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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

For the quarterly period ended December 31, 2003

OR

For the transition period from                      to                     

Commission file number 0-19483

SWS GROUP, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (214) 859-1800

(Former name, former address and former fiscal year, if changed since last report)

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 þ No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ No ¨

As of February 9, 2004, there were 17,145,976 shares of the registrant’s common stock, $.10 par value, outstanding.

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SWS GROUP, INC. AND SUBSIDIARIES

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FORWARD-LOOKING STATEMENTS

From time to time, we make statements (including some contained in this Report) that predict or forecast future events, depend on future events for their accuracy, embody projections or assumptions or that otherwise contain “forward-looking information.” These statements may relate to anticipated changes in revenues or earnings per share, anticipated changes in our businesses or in the amount of client assets under management, anticipated expense levels or expectations regarding financial market conditions.

We caution readers that any forward-looking information we provide is not a guarantee of future performance. Actual results may differ materially as a result of various factors, some of which are outside of our control.

Included among these factors are those discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations –Overview,” “-Critical Accounting Policies and Estimates” and “-Market Risk” in this Report and those discussed in our other reports filed with and available from the Securities and Exchange Commission. All forward-looking statements we make speak only as of the date on which they are made, and we undertake no obligations to update them to reflect events or circumstances occurring after the date on which they were made or to reflect the occurrence of unanticipated events.

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SWS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition

December 31, 2003 and June 27, 2003

(In thousands, except par values and share amounts)

See accompanying Notes to Consolidated Financial Statements.

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SWS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Income and Comprehensive Income

For the three and six months ended December 31, 2003 and 2002

(In thousands, except per share and share amounts)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements.

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SWS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the six months ended December 31, 2003 and 2002

(In thousands)

(Unaudited)

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See accompanying Notes to Consolidated Financial Statements.

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SWS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Three and Six Months Ended December 31, 2003 and 2002

(Unaudited)

GENERAL AND BASIS OF PRESENTATION

The interim consolidated financial statements as of December 31, 2003, and for the three and six-month periods ended December 31, 2003 and 2002, are unaudited; however, in the opinion of management, these interim statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows. These financial statements should be read in conjunction with the audited consolidated financial statements and related notes as of and for the year ended June 27, 2003 filed on Form 10-K. Amounts included for June 27, 2003 are from the audited consolidated financial statements as filed on Form 10-K. All significant intercompany balances and transactions have been eliminated.

The consolidated financial statements include the accounts of SWS Group, Inc. (“Parent”) and its consolidated subsidiaries listed below (collectively with the Parent, “SWS”):

Brokerage Group. Southwest Securities is a New York Stock Exchange (“NYSE”) registered broker/dealer and SWS Financial and May Financial are National Association of Securities Dealers (“NASD”) registered broker/dealers under the Securities Exchange Act of 1934 (“1934 Act”).

SWS filed broker dealer withdrawals with the NASD for Mydiscountbroker and Southwest Clearing on December 4, 2003. The effective date of the Mydiscountbroker withdrawal was December 2, 2003 and the effective date of the Southwest Clearing withdrawal was December 1, 2003.

Asset Management Group. Asset management services are offered through SWS Capital, which administers the Local Government Investment Cooperative (“LOGIC”) fund for cities, counties, schools and other local governments across Texas. LOGIC is an investment program tailored to the needs of local governments within the state of Texas.

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Southwest Advisors, although dormant, is a registered investment advisor under the Investment Advisors Act of 1940.

Banking Group. First Savings is a federally chartered savings association regulated by the Office of Thrift Supervision. FSB Financial purchases non-prime automobile loans and FSB Development develops single-family residential lots.

Other Consolidated Entities. In the first quarter of fiscal 2003, SWS sold SWS Technologies’ internet service provider (“ISP”) customer list and accounts receivable to a third party for $75,000. During fiscal 2003, SWS completed the transition of these accounts with no additional compensation.

Southwest Financial Insurance Agency, Inc. and Southwest Insurance Agency, Inc., together with its subsidiary, hold insurance agency licenses in 42 states for the purpose of facilitating the sale of insurance and annuities for customers of Southwest Securities, Inc. and its correspondents.

