SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(mark one)
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ý |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 |
or
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o |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file No. 0-30066
SANDERS MORRIS HARRIS GROUP INC.
(Exact name of registrant as specified in its charter)
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Texas |
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76-0583569 |
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(State or other jurisdiction of |
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(I.R.S. Employer |
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600 Travis, Suite 3000 |
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(Address of principal executive office) |
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(713) 993-4610 |
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(Registrant’s telephone number, including area code) |
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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 August 2, 2004, was 17,640,140.
SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
1
SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share amounts)
|
|
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June 30, |
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December
31, |
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|
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(unaudited) |
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|
|
||
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ASSETS |
|
|
|
|
|
||
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Cash and cash equivalents |
|
$ |
20,683 |
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$ |
32,590 |
|
|
Receivables, net of allowance of $445 and $400, respectively |
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|
|
|
|
||
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Broker-dealers |
|
871 |
|
522 |
|
||
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Customers |
|
6,190 |
|
3,758 |
|
||
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Related parties |
|
10,012 |
|
6,100 |
|
||
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Other |
|
868 |
|
822 |
|
||
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Deposits with clearing brokers |
|
1,054 |
|
1,054 |
|
||
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Securities owned |
|
33,965 |
|
32,322 |
|
||
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Securities available for sale |
|
3,978 |
|
3,156 |
|
||
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Furniture and equipment, net |
|
7,521 |
|
4,227 |
|
||
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Other assets |
|
2,600 |
|
3,004 |
|
||
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Goodwill |
|
54,703 |
|
49,447 |
|
||
|
Total assets |
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$ |
142,445 |
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$ |
137,002 |
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|
|
|
|
|
|
|
||
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LIABILITIES AND SHAREHOLDERS' EQUITY |
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|
|
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||
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||
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Liabilities: |
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|
|
|
|
||
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Accounts payable and accrued liabilities |
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$ |
13,505 |
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$ |
16,597 |
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Deferred tax liability |
|
82 |
|
647 |
|
||
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Securities sold, not yet purchased |
|
246 |
|
255 |
|
||
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Other liabilities |
|
107 |
|
144 |
|
||
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Total liabilities |
|
13,940 |
|
17,643 |
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||
|
|
|
|
|
|
|
||
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Commitments and contingencies |
|
|
|
|
|
||
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|
|
|
|
|
|
||
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Minority interests |
|
5,714 |
|
4,506 |
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||
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|
|
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|
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|
||
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Shareholders' equity: |
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|
|
|
|
||
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Preferred stock, $0.10 par value; 10,000,000 shares authorized; no shares issued and outstanding |
|
— |
|
— |
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||
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Common stock, $0.01 par value; 100,000,000 shares authorized; 18,379,542 and 17,991,653 shares issued, respectively |
|
184 |
|
180 |
|
||
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Additional paid-in capital |
|
118,506 |
|
113,781 |
|
||
|
Receivables for shares issued |
|
(2,057 |
) |
(1,117 |
) |
||
|
Retained earnings |
|
11,579 |
|
6,015 |
|
||
|
Accumulated other comprehensive loss |
|
(77 |
) |
(70 |
) |
||
|
Unearned compensation |
|
(1,863 |
) |
(638 |
) |
||
|
Treasury stock at cost, 739,402 and 724,003 shares, respectively |
|
(3,481 |
) |
(3,298 |
) |
||
|
Total shareholders' equity |
|
122,791 |
|
114,853 |
|
||
|
Total liabilities and shareholders' equity |
|
$ |
142,445 |
|
$ |
137,002 |
|
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 |
|
Six Months
Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
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||||
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|
|
|
|
|
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|
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||||
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Revenues: |
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|
|
|
|
|
|
|
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||||
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Commissions |
|
$ |
12,613 |
|
$ |
13,321 |
|
$ |
26,523 |
|
$ |
25,633 |
|
|
Principal transactions |
|
1,989 |
|
3,939 |
|
3,442 |
|
5,949 |
|
||||
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Investment banking |
|
7,825 |
|
6,797 |
|
17,361 |
|
10,201 |
|
||||
|
Fiduciary, custodial and advisory fees |
|
4,732 |
|
2,527 |
|
8,252 |
|
4,281 |
|
||||
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Interest and dividends |
|
979 |
|
684 |
|
1,845 |
|
1,209 |
|
||||
|
Other income |
|
517 |
|
351 |
|
1,039 |
|
1,277 |
|
||||
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Total revenues |
|
28,655 |
|
27,619 |
|
58,462 |
|
48,550 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
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Expenses: |
|
|
|
|
|
|
|
|
|
||||
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Employee compensation and benefits |
