UNITED STATES
FORM 10-Q
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2002
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-13731
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
|
Virginia
(State or other jurisdiction of incorporation or organization) |
54-1837743 (I.R.S. Employer Identification No.) |
1001 Nineteenth Street North
(703) 312-9500
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 o
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
| Title | Outstanding | |
|
Class A Common Stock
|
19,991,524 shares as of July 31, 2002 | |
|
Class B Common Stock
|
26,375,999 shares as of July 31, 2002 |
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
| Page Number(s) | |||||||
| Part I. FINANCIAL INFORMATION | |||||||
|
Item 1.
|
Financial Statements — (unaudited)
|
||||||
|
Consolidated Balance Sheets —
June 30, 2002 and December 31, 2001 |
3 | ||||||
|
Consolidated Statements of
Operations —
Three Months Ended June 30, 2002 and 2001 |
4 | ||||||
|
Six Months Ended June 30, 2002
and 2001
|
5 | ||||||
|
Consolidated Statements of Cash
Flows —
Six Months Ended June 30, 2002 and 2001 |
6 | ||||||
|
Notes to Consolidated Financial Statements
|
7–14 | ||||||
|
Item 2.
|
Management’s Discussion and Analysis of
Financial
|
||||||
|
Condition and Results of Operations
|
15–20 | ||||||
|
Item 3.
|
Changes in Information about Market Risk
|
21 | |||||
| Part II. OTHER INFORMATION | |||||||
|
Item 4.
|
Submission of Matters to a Vote of Security
Holders
|
22 | |||||
|
Item 6.
|
Reports on Form 8-K
|
22 | |||||
| SIGNATURES | 23 | ||||||
2
PART I — FINANCIAL INFORMATION
Item 1 — Financial Statements — (Unaudited)
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
| June 30, 2002 | December 31, 2001 | ||||||||||
| (Unaudited) | |||||||||||
|
ASSETS
|
|||||||||||
|
Cash and cash equivalents
|
$ | 50,120 | $ | 46,246 | |||||||
|
Receivables:
|
|||||||||||
|
Investment banking
|
4,273 | 3,464 | |||||||||
|
Asset management fees
|
8,129 | 3,604 | |||||||||
|
Affiliates
|
2,581 | 2,209 | |||||||||
|
Other
|
5,209 | 4,352 | |||||||||
|
Due from clearing broker
|
76,161 | 44,621 | |||||||||
|
Marketable and trading securities, at market value
|
2,216 | 15,706 | |||||||||
|
Bank investment securities
|
23,835 | 8,142 | |||||||||
|
Long-term investments
|
145,045 | 119,982 | |||||||||
|
Bank loans, net of allowances
|
14,071 | 12,459 | |||||||||
|
MMA acquired management contracts
|
18,090 | 18,729 | |||||||||
|
Building, furniture, equipment, software and
leasehold improvements, net of accumulated depreciation and
amortization of $18,601 and $17,138, respectively
|
8,495 | 9,203 | |||||||||
|
Prepaid expenses and other assets
|
4,007 | 3,241 | |||||||||
|
Total assets
|
$ | 362,232 | $ | 291,958 | |||||||
|
LIABILITIES AND SHAREHOLDERS’
EQUITY
|
|||||||||||
|
Liabilities:
|
|||||||||||
|
Trading account securities sold but not yet
purchased, at market value:
|
$ | 9,134 | $ | 13,377 | |||||||
|
Accounts payable and accrued expenses
|
28,299 | 19,179 | |||||||||
|
Accrued compensation and benefits
|
36,136 | 27,775 | |||||||||
|
Bank deposits
|
27,210 | 19,457 | |||||||||
|
Short-term loans payable
|
37,128 | 21,165 | |||||||||
|
Long-term secured loan
|
5,957 | 5,694 | |||||||||
|
Total liabilities
|
143,864 | 106,647 | |||||||||
|
Commitments and contingencies (Note 8)
|
— | — | |||||||||
|
Shareholders’ equity:
|
|||||||||||
|
Preferred Stock, $0.01 par value, 15,000,000
shares authorized, none issued and outstanding
|
— | — | |||||||||
|
Class A Common Stock, $0.01 par value,
150,000,000 shares authorized, 24,580,804 and 23,468,403 shares
issued, respectively
|
246 | 235 | |||||||||
|
Class B Common Stock, $0.01 par value,
100,000,000 shares authorized, 26,375,999 and 26,946,029 shares
issued and outstanding, respectively
|
264 | 269 | |||||||||
|
Additional paid-in capital
|
214,445 | 210,703 | |||||||||
|
Employee stock loan receivable (4,000,000 shares)
|
(23,416 | ) | (22,706 | ) | |||||||
|
Treasury stock, at cost, 617,810 and 809,462
shares, respectively
|
(4,507 | ) | (5,906 | ) | |||||||
|
Accumulated other comprehensive income
|
3,765 | 3,226 | |||||||||
|
Retained earnings (accumulated deficit)
|
27,571 | (510 | ) | ||||||||
|
Total shareholders’ equity
|
218,368 | 185,311 | |||||||||
|
Total liabilities and shareholders’
equity
|
$ | 362,232 | $ | 291,958 | |||||||
See notes to consolidated financial statements.
3
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
| Three Months Ended June 30, | ||||||||||
| 2002 | 2001 | |||||||||
|
Revenues:
|
||||||||||
|
Investment banking:
|
||||||||||
|
Underwriting
|
$ | 25,248 | $ | 9,414 | ||||||
|
Corporate finance
|
9,827 | 18,057 | ||||||||
|
Investment gains
|
1,595 | 5,340 | ||||||||
|
Institutional brokerage:
|
||||||||||
|
Principal transactions
|
8,372 | 5,383 | ||||||||
|
Agency commissions
|
9,954 | 5,962 | ||||||||
|
Asset management:
|
||||||||||
|
Base management fees
|
7,633 | 5,191 | ||||||||
|
Incentive allocations and fees
|
2,902 | 474 | ||||||||
|
Net investment income
|
8,517 | 5,009 | ||||||||
|
Technology sector net investment and incentive
loss
|
(2,432 | ) | (1,684 | ) | ||||||
|
Interest, dividends and other
|
1,638 | 2,006 | ||||||||
|
Total revenues
|
73,254 | 55,152 | ||||||||
|
Expenses:
|
||||||||||
|
Compensation and benefits
|
38,411 | 32,756 | ||||||||
|
Business development and professional services
|
7,982 | 8,205 | ||||||||
|
Clearing and brokerage fees
|
1,817 | 1,588 | ||||||||
|
Occupancy and equipment
|
2,046 | 2,883 | ||||||||
|
Communications
|
2,187 | 1,498 | ||||||||
|
Interest expense
|
430 | 334 | ||||||||
|
Other operating expenses
|
2,602 | 2,778 | ||||||||
|
Total expenses
|
55,475 | 50,042 | ||||||||
|
Net income before taxes
|
17,779 | 5,110 | ||||||||
|
Income tax provision
|
— | — | ||||||||
|
Net income
|
$ | 17,779 | $ | 5,110 | ||||||
|
Basic earnings per share
|
$ | 0.39 | $ | 0.10 | ||||||
|
Diluted earnings per share
|
$ | 0.36 | $ | 0.10 | ||||||
|
Weighted average shares outstanding:
|
||||||||||
|
Basic
|
45,944 | 49,209 | ||||||||
|
Diluted
|
48,772 | 49,230 | ||||||||
See notes to consolidated financial statements.
