SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

 

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  ý        NO  o

 

Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  YES  ý        NO  o

 

The number of shares of the registrant’s Common Stock, par value $0.01 per share, outstanding as of May 1, 2003, was 17,073,844.

 

 

 

SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES

 

INDEX

 

PART I.		CONDENSED CONSOLIDATED FINANCIAL INFORMATION
	Item 1.		Financial Statements
			Condensed Consolidated Balance Sheet as of March 31, 2003 and December 31, 2002 (unaudited)
			Condensed Consolidated Statement of Income for the Three Months Ended March 31, 2003 and 2002 (unaudited)
			Condensed Consolidated Statement of Shareholders’ Equity for the Three Months Ended March 31, 2003 (unaudited)
			Condensed Consolidated Statement of Cash Flows for the Three Months Ended March 31, 2003 and 2002 (unaudited)
			Notes to Condensed Consolidated Financial Statements (unaudited)
	Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.		Quantitative and Qualitative Disclosures About Market Risk
	Item 4.		Controls and Procedures
PART II.		OTHER INFORMATION
	Item 1.		Legal Proceedings
	Item 6.		Exhibits and Reports on Form 8-K

 

1

 

PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements

 

SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share amounts)
(unaudited)

 

		March 31, 2003			December 31, 2002
ASSETS
Cash and cash equivalents		$	30,322		$	34,890
Receivables, net of allowance of $295
Broker-dealers		1,136			641
Customers		2,755			2,026
Related parties		4,950			4,489
Other		577			719
Deposits with clearing brokers		1,502			1,000
Securities owned		17,367			16,995
Securities available for sale		2,760			3,064
Furniture and equipment, net		3,988			4,021
Deferred income taxes, net		414			638
Other assets		1,302			1,167
Goodwill, net of accumulated amortization of $4,268		47,673			47,673
Total assets		$	114,746		$	117,323
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Accounts payable and accrued liabilities		$	11,071		$	15,308
Securities sold, not yet purchased		60			93
Other liabilities		180			190
Total liabilities		11,311			15,591
Commitments and contingencies
Minority interests		200			421
Shareholders’ equity:
Preferred stock, $0.10 par value; 10,000,000 shares authorized; no shares issued and outstanding		—			—
Common stock, $0.01 par value; 100,000,000 shares authorized; 17,625,880 and 17,439,743 shares issued, respectively		176			174
Additional paid-in capital		111,000			109,959
Receivables for shares issued		(1,011		)	(705		)
Accumulated deficit		(2,178		)	(3,367		)
Accumulated other comprehensive loss		(299		)	(243		)
Unearned compensation		(1,219		)	(1,392		)
Treasury stock at cost, 717,503 and 702,849 shares, respectively		(3,234		)	(3,115		)
Total shareholders’ equity		103,235			101,311
Total liabilities and shareholders’ equity		$	114,746		$	117,323

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

2

 

SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(in thousands, except share and per share amounts)
(unaudited)

 

		Three Months Ended March 31,
		2003			2002
Revenues:
Commissions		$	12,312		$	9,660
Principal transactions		2,010			4,783
Investment banking		3,404			3,675
Fiduciary, custodial and advisory fees		1,755			1,713
Interest and dividends		525			427
Other income		926			565
Total revenues		20,932			20,823
Expenses:
Employee compensation and benefits		13,715			13,423
Floor brokerage, exchange and clearance fees		1,430			923
Communications and data processing		1,329			1,005
Occupancy		1,247			1,045
Other general and administrative		2,061			1,903
Total expenses		19,782			18,299
Income before equity in income of limited partnerships, income taxes and minority interests		1,150			2,524
Equity in income of limited partnerships		868			623
		2,018			3,147
Provision for income taxes		(830		)	(1,162		)
Minority interests in net loss (income) of consolidated companies		1			(16		)
Net income		$	1,189		$	1,969
Earnings per share:
Basic		$	0.07		$	0.12
Diluted		$	0.07		$	0.12
Weighted average common shares outstanding:
Basic		16,845,379			16,468,579
Diluted		17,394,518			16,604,213