|
17,118 |
|
16,053 |
|
34,975 |
|
29,467 |
|
||||
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Floor brokerage, exchange and clearance fees |
|
1,310 |
|
1,470 |
|
2,526 |
|
2,900 |
|
||||
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Communications and data processing |
|
1,926 |
|
1,408 |
|
3,462 |
|
2,738 |
|
||||
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Occupancy |
|
1,695 |
|
1,635 |
|
3,403 |
|
2,882 |
|
||||
|
Other general and administrative |
|
2,809 |
|
2,592 |
|
5,254 |
|
4,652 |
|
||||
|
Total expenses |
|
24,858 |
|
23,158 |
|
49,620 |
|
42,639 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
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Income before equity in income of limited partnerships, minority interests and income taxes |
|
3,797 |
|
4,461 |
|
8,842 |
|
5,911 |
|
||||
|
Equity in income of limited partnerships |
|
2,025 |
|
1,985 |
|
2,830 |
|
2,853 |
|
||||
|
|
|
5,822 |
|
6,446 |
|
11,672 |
|
8,764 |
|
||||
|
Minority interests in net income of consolidated companies |
|
(933 |
) |
(686 |
) |
(1,385 |
) |
(986 |
) |
||||
|
Income before income taxes |
|
4,889 |
|
5,760 |
|
10,287 |
|
7,778 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Provision for income taxes |
|
(1,942 |
) |
(2,365 |
) |
(4,070 |
) |
(3,194 |
) |
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net income |
|
$ |
2,947 |
|
$ |
3,395 |
|
$ |
6,217 |
|
$ |
4,584 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
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Earnings per share: |
|
|
|
|
|
|
|
|
|
||||
|
Basic |
|
$ |
0.17 |
|
$ |
0.20 |
|
$ |
0.36 |
|
$ |
0.27 |
|
|
Diluted |
|
$ |
0.16 |
|
$ |
0.19 |
|
$ |
0.34 |
|
$ |
0.26 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Weighted average common shares outstanding: |
|
|
|
|
|
|
|
|
|
||||
|
Basic |
|
17,592,623 |
|
17,115,147 |
|
17,493,334 |
|
16,981,008 |
|
||||
|
Diluted |
|
18,186,799 |
|
17,641,257 |
|
18,088,780 |
|
17,526,008 |
|
||||
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 six months ended June 30, 2004
(in thousands, except shares)
(unaudited)
|
|
|
Amounts |
|
|
|
Shares |
|
|
|
Common stock |
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
180 |
|
|
|
17,991,653 |
|
|
Stock issued pursuant to employee benefit plan |
|
4 |
|
|
|
387,889 |
|
|
|
Balance, end of period |
|
184 |
|
|
|
18,379,542 |
|
|
|
Additional paid-in capital |
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
113,781 |
|
|
|
|
|
|
Stock issued pursuant to employee benefit plan |
|
4,725 |
|
|
|
|
|
|
|
Balance, end of period |
|
118,506 |
|
|
|
|
|
|
|
Receivables for shares issued |
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
($1,117 |
) |
|
|
|
|
|
|
Issuance of restricted stock |
|
(1,566 |
) |
|
|
|
|
|
|
Amortization of notes receivable |
|
626 |
|
|
|
|
|
|
|
Balance, end of period |
|
(2,057 |
) |
|
|
|
|
|
|
Retained earnings |
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
6,015 |
|
|
|
|
|
|
Dividends |
|
(653 |
) |
|
|
|
|
|
|
Net income |
|
6,217 |
|
6,217 |
|
|
|
|
|
Balance, end of period |
|
11,579 |
|
6,217 |
|
|
|
|
|
Accumulated other comprehensive loss |
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
(70 |
) |
|
|
|
|
|
Net change in unrealized depreciation on securities available for sale |
|
(11 |
) |
(11 |
) |
|
|
|
|
Income tax benefit on change |
|
4 |
|
4 |
|
|
|
|
|
Balance, end of period |
|
(77 |
) |
7 |
|
|
|
|
|
Comprehensive income |
|
|
|
6,224 |
|
|
|
|
|
Unearned compensation |
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
(638 |
) |
|
|
|
|
|
Net issuance of restricted stock |
|
(1,685 |
) |
|
|
|
|
|
|
Amortization of unearned compensation |
|
460 |
|
|
|
|
|
|
|
Balance, end of period |
|
(1,863 |
) |
|
|
|
|
|
|
Treasury stock |
|
|
|
|
|
|
|
|
|
Balance, beginning of period |
|
$ |
(3,298 |
) |
|
|
(724,003 |
) |
|
Acquisition of treasury stock |
|
(183 |
) |
|
|
(15,399 |
) |
|
|
Balance, end of period |
|
(3,481 |
) |
|
|
(739,402 |
) |
|
|
Total shareholders' equity and common shares outstanding |
|
$ |
122,791 |
|
|
|
17,640,140 |
|
4
SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For the six months ended June 30, 2004 and 2003
(in thousands)
(unaudited)
|
|
|
2004 |
|
2003 |
|
||
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
||
|
Net income |
|
$ |
6,217 |
|
$ |
4,584 |
|
|
Adjustments to reconcile net income to net cash used in operating activities: |
|
|
|
|
|
||
|
Realized gain on securities available for sale |
|
(12 |
) |
(9 |
) |
||
|
Depreciation |
|
974 |
|
567 |
|
||
|
Provision for bad debts |
|
45 |
|
160 |
|
||
|
Compensation expense related to amortization of notes receivable and unearned compensation |
|
1,086 |
|
864 |
|
||
|
Deferred income taxes |
|
(561 |
) |
512 |
|
||
|
Equity in income of limited partnerships |
|
(2,830 |
) |
(2,853 |
) |
||
|
Minority interests in income of consolidated companies |
|
1,385 |
|
24 |
|
||
|
Changes in operating assets and liabilities excluding effects of acquisition: |
|
|
|
|
|
||
|
Increase in receivables |
|
(5,986 |
) |
(2,040 |
) |
||
|
Decrease (increase) in securities owned |
|
387 |
|
(626 |
) |
||
|
Decrease (increase) in other assets |
|
50 |
|
(965 |
) |
||
|
(Decrease) increase in securities sold, not yet purchased |
|
(9 |
) |
183 |
|
||
|
(Decrease) increase in other liabilities |
|
(37 |
) |
25 |
|
||
|
Decrease in accounts payable and accrued liabilities |
|
(4,140 |
) |
(476 |
) |
||
|
Net cash used in operating activities |
|
(3,431 |
) |
(50 |
) |
||
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
||
|
Capital expenditures |
|
(4,234 |
) |
(460 |
) |
||
|
Acquisition, net of cash acquired of $478 and $142, respectively |
|
(2,938 |
) |
(1,608 |
) |
||
|
Cash of business consolidated |
|
49 |
|
— |
|
||
|
Purchase of securities available for sale |
|
(1,163 |
) |
(784 |
) |
||
|
Proceeds from sales and maturities of securities available for sale |
|
343 |
|
1,302 |
|
||
|
Net cash used in investing activities |
|
(7,943 |
) |
(1,550 |
) |
||
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
||
|
Purchase of treasury stock |
|
(183 |
) |
(168 |
) |
||
|
Proceeds from shares issued |
|
1,478 |
|
2,130 |
|
||
|
Investment by minority interest |
|
27 |
|
38 |
|
||
|
Distributions to minority interests |
|
(1,202 |
) |
(344 |
) |
||
|
Payment of cash dividends |
|
(653 |
) |
(515 |
) |
||
|
Net cash (used in) provided by financing activities |
|
(533 |
) |
1,141 |
|
||
|
Net decrease in cash and cash equivalents |
|
(11,907 |
) |
(459 |
) |
||
|
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD |
|
32,590 |
|
34,890 |
|
||
|
CASH AND CASH EQUIVALENTS AT END OF PERIOD |
|
$ |
20,683 |
|
$ |
34,431 |
|
|
Noncash investing and financing activities: |
|
|
|
|
|
||
|
Cash paid for income taxes |
|
$ |
2,085 |
|
$ |
1,514 |
|
|
Acquisition and consolidation: |
|
|
|
|
|
||
|
Cash |
|
— |
|
142 |
|
||
|
Receivables |
|
— |
|
167 |
|
||
|
Fixed assets |
|
6 |
|
30 |
|
||
|
Other assets |
|
(5 |
) |
— |
|
||
|
Securities owned |
|
(800 |
) |
— |
|
||
|
Goodwill |
|
800 |
|
— |
|
||
|
Accounts payable and accrued liabilities |
|
(18 |
) |
(206 |
) |
||
|
Minority interests |
|
(32 |
) |
— |
|
||
The accompanying notes are an integral part of the condensed consolidated financial statements.