4
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
| Six Months Ended June 30, | ||||||||||
| 2002 | 2001 | |||||||||
|
Revenues:
|
||||||||||
|
Investment banking:
|
||||||||||
|
Underwriting
|
$ | 37,558 | $ | 17,068 | ||||||
|
Corporate finance
|
21,301 | 20,301 | ||||||||
|
Investment gains
|
1,786 | 5,340 | ||||||||
|
Institutional brokerage:
|
||||||||||
|
Principal transactions
|
15,430 | 11,355 | ||||||||
|
Agency commissions
|
18,699 | 12,527 | ||||||||
|
Asset management:
|
||||||||||
|
Base management fees
|
13,629 | 8,098 | ||||||||
|
Incentive allocations and fees
|
4,685 | 842 | ||||||||
|
Net investment income
|
14,539 | 6,614 | ||||||||
|
Technology sector net investment and incentive
loss
|
(3,531 | ) | (8,786 | ) | ||||||
|
Interest, dividends and other
|
3,528 | 4,246 | ||||||||
|
Total revenues
|
127,624 | 77,605 | ||||||||
|
Expenses:
|
||||||||||
|
Compensation and benefits
|
69,730 | 49,007 | ||||||||
|
Business development and professional services
|
14,394 | 13,531 | ||||||||
|
Clearing and brokerage fees
|
2,443 | 3,320 | ||||||||
|
Occupancy and equipment
|
4,255 | 5,383 | ||||||||
|
Communications
|
4,266 | 2,665 | ||||||||
|
Interest expense
|
800 | 415 | ||||||||
|
Other operating expenses
|
5,068 | 4,313 | ||||||||
|
Total expenses
|
100,956 | 78,634 | ||||||||
|
Net income (loss) before taxes and extraordinary
gain
|
26,668 | (1,029 | ) | |||||||
|
Income tax provision
|
— | — | ||||||||
|
Net income (loss) before extraordinary
gain
|
26,668 | (1,029 | ) | |||||||
|
Extraordinary gain
|
1,413 | — | ||||||||
|
Net income (loss)
|
$ | 28,081 | $ | (1,029 | ) | |||||
|
Basic earnings (loss) per share before
extraordinary gain
|
$ | 0.58 | $ | (0.02 | ) | |||||
|
Diluted earnings (loss) per share before
extraordinary gain
|
$ | 0.56 | $ | (0.02 | ) | |||||
|
Basic earnings (loss) per share
|
$ | 0.61 | $ | (0.02 | ) | |||||
|
Diluted earnings (loss) per share
|
$ | 0.59 | $ | (0.02 | ) | |||||
|
Weighted average shares outstanding:
|
||||||||||
|
Basic
|
45,804 | 49,298 | ||||||||
|
Diluted
|
47,500 | 49,298 | ||||||||
See notes to consolidated financial statements.
5
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
| Six Months Ended June 30, | |||||||||
| 2002 | 2001 | ||||||||
|
Cash flows from operating
activities:
|
|||||||||
|
Net income (loss)
|
$ | 28,081 | $ | (1,029 | ) | ||||
|
Non-cash items included in earnings:
|
|||||||||
|
Incentive allocations and fees and net investment
(income) loss from long-term investments
|
(9,781 | ) | 6,108 | ||||||
|
Depreciation and amortization
|
2,102 | 3,136 | |||||||
|
Extraordinary gain
|
(1,413 | ) | — | ||||||
|
Other
|
263 | 134 | |||||||
|
Changes in operating assets:
|
|||||||||
|
Restricted cash
|
— | 6,926 | |||||||
|
Receivables:
|
|||||||||
|
Investment banking
|
(809 | ) | (437 | ) | |||||
|
Asset management fees
|
(4,525 | ) | (912 | ) | |||||
|
Affiliates
|
(390 | ) | 1,341 | ||||||
|
Other
|
2,176 | 2,192 | |||||||
|
Due from clearing broker
|
(31,540 | ) | (10,309 | ) | |||||
|
Marketable and trading securities
|
13,490 | (4,094 | ) | ||||||
|
Prepaid expenses and other assets
|
(766 | ) | 340 | ||||||
|
Changes in operating liabilities:
|
|||||||||
|
Trading account securities sold but not yet
purchased
|
(4,243 | ) | 5,870 | ||||||
|
Accounts payable and accrued expenses
|
9,120 | 379 | |||||||
|
Accrued compensation and benefits
|
8,361 | 415 | |||||||
|
Net cash provided by operating activities
|
10,126 | 10,060 | |||||||
|
Cash flows from investment
activities:
|
|||||||||
|
MMA/ Rushmore acquisition, net of cash acquired
|
— | (17,500 | ) | ||||||
|
Bank investment securities, net
|
(15,556 | ) | 1,147 | ||||||
|
Bank loans, net of allowances
|
(1,612 | ) | (2,894 | ) | |||||
|
Purchases of fixed assets, net
|
(755 | ) | (1,493 | ) | |||||
|
Cost of purchases of long-term investments
|
(29,312 | ) | (8,225 | ) | |||||
|
Proceeds from sales of long-term investments
|
12,830 | 25,332 | |||||||
|
Net cash used in investing activities
|
(34,405 | ) | (3,633 | ) | |||||
|
Cash flows from financing
activities:
|
|||||||||
|
Repayments of long-term secured loans
|
— | (310 | ) | ||||||
|
Borrowings (repayments) of short-term loans
|
15,963 | — | |||||||
|
Net increase (decrease) in bank deposits
|
7,753 | (5,706 | ) | ||||||
|
Proceeds from issuance of common stock
|
3,038 | — | |||||||
|
Issuance of treasury common stock
|
1,399 | 576 | |||||||
|
Net cash provided by (used in) financing
activities
|
28,153 | (5,440 | ) | ||||||
|
Net increase in cash and cash equivalents
|
3,874 | 987 | |||||||
|
Cash and cash equivalents, beginning of period
|
46,246 | 52,337 | |||||||
|
Cash and cash equivalents, end of period
|
$ | 50,120 | $ | 53,324 | |||||
See notes to consolidated financial statements.
6
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
1. Basis of Presentation:
The consolidated financial statements of Friedman, Billings, Ramsey Group, Inc. and subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Therefore, they do not include all information required by accounting principles generally accepted in the United States of America for complete financial statements. The interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the results for the periods presented. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for interim periods are not necessarily indicative of the results for the entire year. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2001 included on Form 10-K filed by the Company under the Securities Exchange Act of 1934.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. There were no changes to assumptions or critical accounting policies. Actual results could differ from those estimates.
Certain amounts in the consolidated financial statements and notes for prior periods have been reclassified to conform to the current period presentation.
