000, respectively.
The Company adopted an Employee Stock Purchase Plan ("Plan") as of
August 30, 1994 to enable employees of the Company to purchase up to 468,227
shares of common stock of the Company. Substantially all full-time employees
were eligible to purchase a minimum of $2,500 up to a maximum of $50,000 of the
common stock, subject to certain limitations, at a price of $6.89 per share. The
terms of the Plan provide that the Company will loan the full purchase price of
the stock to the employee under a promissory note due in monthly installments
over a five-year period, bearing interest at the Applicable Federal Rate (6.60%
at June 27, 1997). A total of 61,122 shares were sold under the terms of the
Plan, resulting in loans to employees of $421,000. The amount outstanding under
these notes at June 27, 1997 was $137,000.
On November 6, 1996, the shareholders of the Company approved the
Stock Option Plan ("Option Plan") adopted by the Board of Directors on September
17, 1996, pursuant to which options may be granted to eligible employees of the
Company or its subsidiaries for the purchase of an aggregate of 1,000,000 shares
of common stock of the Company. No options were granted under the Option Plan in
fiscal year 1997.
On November 6, 1996, the shareholders of the Company approved the
Phantom Stock Plan ("Phantom Plan") adopted by the Board of Directors on
September 17, 1996. The Phantom Plan allows non-employee directors to receive
directors fees in the form of common stock units. No units were issued under the
Phantom Plan in fiscal 1997.
F-11
10. LIABILITIES SUBORDINATED TO CLAIMS OF GENERAL CREDITORS
Liabilities subordinated to the claims of general creditors represent
loans to ESTC. The loans are covered by agreements approved by the Exchange, and
are thus available to the Company in computing net capital under the Rule. To
the extent that such borrowings are required for the Company's continued
compliance with the minimum net capital requirements, they may not be repaid.
Subordinated notes include the following (in thousands):
Due to officer, due 1/31/98, interest at 2%/(1)/ $ 400
Due to officer, due 2/28/98, interest at prime + 1/2% 500
Due to officer, due 8/31/97, interest at prime + 1/2% 500
---------------
$1,400
===============
/(1)/ This subordinated note is related to secured demand notes receivable
which bear interest at 2% and are collateralized by securities with a
market value of approximately $9,457,000 at June 27, 1997.
11. COMMITMENTS AND CONTINGENCIES
The Company leases its offices under noncancelable operating lease
agreements. During fiscal 1997, the Company entered into various noncancelable
operating lease agreements relating to data processing equipment used in the
brokerage operations. Rental expense for fiscal years 1997, 1996 and 1995,
aggregated approximately $3,172,000, $2,543,000, and $2,092,000, respectively.
At June 27, 1997, the future rental payments for the noncancelable
leases for each of the following five fiscal years and thereafter follow (in
thousands):
Year ending:
1998 $ 4,972
1999 4,843
2000 3,619
2001 2,844
2002 2,484
Thereafter 6,854
----------
Total payments due $25,616
==========
In the general course of its brokerage business and the business of
clearing for other brokerage firms, the Company and/or its subsidiaries have
been named as defendants in various lawsuits and arbitration proceedings. These
claims allege violation of Federal and state securities laws. Management
believes that resolution of these claims will not result in any material adverse
effect on the Company's consolidated financial position or results of
operations.
12. AFFILIATE TRANSACTIONS
The Company, through its principal subsidiary, Southwest, provides
accounting and administrative services for its subsidiaries and clears all
customer transactions for BTS and Sovereign. The assets discussed in Note 2 are
segregated in a special reserve account at Trust Company for the exclusive
benefit of customers under Rule 15c3-3 of the 1934 Act. Westwood serves as the
investment manager for these assets. In addition, Westwood serves as the
investment manager of the common trust funds of Trust Company.
13. FINANCIAL INSTRUMENTS WITH OFF-STATEMENT OF FINANCIAL CONDITION RISK
In the normal course of business, the broker/dealer subsidiaries
engage in activities involving the execution, settlement and financing of
various securities transactions. These activities may expose the Company to off-
statement of financial condition credit and market risks in the event the
customer or counterparty is unable to fulfill its contractual obligation. Such
risks may be increased by volatile trading markets.
F-12
As part of its normal brokerage activities, Southwest sells securities
not yet purchased (short sales) for its own account. The establishment of short
positions exposes the Company to off-statement of financial condition market
risk in the event prices increase, as Southwest may be obligated to acquire the
securities at prevailing market prices.
The Company seeks to control the risks associated with its customer
activities, including customer accounts of its correspondents for which it
provides clearing services, by requiring customers to maintain margin collateral
in compliance with various regulatory and internal guidelines. The required
margin levels are monitored daily and, pursuant to such guidelines, customers
are required to deposit additional collateral or to reduce positions when
necessary.
A portion of the Company's customer activity involves short sales and
the writing of option contracts. Such transactions may require the Company to
purchase or sell financial instruments at prevailing market prices in order to
fulfill the customer's obligations.
At times, the Company lends money using reverse repurchase agreements.
All positions are collateralized by U.S. Government or U.S. Government agency
securities. Such transactions may expose the Company to off-statement of
financial condition risk in the event such borrowers do not repay the loans and
the value of collateral held is less than that of the underlying receivable.
These agreements provide the Company with the right to maintain the relationship
between market value of the collateral and the receivable.