5
Sanders Morris Harris Group Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Through its operating subsidiaries Sanders Morris Harris Inc. (“SMH”), Salient Capital Management (“Salient/PMT”), SMH Capital Advisors (“SMCA”) and Charlotte Capital, the Company provides a broad range of financial services, including institutional, prime and retail brokerage, principal trading, investment banking, 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 1999 through 2004. The acquisitions were accounted for using the purchase method.
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 June 30, 2004, our results of operations for the three and six months ended June 30, 2004 and 2003, and our cash flows for the six months ended June 30, 2004 and 2003. 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, 2003.
In December 2003, the FASB issued FASB Interpretation No. 46R (revised December 2003), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. The Company was required to apply FIN 46R to variable interests in VIEs in its consolidated financial statements beginning with the quarter ended March 31, 2004. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The Company has identified one entity that requires consolidation under this Interpretation. Consolidation of this entity increased the Company’s assets by approximately $22,000, liabilities by approximately $25,000 and had an insignificant effect on the other basic consolidated financial statements.
Stock-Based Compensation
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.
6
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 |
|
Six Months
Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
|
|
(in thousands, except per share) |
|
(in thousands, except per share) |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net income as reported |
|
$ |
2,947 |
|
$ |
3,395 |
|
$ |
6,217 |
|
$ |
4,584 |
|
|
Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
|
(189 |
) |
(109 |
) |
(250 |
) |
(233 |
) |
||||
|
Pro forma net income |
|
$ |
2,758 |
|
$ |
3,286 |
|
$ |
5,967 |
|
$ |
4,351 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Earnings per share |
|
|
|
|
|
|
|
|
|
||||
|
Basic-as reported |
|
$ |
0.17 |
|
$ |
0.20 |
|
$ |
0.36 |
|
$ |
0.27 |
|
|
Basic-pro forma |
|
$ |
0.16 |
|
$ |
0.19 |
|
$ |
0.34 |
|
$ |
0.26 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Diluted-as reported |
|
$ |
0.16 |
|
$ |
0.19 |
|
$ |
0.34 |
|
$ |
0.26 |
|
|
Diluted-pro forma |
|
$ |
0.15 |
|
$ |
0.19 |
|
$ |
0.33 |
|
$ |
0.25 |
|
Reclassifications
Certain reclassifications have been made to the 2003 condensed consolidated financial statements to conform them with the 2004 presentation. The reclassifications had no effect on retained earnings, results of operations or cash flows as previously reported.
On April 1, 2004, the Company acquired a 69% interest in Charlotte Capital. Employees of Charlotte Capital retained a 31% ownership interest in the firm. Charlotte Capital, based in Charlotte, North Carolina, manages approximately $400 million in assets for institutional investors in small cap value and mid cap value styles. SMHG paid $3.4 million in cash at closing, and is obligated to pay an additional amount in 18 months. The base amount of the additional payment is $2.3 million; however, it may be adjusted up or down based on changes in the firm’s revenues and assets under management for the 18 month period beginning April 1, 2004. Employees of Charlotte Capital can earn up to an additional 9% ownership interest by achieving specified revenue run rates during the 18-month period following closing. The acquisition was accounted for as a purchase, and accordingly, the financial information of Charlotte Capital has been included in the Company’s consolidated financial statements from April 1, 2004. The initial consideration of $3.4 million exceeded the fair market value of identifiable net tangible assets by approximately $4.5 million, which has been recorded as goodwill.
On May 2, 2003, the Company acquired a 50% ownership interest in the Salient companies. Additionally, the Company acquired a 23.15% profits interest in the advisor to The Endowment Fund, a related entity. The former owners of Salient and The Endowment Fund received cash payments totaling $1.75 million and may later receive an additional $250,000 cash payment and up to 1,200,000 common shares of the Company based on profitability of Salient/PMT for the year ended December 31, 2004. No additional consideration has been earned through June 30, 2004. The Salient companies and Pinnacle Management & Trust Company (“PMT”) were contributed to Salient Capital Management, which entity’s Class A limited partner units are jointly owned by the Company and the former owners of Salient. Additionally, the Company received Class B limited partner units of Salient/PMT which, in the event of a liquidation or sale of Salient/PMT, entitles the Company to first receive proceeds, if any, equal to the net
7
asset value of PMT as of May 2, 2003, (approximately $4.4 million) with the remaining proceeds to be divided equally among the owners of the Class A units. The Salient companies provide investment advisory services to individuals and institutions. The Endowment Fund is a diversified fund of funds using hedge fund managers that specialize in a variety of investment approaches. The acquisitions were accounted for as a purchase, and accordingly, the financial information of the Salient companies and the advisor to The Endowment Fund has been included in the Company’s consolidated financial statements from May 2, 2003. The purchase price of approximately $1.8 million exceeded the fair market value of identifiable net assets by approximately $1.7 million, which has been recorded as goodwill. The Company uses the consolidation method to account for its investment in Salient/PMT.
On December 2, 2003, the Company acquired the Tulsa, Oklahoma branch office of U.S. Bancorp Piper Jaffray Inc. The Tulsa office provides retail brokerage services to its clients. The former owner of the Tulsa office received $377,000 in cash. The acquisition was accounted for as a purchase and, accordingly, the financial information of the Tulsa office has been included in the Company’s consolidated financial statements from December 2, 2003. The purchase price of approximately $377,000 exceeded the fair value of identifiable net assets acquired by approximately $17,000, which has been recorded as goodwill.
Securities owned and securities sold, not yet purchased as of June 30, 2004 were as follows:
|
|
|
Owned |
|
Sold, Not
Yet |
|
||
|
|
|
(in thousands) |
|
||||
|
Marketable: |
|
|
|
|
|
||
|
U.S. Government and agency |
|
$ |
2,020 |
|
$ |
— |
|
|
Corporate stocks |
|
516 |
|
246 |
|
||
|
Corporate bonds and commercial paper |
|
5,420 |
|
— |
|
||
|
|
|
7,956 |
|
246 |
|
||
|
Not readily marketable: |
|
|
|
|
|
||
|
Partnerships |
|
19,113 |
|
— |
|
||
|
Corporate stocks and warrants |
|
6,896 |
|
— |
|
||
|
|
|
$ |
33,965 |
|
$ |
246 |
|
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., Life Sciences Opportunity Fund, L.P., Life Sciences Opportunity Fund (Institutional), L.P., Life Sciences Opportunity Fund II, L.P., Life Sciences Opportunity Fund (Institutional) II, L.P. and 2003 Houston Energy Partners, L.P.
The Company has issued a letter of credit in the amount of $1.5 million to the owner of one of the offices that we lease to secure payment of our lease obligation for that facility. The letter of credit is secured by securities owned in the amount of $1.5 million.