2. Comprehensive Income:
The components of comprehensive income are (in thousands):
| Three Months Ended | Six Months Ended | ||||||||||||||||
| June 30, | June 30, | ||||||||||||||||
| 2002 | 2001 | 2002 | 2001 | ||||||||||||||
|
Net income (loss)
|
$ | 17,779 | $ | 5,110 | $ | 28,081 | $ | (1,029 | ) | ||||||||
|
Other comprehensive income:
|
|||||||||||||||||
|
Net change in unrealized investment gains related
to available-for-sale securities, bank securities and investment
in FBR Asset Investment Corporation
|
2,336 | 2,293 | 539 | 4,813 | |||||||||||||
|
Comprehensive income
|
$ | 20,115 | $ | 7,403 | $ | 28,620 | $ | 3,784 | |||||||||
| 3. | Long-Term Investments, Incentive Allocations and Net Investment Income: |
The Company records three types of asset management revenue:
| 1. | Certain of the Company’s subsidiaries act as investment advisers and receive management fees for the management of proprietary investment partnerships, mutual funds and FBR Asset Investment Corporation (“FBR-Asset”), based upon the amount of capital committed or under management. This revenue is recorded in base management fees in the Company’s statements of operations as earned. | |
| 2. | The Company also receives incentive allocations based upon the operating results of the partnerships and incentive fees from FBR-Asset. Incentive income represents a share of the gains in the partnerships and FBR-Asset, and is recorded in incentive allocations and fees and technology sector net investment and incentive loss in the Company’s statements of operations. The Company records incentive income from the partnerships based on when it is earned according to the related partnership or operating agreement. |
7
| 3. | The Company also records allocations, under the equity method of accounting, for its proportionate share of the earnings or losses of the partnerships and FBR-Asset. Income or loss allocations are recorded in net investment income (loss) and technology sector net investment and incentive loss in the Company’s statements of operations. |
Long-term investments consist of the following (in thousands):
| June 30, 2002 | December 31, 2001 | ||||||||
|
Equity method investments:
|
|||||||||
|
Proprietary investment partnerships excluding
technology sector
|
$ | 37,348 | $ | 42,619 | |||||
|
FBR Asset Investment Corporation
|
68,850 | 42,460 | |||||||
|
Marketable securities
|
4,630 | 4,894 | |||||||
|
Private debt investments
|
7,500 | 7,500 | |||||||
|
Cost method investments excluding technology
sector
|
750 | — | |||||||
|
Other
|
1,702 | 839 | |||||||
| 120,780 | 98,312 | ||||||||
|
Equity method investments — technology
sector
|
16,928 | 14,584 | |||||||
|
Cost method investments — technology
sector
|
7,337 | 7,086 | |||||||
| 24,265 | 21,670 | ||||||||
| $ | 145,045 | $ | 119,982 | ||||||
FBR Asset Investment Corporation (“FBR-Asset”)
During the quarter ended June 30, 2002, the Company recorded $8,761 ($13,217 year to date) of net investment income in the statement of operations for its proportionate share (reflecting share issuances) of FBR-Asset’s net income. In addition, during the quarter, the Company purchased 314,009 shares of FBR-Asset. As a result of this transaction, the Company purchased its interest above book value which, in accordance, with Statement of Financial Accounting Standards (“SFAS”) No. 141, created goodwill of $1,363. During the second quarter of 2002, the Company reduced its carrying basis of FBR-Asset for declared dividends of $3,015. During the quarter, the Company also recorded, in other comprehensive income, $2,259 of unrealized investment gains for its proportionate share of FBR-Asset’s net unrealized gains related to available-for-sale securities. During the first six months of 2002, the Company reduced its carrying basis of FBR-Asset for declared dividends of $5,747. During the first half of 2002, the Company also recorded, in other comprehensive income, $395 of unrealized investment gains for its proportionate share of FBR-Asset’s net unrealized gains related to available-for-sale securities. As of June 30, 2002, the net unrealized gain related to FBR-Asset and included in the Company’s accumulated other comprehensive income has increased to $3,550.
As of June 30, 2002, FBR-Asset’s market value per share was $33.35, which results in the Company’s investment in FBR-Asset having a market value of $83,375 compared with the book value at which the Company carries its investment of $68,850. The Company’s investment in FBR-Asset of $68,850 represents 47 percent of the Company’s total long-term investments and 19 percent of the Company’s total assets as of June 30, 2002. The following table summarizes FBR-Asset’s statements of financial condition and income statements (in thousands):
| FBR-Asset | ||||||||
| June 30, 2002 | December 31, 2001 | |||||||
|
Total assets
|
$ | 4,093,802 | $ | 1,325,125 | ||||
|
Total liabilities
|
3,403,765 | 1,121,260 | ||||||
|
Total equity
|
$ | 690,037 | $ | 203,865 | ||||
|
FBR’s share of total equity
|
$ | 68,850 | $ | 42,460 | ||||
8
| FBR-Asset | ||||||||||||||||
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2002 | 2001 | 2002 | 2001 | |||||||||||||
|
Gross revenues
|
$ | 44,555 | $ | 6,127 | $ | 64,964 | $ | 9,307 | ||||||||
|
Total expenses
|
20,465 | 2,451 | 30,130 | 4,938 | ||||||||||||
|
Net income before net investment income (loss)
|
24,090 | 3,676 | 34,834 | 4,369 | ||||||||||||
|
Net investment income (loss)
|
7,608 | 348 | 14,823 | (217 | ) | |||||||||||
|
Net income before taxes
|
31,698 | 4,024 | 49,657 | 4,152 | ||||||||||||
|
Income tax provision
|
111 | — | 166 | — | ||||||||||||
|
Net income
|
$ | 31,587 | $ | 4,024 | $ | 49,491 | $ | 4,152 | ||||||||
Available-For-Sale Securities
As of June 30, 2002, the unrealized gains related to available-for-sale securities have increased to $215 and are included in accumulated other comprehensive income.
4. Executive Officer Compensation:
During 2002, certain of the Company’s executive officers are eligible for incentive bonuses under the Key Employee Incentive Plan (the “Plan”). The incentive bonus pool is calculated as up to twenty percent of pre-tax profits. During the six months ended June 30, 2002, the Company recorded $7,020 of executive officer compensation, and, as of June 30, 2002, the Company has $5,530 of executive officer compensation accrued.
5. Income Taxes:
The Company has a net operating loss (NOL) carryforward to offset future taxable income. As of June 30, 2002, the Company has gross NOL carryforwards of approximately $20 million that expire through 2020. The Company maintains a valuation allowance related to the NOL and a net deferred tax asset. As a result of recording the valuation allowance, based on current evidence, the Company estimates that future income tax provisions recorded in the Consolidated Statement of Operations will be calculated excluding approximately $30 million in pre-tax income.
6. Net Capital Requirements:
The Company’s U.S. 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 and requires the ratio of aggregate indebtedness to net capital, both as defined by the rule, not to exceed 15 to 1. The Company’s U.K. broker-dealer subsidiary is subject to the net capital rules of the Financial Services Authority. As of June 30, 2002, the broker-dealer subsidiaries had aggregate net capital of $51.1 million, which exceeded the requirements by $46.9 million.
9
7. Earnings (Loss) Per Share:
The following table presents the computations of basic and diluted earnings per share for the three and six months ended June 30, 2002 and 2001:
| Three Months Ended | Three Months Ended | ||||||||||||||||
| June 30, 2002 | June 30, 2001 | ||||||||||||||||
| Basic | Diluted | Basic | Diluted | ||||||||||||||
|
Weighted average shares outstanding:
|
|||||||||||||||||
|
Common stock
|
45,944 | 45,944 | 49,209 | 49,209 | |||||||||||||
|
Stock options
|
— | 2,828 | — | 21 | |||||||||||||
|
Weighted average common and common equivalent
shares outstanding
|
45,944 | 48,772 | 49,209 | 49,230 | |||||||||||||
|
Net earnings applicable to common stock
|
$ | 17,779 | $ | 17,779 | $ | 5,110 | $ | 5,110 | |||||||||
|
Earnings per common share
|
$ | 0.39 | $ | 0.36 | $ | 0.10 | $ | 0.10 | |||||||||
| Six Months Ended | Six Months Ended | ||||||||||||||||
| June 30, 2002 | June 30, 2001 | ||||||||||||||||
| Basic | Diluted | Basic | Diluted | ||||||||||||||
|
Weighted average shares outstanding:
|
|||||||||||||||||
|
Common stock
|
45,804 | 45,804 | 49,298 | 49,298 | |||||||||||||
|
Stock options
|
— | 1,696 | — | — | |||||||||||||
|
Weighted average common and common equivalent
shares outstanding
|
45,804 | 47,500 | 49,298 | 49,298 | |||||||||||||
|
Net earnings (loss) applicable to common
stock
|
$ | 28,081 | $ | 28,081 | $ | (1,029 | ) | $ | (1,029 | ) | |||||||
|
Earnings (loss) per common share
|
$ | 0.61 | $ | 0.59 | $ | (0.02 | ) | $ | (0.02 | ) | |||||||
As of June 30, 2002 and 2001, respectively, 11,566,782 and 12,370,800 (includes 4,000,000 and 3,382,400 shares in 2002 and 2001, respectively, associated with the Employee Stock Purchase and Loan Plan that are treated as options) options to purchase shares of common stock were outstanding. As of June 30, 2002 and 2001, respectively, 4,129,353 and 5,671,962 of the total outstanding options were exercisable and 2,518,575 and 12,370,800 were anti-dilutive.