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

3

 

SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
For the three months ended March 31, 2003
(in thousands, except shares)
(unaudited)

 

		Amounts					Shares
Common stock
Balance, beginning of period		$	174				17,439,743
Stock issued pursuant to employee benefit plan		2					186,137
Balance, end of period		176					17,625,880
Additional paid-in capital
Balance, beginning of period		$	109,959
Stock issued pursuant to employee benefit plan		1,555
Dividends		(514		)
Balance, end of period		111,000
Receivables for shares issued
Balance, beginning of period		$	(705	)
Issuance of restricted stock		(515		)
Amortization of notes receivable		209
Balance, end of period		(1,011		)
Accumulated deficit
Balance, beginning of period		$	(3,367	)
Net income		1,189			1,189
Balance, end of period		(2,178		)	1,189
Accumulated other comprehensive loss
Balance, beginning of period		$	(243	)
Net change in unrealized depreciation on securities available for sale		(88		)	(88	)
Income tax benefit on change		32			32
Balance, end of period		(299		)	(56	)
Comprehensive income					1,133
Unearned compensation
Balance, beginning of period		$	(1,392	)
Net issuance of restricted stock		(34		)
Amortization of unearned compensation		207
Balance, end of period		(1,219		)
Treasury stock
Balance, beginning of period		$	(3,115	)			(702,849	)
Acquisition of treasury stock		(119		)			(14,654	)
Balance, end of period		(3,234		)			(717,503	)
Total shareholders’ equity and common shares outstanding		$	103,235				16,908,377

 

4

 

SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For the three months ended March 31, 2003 and 2002
(in thousands)
(unaudited)

 

		2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,189		$	1,969
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Realized gain on securities available for sale		—			(4		)
Depreciation		273			199
Provision for bad debts		—			183
Compensation expense related to amortization of notes receivable and unearned compensation		416			206
Deferred income taxes		258			532
Minority interests in loss of consolidated companies		(1		)	16
Changes in operating assets and liabilities:
Increase in receivables		(1,543		)	(131		)
Increase in deposits with clearing brokers		(502		)	—
Increase in securities owned		(372		)	(982		)
Increase in other assets		(135		)	(536		)
Decrease in securities sold, not yet purchased		(33		)	(28		)
Decrease in other liabilities		(10		)	(15		)
Increase (decrease) in accounts payable and accrued liabilities		(4,327		)	731
Net cash (used in) provided by operating activities		(4,791		)	2,140
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures		(240		)	(399		)
Purchase of securities available for sale		(33		)	(859		)
Proceeds from sales and maturities of securities available for sale		250			178
Net cash used in investing activities		(23		)	(1,080		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock		(119		)	(555		)
Collection of receivable for shares issued		—			48
Proceeds from shares issued		1,008			530
Distributions to minority interests		(219		)	—
Payments of cash dividends		(424		)	—
Net cash provided by financing activities		246			23
Net (decrease) increase in cash and cash equivalents		(4,568		)	1,083
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		34,890			30,410
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	30,322		$	31,493
Noncash investing and financing activities:
Cash paid for income taxes		$	139		$	505

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

5

 

Sanders Morris Harris Group Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

1.              BASIS OF PRESENTATION

 

Nature of Operations

 

Through its operating subsidiaries Pinnacle Management & Trust Co. (“PMT”), Sanders Morris Harris Inc. (“SMH”) and SMH Capital Advisors (“SMCA”), the Company provides a broad range of financial services, including institutional, prime and retail brokerage, investment banking, other investment banking services,  merchant banking, financial advisory, trust related services, investment management and financial planning. The Company serves a diverse group of institutional, corporate and individual clients.

 

The Company merged with and acquired its operating subsidiaries in 2001, 2000 and 1999.  The acquisitions were accounted for using the purchase method.