STOCK OPTION AND RESTRICTED STOCK PLANS

At December 31, 2003, SWS had two stock option plans, the SWS Group, Inc. Stock Option Plan (the “1996 Plan”), and the SWS Group, Inc. 1997 Stock Option Plan (the “1997 Plan”). The 1996 Plan reserves shares of SWS’ common stock for issuance to eligible employees of SWS or its subsidiaries, as well as to non-employee members of the Board of Directors. The 1997 Plan reserves shares of SWS’ common stock for eligible employees or potential employees of SWS or its subsidiaries. Officers and directors are not eligible to receive options under the 1997 Plan. Options granted under the 1996 and 1997 Plans have a maximum ten-year term, and the vesting period is determined on an individual basis by the Compensation Committee of the Board of Directors. Options granted to non-employee directors under the 1996 Plan are fully vested six months after grant and have a five-year term.

At the discretion of the Compensation Committee, the stock options outstanding and shares reserved for issuance, as well as the options’ exercise prices, were adjusted for various stock dividends declared by the Board of Directors from 1997 through 2001. In fiscal 2002, all stock options and exercise prices were adjusted to reflect the spin-off of SWS’ primary asset management subsidiary. Shares issued and remaining for future issuance under these option plans reflect stock dividends issued by the Company, as well as the adjustment for the asset management subsidiary spin-off.

The Company accounts for the plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation (in thousands, except share and per share amounts):

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The fair value of each option was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for the three and six months ended December 31, 2003 and 2002:

On November 12, 2003, the shareholders of SWS Group Inc. approved the adoption of the SWS Group, Inc. 2003 Restricted Stock Plan (“Restricted Stock Plan”). The Restricted Stock Plan allows for awards of stock to SWS’s directors, officers and employees. The Restricted Stock Plan authorizes the granting of awards up to 500,000 shares of SWS’s common stock. No more than 200,000 of the authorized shares may be newly issued shares of common stock. The Restricted Stock Plan terminates on August 21, 2013. The vesting period is determined on an individualized basis by the Compensation Committee of the Board of Directors. In general, restricted stock granted under the Restricted Stock Plan is fully vested after three years. On November 12, 2003, the Board of Directors approved grants to various officers totaling 45,727 shares under the Restricted Stock Plan. As a result of these grants, SWS recorded deferred compensation of approximately $930,000 and as of December 31, 2003 has recognized compensation expense of approximately $39,000.

CASH & CASH EQUIVALENTS

The Company includes cash on hand, cash in banks and highly liquid investments with original maturities of three months or less as cash and cash equivalents.

EQUITY METHOD INVESTMENTS

SWS is a part owner of Comprehensive Software Systems, Ltd. (“CSS”), a software development company formed in 1993 to develop a new brokerage front- and back-office system. SWS initially acquired a 7.96% interest in CSS and accounted for the investment on the cost basis. Through subsequent investments by SWS, SWS’ ownership in CSS increased in fiscal 2002 to 25.08%. Consequently, SWS implemented the equity method of accounting, prescribed by APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock,” with respect to its investment in CSS. Summarized financial information of CSS is as follows (in thousands):

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As required by APB Opinion No. 18, SWS recorded its share of undistributed loss from CSS’ operations, as well as amortization expense on the portion of the investment designated as goodwill. Additionally, SWS determined that the investment in CSS and its related goodwill was fully impaired based on an analysis of the projected cash flow from the investment. Therefore, SWS wrote-off the investment in CSS and the related goodwill in June 2002.

On December 6, 2002, SWS entered into a loan agreement with CSS under which SWS agreed to advance to CSS the principal sum of $3,250,000 in quarterly installments of $812,500 beginning January 6, 2003. The unpaid principal balance of the note bears interest at 6% per annum. The note is payable in equal monthly installments beginning January 1, 2008 with the final payment due January 1, 2013. In June of 2003, SWS and CSS amended the loan agreement to provide that SWS would increase the two remaining quarterly installments to $937,500. All other terms of the note were unchanged.