8
Securities available for sale at June 30, 2004 were as follows:
|
|
|
Amortized |
|
Gross Unrealized |
|
Estimated |
|
||||||
|
Gains |
|
Losses |
|||||||||||
|
|
|
(in thousands) |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
U.S. Government and agency obligations |
|
$ |
1,043 |
|
$ |
2 |
|
$ |
(11 |
) |
$ |
1,034 |
|
|
Marketable equity securities |
|
2,006 |
|
77 |
|
(184 |
) |
1,899 |
|
||||
|
Corporate bonds |
|
251 |
|
1 |
|
- |
|
252 |
|
||||
|
Partnerships |
|
800 |
|
2 |
|
(9 |
) |
793 |
|
||||
|
Total |
|
$ |
4,100 |
|
$ |
82 |
|
$ |
(204 |
) |
$ |
3,978 |
|
The contractual maturities of debt securities available for sale at June 30, 2004, were as follows:
|
Due before 5 years |
|
$ |
996 |
|
|
Due after 25 years through 30 years |
|
$ |
290 |
|
Gross realized gains on sales of securities available for sale were $13,000 for the six months ended June 30, 2004 and $36,000 for the six months ended June 30, 2003. Gross realized losses on securities available for sale were $1,000 for the six months ended June 30, 2004 and $27,000 for the six months ended June 30, 2003.
The Company has pledged securities valued at $250,000 to the bank commissioner of the state of Oklahoma to secure its performance of fiduciary duties for trust activities in that state.
The differences between the effective tax rate reflected in the income tax provision from operations and the statutory federal rate were as follows:
|
|
|
Three
Months Ended |
|
Six Months
Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
|
|
(in thousands) |
|
(in thousands) |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Tax computed using the statutory rate |
|
$ |
1,662 |
|
$ |
1,958 |
|
$ |
3,498 |
|
$ |
2,645 |
|
|
State income taxes and other |
|
280 |
|
407 |
|
572 |
|
549 |
|
||||
|
Total |
|
$ |
1,942 |
|
$ |
2,365 |
|
$ |
4,070 |
|
$ |
3,194 |
|
There were no firm underwriting commitments open at June 30, 2004.
The Company and its subsidiaries have obligations under operating leases that expire by 2014 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.
9
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.
The Company has issued a letter of credit in the amount of $1.5 million to the owner of one of the offices that we lease to secure payment of our lease obligation for that facility. The letter of credit is secured by securities owned in the amount of $1.5 million.
Basic and diluted earnings per-share computations for the periods indicated were as follows:
|
|
|
Three Months Ended June 30, |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
|
|
(in thousands, except share and per share amounts) |
|
||||
|
Computation of basic and diluted income per common share for the three months ended June 30: |
|
|
|
|
|
||
|
Net income |
|
$ |
2,947 |
|
$ |
3,395 |
|
|
Weighted average number of common shares outstanding |
|
17,592,623 |
|
17,115,147 |
|
||
|
Common shares issuable under stock option plan |
|
984,027 |
|
1,079,830 |
|
||
|
Less shares assumed repurchased with proceeds |
|
(389,851 |
) |
(553,720 |
) |
||
|
Weighted average common shares outstanding |
|
18,186,799 |
|
17,641,257 |
|
||
|
Basic income per common share |
|
$ |
0.17 |
|
$ |
0.20 |
|
|
Diluted income per common share |
|
$ |
0.16 |
|
$ |
0.19 |
|
|
|
|
Six Months Ended June 30, |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
|
|
(in thousands, except share and per share amounts) |
|
||||
|
Computation of basic and diluted income per common share for the six months ended June 30: |
|
|
|
|
|
||
|
Net income |
|
$ |
6,217 |
|
$ |
4,584 |
|
|
Weighted average number of common shares outstanding |
|
17,493,334 |
|
16,981,008 |
|
||
|
Common shares issuable under stock option plan |
|
984,026 |
|
1,079,831 |
|
||
|
Less shares assumed repurchased with proceeds |
|
(388,580 |
) |
(534,831 |
) |
||
|
Weighted average common shares outstanding |
|
18,088,780 |
|
17,526,008 |
|
||
|
Basic income per common share |
|
$ |
0.36 |
|
$ |
0.27 |
|
|
Diluted income per common share |
|
$ |
0.34 |
|
$ |
0.26 |
|
Outstanding stock options (45,000 for the three and six months ended June 30, 2004, and 50,000 for the three and six months ended June 30, 2003) have not been included in diluted earnings per common share because to do so would have been antidilutive for the periods presented.
SMHG operates through six business segments: Retail Brokerage, Institutional Brokerage, Asset Management, Prime Brokerage, Investment Banking, and Corporate and Other. The business segments are based upon factors such as the services provided and distribution channels served. Certain services are
10
provided to customers through more than one of our business segments. Prior to April 2004, the Company aggregated the brokerage and investment banking businesses into one segment.
The Retail Brokerage segment distributes a range of financial products through its branch distribution network, including equity and fixed income securities, mutual funds and annuities. Retail revenues consist of commissions and principal credits earned on equity and fixed income transactions in customer brokerage accounts, distribution fees earned from mutual funds, fees earned from managed accounts, and net interest on customers’ margin loan and credit account balances. Additionally, retail revenues include sales credits from investment banking transactions such as the distribution of underwritings that we co-manage or in which we participate and private placements of securities in which we serve as placement agent. The firm employs registered representatives and also licenses independent financial advisors.
The Institutional Brokerage segment distributes equity and fixed income products through its distribution network to its institutional clients. Institutional revenues consist of commissions and principal credits earned on transactions in customer brokerage accounts, a small amount of net interest on customers’ margin loan and credit account balances, and sales credits from the distribution of investment banking products.
The Asset Management segment provides investment advisory, wealth and investment management, financial planning, and trust services to institutional and individual clients. Advisory fees are based on such factors as the amount of assets under management and the type of services provided. The asset management segment may earn commission revenues from the sale of equity, fixed income, mutual fund, and annuity products; and sales credits from the distribution of investment banking issues. In addition, performance fees may be earned for exceeding performance benchmarks for the investment portfolios in the limited partnerships that we manage.
The Prime Brokerage segment provides trade execution, clearing, custody and other back-office services to hedge funds. Prime broker revenues consist of commissions and principal credits earned on equity, and fixed income transactions; interest income from securities lending services to customers; and net interest on customers’ margin loan and credit account balances.