 

Consolidation

 

The unaudited condensed consolidated financial statements of the Company include the accounts of its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation.

 

In management’s opinion, the unaudited condensed consolidated financial statements include all adjustments necessary for a fair presentation of our consolidated financial position at March 31, 2003, our results of operations for the three months ended March 31, 2003 and 2002, and our cash flows for the three months ended March 31, 2003 and 2002.  All adjustments are of a normal recurring nature. Interim results are not necessarily indicative of results for a full year.

 

These financial statements and notes should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2002.

 

Effects of Recently Issued Accounting Standards

 

SFAS No. 141 entitled Business Combinations was issued in June 2001 and became effective July 1, 2001.  SFAS No. 141 requires that all business combinations be accounted for using the purchase method of accounting, which requires that acquisitions be recorded at fair value as of the date of acquisition.  SFAS No. 142 entitled Goodwill and Other Intangible Assets was also issued in June 2001, in concert with SFAS No. 141.  SFAS No. 142 became effective for us on January 1, 2002.  SFAS No. 142 requires SMHG to perform goodwill impairment tests on at least an annual basis.  There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.

 

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.  This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation.  The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in a variable interest entity obtained after January 31, 2003.  For public enterprises, such as the Company, with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation is applied to the enterprise no later than the beginning of the first annual or interim reporting period beginning after June 15, 2003.  The application of this Interpretation is not expected to have a material effect on the Company’s consolidated financial statements.  The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes effective.  The Company is currently evaluating the effect of this Interpretation on its potential variable interest entities that would require consolidation under this Interpretation.

 

6

 

Compensation

 

Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation – Transaction and Disclosure, was issued in December 2002.  SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods for transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS No 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  The Company has adopted the disclosure provisions included on SFAS No. 148 in the notes to the consolidated financial statements contained herein.

 

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation an Interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed plan stock options.  Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price.

 

The following table illustrates the effect on net income as if the Company had applied the fair value recognition provisions of SFAS No. 123 as amended by SFAS No. 148:

 

		Three Months Ended March 31,
		2003			2002
Net income as reported		$	1,189		$	1,969
Deduct:  Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(36		)	(137		)
Pro forma net income		$	1,153		$	1,832
Earnings per share
Basic-as reported		$	0.07		$	0.12
Basic-pro forma		$	0.07		$	0.11
Diluted-as reported		$	0.07		$	0.12
Diluted-pro forma		$	0.07		$	0.11

 

Reclassifications

 

Certain reclassifications have been made to the 2002 condensed consolidated financial statements to conform them with the 2003 presentation.  The reclassifications had no effect on accumulated deficit, results of operations or cash flows as previously reported.

 

7

 

2.              SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED

 

Securities owned and securities sold, not yet purchased as of March 31, 2003 were as follows:

 

		Owned			Sold, Not Yet Purchased
		(in thousands)
Marketable:
Corporate stocks (cost $248)		$	229		$	60
Corporate bonds and commercial paper (cost $1,921)		1,554			—
		1,783			60
Not readily marketable:
Partnerships (cost $6,084)		10,905			—
Corporate stocks and warrants (cost $2,630)		4,679			—
		$	17,367		$	60

 

Securities not readily marketable include investment securities (a) for which there is no market on a securities exchange or no independent publicly quoted market, (b) that cannot be publicly offered or sold unless registration has been effected under the Securities Act of 1933, or (c) that cannot be offered or sold because of other arrangements, restrictions, or conditions applicable to the securities or to the Company.  Not readily marketable securities consist of investments in limited partnerships, equities, options and warrants.  The investments in limited partnerships are accounted for using the equity method, which approximates fair value, and principally consist of Environmental Opportunities Fund, L.P., Environmental Opportunities Fund II, L.P., Environmental Opportunities Fund II (Institutional), L.P., Corporate Opportunities Fund, L.P., Corporate Opportunities Fund (Institutional), L.P., Sanders Opportunity Fund, L.P., Sanders Opportunity Fund (Institutional), L.P., Tactical Opportunities High Yield Fund, L.P., and Life Sciences Opportunity Fund, L.P.