8. Commitments and Contingencies:
Contractual Obligations
The Company has contractual obligations to make future payments in connection with short and long-term debt and non-cancelable lease agreements as well as uncalled capital commitments to various investment partnerships that may be called over the next ten years. The following table sets forth these contractual obligations by fiscal year:
| 2002 | 2003 | 2004 | 2005 | 2006 | Thereafter | Total | |||||||||||||||||||||||
|
Short-term debt(1)
|
$ | 37,128 | $ | 970 | $ | — | $ | — | $ | — | $ | — | $ | 38,098 | |||||||||||||||
|
Long-term debt
|
— | — | 970 | 970 | 970 | 4,850 | 7,760 | ||||||||||||||||||||||
|
Minimum rental commitments
|
2,168 | 3,412 | 1,858 | 541 | 396 | 1,669 | 10,044 | ||||||||||||||||||||||
|
Uncalled capital commitments(2)
|
— | — | — | — | — | — | — | ||||||||||||||||||||||
|
Total Contractual Obligations
|
$ | 39,296 | $ | 4,382 | $ | 2,828 | $ | 1,511 | $ | 1,366 | $ | 6,519 | $ | 55,902 | |||||||||||||||
| (1) | The short-term debt obligation in 2002 includes $9.6 million in the form of a demand note which can be called at anytime. |
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| (2) | The table above does not include approximately $11.9 million of uncalled capital commitments to various investment partnerships that may be called over the next ten years because the Company cannot currently determine when, if ever, the commitments will be called. |
Litigation
As of June 30, 2002, the Company is not a defendant or plaintiff in any lawsuits or arbitrations that are expected to have a material adverse effect on the Company’s financial condition. The Company is a defendant in a small number of civil lawsuits and arbitrations (together “litigation”) relating to its various businesses. In addition, the Company is subject to regulatory oversight relating to its various businesses, including examination by regulatory bodies and requests for information relating to such examinations. There can be no assurance that these matters will not have a material adverse effect on the Company’s financial condition or results of operations in a future period. However, based on management’s review with counsel, including a review of the reserves set aside for litigation, resolution of these matters is not expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity. However, if, during any period, a potential adverse contingency should become probable or resolved, the results of operations in that period could be materially affected.
Many aspects of the Company’s business involve substantial risks of liability and litigation. Underwriters, broker-dealers and investment advisers are exposed to liability under Federal and state securities laws, other Federal and state laws and court decisions, including decisions with respect to underwriters’ liability and limitations on indemnification, as well as with respect to the handling of customer accounts. For example, underwriters may be held liable for material misstatements or omissions of fact in a prospectus used in connection with the securities being offered and broker-dealers may be held liable for statements made by their securities analysts or other personnel. In certain circumstances, broker-dealers and asset managers may also be held liable by customers and clients for losses sustained on investments. In recent years, there has been an increasing incidence of litigation involving the securities industry, including class actions that seek substantial damages. The Company is subject to the risk of litigation, including litigation that may be without merit. As the Company intends to actively defend such litigation, significant legal expenses could be incurred. An adverse resolution of any future litigation against the Company could materially affect the Company’s operating results and financial condition.
9. Segment Information:
The Company considers its capital markets and asset management operations to be two separate reportable segments. During the third and fourth quarters of 2001, the Company significantly scaled-down the online financial services segment as well as recorded impaired capitalized software costs associated with this segment. Therefore, the online financial services segment reported in previous periods has been combined with the capital markets segment in 2002. The Company has developed systems and methodologies to allocate overhead costs to its business units and, accordingly, presents segment information consistent with internal
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management reporting. There are no significant revenue transactions between the segments. The following table illustrates the financial information for its segments for the periods presented (in thousands):
| Online | |||||||||||||||||
| Capital | Asset | Financial | Consolidated | ||||||||||||||
| Markets | Management | Services | Totals | ||||||||||||||
|
Three Months Ended June 30, 2002
|
|||||||||||||||||
|
Total revenues
|
$ | 54,259 | $ | 18,995 | $ | — | $ | 73,254 | |||||||||
|
Pre-tax income
|
10,230 | 7,549 | — | 17,779 | |||||||||||||
|
Three Months Ended June 30, 2001
|
|||||||||||||||||
|
Total revenues
|
44,103 | 10,930 | 119 | 55,152 | |||||||||||||
|
Pre-tax income (loss)
|
4,108 | 2,147 | (1,145 | ) | 5,110 | ||||||||||||
|
Six Months Ended June 30, 2002
|
|||||||||||||||||
|
Total revenues
|
93,819 | 33,805 | — | 127,624 | |||||||||||||
|
Pre-tax income
|
14,063 | 14,018 | — | 28,081 | |||||||||||||
|
Six Months Ended June 30, 2001
|
|||||||||||||||||
|
Total revenues
|
67,720 | 9,672 | 213 | 77,605 | |||||||||||||
|
Pre-tax income (loss)
|
1,111 | 253 | (2,393 | ) | (1,029 | ) | |||||||||||
10. Related Party Transactions:
FBR-Asset
The Company has a management agreement with FBR-Asset, expiring on December 17, 2002. The Company performs portfolio management services on behalf of FBR-Asset. These services include, but are not limited to, consulting with FBR-Asset on purchase and sale opportunities, collection of information, and submission of reports pertaining to FBR-Asset’s assets, interest-rates, and general economic conditions, and periodic review and evaluation of the performance of FBR-Asset’s portfolio of assets.
The Company is entitled to a quarterly “base” management fee equal to the sum of (1) 0.20 percent per annum (adjusted to reflect a quarterly period) of the average book value of the mortgage assets of FBR-Asset during each calendar quarter and (2) 0.75 percent per annum (adjusted to reflect a quarterly period) of the average book value of the remainder of FBR-Asset’s invested assets during each calendar quarter. The Company recorded $2.0 million in base management fees during the second quarter of 2002, $3.1 million during the first half of 2002 and $1.8 million for the year ended December 31, 2001.
The Company is also entitled to receive incentive fees based on the performance of FBR-Asset. The Company is entitled to an incentive fee calculated by reference to the preceding 12-month period, calculated as: funds from operations, plus net realized gains or losses from asset sales, less the threshold amount (all computed on a weighted average share outstanding basis), multiplied by 25 percent. The threshold amount is calculated as the weighted average issuance price per share of all shares of FBR-Asset, which was $25.30 at June 30, 2002, multiplied by a rate equal to the ten-year U.S. Treasury rate plus five percent per annum. The Company recorded $2.8 million in incentive fees during the second quarter of 2002, $4.5 million during the first half of 2002 and $1.7 million for the year ended December 31, 2001.