SWS resumed recording its share of the undistributed losses of CSS due to this loan agreement. SWS’ share of the undistributed losses of CSS for the three and six months ended December 31, 2003 was $795,800 and $1,803,000, respectively. SWS’ percentage of losses was less than the $937,500 and $1,875,000, respectively, loaned during the three and six months ended December 31, 2003 by $141,700 and $72,000, respectively. From inception of the loan to date, SWS’ percentage of losses of $3,879,200 was greater than the $3,500,000 loaned by $379,200. As a result, there is no recorded equity investment or loan receivable from CSS at December 31, 2003.

Effective December 20, 2003, SWS agreed to an additional equity investment in CSS of $2.9 million, resulting in the purchase of 5.8 million shares of CSS common stock. This purchase will be made in equal quarterly installments and will ultimately result in increasing SWS’s position in CSS to 30.22%. The first installment of $721,475 was made in January 2004.

SWS has four other investment vehicles, which are accounted for under the equity method. One is a limited partnership venture capital fund. Upon formation of this fund, SWS committed $5 million to the fund. As of December 31, 2003, SWS had contributed $2.5 million from inception to date. During the three and six months ended December 31, 2003, SWS recorded losses of $ 251,000 and $506,000, respectively, related to this investment.

SWS also has a 33.33% investment in a business, which provides option execution services. SWS entered into this investment on January 2, 2003. As of December 31, 2003, SWS has made the initial investment of $10,000, recorded its share of gains for the quarter of $ 7,000, losses for the six month period of $62,000,

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and made loans to the entity totaling $475,000. SWS loaned $250,000 with an interest rate of 10% due on June 27, 2003. As of December 31, 2003, $40,000 of the outstanding balance had been repaid. The second loan of $225,000 represents subordinated debt, bears interest at a rate of 3%, and matures March 1, 2006. SWS also provides option clearing services to the entity at cost.

The Financial Accounting Standards Board issued Financial Interpretation (“FIN”) No. 46 on January 17, 2003 and the revised version, FIN No. 46R in December 2003. Upon review of its investments, SWS determined that it does not have any variable interest entities (“VIE”), as defined by FIN No. 46R, that should be consolidated.

SWS’ two remaining equity investments had total losses for the three and six months ended December 31, 2003 of $103,000 and $205,000, respectively.

SWS has an investment in Archipelago Holding, L.L.C., recorded at its cost of zero. SWS’s 303,456 shares represent less than 0.2% of Archipelago Holding, L.L.C.

ASSETS SEGREGATED FOR REGULATORY PURPOSES

At December 31, 2003, SWS had reverse repurchase agreements of approximately $177,632,000 and related cash and accrued interest of approximately $44,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the 1934 Act. These reverse repurchase agreements were collateralized by U.S. Government securities with a market value of approximately $180,052,000. SWS had no positions in reverse repurchase agreements in special reserve bank accounts for the Proprietary Accounts of Introducing Brokers (“PAIB”) at December 31, 2003. SWS also had approximately $175,700,000 of cash and accrued interest of $198,000 held in a reserve account at December 31, 2003.

At June 27, 2003, SWS had U.S. Treasury securities with a market value of approximately $248,143,000, reverse repurchase agreements of approximately $191,990,000, and related cash and accrued interest of approximately $51,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the 1934 Act. These reverse repurchase agreements were collateralized by U.S. Government securities with a market value of approximately $194,647,000. SWS also had approximately $1,000,000 in reverse repurchase agreements in special reserve bank accounts for the PAIB at June 27, 2003. The reverse repurchase agreements in the PAIB accounts were collateralized by U.S. Government securities with a market value of approximately $1,003,000.

MARKETABLE EQUITY SECURITIES

SWS’ shares of Knight Trading Group, Inc. (“Knight”) and U.S. Home Systems, Inc. (“USHS”) common stock are classified as marketable equity securities available for sale. Consequently, the unrealized holding gains (losses), net of tax, are recorded as a separate component of stockholders’ equity on the consolidated statements of financial condition. At December 31, 2003 and June 27, 2003, SWS held 373,550 shares of Knight common stock with a cost basis of $48,000. At December 31, 2003 and June 27, 2003, SWS held 457,154 and 365,723, respectively, shares of USHS with a cost basis of $2,018,000 and $936,000, respectively. The market value of the Knight shares was $5,476,000 at December 31, 2003 and $2,436,000 at June 27, 2003. The market value of the USHS shares was $5,075,000 at December 31, 2003 and $3,163,000 at June 27, 2003.