The Investment Banking segment provides corporate securities underwriting, private financings and financial advisory services. We participate in corporate securities distributions as a manager, co-manager or member of an underwriting syndicate or of a selling group in public offerings managed by other underwriters. Fees earned for our role as an advisor, manager, or underwriter are included in the investment banking segment. Sales credits associated with the distribution of investment banking products are reported in Retail Brokerage, Institutional Brokerage or Asset Management as determined by the distribution channel.
The Corporate and Other segment include realized and unrealized gains and losses on the Company’s investment portfolios and interest and dividends earned on our cash and securities positions. Unallocated corporate revenues and expenses are included in Corporate and Other.
11
The following summarizes certain financial information of each reportable business segment for the three and six months ended June 30, 2004 and 2003, respectively. SMHG does not analyze asset information in all business segments.
|
|
|
Three
Months Ended |
|
Six Months
Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
|
|
(in thousands) |
|
(in thousands) |
|
||||||||
|
Revenues: |
|
|
|
|
|
|
|
|
|
||||
|
Retail brokerage |
|
4,360 |
|
$ |
3,572 |
|
$ |
8,466 |
|
$ |
6,464 |
|
|
|
Institutional brokerage |
|
8,085 |
|
8,607 |
|
16,306 |
|
15,430 |
|
||||
|
Asset management |
|
7,400 |
|
4,373 |
|
13,632 |
|
8,099 |
|
||||
|
Prime brokerage |
|
4,828 |
|
6,440 |
|
9,831 |
|
12,248 |
|
||||
|
Investment banking |
|
3,122 |
|
3,836 |
|
8,972 |
|
5,297 |
|
||||
|
Corporate and other |
|
860 |
|
791 |
|
1,255 |
|
1,012 |
|
||||
|
Total |
|
$ |
28,655 |
|
$ |
27,619 |
|
$ |
58,462 |
|
$ |
48,550 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Income (loss) before equity in income (loss) of limited partnerships, income taxes and minority interests: |
|
|
|
|
|
|
|
|
|
||||
|
Retail brokerage |
|
$ |
421 |
|
$ |
306 |
|
$ |
619 |
|
$ |
204 |
|
|
Institutional brokerage |
|
1,350 |
|
1,665 |
|
2,786 |
|
2,683 |
|
||||
|
Asset management |
|
2,562 |
|
1,459 |
|
4,348 |
|
2,674 |
|
||||
|
Prime brokerage |
|
723 |
|
1,237 |
|
1,629 |
|
2,285 |
|
||||
|
Investment banking |
|
1,154 |
|
2,008 |
|
4,592 |
|
2,784 |
|
||||
|
Corporate and other |
|
(2,413 |
) |
(2,214 |
) |
(5,132 |
) |
(4,719 |
) |
||||
|
Total |
|
$ |
3,797 |
|
$ |
4,461 |
|
$ |
8,842 |
|
$ |
5,911 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Equity in income (loss) of limited partnerships: |
|
|
|
|
|
|
|
|
|
||||
|
Retail brokerage |
|
$ |
— |
|
$ |
— |
|
$ |
— |
|
$ |
— |
|
|
Institutional brokerage |
|
— |
|
— |
|
— |
|
— |
|
||||
|
Asset management |
|
2,031 |
|
1,783 |
|
2,763 |
|
2,557 |
|
||||
|
Prime brokerage |
|
— |
|
— |
|
— |
|
— |
|
||||
|
Investment banking |
|
— |
|
— |
|
— |
|
— |
|
||||
|
Corporate and other |
|
(6 |
) |
202 |
|
67 |
|
296 |
|
||||
|
Total |
|
$ |
2,025 |
|
$ |
1,985 |
|
$ |
2,830 |
|
$ |
2,853 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Minority interests in net (income) loss of consolidated companies: |
|
|
|
|
|
|
|
|
|
||||
|
Retail brokerage |
|
$ |
— |
|
$ |
— |
|
$ |
— |
|
$ |
— |
|
|
Institutional brokerage |
|
— |
|
— |
|
— |
|
— |
|
||||
|
Asset management |
|
(934 |
) |
(686 |
) |
(1,399 |
) |
(986 |
) |
||||
|
Prime brokerage |
|
— |
|
— |
|
— |
|
— |
|
||||
|
Investment banking |
|
— |
|
— |
|
— |
|
— |
|
||||
|
Corporate and other |
|
1 |
|
— |
|
14 |
|
— |
|
||||
|
Total |
|
$ |
(933 |
) |
$ |
(686 |
) |
$ |
(1,385 |
) |
$ |
(986 |
) |
|
|
|
|
|
|
|
|
|
|
|
||||
|
Income (loss) before income taxes: |
|
|
|
|
|
|
|
|
|
||||
|
Retail brokerage |
|
$ |
421 |
|
$ |
306 |
|
$ |
619 |
|
$ |
204 |
|
|
Institutional brokerage |
|
1,350 |
|
1,665 |
|
2,786 |
|
2,683 |
|
||||
|
Asset management |
|
3,659 |
|
2,556 |
|
5,712 |
|
4,245 |
|
||||
|
Prime brokerage |
|
723 |
|
1,237 |
|
1,629 |
|
2,285 |
|
||||
|
Investment banking |
|
1,154 |
|
2,008 |
|
4,592 |
|
2,784 |
|
||||
|
Corporate and other |
|
(2,418 |
) |
(2,012 |
) |
(5,051 |
) |
(4,423 |
) |
||||
|
Total |
|
$ |
4,889 |
|
$ |
5,760 |
|
$ |
10,287 |
|
$ |
7,778 |
|
12
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 1,319,523 shares of Common Stock available for grant under the Incentive Plan at June 30, 2004.
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.
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.
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.
Restricted Stock
The Incentive Plan provides for the issuance of restricted stock to eligible employees. The restricted shares vest over varying periods. All shares issued are valued at the closing price on the date the shares are issued. The value of the shares is recorded as unearned compensation and is shown as a separate component of shareholders’ equity. Unearned compensation is amortized to compensation expense over the vesting period.
The following summarizes certain information related to the CIP and restricted stock plans for the three and six months ended June 30, 2004 and 2003.
|
|
|
Three
Months Ended |
|
Six Months
Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
|
|
(in thousands, except shares) |
|
(in thousands, except shares) |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Number of shares issued |
|
147,314 |
|
24,125 |
|
265,451 |
|
92,778 |
|
||||
|
Value of shares issued |
|
$ |
1,816 |
|
$ |
236 |
|
$ |
3,252 |
|
$ |
785 |
|
|
Additions to unearned compensation |
|
1,159 |
|
22 |
|
1,685 |
|
57 |
|
||||
|
Additions to notes receivable |
|
658 |
|
213 |
|
1,566 |
|
729 |
|
||||
|
Amortization of unearned compensation |
|
(274 |
) |
275 |
|
(460 |
) |
481 |
|
||||
|
Amortization of notes receivable |
|
(326 |
) |
175 |
|
(626 |
) |
384 |
|
||||
13
The Company had receivables from related parties totaling $10.0 million at June 30, 2004, primarily consisting of $1.5 million of unpaid management fees earned by the Company for managing the limited partnerships, $5.3 million of notes receivable from employees, consultants and other related parties and a secured note receivable in the amount of $3.0 million that the Company expects to convert into an investment during the second half of 2004.