The Company had engaged Fixed Income Discount Advisory Company, Inc. (“FIDAC”) to manage FBR-Asset’s mortgage asset investment program (the “Mortgage Portfolio”) as a sub-adviser. As compensation for rendering services, FIDAC was entitled to a sub-advisory fee based on the average gross asset value managed by FIDAC. On March 22, 2002, the Company notified FIDAC that it had decided to terminate the sub-advisory agreement with FIDAC. The decision to terminate the sub-advisory agreement with FIDAC was based on the Company’s determination, after consultation with FBR-Asset’s Board of Directors, that it would be in the best interests of FBR-Asset and its shareholders to terminate the sub-advisory agreement in light of the increased size of FBR-Asset’s equity capital and mortgage-backed securities portfolio. The sub-advisory agreement ended in accordance with its terms on April 30, 2002. Concurrently with the end of the sub-advisory agreement, the Company and FBR-Asset have agreed to a reduction of the management fee that FBR-Asset will be required to pay the Company under the management agreement from 0.25 percent to
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0.20 percent per annum of the average book value of FBR-Asset’s Mortgage Portfolio during each calendar quarter.
As of June 30, 2002, the Company and its affiliated entities owned 2,744,700 shares or 10.95 percent of the outstanding common stock of FBR-Asset. As of December 31, 2001, the Company and its affiliated entities owned 2,349,186 shares or 27.63 percent of the outstanding common stock of FBR-Asset.
The Company entered into an agreement in August 2001 with FBR-Asset and its registered broker-dealer subsidiary, Pegasus Capital Corporation (“Pegasus”) regarding FBR-Asset’s extension of credit to or investment in entities that are or may be the Company’s investment banking clients. During the second quarter of 2002, pursuant to this agreement, the Company paid $0.3 million in fees to FBR-Asset from one investment banking transaction. During the first half of 2002, pursuant to this agreement, the Company paid $0.6 million in fees to FBR-Asset from two investment banking transactions. Fees are paid when the related investment banking transaction is completed. In 2001, pursuant to this agreement, the Company paid $2.9 million in fees to FBR-Asset from three investment banking transactions and one unfunded commitment.
During the second quarter of 2002, in connection with the Company’s broker-dealer subsidiary underwriting two follow-on public offerings for FBR-Asset, the Company earned $6.9 million in fees in its capital markets segment. During the first six months of 2002, in connection with the Company’s broker-dealer subsidiary underwriting three follow-on public offerings for FBR-Asset, the Company earned $10.1 million in fees.
Employee Stock Purchase and Loan Plan
In connection with the Employee Stock Purchase and Loan Plan, the Company issued five-year, limited recourse promissory notes to employees with interest accruing at 6.5% accreting to principal for the remaining purchase price. The notes are collateralized by all of the stock purchased under the plan. As of June 30, 2002 and December 31, 2001, the balance on these loans was $23,416 and $22,706, respectively.
Employee Bank Loans
In addition, FBR Group employees may apply for first mortgage residential loans from FBR National Bank & Trust. As of June 30, 2002 and December 31, 2001, the balance of outstanding loans to employees was $6,194 and $6,444, respectively.
11. Extraordinary Gain:
In February 2002, the Company exercised 415,805 warrants of FBR-Asset. As a result of this transaction, the Company’s purchase price was below its interest in the net assets acquired creating negative goodwill which, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” the Company recorded as an extraordinary gain of $1,413.
12. Accounting Developments:
The Company adopted SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 141 provides that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. In addition, it provides that the cost of an acquired entity should be allocated to the assets acquired including identifiable intangible assets, and liabilities assumed based on their estimated fair values at the date of acquisition. The excess cost over the fair value of the net assets acquired should be recognized as goodwill. SFAS No. 142 provides that goodwill is no longer amortized and the value of an identifiable intangible asset should be amortized over its useful life, unless the asset is determined to have an indefinite useful life. Adoption of SFAS No. 141 and SFAS No. 142 had no effect on the Company’s financial statements.
At the end of June 2001, the Financial Accounting Standards Board concluded deliberations and unanimously voted to issue SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 requires that obligations associated with the retirement of a tangible long-lived asset be recorded as a liability when those obligations are incurred, with the amount of the liability initially measured at fair value. SFAS
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No. 143 will be effective for financial statements for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 is not expected to have a material effect on the financial statements of the Company.
SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” This statement, which was effective for fiscal years beginning after December 15, 2001, principally deals with implementation issues of SFAS No. 121, including developing a single accounting model for long-lived assets to be disposed of by sale. The adoption of SFAS No. 144 did not have a material effect on the financial statements of the Company.
SFAS No. 145, “Rescission of FASB Statements Nos. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002” primarily provides guidance for reporting gains and losses from extinguishments of debt and sale-leaseback transactions and is effective for fiscal years beginning after May 15, 2002. The adoption of SFAS No. 145 is not expected to have a material effect on the financial statements of the Company.
SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The adoption of SFAS No. 146, which is effective for exit or disposal activities that are initiated after December 31, 2002, is not expected to have a material effect on the financial statements of the Company.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following analysis of the consolidated financial condition and results of operations of Friedman, Billings, Ramsey Group, Inc. (the “Company”) should be read in conjunction with the unaudited Consolidated Financial Statements as of June 30, 2002 and 2001, and the Notes thereto and the Company’s 2001 Annual Report on Form 10-K.
BUSINESS ENVIRONMENT
Our principal business activities, investment banking (capital raising and merger and acquisition and advisory services), institutional brokerage and asset management (including proprietary investments), are linked to the capital markets. In addition, our business activities are focused in the financial services, real estate, technology, energy, healthcare and diversified industries sectors. Historically, we have focused on small and mid-cap stocks, although our research coverage and associated brokerage activities increasingly involve larger-cap stocks. By their nature, our business activities are highly competitive and are not only subject to general market conditions, volatile trading markets and fluctuations in the volume of market activity, but also to the conditions affecting the companies and markets in our areas of focus.
In the first half of 2002, we continued to experience an increase in underwriting, private placement, M&A and advisory activity, especially in two of our focused industry sectors: the financial institutions and real estate sectors and, to a lesser extent, the energy, healthcare and technology sectors. The economic slowdown that began in the second half of 2000, however, continued to adversely affect equity valuations and has now adversely affected the broad equity markets. In addition, the advent of decimal pricing in 2001 has continued to adversely affect secondary equity market trading margins.
Our revenues and net income are subject to substantial positive and negative fluctuations due to a variety of factors that cannot be predicted with great certainty. These factors include the overall condition of the economy and the securities markets as a whole and of the sectors on which we focus. For example, a significant portion of the performance based or incentive revenues that we recognize from our venture capital, private equity and other asset management activities is based on the value of securities held by the funds we manage. The value of these securities includes unrealized gains or losses that may change from one period to another. The downturn in the technology sector has adversely affected this portion of our business and caused reductions in certain unrealized gains in technology sector securities held by us either directly or through funds we manage. Although, when market conditions permit, we may take steps to realize or lock-in gains on these securities, these securities are often illiquid and therefore, such steps may not be possible, and the value of these securities is subject to increased market risk.
Fluctuations in revenues and net income also occur due to the overall level of market activity which, among other things, affects the flow of investment dollars and the size, number and timing of investment banking transactions. In addition, a downturn in the level of market activity can lead to a decrease in brokerage commissions. Therefore, net income and revenues in any particular period may not be representative of full-year results and may vary significantly from year to year and from quarter to quarter.
The financial services industry continues to be affected by an intensifying competitive environment. The relaxation of banks’ barriers to entry into the securities industry and expansion by insurance companies into traditional brokerage products, coupled with the repeal of laws separating commercial and investment banking activities, has changed the number and size of companies competing for a similar customer base, many of which have greater capital resources and additional associated services with which to pursue these activities.