 

3.              SECURITIES AVAILABLE FOR SALE

 

Securities available for sale at March 31, 2003 were as follows:

 

		Amortized Cost			Gross Unrealized						Estimated Fair Value
					Gains			Losses
		(in thousands)
U.S. Government and agency obligations		$	1,060		$	14		$	(9	)	$	1,065
Marketable equity securities		2,174			18			(497		)	1,695
Total		$	3,234		$	32		$	(506	)	$	2,760

 

The contractual maturities of debt securities available for sale at March 31, 2003, were as follows:

 

Due before 5 years

$

1,065

 

8

 

Gross gains on sales of securities available for sale were $7,000 for the three months ended March 31, 2002.  Gross realized losses, including unrealized permanent impairment losses, on securities available for sale were  $3,000 for the three months ended March 31, 2002.  No gains or losses on sales of securities available for sale were recorded during the three months ended March 31, 2003.

 

4.              INCOME TAXES

 

The differences between the effective tax rate reflected in the income tax (benefit) provision from operations and the statutory federal rate were as follows:

 

		Three Months Ended March 31,
		2003			2002
		(in thousands)
Tax computed using the statutory rate		$	670		$	1,070
State income taxes and other		160			92
Total		$	830		$	1,162

 

5.              COMMITMENTS AND CONTINGENCIES

 

There were no firm underwriting commitments open at March 31, 2003.

 

The Company and its subsidiaries have obligations under operating leases that expire by 2012 with initial noncancelable terms in excess of one year.

 

The Company is a party to various legal proceedings that are of an ordinary or routine nature incidental to its operations.  The Company believes it has adequately reserved for such litigation matters and that they will not have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

 

The Company has uncommitted financing arrangements with clearing brokers who finance customer accounts, certain broker-dealer balances and firm trading positions.  Although these customer accounts and broker-dealer balances are not reflected on the consolidated balance sheet for financial accounting and reporting purposes, the Company has generally agreed to indemnify these clearing brokers for losses they may sustain in connection with the accounts, and therefore, retains risk on these accounts.  The Company is required to maintain certain cash or securities on deposit with its clearing brokers.

 

9

 

6.              EARNINGS PER COMMON SHARE

 

Basic and diluted earnings per-share computations for the periods indicated were as follows:

 

		Three Months Ended March 31,
		2003			2002
		(in thousands, except share and per share amounts)
Computation of basic and diluted income per common share for the three months ended March 31:
Net income		$	1,189		$	1,969
Weighted average number of common shares outstanding		16,845,379			16,468,579
Common shares issuable under stock option plan		1,309,511			1,065,348
Less shares assumed repurchased with proceeds		(760,372		)	(929,714		)
Weighted average common shares outstanding		17,394,518			16,604,213
Basic and diluted income per common share		$	0.07		$	0.12

 

Outstanding stock options exercisable for 50,000 common shares for the three months ended March 31, 2003 and 247,000 common shares for the three months ended March 31, 2002 have not been included in diluted earnings per common share because their inclusion would have been antidilutive for the periods presented.

 

7.              BUSINESS SEGMENT INFORMATION

 

The Company’s businesses operate in two reportable business segments.  The Company’s investment banking and brokerage segment includes the operations of SMH.  SMH is an investment banking and brokerage firm whose activities primarily include securities underwriting, other investment banking services, private placements, and institutional, prime and retail brokerage.  The Company’s asset management segment includes the operations of PMT and SMH Capital Advisors.  PMT is a state chartered trust company providing a variety of trust services, including investment management, estate settlement and retirement planning.  SMH Capital Advisors provides financial planning services to individuals and asset management services to investors with an emphasis on fixed income securities.  The following summarizes certain financial information of each reportable segment for the three months ended March 31, 2003 and 2002, respectively.