14
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, principal trading, 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.
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 other 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 second quarter of 2004, compensation and benefits represented 69% of total expenses, and 60% of total revenues compared to 69% of total expenses, and 58% of total revenues during the comparable period in 2003. During the first six months of 2004, compensation and benefits represented 70% of total expenses, and 60% of total revenues compared to 69% of total expenses and 61% of total revenues during the comparable period in 2003.
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 Pershing LLC, a member of BNY Securities Group and a subsidiary of The Bank of New York 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, market data and software program providers.
Our financial services business is affected by general economic conditions. The improvement in the economy, as well as in the overall stock market has had a positive impact on underwriting fees derived from public offerings and advisory fees from private placements. During 2004, the
15
increase in interest rates during the first six months led to a decrease in residential loan refinancing, which had a negative impact on that portion of our business that derives its income from mortgage-backed fixed-income securities. In the second quarter of 2004, stock trading volume declined significantly from the same period in 2003.
Our revenues relating to asset-based advisory services and managed accounts are typically from fees based on the market value of assets under management. The overall increase in equity prices resulted in growth in the values of our customers’ investment portfolios, which in turn led to higher management fees for the Company. The improved stock market has caused many of our customers to rebalance their investment portfolios, thereby reducing concentrations in money market instruments and increasing exposure to equity and other securities with a greater potential for growth.
We have organized 13 private equity funds for the purpose of investing in public and private companies that we believe are either significantly undervalued relative to their growth potential or have substantial prospects for capital growth. We invest in these funds along with our clients and earn management fees based on capital commitments, net assets or capital contributions. We also receive incentive compensation of a portion of the profit if the profit exceeds specified hurdle rates. The improvement in the overall stock market, as well as in individual investment positions owned by the private equity funds provided the Company with realized and unrealized gains from its ownership interests and incentive compensation due to fund performance.
We invest a portion of our excess cash in public equity and debt securities that we feel are undervalued. Additionally, we may receive warrants as a part of our compensation for investment banking services.
We have expanded both the range and depth of services offered to our clients through a combination of acquisitions and internal expansion. This growth has necessitated that we add personnel, as well as production-related incentive compensation plans. We have also improved and expanded our infrastructure including facilities, technology, and information services, to enable us to better compete with other firms that offer services similar to ours.
Results of Operations
Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003
FINANCIAL OVERVIEW
Total revenues were $28.7 million in the second quarter of 2004 compared to $27.6 million for the same quarter in 2003. An increase in investment banking revenue and fiduciary, custodial and advisory fees was partially offset by a decline in revenues from prime brokerage services. Total expenses for the 2004 period increased to $24.9 million from $23.2 million in the same quarter of the previous year. Minority interests in net income of consolidated companies increased to $933,000 during the second quarter of 2004 from $686,000 during the second quarter of 2003. Net income for the three month period ended June 30, 2004 declined to $2.9 million from $3.4 million in the same period in 2003. Basic income per share was $0.17 for the three months ended June 30, 2004 compared to $0.20 for the same period in 2003. Diluted income per share was $0.16 for the three months ended June 30, 2004 compared to $0.19 for the same period in 2003.
Commissions revenue declined to $12.6 million in the second quarter of 2004 from $13.3 million in 2003, primarily due to decreased trading volume in our prime brokerage division. Principal transactions revenue totaled $2.0 million for the 2004 period versus $3.9 million in the second quarter of 2003. Revenues from fixed income brokerage declined to $1.4 million during the second quarter of 2004 from $2.4 million during the comparable prior year quarter mainly due to a decline in residential loan refinancing. Investment banking revenue increased to $7.8 million during the second quarter of 2004 from $6.8 million in the same period of 2003, principally due to an increase in fees earned from the Company’s participation in underwriting syndicates. Revenues from fiduciary, custodial and advisory fees increased to $4.7 million in the second quarter of 2004 from $2.5 million in same quarter of 2003. The acquisitions of Salient during the
16
second quarter of 2003 and Charlotte Capital during the second quarter of 2004, the December 2003 start up of a new private equity fund managed by the Company with a focus on life sciences investments and growth in assets under management have contributed to the increase in revenues from advisory fees. Interest and dividend income increased to $979,000 in 2004 from $684,000 in the same period last year. Interest income has increased due to higher margin interest reflecting an increase in margin balances. Other income increased from $351,000 during 2003 to $517,000 during 2004, due to an increase in fees earned on the Company’s cash balances and customer credit balances at its clearing brokers resulting from higher deposit balances.
During the three months ended June 30, 2004, employee compensation and benefits increased to $17.1 million from $16.1 million in the same period last year due to the higher revenue during 2004. Floor brokerage, exchange and clearance fees declined to $1.3 million in the second quarter of 2004 from $1.5 million in the same quarter of 2003 reflecting lower clearing and execution costs resulting from the reduced trading volume attributable to prime brokerage services. Communication and data processing costs increased to $1.9 million in 2004 from $1.4 million in the same period last year resulting from increased personnel and additional offices. Occupancy costs totaled $1.7 million during the second quarter of 2004, compared to $1.6 million in the prior year quarter due to expansion of our New York City offices, the addition of Charlotte Capital in April 2004 and the Tulsa office of U.S. Bankcorp Piper Jaffray Inc., which was acquired in December 2003. Other general and administrative expenses increased to $2.8 million during the second three months of 2004 from $2.6 million in the second quarter of last year mainly due to our growth.
Minority interests in net income of consolidated companies reflect the portion of net income attributable to minority interest ownership of entities included in the Company’s consolidated financial statements. Income attributable to minority interests increased to $933,000 during the second quarter of 2004 from $686,000 during the second quarter of 2003, principally due to increased income from our share of the income of the limited partnerships managed by the Company.
The effective tax rate from operations was 40% for the three months ended June 30, 2004 compared to 41% for the three months ended June 30, 2003.
RESULTS BY SEGMENT
Retail Brokerage
Revenues from retail brokerage increased to $4.4 million from $3.6 million, and income before income taxes increased to $421,000 from $306,000. Commission revenue increased to $2.3 million from $1.4 million reflecting increased trading volume due to the additions of several new retail brokers and the Tulsa office in December 2003. Sales credits from investment banking transactions decreased to $1.0 million from $1.4 million, due to a decline in fees earned from the Company’s participation in private placement transactions. Compensation expense increased to $3.1 million from $2.7 million due to the revenue increase.