In order to compete in this increasingly competitive environment, we continually evaluate each of our businesses across varying market conditions for competitiveness, profitability and alignment with our long-term strategic objectives, including the diversification of revenue sources. As a result, we may choose, from time to time, to reallocate resources based on the opportunities for profitability and revenue growth for each of our businesses relative to our commitment of resources.
RESULTS OF OPERATIONS
Three months ended June 30, 2002 compared to three months ended June 30, 2001
The Company’s revenues increased 33% from $55.2 million in 2001 to $73.3 million in 2002 primarily due to an increase in revenues from asset management and institutional brokerage and, to a lesser extent, investment banking revenues.
15
Underwriting revenue increased 168% from $9.4 million in 2001 to $25.2 million in 2002. The increase is attributable to more managed transactions completed in 2002 as well as a larger average size per transaction. During the second quarter of 2002, the Company managed 14 public offerings raising $1.5 billion and generating $25.2 million in revenues. Underwriting revenue during the second quarter of 2002 included $6.9 million in fees associated with FBR-Asset’s two secondary offerings in April and June 2002. During the second quarter of 2001, the Company managed five public offerings, raising $391.4 million and generating $9.4 million in revenues. The average size of underwritten transactions for which we were a lead or co-manager increased from $78.3 million in 2001 to $103.6 million in 2002.
Corporate finance revenue decreased 46% from $18.1 million in 2001 to $9.8 million in 2002 due primarily to one large private placement in 2001. The Company completed two private placements in 2001 generating $15.5 million in revenues compared to two private placements generating $3.9 million in revenues in 2002. M&A and advisory fee revenue increased from $2.6 million in 2001 to $5.9 million in 2002 due to an increase in the number of deals completed. In 2001, the Company completed three M&A transactions compared to five completed transactions in 2002.
Institutional brokerage revenue from principal transactions (primarily client transactions in Nasdaq securities) increased 56% from $5.4 million in 2001 to $8.4 million in 2002. The Company believes that this increase is due to the fact that we have continued to achieve greater penetration of institutional accounts through broader research coverage and sales and trading services. Net trading gains were $1.1 million in 2002 compared to $0.4 million in 2001.
Institutional brokerage agency commissions increased 67% from $6.0 million in 2001 to $10.0 million in 2002. The Company believes that this increase is due to the fact that we have continued to achieve greater penetration of institutional accounts through broader research coverage and sales and trading services.
Asset management base management fees increased 47% from $5.2 million in 2001 to $7.6 million in 2002 primarily due to additional fees earned as a result of the increased size of FBR-Asset and, to a lesser extent, our other managed vehicles.
Asset management incentive allocations and fees increased from $0.5 million in 2001 to $2.9 million in 2002. Incentive allocations in 2002 are primarily from FBR-Asset.
Asset management net investment income increased 70% from $5.0 million in 2001 to $8.5 million in 2002. Net investment income in 2002 includes: $8.8 million of net investment income generated from our investment in FBR-Asset (reflecting share issuances) and $0.1 million of realized gains related to available-for-sale securities offset by $(0.3) million of net investment loss from investments in managed vehicles and $(0.1) million of net investment loss related to losses on our marketable securities. Net investment income in 2001 includes: $3.4 million of net investment income related to investments in our managed vehicles; $1.7 million of realized gains related to a private, mezzanine debt investment; and $1.6 million of net investment income related to our investment in FBR-Asset offset by $(1.0) million of “other than temporary” unrealized depreciation related to an available-for-sale security and $(0.7) million of net investment loss related to losses on our marketable securities.
Asset management technology sector net investment and incentive loss increased 44% from $(1.7) million in 2001 to $(2.4) million in 2002. Technology sector net investment and incentive loss in 2002 was primarily from investments in venture capital proprietary investment partnerships and other managed vehicles and, to a lesser extent, from a third party fund that was invested primarily in public securities. Technology sector net investment and incentive loss in 2001 was primarily from investments in venture capital proprietary investment partnerships.
Unrealized gains related to our investments that are included in “accumulated other comprehensive income” in our balance sheet totaled $3.8 million as of June 30, 2002. If and when we liquidate these or determine that a decline in value of these investments is “other than temporary”, a portion or all of the gains or losses will be recognized as investment income (loss) in the statement of operations during the period in which the liquidation or determination is made. Our investment portfolio is exposed to future downturns in the markets and private debt and equity securities are exposed to deterioration of credit quality, defaults and downward valuations. On a quarterly basis, we review the valuations of our private debt and equity investments. If and when we determine that the net realizable value of these investments is less than our carrying value, we will reflect the reduction as an investment loss.
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Net interest, dividends, and other revenue (net of interest expense) decreased 28% from $1.7 million in 2001 to $1.2 million in 2002 primarily due to increased interest expense as a result of our short-term loans as well as interest accretion associated with our long-term secured loan and a decrease in earnings on invested cash primarily as a result of a decline in interest rates.
Total expenses increased 11% from $50.0 million in 2001 to $55.5 million in 2002 due primarily to an increase in variable compensation expense associated with increased revenue.
Compensation and benefits expense increased 17% from $32.8 million in 2001 to $38.4 million in 2002. This increase was primarily due to an increase in variable compensation associated with investment banking and institutional brokerage, and a new executive officer compensation plan in 2002, which is calculated as up to twenty percent of pre-tax profits. As a percentage of revenues, compensation and benefits expense decreased from 59% in 2001 to 52% in 2002.
Business development and professional services decreased 3% from $8.2 million in 2001 to $8.0 million in 2002 primarily due to a decrease in recruiting expenses offset by an increase in travel and legal expenses associated primarily with the increase in investment banking activity.
Clearing and brokerage fees increased 14% from $1.6 million in 2001 to $1.8 million in 2002 as a result of increased volume. As a percentage of institutional brokerage revenue, clearing and brokerage fees decreased from 14% in 2001 to 10% in 2002. This percentage decrease is attributable to new clearing and execution arrangements finalized in 2002.
Occupancy and equipment expense decreased 29% from $2.9 million in 2001 to $2.0 million in 2002 primarily due to a decrease in depreciation and amortization expense. Depreciation and amortization expense decreased $0.7 in 2002 compared to 2001. The decline in depreciation and amortization expense is primarily a result of amortization related to fbr.com software costs of $0.6 million in 2001. These capitalized costs were impaired during the third quarter of 2001 and were consequently written-off.
Communications expense increased 46% from $1.5 million in 2001 to $2.2 million in 2002 primarily due to the opening of new offices and increased levels of business.
Other operating expenses were fairly stable decreasing 6% from $2.8 million in 2001 to $2.6 million in 2002.
Six months ended June 30, 2002 compared to six months ended June 30, 2001
The Company’s revenues increased 64% from $77.6 million in 2001 to $127.6 million in 2002 primarily due to an increase in revenues from asset management and investment banking and, to a lesser extent, institutional brokerage revenues.
Underwriting revenue increased 120% from $17.1 million in 2001 to $37.6 million in 2002. The increase is attributable to more managed transactions completed in 2002 as well as a larger average size per transaction. During the first half of 2002, the Company managed 24 public offerings raising $2.6 billion and generating $37.6 million in revenues. Underwriting revenue during the first half of 2002 included $10.9 million in fees associated with FBR-Asset’s three secondary offerings in January, April and June 2002. During the first half of 2001, the Company managed eight public offerings, raising $574.0 million and generating $17.1 million in revenues. The average size of underwritten transactions for which we were a lead or co-manager increased from $71.2 million in 2001 to $107.5 million in 2002.