The Company arranges secured financing by pledging securities owned
and unpaid customer securities for short-term borrowings to satisfy margin
deposits of clearing organizations. The Company also actively participates in
the borrowing and lending of securities. In the event the counterparty in these
and other securities loaned transactions is unable to return such securities
pledged or borrowed or to repay the deposit placed with them, the Company may be
exposed to the risks of acquiring the securities at prevailing market prices or
holding collateral possessing a market value less than that of the related
pledged securities. The Company seeks to control the risks by monitoring the
market value of securities pledged and requiring adjustments of collateral
levels where necessary.
14. SUBSEQUENT EVENTS
On August 28, 1997, the Board of Directors declared a ten percent
stock dividend payable on October 1, 1997 to shareholders of record at the close
of business on September 15, 1997. Per share amounts, dividends per share,
shares outstanding as of June 27, 1997 and weighted average shares outstanding
have been restated in the accompanying financial statements.
F-13
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Southwest Securities Group, Inc.:
We have audited the consolidated financial statements of Southwest
Securities Group, Inc. and subsidiaries as listed in the accompanying index on
page F-1. In connection with our audits of the consolidated financial
statements, we also have audited the financial statement schedule as listed in
the accompanying index at Part IV. These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Southwest
Securities Group, Inc. and subsidiaries as of June 27, 1997 and June 28, 1996,
and the results of their operations and their cash flows for each of the years
in the three-year period ended June 27, 1997, in conformity with generally
accepted accounting principles. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
KPMG Peat Marwick LLP
Dallas, Texas
July 29, 1997
except Note 14, which is as of August 28, 1997
F-14
S-1
SCHEDULE I - Condensed Financial Information of Registrant
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Condensed Financial Information of Registrant
Condensed Statements of Financial Condition
-------------------------------------------
June 27, 1997 and June 28, 1996
(In thousands)
ASSETS 1997 1996
- ------ ------------------- -------------------
Investment in subsidiaries, at equity $ 92,807 $64,939
Notes receivable from subsidiaries 16,700 19,500
Other assets 3,483 1,624
------------------- -------------------
$112,990 $86,063
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Loans payable $ 4,000 $ --
Other liabilities 2,062 1,614
Stockholders' equity 106,928 84,449
------------------- -------------------
$112,990 $86,063
=================== ===================
S-1 (CONTINUED)
SCHEDULE I - Condensed Financial Information of Registrant - Continued
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Condensed Financial Information of Registrant
Condensed Statements of Income and
-----------------------------------
Stockholders' Equity
--------------------
Years Ended June 27, 1997, June 28, 1996 and June 30, 1995
(In thousands)
1997 1996 1995
-------------- ------------- --------------
Revenues - Interest and other income $ 2,941 $ 3,211 $ 2,758
-------------- ------------- --------------
Expenses:
Interest expense 23 2 39
Other expenses 1,972 780 972
-------------- ------------- --------------
1,995 782 1,011
-------------- ------------- --------------
Income before income tax expense
and equity in earnings of subsidiaries 946 2,429 1,747
Income tax expense (400) (1,189) (635)
-------------- ------------- --------------
Income before equity in earnings of subsidiaries 546 1,240 1,112
Equity in earnings of subsidiaries 16,437 12,800 4,556
-------------- ------------- --------------
Net income 16,983 14,040 5,668
Stockholders' equity at beginning of year 84,449 71,541 63,866
Net proceeds from issuance of common stock -- 250 --
Issuance of common stock for acquisition 7,134 -- 5,000
Proceeds from employees for Employee Stock Purchase Plan 141 98 45
Dividends (1,779) (1,406) (1,158)
Treasury stock acquired -- (74) (1,880)
-------------- ------------- --------------
Stockholders' equity at end of year $106,928 $84,449 $71,541
============== ============= ==============
S-1 (CONTINUED)
SCHEDULE I - Condensed Financial Information of Registrant - Continued
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Condensed Financial Information of Registrant
Condensed Statements of Cash Flows
----------------------------------
Years Ended June 27, 1997, June 28, 1996 and June 30, 1995
(In thousands)
1997 1996 1995
--------------- --------------- ---------------
Cash flows from operating activities:
Net income $ 16,983 $ 14,040 $ 5,668
Adjustments:
Undistributed equity in earnings of subsidiaries (20,695) (12,800) (4,556)
Depreciation and amortization -- 175 403
Other 186 887 (316)
--------------- --------------- ---------------
Net cash provided by (used in) operating
activities (3,526) 2,302 1,199
--------------- --------------- ---------------
Cash flows from investing activities:
Proceeds from (payments on) notes and other
accounts with subsidiaries 1,515 (847) 5,593
Purchase of investments -- (367) (3,124)
--------------- --------------- ---------------
Net cash provided by (used in) investing
activities 1,515 (1,214) 2,469
--------------- --------------- ---------------
Cash flows from financing activities:
Purchase of treasury stock -- (74) (1,880)
Net increase in notes payable 4,000 -- --
Payments of capital lease obligations -- -- (723)
Net proceeds from issuance of common stock -- 250 --
Dividends on common stock (2,130) (1,362) (1,110)
Proceeds from employees for Employee Stock Purchase
Plan 141 98 45
--------------- --------------- ---------------
Net cash provided by (used in) financing
activities 2,011 (1,088) (3,668)
--------------- --------------- ---------------
Net change in cash -- -- --
Cash at beginning of year 1 1 1
--------------- --------------- ---------------
Cash at end of year $ 1 $ 1 $ 1
=============== =============== ===============
- ---------------
Note: During 1995, the Company loaned $421,000 to employees under an Employee
Stock Purchase Plan for the purchase of 61,122 shares of Treasury stock. During
1997 and 1995, the Company issued common stock valued at $7,134,000 and
$5,000,000 related to acquisitions.