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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999, OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 0-30066
PINNACLE GLOBAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
TEXAS 76-0583569
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
5599 SAN FELIPE, SUITE 555
HOUSTON, TEXAS 77056
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
Registrant's telephone number, including area code: (713) 993-4610
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value per share
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of March 24, 2000, the registrant had 14,111,301 outstanding shares of
Common Stock, par value $0.01 per share, and at such date, the aggregate market
value of the shares of Common Stock held by nonaffiliates of the registrant was
$29,282,436. For purposes of this computation, all executive officers, directors
and 5% beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed an admission that such officers, directors
and beneficial owners are, in fact, affiliates of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Notice of Annual Meeting of Shareholders and definitive Proxy
Statement pertaining to the 2000 Annual Meeting of Shareholders (the "Proxy
Statement") and filed pursuant to Regulation 14A is incorporated herein by
Reference into Part III of this report.
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PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
INDEX
PART I.
Item 1. Business.................................................................... 1
Item 2. Properties.................................................................. 13
Item 3. Legal Proceedings........................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders......................... 13
PART II.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters... 14
Item 6. Selected Financial Data..................................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..................................................... 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................. 20
Item 8. Financial Statements and Supplementary Data................................. 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................................. 45
PART III.
Item 10. Directors and Executive Officers of the Registrant.......................... 45
Item 11. Executive Compensation...................................................... 45
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 45
Item 13. Certain Relationships and Related Transactions.............................. 45
PART IV.
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K.............. 46
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PART 1.
ITEM 1. BUSINESS
GENERAL
Pinnacle Global Group, Inc. provides a broad range of financial services
through its wholly owned operating subsidiaries. Our financial services include
institutional and retail brokerage, investment banking, merchant banking,
secondary market loan and loan servicing placement, trust related services and
asset management. We serve a diverse group of institutional, corporate and
individual clients.
We are the successor issuer to TEI Inc., which is now a wholly owned
subsidiary. During 1995, 1996 and 1997, we disposed of all of its operations
other than its liquid waste business and the related facility located in
Charlotte, North Carolina. The liquid waste business is operated as a
discontinued operation through our subsidiary Energy Recovery Resources, Inc.
From January 1997 through the first quarter of 1998, our management
actively evaluated strategies and financial alternatives for maximizing
shareholder value. In late April 1998, we reached an agreement in principle to
combine with three Houston-based financial services firms. These firms were
Harris Webb & Garrison, Inc., a full service regional investment banking,
brokerage and financial services firm serving the southwestern United States,
Pinnacle Management & Trust, a Texas state-chartered trust company and
investment management firm, and Spires Financial, L.P., a regional institutional
brokerage services and investment banking firm specializing in fixed-income
securities and whole loan and loan servicing transactions.
On January 29, 1999, Pinnacle completed the combination of Harris Webb &
Garrison, Pinnacle Management & Trust and Spires Financial, with Pinnacle
emerging as the new public holding company. In the combination, just over 50% of
our outstanding common shares were issued to TEI's former shareholders in
exchange for their TEI common shares, and slightly less than 50%, or 3,562,500
common shares, were issued to the former owners of the financial services firms.
Immediately after the combination, our board included six former TEI directors
and six designees of the financial services firms. Executive officers of the
financial services firms became our primary executive officers, with TEI's
former president and chief executive officer continuing as our Vice-Chairman.
In March 1999, our management decided to discontinue the operations of
Energy Recovery Resources' liquid waste business effective December 31, 1998.
These operations, which are conducted primarily in Charlotte, North Carolina and
surrounding areas, involve the treating, recycling, and handling of wastewater,
waste oil and other non-hazardous fluid waste for owners and operators of
underground and above ground storage tanks and other commercial and industrial
waste generators. Our management believes the sale of the liquid waste business
and related Charlotte, North Carolina facility will be accomplished during 2000.
On January 31, 2000, we completed the merger of Harris Webb & Garrison, our
investment banking subsidiary, with Sanders Morris Mundy Inc. Sanders Morris
Mundy survived the merger, was renamed "Sanders Morris Harris Inc" and became
our wholly owned subsidiary. In the Sanders merger, we issued 7,125,220 of our
common shares to the former shareholders of the Sanders firm, increasing our
total outstanding common shares to approximately 14.25 million. As a result of
the Sanders merger, three former directors of the Sanders firm became Pinnacle
directors, with one director, Don A. Sanders, becoming our Vice-Chairman. The
other two Sanders director designees retained primary management responsibility
of the new Sanders Morris Harris subsidiary. Sanders Morris Mundy is a twelve
year-old investment banking and brokerage firm based in Houston, Texas, with
branch offices in New York City, Denver and Chicago.
Pinnacle was incorporated in Texas in August 1998 in connection with the
January 1999 combination. Our principal executive offices are located at 5599
San Felipe, Suite 555, Houston, Texas 77056, and our telephone number is (713)
993-4610.
The historical financial information contained in this document for 1995
through 1998 does not include any results of operations or the financial
position of our current businesses acquired in the January 1999 combination nor
does it reflect the January 2000 Sanders merger. Our operations prior to 1999
reflect only corporate activities and the results of our discontinued
operations. The historical financial information contained in this document for
1999 relates to our
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financial condition after giving effect to the January 1999 combination and our
results of operations include operations of the financial firms since the date
of acquisition, January 31, 1999. None of our historical financial information
contained in this document includes any financial data or results of operations
of Sanders Morris Mundy Inc. The following description of our business includes
the operations of the combined company after giving effect to both the January
1999 combination and the January 2000 Sanders merger, except for our
discontinued business.