 

10

 

(in thousands)		Investment Banking and Brokerage			Investment Management			Corporate and Other			Consolidated Total
Three Months Ended March 31, 2003
Revenues		$	19,355		$	1,411		$	166		$	20,932
Expenses		(18,145		)	(1,314		)	(323		)	(19,782		)
Income (loss) before equity in income of limited partnerships, income taxes and minority interests		1,210			97			(157		)	1,150
Equity in income of limited partnerships		774			—			94			868
Income (loss) before income taxes and minority interests		$	1,984		$	97		$	(63	)	$	2,018
Three Months Ended March 31, 2002
Revenues		$	19,498		$	1,309		$	16		$	20,823
Expenses		(16,491		)	(1,123		)	(685		)	(18,299		)
Income (loss) before equity in income of limited partnerships, income taxes and minority interests		3,007			186			(669		)	2,524
Equity in income of limited partnerships		547			—			76			623
Income (loss) before income taxes and minority interests		$	3,554		$	186		$	(593	)	$	3,147

 

(in thousands)		Investment Banking and Brokerage			Investment Management			Corporate and Other			Consolidated Total
Total assets as of March 31, 2003		$	77,739		$	6,713		$	30,294		$	114,746
Total assets as of December 31, 2002		$	80,614		$	6,701		$	30,008		$	117,323

 

8.              EMPLOYEE BENEFIT PLANS

 

Under its 1998 Incentive Plan, as amended, the Company has reserved 25% of the issued and outstanding Common Stock of the Company, or 4,000,000 shares of Common Stock, whichever is greater, for the purpose of issuing incentive awards under the Incentive Plan.  The Company had 1,523,986 shares of Common Stock available for grant under the Incentive Plan at March 31, 2003.

 

Stock Options

 

The Incentive Plan provides for the issuance to eligible employees of, among other things, incentive and non-qualified stock options, that may expire up to 10 years from the date of grant.  The outstanding options vest over varying periods and have an exercise price equal to the closing price of the Company’s stock on the date of the grant.

 

Restricted and Capital Incentive Plan (“CIP”)

 

Effective January 2, 2001, the Company adopted the CIP under its Incentive Plan in which eligible employees may purchase shares of the Company’s restricted common stock at a discount of up to 33 1/3 % of the 20-day average of the closing sales prices for a share of the Company’s common stock, ending on the day prior to the date the shares are issued.  The CIP was amended effective November 1, 2001 to include eligible consultants as potential participants under the program.

 

11

 

All shares issued are valued at the closing price on the date the shares are issued.  Consideration paid through the deferral of salaries, commissions, or discretionary bonuses is recorded as compensation expense on the date the shares are issued.  The difference between the value of the shares issued and the consideration paid is recorded as unearned compensation and is shown as a separate component of shareholders’ equity.  Additionally, shares are issued under the Incentive Plan in conjunction with notes receivable, which are also shown as a separate component of shareholders’ equity. Unearned compensation and the notes receivable are amortized to compensation expense over the three-year vesting periods.

 

The following summarizes certain information related to the CIP for the three months ended March 31, 2003 and 2002.

 

		Three Months Ended March 31,
		2003			2002
		(in thousands, except shares)
Number of shares issued		68,653			229,025
Value of shares issued		$	549		$	1,207
Additions to unearned compensation		34			605
Additions to notes receivable		515			234
Amortization of unearned compensation		207			109
Amortization of notes receivable		209			97

 

9.              RELATED PARTIES

 

The Company had receivables from related parties totaling $5.0 million at March 31, 2003, primarily consisting of $1.4 million of unpaid management fees earned on the Company’s investments in limited partnerships and $3.0 million of notes receivable from employees and consultants.

 

12

 

Item 2.           Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and their related notes.

 

General

 

We provide diversified financial services through our subsidiaries, including institutional, prime and retail brokerage, investment banking, merchant banking, financial advisory, trust related services, investment management and financial planning. All of these activities are highly competitive and are sensitive to many factors outside our control, including those factors listed under “Factors Affecting Forward-Looking Statements.”