Institutional Brokerage
Revenues from institutional brokerage declined to $8.1 million from $8.6 million, and income before taxes declined to $1.4 million from $1.7 million. Commission revenue declined to $4.6 million from $5.6 million due to a slowdown in institutional commission transactions. However, sales credits from investment banking transactions increased to $2.5 million from $1.3 million, due to increases in fees earned from the Company’s participation in underwriting syndicates. Principal transaction revenue declined to $851,000 from $1.5 million due to reduced trading volume from fixed income products relating to fewer residential home refinancings caused by higher interest rates.
17
Asset Management
Revenues from asset management increased to $7.4 million from $4.4 million, and income before taxes increased to $3.7 million from $2.6 million. Fiduciary, custodial and advisory fees increased to $4.4 million from $2.4 million. The acquisition of Charlotte Capital in April 2004, growth in assets under management at Salient/PMT and Cummer/Moyers, and the December 2003 startup of a new private equity fund managed by the Company with a focus on life sciences investments have contributed to the increase in revenues from advisory fees. Sales credits from investment banking transactions increased to $1.1 million from $318,000 due to increases in fees earned from the Company’s participation in underwriting syndicates. Compensation expense rose to $3.2 million from $1.8 million related to the higher revenues. Minority interests in net income of consolidated companies reflect the portion of net income attributable to minority interest ownership of entities included in the Company’s consolidated financial statements. Income attributable to minority interests, which reduce SMHG’s pretax income, increased to $934,000 from $686,000, principally due to income from one of the limited partnerships of which minority interests own 40%, and the addition of Charlotte Capital in April 2004, of which minority interests own 31%.
Prime Brokerage
Revenues from prime brokerage declined to $4.8 million from $6.4 million, and income before taxes declined to $723,000 from $1.2 million. Commission revenue declined to $3.9 million from $5.0 million reflecting the loss of assets managed by one of our prime brokerage clients during the first half of 2004. That loss has been replaced with new customers who are expected to begin trading through the Company during the second half of 2004. Principal transactions revenues declined to $596,000 from $1.1 million due to reduced trading volume from fixed income products. Compensation expense declined to $2.3 million from $2.9 million due to lower revenues.
Investment Banking
Revenues from investment banking declined to $3.1 million from $3.8 million, and income before taxes declined to $1.2 million from $2.0 million. The revenue decline is primarily due to a reduced number of private placement transactions during the second quarter of 2004.
Corporate and Other
Revenues from corporate and other increased to $860,000 from $791,000, and the loss before taxes increased to $2.4 million from $2.0 million. Compensation expense increased to $1.7 million from $1.5 million. The change in value of our investments in limited partnerships resulted in a loss of $6,000 in 2004, compared to a gain of $202,000 during 2003.
Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003
FINANCIAL OVERVIEW
Total revenues increased to $58.5 million in the first half of 2004 from $48.6 million for the same period in 2003, principally due to increases in fiduciary, custodial and advisory fees and investment banking. Total expenses for the same 2004 period increased to $49.6 million from $42.6 million in the same period of the previous year. Equity in income of limited partnerships totaled $2.8 million during the first six months of 2004 compared to $2.9 million during the first six months of 2003. Minority interests in net income of consolidated companies increased to $1.4 million during the first six months of 2004 from $986,000 during the first six months of 2003. Net income for the six month period ended June 30, 2004 increased to $6.2 million from $4.6 million in the same period in 2003. Basic income per share was $0.36 for the six months ended June 30, 2004 compared to $0.27 for the same period in 2003. Diluted income per share was $0.34 for the six months ended June 30, 2004, compared to $0.26 for the same period in 2003.
18
Commissions revenue increased to $26.5 million in the first six months of 2004 from $25.6 million in 2003, primarily as a result of increased trading volume in our retail brokerage division. Principal transactions revenue totaled $3.4 million for the 2004 period versus $5.9 million in 2003. Revenues from fixed income brokerage declined from $4.0 million during the first six months of 2003 to $2.5 million during the first six months of 2004 primarily from a decline in residential loan refinancings. Investment banking revenue increased to $17.4 million during the first six months of 2004 from $10.2 million in the same period of 2003, principally due to an increase in fees earned from private placement transactions. Revenues from fiduciary, custodial and advisory fees increased to $8.3 million in the first half of 2004 from $4.3 million in same period of 2003. The acquisition of Charlotte Capital in April 2004, growth in assets under management at Salient/PMT and Cummer/Moyers, and the December 2003 startup of a new private equity fund managed by the Company with a focus on life sciences investments have contributed to the increase in revenues from fiduciary, custodial and advisory fees. Interest and dividend income increased to $1.8 million in 2004 from $1.2 million in the same period last year. Other income declined to $1.0 million during the first six months of 2004 from $1.3 million during the same period in 2003.
During the six months ended June 30, 2004, employee compensation and benefits increased to $35.0 million from $29.5 million in the same period last year, reflecting commissions and bonuses paid on increased revenues. Floor brokerage, exchange and clearance fees declined to $2.5 million in the first half of 2004 from $2.9 million in the same period of 2003 reflecting decreased clearing and execution costs resulting from the reduced trading volume attributable to prime brokerage services. Communication and data processing costs increased to $3.5 million in 2004 from $2.7 million in the same period last year resulting primarily from increased personnel and additional offices. Occupancy costs totaled $3.4 million during the first half of 2004, compared to $2.9 million in the prior year period. Other general and administrative expenses increased to $5.3 million during the first half of 2004 from $4.7 million in the first six months of last year mainly due to our growth.
The effective tax rate from operations was 40% for the six months ended June 30, 2004 compared to 41% for the six months ended June 30, 2003.
RESULTS BY SEGMENT
Retail Brokerage
Revenues from retail brokerage increased to $8.5 million from $6.5 million, and income before income taxes increased to $619,000 from $204,000. Commission revenue increased to $4.8 million from $2.6 million reflecting increased trading volume due to the additions of several new retail brokers and the Tulsa office in December 2003. Compensation expense increased to $6.1 million from $5.0 million due to the revenue increase.
Institutional Brokerage
Revenues from institutional brokerage increased to $16.3 million from $15.4 million, and income before taxes increased to $2.8 million from $2.7 million. Sales credits from investment banking transactions increased to $4.6 million from $2.1 million due to increases in fees earned from (i) the Company’s participation in underwriting syndicates and (ii) private placement transactions. Principal transaction revenue declined to $1.4 million from $2.4 million due to reduced trading volume from fixed income products relating to fewer residential home refinancings caused by higher interest rates. Compensation expense increased to $10.6 million from $9.9 million due to the higher revenues.