Corporate finance revenue increased 5% from $20.3 million in 2001 to $21.3 million in 2002 due primarily to an increase in the number of M&A and private placement transactions completed in 2002 offset by a smaller average size per private placement transaction in 2002, due to one large private placement in 2001. The Company completed two private placements generating $15.6 million in revenues in 2001 compared to three private placement generating $7.0 million in revenues in 2002. M&A and advisory fee revenue increased from $4.7 million in 2001 to $14.3 million in 2002 due to an increase in the number of deals completed. In 2001, the Company completed six M&A transactions compared to nine completed transactions in 2002.
Institutional brokerage revenue from principal transactions (primarily client transactions in Nasdaq securities) increased 36% from $11.4 million in 2001 to $15.4 million in 2002. The Company believes that this increase is due to the fact that we have continued to achieve greater penetration of institutional accounts
17
Institutional brokerage agency commissions increased 49% from $12.5 million in 2001 to $18.7 million in 2002. The Company believes that this increase is due to the fact that we have continued to achieve greater penetration of institutional accounts through broader research coverage and sales and trading services.
Asset management base management fees increased 68% from $8.1 million in 2001 to $13.6 million in 2002 primarily due to additional fees earned as a result of the increased size of FBR-Asset and other managed vehicles and, to a lesser extent, our acquisition of MMA/ Rushmore.
Asset management incentive allocations and fees increased from $0.8 million in 2001 to $4.7 million in 2002. Incentive allocations in 2002 are primarily from FBR-Asset.
Asset management net investment income increased 120% from $6.6 million in 2001 to $14.5 million in 2002. Net investment income in 2002 includes: $13.2 million of net investment income generated from our investment in FBR-Asset (reflecting share issuances), $1.3 million of net investment income from investments in managed vehicles, and $0.2 million of realized gains related to available-for-sale securities offset by $(0.2) million of net investment loss related to losses on our marketable securities. Net investment income in 2001 includes: $4.3 million of net investment income related to investments in our managed vehicles; $1.7 million of realized gains related to a private, mezzanine debt investment; and $2.0 million of net investment income related to our investment in FBR-Asset offset by $(1.0) million of “other than temporary” unrealized depreciation related to an available-for-sale security and $(0.4) million of net investment loss related to losses on our marketable securities.
In February 2002, the Company exercised 415,805 warrants of FBR-Asset. As a result of this transaction, the Company’s purchase price was below its interest in the net assets acquired creating negative goodwill which, in accordance with SFAS No. 142, the Company recorded as an extraordinary gain of $1.4 million.
Asset management technology sector net investment and incentive loss decreased 60% from $(8.8) million in 2001 to $(3.5) million in 2002 as a result of significant declines in the value of portfolio companies of FBR Technology Ventures Partners, L.P. (“TVP I”) and FBR Technology Venture Partners II (“TVP II”) in 2001. Technology sector net investment and incentive loss in 2001 was primarily from investments in venture capital proprietary investment partnerships, of which $(6.5) million was associated with TVP I and TVP II. Technology sector net investment and incentive loss in 2002 was primarily from investments in venture capital proprietary investment partnerships and other managed vehicles, of which $(1.2) million was associated with TVP I and TVP II, and, to a lesser extent, from a third party fund that was invested primarily in public securities.
Unrealized gains related to our investments that are included in “accumulated other comprehensive income” in our balance sheet totaled $3.8 million as of June 30, 2002. If and when we liquidate these or determine that a decline in value of these investments is “other than temporary”, a portion or all of the gains or losses will be recognized as investment income (loss) in the statement of operations during the period in which the liquidation or determination is made. Our investment portfolio is exposed to future downturns in the markets and private debt and equity securities are exposed to deterioration of credit quality, defaults and downward valuations. On a quarterly basis, we review the valuations of our private debt and equity investments. If and when we determine that the net realizable value of these investments is less than our carrying value, we will reflect the reduction as an investment loss.
Net interest, dividends, and other revenue (net of interest expense) decreased 29% from $3.8 million in 2001 to $2.7 million in 2002 primarily due to increased interest expense as a result of our short-term loans as well as interest accretion associated with our long-term secured loan and a decrease in earnings on invested cash primarily as a result of a decline in interest rates.
Total expenses increased 28% from $78.6 million in 2001 to $101.0 million in 2002 due primarily to an increase in variable compensation expense associated with increased revenue.
Compensation and benefits expense increased 42% from $49.0 million in 2001 to $69.7 million in 2002. This increase was primarily due to an increase in variable compensation associated with investment banking and institutional brokerage, and a new executive officer compensation plan in 2002, which is calculated as up to twenty percent of pre-tax profits. As a percentage of revenues, compensation and benefits expense decreased from 63% in 2001 to 55% in 2002.
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Business development and professional services increased 6% from $13.5 million in 2001 to $14.4 million in 2002 primarily due to an increase in travel and legal expenses associated primarily with the increase in investment banking activity and, to a lesser extent, increased costs associated with our acquisition of MMA/ Rushmore in April 2001, offset by a decrease in recruiting expenses.
Clearing and brokerage fees decreased 26% from $3.3 million in 2001 to $2.4 million in 2002. As a percentage of institutional brokerage revenue, clearing and brokerage fees decreased from 14% in 2001 to 7% in 2002. This percentage decrease is attributable to new clearing and execution arrangements finalized in 2002.
Occupancy and equipment expense decreased 21% from $5.4 million in 2001 to $4.3 million in 2002 primarily due to a decrease in depreciation and amortization expense. Depreciation and amortization expense decreased $1.2 in 2002 compared to 2001. The decline in depreciation and amortization expense is primarily a result of amortization related to fbr.com software costs of $1.3 million in 2001. These capitalized costs were impaired during the third quarter of 2001 and were consequently written-off.
Communications expense increased 60% from $2.7 million in 2001 to $4.3 million in 2002 primarily due to the opening of new offices and increased levels of business.
Other operating expenses increased 18% from $4.3 million in 2001 to $5.1 million in 2002 primarily due to the opening of new offices as well as our acquisition of MMA/ Rushmore in April 2001. During 2002, the Company recorded $0.7 million in amortization expense associated with the MMA acquired management contracts.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have satisfied our liquidity and regulatory capital needs through three primary sources: (1) internally generated funds; (2) equity capital contributions; and (3) credit provided by banks, clearing brokers, and affiliates of our principal clearing broker. We have used, and may continue to use temporary subordinated loans in connection with regulatory capital requirements to support our underwriting activities. At June 30, 2002, we had $37.1 million of short-term loans payable, of which $17.5 million represented repurchase agreements, $10.0 million was in the form of a subordinated loan and $9.6 million was on margin. We have no long-term debt other than acquisition debt of $6.0 million.
Our principal assets consist of cash and cash equivalents, receivables, securities held for trading purposes and long-term investments. As of June 30, 2002, liquid assets consisted primarily of cash and cash equivalents of $50.1 million and a receivable for cash on deposit with FBRC’s clearing broker of $76.2 million, for a total of $126.3 million. Cash equivalents consist primarily of money market funds invested in debt obligations of the U.S. government. We also held $2.2 million in liquid marketable securities.
As of June 30, 2002, we had $10.0 million outstanding under a $40.0 million subordinated revolving loan from an affiliate of FBRC’s clearing broker that is allowable for net capital purposes. Subsequent to June 30, 2002, we repaid the outstanding $10.0 million loan and renewed the subordinated credit line that expired December 2001. The new agreement expires in August 2004. Additionally, during the second quarter of 2002, we finalized a $20.0 million working capital line of credit with a commercial bank. The line of credit is secured by employee receivables and is subject to liquidity tests. As of June 30, 2002, our borrowing capacity was $9.1 million, of which none was drawn down, at interest terms of LIBOR plus 1.95 percent. The line of credit expires June 7, 2003.