During the quarter, SWS received an additional 91,431 shares of the common stock of USHS that had been held in escrow under the terms of a sales agreement. The additional shares were issued after no material contingencies were found related to the operations of First Consumer Credit, LLC, a business that the Bank sold in October 2001. The Bank paid the shares to the Parent in the form of a dividend. The shares were recorded at fair market value resulting in a gain of $1,082,000 (after-tax gain of $703,000).

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The “specific identification” method is used to determine the cost of marketable securities sold. At December 31, 2003 and June 27, 2003, all of the Knight shares held were hedged by the 5% Exchangeable Subordinated Notes (“Notes”) issued in the form of DARTS^SM (or “Derivative Adjustable Ratio Securities^SM”) and subject to the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended.

There were no sales of Knight or USHS stock in the three and six -month periods ending December 31, 2003 and 2002.

RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS

At December 31, 2003 and June 27, 2003, SWS had receivable from and payable to brokers, dealers and clearing organizations related to the following (in thousands):

SWS participates in the securities borrowing and lending business by borrowing and lending securities other than those of its clients. SWS adjusts open positions to market value according to standard industry practices. SWS has received collateral of $2,946,641,000 under securities lending agreements, of which the Company has repledged $2,833,857,000 at December 31, 2003. At June 27, 2003, the Company had collateral of $2,401,665,000 under securities lending agreements, of which the Company had repledged $2,286,526,000.

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LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES

Loans receivable, excluding loans held for sale, at December 31, 2003 and June 27, 2003 are summarized as follows (in thousands):

Impairment of loans with a recorded investment of approximately $8,279,000 and $11,692,000 at December 31, 2003 and June 27, 2003, respectively, has been recognized in conformity with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan - an Amendment of SFAS No. 5 and SFAS No. 15,” as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures - an Amendment of FASB Statement No. 114.”

An analysis of the allowance for probable loan losses for the three and six-month periods ended December 31, 2003 and 2002 is as follows (in thousands):

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SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED

At December 31, 2003 and June 27, 2003, SWS held securities owned and securities sold, not yet purchased as follows (in thousands):

During the quarter certain of the above securities have been pledged to secure short-term borrowings and as security deposits at clearing organizations for SWS’ clearing business. Securities pledged as security deposits at clearing organizations were $2,593,000 and $1,945,000 at December 31, 2003 and June 27, 2003, respectively. Additionally, at December 31, 2003 and June 27, 2003, SWS had pledged firm securities valued at $214,000 and $242,000, respectively, in conjunction with securities lending activities.

GOODWILL

In June 2001, the Financial Accounting Standards Board issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 addresses financial accounting and reporting for acquired goodwill. This statement also addresses how goodwill and other intangibles should be accounted for after they have been initially recognized in the financial statements. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. The statement also provides specific guidance for impairment testing. In accordance with the transition provisions of SFAS No. 142, SWS performed the first step of transition impairment testing, by determining the fair value of the reporting units with goodwill, during the second quarter of fiscal 2003. SWS performed its annual assessment of the fair value of goodwill during fiscal 2004, and based on the results of the valuation, SWS’ goodwill balance was not impaired.

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SWS has two reporting units with goodwill - Southwest Securities and the Bank. Changes in the carrying value of goodwill during the six-month period ended December 31, 2003, by segment and in the aggregate, are summarized in the following table (in thousands):

In accordance with SFAS No. 142, SWS ceased amortizing its goodwill at the date of adoption.

SOFTWARE DEVELOPMENT

In accordance with Statement of Position No. 98-1 “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” SWS has capitalized $300,000 and $353,000 of software development up-grade costs associated with the CSS technology platform for the three and six months ended December 31, 2003. There were $154,000 of capitalized software development costs for the three and six months ended December 31, 2002. These capitalized costs are primarily labor related and will be depreciated over a three-year period.