 

We closely monitor our operating environment to enable us to respond promptly to market cycles. In addition, we seek to lessen earnings volatility by controlling expenses, increasing fee-based business and developing new revenue sources. Nonetheless, operating results for any specific period should not be considered representative of future performance.

 

Components of Revenues and Expenses

 

Revenues.                  Our revenues are comprised primarily of (1) commission revenue from retail, prime and institutional brokerage transactions, (2) fees from asset-based advisory services, (3) principal and agent transactions, (4) investment banking revenue from corporate finance fees, public and private offerings, mergers and acquisitions, merchant banking and (5) fees from asset management, financial planning and fiduciary services.  We also earn interest on the cash held and dividends received from the equity securities held by us for our corporate capital accounts and have realized and unrealized gains (or losses) on securities in our inventory account.  Interest income results from interest earned on our inventories of fixed income securities prior to sale, and from interest and dividends earned on investments in our capital accounts.

 

Expenses.                   Our expenses consist of (1) employee compensation and benefits, (2) brokerage and clearing costs, and (3) other expenses.  Compensation and benefits have both a variable component based on revenue production and a fixed component.  The variable component includes institutional and retail sales commissions, bonuses, overrides, and trading desk incentives.  Retail and institutional commissions are based on a competitive commission schedule.  The investment banking group and the research group receive a salary and discretionary bonus as compensation.  The fixed component includes administrative and executive salaries, payroll taxes, employee benefits and temporary employee costs.  Compensation and benefits is our largest expense item and includes wages, salaries and benefits. During the first three months of 2003, compensation and benefits represented 69% of total expenses, and 66% of total revenues compared to 73% of total expenses, and 64% of total revenues during the comparable period in 2002.

 

Brokerage and clearance expenses include clearing and trade execution costs associated with the retail, prime and institutional brokerage business at SMH.  SMH clears its transactions primarily through the Pershing Division of Donaldson, Lufkin and Jenrette Securities Corporation, a Credit Suisse First Boston Company, and other clearing brokers.

 

Other expenses include (1) occupancy and equipment expenses, such as rent and utility charges for facilities, and (2) communications and data processing expenses, such as third-party systems, quotes, market data and software program providers.

 

13

 

Results of Operations

 

Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

 

Total revenues were $20.9 million in the first quarter of 2003 compared to $20.8 million for the same quarter in 2002.  An increase in commission revenue from prime brokerage services was partially offset by a decline in fixed income brokerage revenues.  Total expenses for the same 2003 period increased to $19.8 million from $18.3 million in the same quarter of the previous year.  Equity in income of limited partnerships increased from $623,000 during the first quarter of 2002 to $868,000 during the first quarter of 2003, due to increases in the Company’s share of the values of securities held in the investment portfolios of the limited partnerships managed by the Company.  Net income for the three month period ended March 31, 2003 declined to $1.2 from $2.0 million in the same period in 2002.  Basic and diluted income per share was $0.07 for the three months ended March 31, 2003 compared to $0.12 for the same period in 2002.

 

Commissions revenue increased to $12.3 million in the first quarter of 2003 from $9.7 million in 2002, primarily as a result of increased trading volume related to the growth of both the number and size of prime broker accounts.  Principal transactions revenue totaled $2.0 million for the 2003 period versus $4.8 million in the first quarter of 2002.  Revenues from fixed income brokerage declined to $1.6 million during the first quarter of 2003 from $3.9 million during the comparable prior year quarter due to the reduced impact on the mortgage-related securities market caused by stabilizing interest rates in the current year, compared to declining interest rates during the first quarter of 2002.  Investment banking revenue declined to $3.4 million during the first quarter of 2003 from $3.7 million in the same period of 2002, principally due to a decline in fees earned from private placement transactions.  Revenues from fiduciary, custodial and advisory fees increased to $1.8 million in the first quarter of 2003 from $1.7 million in same quarter of 2002.  Interest and dividend income increased to $525,000 in 2003 from $427,000 in the same period last year.  Other income increased from $565,000 during 2002 to $926,000 during 2003, due to an increase in interest earned on the Company’s cash balances and customer credit balances at its clearing brokers as well as increased fees earned from the sale of insurance annuity products.