Long-term investments consist primarily of FBR-Asset, investments in managed partnerships, including hedge, private equity and venture capital funds in which we serve as managing partner, our investment in Capital Crossover Partners (a partnership we do not manage), available-for-sale securities and our investment in a long-term mezzanine, debt instrument of a privately held company. Although our investments in hedge and venture capital funds and other limited partnerships are for the most part illiquid, the underlying investments of such entities are, in the aggregate, mostly publicly-traded, liquid equity and debt securities, some of which may be restricted due to contractual “lock-up” requirements. During the first half of 2002, we redeployed approximately $10 million of capital from hedge fund investments to FBR-Asset and Capital Crossover Partners.
We are a financial holding company (an “FHC”) under the Gramm-Leach-Bliley Act of 1999, or GLB Act, and are therefore subject to supervision, regulation and examination by federal banking regulatory agencies. FHC’s are required to maintain capital levels in accordance with regulatory requirements. The minimum ratio of total capital to risk weighted assets is 8.0 percent and the minimum ratio of tier one capital
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FBRC and FBRIS, as broker-dealers, are registered with the Securities and Exchange Commission (“SEC”) and are members of the National Association of Securities Dealers, Inc. Additionally, FBRIL is registered with the Financial Services Authority (“FSA”) of the United Kingdom. As such, they are subject to the minimum net capital requirements promulgated by the SEC and FSA. As of June 30, 2002, all of our broker/dealers were required to maintain minimum regulatory net capital of $4.2 million and had total regulatory net capital of $51.1 million, which was $46.9 million in excess of their requirement. Regulatory net capital requirements increase when the broker/ dealers are involved in underwriting activities based upon a percentage of the amount being underwritten.
On April 1, 2001, we completed the acquisition of Money Management Associates, LP (“MMA”) and Rushmore Trust and Savings, FSB (“Rushmore”). MMA was a privately held investment adviser with $933.4 million in assets under management as of March 31, 2001. Together, MMA and Rushmore were the investment adviser, servicing agent or administrator for more than 20 mutual funds. Upon closing, Rushmore was re-chartered as a national bank and was named FBR National Bank & Trust (“FBR National Bank”).
Quantitative measures established by regulation to ensure capital adequacy require FBR National Bank to maintain minimum capital levels and ratios of tangible and core capital (defined in the regulations) to total adjusted assets (as defined), and of total capital (as defined) to risk-weighted assets (as defined). Management believes, as of June 30, 2002, FBR National Bank meets all capital adequacy requirements to which it is subject.
As of June 30, 2002, the most recent notification from the Office of the Comptroller of Currency (OCC) categorized FBR National Bank as “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, FBR National Bank must maintain minimum tangible core and risk-based ratios. There are no conditions or events since that notification that management believes have changed FBR National Bank’s “well-capitalized” status.
We believe that our current level of equity capital, including funds generated from operations, are adequate to meet our liquidity and regulatory capital requirements and other activities. We may, however, seek debt or equity financing, in public or private transactions, or otherwise re-deploy assets, to provide capital for corporate purposes and/or to fund strategic business opportunities, including possible acquisitions, joint ventures, alliances or other business arrangements which could require substantial capital outlays. Our policy is to evaluate strategic business opportunities, including acquisitions and divestitures, as they arise.
As of June 30, 2002, we had $11.9 million of uncalled commitments to various investment partnerships that may be called over the next ten years.
We constantly review our capital needs and sources, the cost of capital and return on equity, and we seek strategies to provide favorable returns on capital. In evaluating our anticipated capital needs and current cash resources during 1998, our Board of Directors authorized a share repurchase program of up to 2,500,000 shares of our company’s Class A Common Stock. Since announcing the share repurchase program, we repurchased 1,468,027 shares as of June 30, 2002, leaving 1,031,973 additional shares authorized for repurchase. Of the total shares repurchased, 850,217 have been reissued to employees pursuant to our Employee Stock Purchase Plan.
As of June 30, 2002, we had net operating losses (“NOL”) for tax purposes of approximately $20 million that expire through 2020. We maintain a valuation allowance related to the NOL and a net deferred tax asset. As a result of recording the valuation allowance, based on current evidence, we estimate that future income tax provisions recorded in the Consolidated Statement of Operations will be calculated excluding approximately $30 million in pre-tax income.
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Item 3. Changes In Information About Market Risk
None.
Forward-Looking Statements
This Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Some of the forward-looking statements can be identified by the use of forward-looking words such as “believes”, “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates” or “anticipates” or the negative of those words or other comparable terminology. Such statements include, but are not limited to, those relating to the effects of growth, our principal investment activities, levels of assets under management and our current equity capital levels. Forward-looking statements involve risks and uncertainties. You should be aware that a number of important factors could cause our actual results to differ materially from those in the forward-looking statements. These factors include, but are not limited to, competition among venture capital firms and the high degree of risk associated with venture capital investments, the effect of demand for public offerings, mutual fund and 401(k) and pension plan inflows or outflows, volatility of the securities markets, available technologies, government regulation, economic conditions and competition for business and personnel in the business areas in which we focus, fluctuating quarterly operating results, the availability of capital to us and risks related to online commerce. We will not necessarily update the information presented or incorporated by reference in this Form 10-Q if any of these forward-looking statements turn out to be inaccurate. For a more detailed discussion of the risks affecting our business see our Form 10-K for 2001 and especially the section “Business—Factors Affecting Our Business, Operating Results and Financial Condition”.
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Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on June 7, 2001 at which shareholders took the following actions:
| 1. | The election of the five directors of the Company. | |
| 2. | The ratification of the appointment of PricewaterhouseCoopers LLP as the Company’s independent auditors for 2002. |
The results of the voting in connection with the preceding items were as follows:
1. Election of Directors: A total of 93,912,747 votes were received for this item.
| For | Against | Abstain | ||||||||||
|
Emanuel J. Friedman
|
91,615,846 | 2,296,901 | — | |||||||||
|
Eric F. Billings
|
91,615,846 | 2,296,901 | — | |||||||||
|
Daniel J. Altobello
|
92,819,046 | 1,093,701 | — | |||||||||
|
W. Russell Ramsey
|
92,819,046 | 1,093,701 | — | |||||||||
|
Wallace L. Timmeny
|
92,819,046 | 1,093,701 | — | |||||||||
2. Ratification of the Appointment of PricewaterhouseCoopers LLP: A total of 93,912,747 votes were received for this item.
| For | Against | Abstain | ||||||||||
| 93,757,096 | 150,601 | 5,050 | ||||||||||
Item 6. Reports on Form 8-K
| • | August 1, 2002: Second Quarter 2002: Earnings Press Release, Table of Assets Under Management and Long-Term Investment Matrix | |
| • | July 11, 2002: Press release announcing expected earnings for the second quarter 2002 | |
| • | May 22, 2002: First Quarter 2002 Earnings Presentation available on FBR website and attached to 8-K | |
| • | May 2, 2002: First Quarter 2002 Earnings Press Release and conference call transcript | |
| • | April 23, 2002: Press release announcing that FBR would release first quarter 2002 results after the market closes on May 1, 2002 | |
| • | April 10, 2002: Material presented at the Sidoti & Co. Investor Conference |
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SIGNATURES
Pursuant to the requirements 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.
| Friedman, Billings, Ramsey Group, Inc. |
| By: | /s/ KURT R. HARRINGTON |
|
|
|
| Kurt R. Harrington | |
| Senior Vice President and Chief Financial Officer | |
| (Principal Financial and Accounting Officer) |
Date: August 14, 2002
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