Asset Management
Revenues from asset management increased to $13.6 million from $8.1 million, and income before taxes increased to $5.7 million from $4.2 million. Fiduciary, custodial and advisory fees increased to $7.6 million from $4.0 million. The acquisition of Charlotte Capital in April 2004, growth in assets under management at Salient/PMT and Cummer/Moyers, and the December 2003 startup of a new private equity fund managed by
19
the Company with a focus on life sciences investments have contributed to the increase in revenues from advisory fees. Compensation expense rose to $6.0 million from $3.4 million related to the higher revenues. Income attributable to minority interests, which reduce SMHG’s pretax income, increased to $1.4 million from $986,000, principally due to income from one of the limited partnerships, of which minority interests own 40%, and the addition of Charlotte Capital in April 2004, of which minority interests own 31%.
Prime Brokerage
Revenues from prime brokerage declined to $9.8 million from $12.2 million, and income before taxes declined to $1.6 million from $2.3 million. Commission revenue declined to $8.1 million from $9.8 million reflecting the loss of assets managed by one of our prime brokerage clients during the first half of 2004. That loss has been replaced with new customers who are expected to begin trading through the Company during the second half of 2004. Principal transactions revenues declined to $1.0 million from $1.8 million due to reduced trading volume from fixed income products. Compensation expense declined to $4.9 million from $5.8 million due to lower revenues.
Investment Banking
Revenues from investment banking increased to $9.0 million from $5.3 million, and income before taxes rose to $4.6 million from $2.8 million. The revenue increase is primarily due to an increase in both the number and size of private placement transactions, as well as an increase in advisory, underwriting and management fees due to the Company’s participation in these private placements. Compensation expense increased to $3.5 million from $2.3 million due to the revenue increase.
Corporate and Other
Revenues from corporate and other increased to $1.3 million from $1.0 million, and the loss before taxes increased to $5.1 million from $4.4 million. Compensation expense increased to $3.8 million from $3.1 million, primarily due to bonus expense related to the increased income. The change in value of our investments in limited partnerships resulted in income of $67,000 in 2004, compared to $296,000 during 2003.
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 June 30, 2004, we had approximately $20.7 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 24% of our total assets at the end of the first quarter.
For the six months ended June 30, 2004, net cash used in operations totaled $3.4 million versus $50,000 during the first six months of 2003. Accounts payable and accrued liabilities declined by $4.1 million during the six months ended June 30, 2004, principally due to the payment of accrued compensation during the first quarter of 2004. Receivables increased by $6.0 million, primarily due to the addition of a secured receivable that the Company expects to convert into an investment during the second half of 2004, as well as an increase in receivables from customers due to the increase in revenues.
Capital expenditures for the first half of 2004 were $4.2 million, mainly for the purchase of furniture and computer equipment and software, as well as for leasehold improvements, necessary for our growth. During the first six months of 2004, we reacquired 15,399 of our common shares at a total cost of approximately $183,000. Dividends paid to shareholders totaled $653,000 during the first six months of 2004.
20
At June 30, 2004, 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
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 June 30, 2004. 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 June 30, 2004, the Company’s trading equity and debt securities were recorded at a fair value of approximately $8.0 million. These trading equity and debt securities are subject to equity price risk. This risk would amount to approximately $800,000 million 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-15(e)
21
promulgated under the Exchange Act, as of the end of the fiscal period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in ensuring that the information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. There have been no changes made in our internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
22
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 4. Submission of Matters to a Vote of Security Holders
On June 17, 2004, the Company held its annual meeting of shareholders to vote for election of directors to the Company’s Board of Directors. Each nominee was elected and the results of the votes were as follows:
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Number of |
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Number of |
|
Number of |
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|
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|
|
|
|
|
|
George L. Ball |
|
16,201,168 |
|
220,499 |
|
— |
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Robert E. Garrison II |
|
16,201,993 |
|
219,674 |
|
— |
|
|
Titus H. Harris, Jr. |
|
16,201,423 |
|
220,244 |
|
— |
|
|
Ben T. Morris |
|
16,224,605 |
|
197,062 |
|
— |
|
|
Nolan Ryan |
|
16,231,863 |
|
189,804 |
|
— |
|
|
Don A. Sanders |
|
16,200,718 |
|
220,949 |
|
— |
|
|
W. Blair Waltrip |
|
16,200,143 |
|
221,524 |
|
— |
|
|
Dan S. Wilford |
|
15,317,149 |
|
1,104,518 |
|
— |
|
|
Richard E. Bean |
|
15,529,246 |
|
892,421 |
|
— |
|
|
Robert M. Collie |
|
16,232,171 |
|
189,496 |
|
— |
|
|
Charles W. Duncan III |
|
16,232,171 |
|
189,496 |
|
— |
|
|
Gerald H. Hunsicker |
|
16,229,852 |
|
191,815 |
|
— |
|
|
Scott McClelland |
|
16,230,302 |
|
191,365 |
|
— |
|
|
Dr. Albert W. Niemi, Jr. |
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16,230,127 |
|
191,540 |
|
— |
|
On August 3, 2004, our Board of Directors adopted amendments to our bylaws to provide for advisory directors and to authorize our Chief Executive Officer to sign stock certificates.
23
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
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Exhibit |
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Description |
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3.1 |
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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). |
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*3.2 |
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Amended and Restated Bylaws of the Company as amended through August 3, 2004. |
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*31.1 |
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Rule 13a-14(a)/15d – 14(a) Certification of Chief Executive Officer. |
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*31.2 |
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Rule 13a-14(a)/15d – 14(a) Certification of Chief Financial Officer. |
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*32.1 |
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Certification Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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*32.2 |
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Certification Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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* Filed herewith. |
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(b) Reports on Form 8-K.
On April 22, 2004, the Company filed a current report on Form 8-K under Item 9 relating to a presentation made by the Company at an investor relations conference.
On May 7, 2004, the Company filed a current report on Form 8-K under Item 5 relating to the declaration by its board of directors of a cash dividend in the amount of $0.0375 per share of common stock and under Item 12 relating to a press release announcing its earnings for the quarter ended March 31, 2004.
On June 18, 2004, the Company filed a current report on Form 8-K under Item 5 related to the election of five new members of its Board of Directors.
24
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.
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SANDERS MORRIS HARRIS GROUP INC. |
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By |
/s/ BEN T. MORRIS |
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Ben T. Morris |
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|
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Chief Executive Officer |
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By |
/s/ RICK BERRY |
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Rick Berry |
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|
|
|
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Chief Financial Officer |
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Date: August 9, 2004 |
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25