 

During the three months ended March 31, 2003, employee compensation and benefits, increased to $13.7 million from $13.4 million in the same period last year.  Floor brokerage, exchange and clearance fees increased to $1.4 million in the first quarter of 2003 from $923,000 in the same quarter of 2002 reflecting increased clearing and execution costs resulting from the additional trading volume attributable to the growth in revenues from prime brokerage services.  Communication and data processing costs increased to $1.3 million in 2003 from $1.0 million in the same period last year resulting primarily from increased personnel and trading volumes related to the prime brokerage division.  Occupancy costs totaled $1.2 million during the first quarter of 2003, compared to $1.0 million in the prior year quarter.  Other general and administrative expenses increased to $2.1 million during the first three months of 2003 from $1.9 million in the first quarter of last year mainly due to the growth in the prime brokerage division.

 

The effective tax rate from operations was 41% for the three months ended March 31, 2003 compared to 37% for the three months ended March 31, 2002.

 

Liquidity and Capital Resources

 

We intend to satisfy a large portion of our funding needs with our own capital resources, consisting largely of internally generated earnings and liquid assets we currently hold.

 

At March 31, 2003, we had approximately $30.3 million in cash and cash equivalents, which together with receivables from broker-dealers, deposits with clearing brokers, marketable securities owned, and securities available for sale represented about 33% of our total assets at the end of the first quarter.

 

 

14

 

For the three months ended March 31, 2003, net cash used in operations totaled $4.8 million versus net cash provided by operations of $2.1 million during the first three months of 2002.  Accounts payable and accrued liabilities declined by $4.3 million during the three months ended March 31, 2003, principally due to the payment of accrued compensation during the first quarter of 2003.  Accounts receivable increased by $1.5 million during the first three months of 2003, primarily due to increases in management fees owed to the Company by the limited partnerships, and in notes receivable from other related parties.

 

Capital expenditures for the first quarter of 2003 were $240,000, mainly for the purchase of furniture and computer equipment and software, as well as for leasehold improvements, necessary for our growth.  During the first three months of 2003, we reacquired 14,654 of our common shares at a total cost of approximately $119,000.

 

At March 31, 2003, SMH, our registered broker-dealer subsidiary, was in compliance with the net capital requirements of the Securities and Exchange Commission’s Uniform Net Capital Rules and had capital in excess of the required minimum.  PMT was in compliance with the Texas Department of Banking net capital requirement and had capital in excess of the required minimum.

 

We are a party to various legal proceedings that are of an ordinary or routine nature incidental to our operations.  We believe we have adequately reserved for such litigation matters and that they will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

 

Factors Affecting Forward-Looking Statements

 

This quarterly report on 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 and Exchange Act of 1934, as amended (the “Acts”). These forward-looking statements may relate to such matters as anticipated financial performance, future revenues or earnings, business prospects, projected ventures, new products, anticipated market performance and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. To comply with the safe harbor, the Company cautions readers that a variety of factors could cause the Company’s actual results to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. These risks and uncertainties, many of which are beyond the Company’s control, include, but are not limited to (1) trading volume in the securities markets; (2) volatility of the securities markets and interest rates; (3) changes in regulatory requirements, which could affect the demand for the Company’s services or the cost of doing business; (4) general economic conditions, both domestic and foreign, especially in the regions where the Company does business; (5) changes in the rate of inflation and related impact on securities markets; (6) competition from existing financial institutions and other new participants in the securities markets; (7) legal developments affecting the litigation experience of the securities industry; (8) successful implementation of technology solutions; (9) changes in valuations of the Company’s trading and warrant portfolios resulting from mark-to-market adjustments; (10) dependence on key personnel and (11) demand for the Company’s services. The Company does not undertake to publicly update or revise any forward-looking statements.