SHORT-TERM BORROWINGS

SWS has credit arrangements with commercial banks, which include broker loan lines up to $275,000,000. These lines of credit are used primarily to finance securities owned, securities held for correspondent broker/dealer accounts and receivables in customers’ margin accounts. These lines may also be used to release pledged collateral against day loans. These credit arrangements are provided on an “as offered” basis and are not committed lines of credit. These arrangements can be terminated at any time by the lender. Any outstanding balance under these credit arrangements is due on demand and bears interest at rates indexed to the federal funds rate. There were no borrowings under these arrangements at December 31, 2003 or June 27, 2003.

In addition to the broker loan lines, SWS has a $20,000,000 unsecured line of credit that is due on demand and bears interest at rates indexed to the federal funds rate. The total amount of borrowings available under this line of credit is reduced by the amount outstanding under the unsecured letters of credit at the time of borrowing. At December 31, 2003 and June 27, 2003, the total amount available for borrowings was $16,750,000 and $17,750,000, respectively. There were no amounts outstanding on this line at December 31, 2003 and June 27, 2003.

SWS has an irrevocable letter of credit agreement aggregating $61,000,000 and $57,000,000 at December 31, 2003 and June 27, 2003, respectively, pledged to support its open options positions with an options clearing organization. The letter of credit bears interest at the brokers’ call rate, if drawn, and is renewable semi-annually. This letter of credit is fully collateralized by marketable securities held in client and non-client margin accounts with a value of $76,075,000 and $76,298,000 at December 31, 2003 and June 27, 2003, respectively. SWS also has unsecured letters of credit, aggregating $2,250,000 at both December 31, 2003 and June 27, 2003, pledged to support its open positions with securities clearing organizations. The unsecured letters of credit bear interest at 1%, if drawn, and are renewable semi-annually. At December 31, 2003, SWS had an additional unsecured letter of credit issued for a sub-lease

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to the sub-leasee of space previously occupied by Mydiscountbroker in the amount of $1,000,000. This letter of credit bears interest at 1%, if drawn, and is renewable annually.

In addition to using client securities to finance bank loans, SWS also pledges client securities as collateral in conjunction with SWS’ securities lending activities. At December 31, 2003, approximately $505,730,000 of client securities under customer margin loans was available to be repledged, of which SWS has pledged $21,952,000 under securities loan agreements. At June 27, 2003, $389,240,000 of client securities under customer margin loans was available to be pledged, of which the Company has repledged $16,753,000 under securities loan agreements.

At December 31, 2003 and June 27, 2003, SWS had no repurchase agreements outstanding.

DEPOSITS

Deposits at December 31, 2003 and June 27, 2003 are summarized as follows (dollars in thousands):

The weighted average interest rate on deposits was approximately 1.67% at December 31, 2003 and 1.98% at June 27, 2003.

At December 31, 2003, scheduled maturities of certificates of deposit were as follows (in thousands):

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ADVANCES FROM THE FEDERAL HOME LOAN BANK (“FHLB”)

At December 31, 2003 and June 27, 2003, advances from the FHLB were due as follows (in thousands):

Pursuant to collateral agreements, the advances from the FHLB, with interest rates ranging from 3.29% to 7.7%, are collateralized by approximately $86 million of collateral value (as defined) in qualifying loans at December 31, 2003 (calculated at September 30, 2003). At June 27, 2003 (calculated at March 31, 2003), advances with interest rates from 1.2% to 7.7% were collateralized by approximately $87 million of collateral value in qualifying loans.

EXCHANGEABLE SUBORDINATED NOTES

SWS adopted SFAS No. 133 effective July 1, 2000. SFAS No. 133 is applicable to the Notes due 2004 with a face value of $21.2 million. SWS issued the Notes in June 1999 in the form of DARTS^SM, or Derivative Adjustable Ratio Securities^SM. 373,550 DARTS were outstanding at both December 31, 2003 and June 27, 2003.

SFAS No. 133 requires fair value recognition of the Notes’ embedded derivative by adjusting the Notes’ liability account in the consolidated statements of financial condition. The following table reflects the activity in the Notes’ liability account for the three and six-month periods ended December 31, 2003 and 2002 (in thousands):