 

Item 3.           Quantitative and Qualitative Disclosures About Market Risk

 

Market Risks

 

At March 31, 2003, PMT had equity securities under management with a fair value of $415 million.  PMT’s fee income for the three months ended March 31, 2003 would have been reduced by approximately $53,000 assuming a hypothetical 10% decrease in the value of its equity securities under management.  PMT’s securities available for sale are recorded at a fair value of approximately $2.8 million at March 31, 2003.  These securities are subject to equity price risk.  These securities have an original cost of $3.2 million.  At March 31, 2003, the unrealized decline in market value totaling $474,000, less tax benefit of $175,000, has been included as a separate component of shareholders’ equity.

 

 

15

 

Management evaluates the realizability of securities available for sale to determine if a decline in value is other than temporary.  Such evaluation considers the length of time and the extent to which market value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.  Management believes the unrealized losses are temporary at March 31, 2003.  However, a write-down accounted for as a realized loss may be necessary in the future.

 

The Company’s trading equity and debt securities are marked to market on a daily basis.  At March 31, 2003, the Company’s trading equity and debt securities were recorded at a fair value of approximately $1.8 million.  These trading equity and debt securities are subject to equity price risk.  This risk would amount to approximately $180,000 based on a potential loss in fair value from a hypothetical 10% decrease in the market value of such equity and debt securities.  The actual equity price risk related to the trading equity and debt securities may differ substantially.

 

Item 4.           Controls and Procedures

 

Our management, including our Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-14(c) promulgated under the Securities and Exchange Act of 1934, as amended) as of a date (the “Evaluation Date”) within 90 days prior to the filing date of this report.  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective for timely gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934, as amended.  There have been no significant changes made in our internal controls or in other factors that could significantly affect our internal controls subsequent to the Evaluation Date.

 

16

 

PART II.  OTHER INFORMATION

 

Item 1.           Legal Proceedings

 

We are a party to various legal proceedings that are of an ordinary or routine nature incidental to our operations.  Certain of our litigation and claims are covered by insurance with a maximum deductible of $50,000.  We believe we have adequately reserved for such litigation matters and that they will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

Exhibit Number		Description
3.1		Articles of Incorporation of the Company, as amended  (filed as Exhibit 3.1 to the Company’s Form 10-K for the year ended December 31, 2001 (File No. 000-30066) and incorporated herein by reference).
3.2		Amended and Restated Bylaws of the Company (filed as Exhibit 3.2 to the Company’s Form 10-K for the year ending December 31, 1998 (File No. 000-30066) and incorporated herein by reference).
*99.1		Certification Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*99.2		Certification Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

*  Filed herewith.

 

(b)         Reports on Form 8-K.

 

On February 25, 2003, the Company filed a current report on Form 8-K relating to the declaration by its board of directors of a cash dividend in the amount of $0.03 per share of common stock.

 

 

17

 

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.

 

 

	SANDERS MORRIS HARRIS GROUP INC.
	By	/s/  BEN T. MORRIS
		Ben T. Morris
		Chief Executive Officer
	By	/s/  RICK BERRY
		Rick Berry
		Chief Financial Officer
Date:  May 12, 2003

 

18

 

CERTIFICATIONS

 

I, Ben T. Morris, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of Sanders Morris Harris Group Inc.;

 

2.                                       Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                                       The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)                                     evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a)                                      all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)                                     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date:  May 12, 2003
/s/ BEN T. MORRIS
Ben T. Morris
Chief Executive Officer

 

19

 

I, Rick Berry, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of Sanders Morris Harris Group Inc.;

 

2.                                       Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                                       The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)                                     evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a)                                      all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b)                                     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date:  May 12, 2003
/s/  RICK BERRY
Rick Berry
Chief Financial Officer

 

20