BUSINESS STRATEGY
Our business strategy is to (1) increase our asset management and trust
business; (2) expand our fixed-income securities trading activities; (3)
increase our capital markets activities; (4) improve the profitability of our
brokerage operations; and (5) enhance the range of financial services we offer
our clients. Additionally, management plans to supplement our internal growth
with strategic acquisitions. We also believe certain cross-selling opportunities
among the financial services firms, and certain unquantified potential operating
efficiencies, will be available. The principal elements of our business strategy
are:
- INCREASE ASSET MANAGEMENT AND TRUST BUSINESS. Our management intends
to grow the business by expanding its asset management and trust
services related business by improving Pinnacle Management & Trust's
interface with our brokerage subsidiaries, and by increasing the
assets under our management through acquisitions and internal growth.
We believe that the brokerage network added through the Sanders merger
will enhance Pinnacle Management & Trust's marketing opportunities.
- EXPAND FIXED-INCOME SECURITIES ACTIVITIES. We believe that Spires'
proprietary technology and growing sales force represent an
opportunity to profitably expand its fixed-income securities trading
business. We believe the increased capital and inventory capacity that
we provide Spires has allowed for the successful implementation of
this strategy.
- INCREASE CAPITAL MARKETS ACTIVITIES. We intend to increase our
investment banking and merchant banking business by committing greater
resources to, and by carefully focusing our investment research
coverage on companies, industries and geographic regions that
management believes offer the greatest opportunities. We have added
significant scale and depth to our investment banking and financial
advisory activities with the completion of the Sanders merger as
indicated by the number of underwritings, private placements and
advisory transactions in which the Sanders firm has historically
participated. We also believe that consolidation within the investment
banking industry will offer greater opportunities for high caliber
firms that maintain their local and industry-specific focus.
- IMPROVE PROFITABILITY OF BROKERAGE OPERATIONS. We intend to improve
the profitability of our brokerage operations primarily by hiring
additional experienced and productive investment executives and by
providing our financial advisors with specialized training, product
offerings, information systems, support and access to the services of
each of our financial services companies. Our management believes
that the implementation of this strategy will be aided by the Sanders
merger, which brings us the industry reputation, distribution and
proprietary investment research capabilities of that firm.
- ENHANCE PERSONALIZED, HIGH-END SERVICE. We seek to provide excellent
investment advice suited to each client. To that end, our financial
services subsidiaries have traditionally sought to attract and retain
clients by offering a high level of personal service. We intend to
increase that commitment by providing our clients with advanced
account and investment information systems, flexibility in determining
appropriate fee schedules for certain services based upon the level of
client needs, and by providing an array of investment and financial
planning services.
- SUPPLEMENT GROWTH WITH STRATEGIC ACQUISITIONS. Our management plans to
actively pursue opportunities to acquire or combine with other firms
with complementary businesses to strengthen or expand the firm's
geographic or product offering base. We acted on this strategy by
joining our firm with Sanders Morris Mundy in January 2000. Our
management believes that additional attractive acquisition
opportunities exist, particularly among smaller, specialized regional
financial firms that want to affiliate with a larger company while
still retaining their identity and entrepreneurial culture. In
addition, we believe that the consolidation
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trend in the financial services industry will allow us to hire proven
financial professionals who prefer the ambience and opportunities
inherent in a creative regional firm. Management believes that
acquisitions may also allow us to realize cost benefits by leveraging
our infrastructure.
SERVICES
We provide our financial services through our operating subsidiaries
Sanders Morris Harris, Pinnacle Management & Trust, and Spires Financial. The
financial services offered by each of these entities, which we refer to as
"SMH," "PMT," and "Spires," are described below.
SMH
GENERAL. With the closing of the Sanders merger in January 2000, we
significantly expanded the scale and resources of our brokerage, investment
banking and supporting investment research activities. For the year ended
December 31, 1999, Sanders Morris Mundy had total revenues of approximately
$34.6 million and net income of $5.6 million, as compared to total revenue of
$5.3 million and a net income of approximately $16,000 generated by HWG, our
predecessor investment banking subsidiary.
RETAIL BROKERAGE. Our strategic plan in the retail brokerage business is to
attract and retain experienced financial advisors, especially those able to
utilize our sophisticated investment programs. Our retail brokerage business is
focused on high net worth individuals with whom we have developed and maintained
relationships over time, including a core group of individual investors
originally developed by the founders of Sanders Morris Mundy. As a full service
broker, we offer our retail clients brokerage services relating to corporate
debt and equity securities, including the securities of companies followed by
our research analysts, underwritings that we co-manage or in which we
participate, private placements of securities in which we serve as placement
agent, mutual funds, 401(k) plans, wrap-fee programs, money market funds, and
insurance products. Commissions are charged on agency transactions in
exchange-listed securities and securities quoted on the Nasdaq National Market
or in the over-the-counter market. In addition to retail commissions, we
generate fee revenue from asset-based advisory services and managed accounts
where the charges are based on a percentage of the assets held in the client's
account in lieu of commissions on a transaction-by-transaction basis.
We provide our retail clients with a broad range of services delivered
in a personalized, service-oriented manner. In addition to recommending and
effecting transactions in securities, we provide other services to our retail
clients that include portfolio strategy, investment research service,
financial planning, assistance in the sale of restricted securities and tax,
trust and estate advice. Clients can access their personal portfolio on-line
and use our extensive research library.
At February 29, 2000, we had 103 Series 7-licensed individuals who
average over 15 years experience in the securities brokerage business. We
generally do not hire inexperienced brokers or trainees to work as retail
brokers. We believe we can attract and retain experienced brokers by
providing them with a high level of support, a corporate culture that
encourages performance, employee stock ownership, advanced technologies,
competitive compensation packages, and the opportunity for them and their
clients to participate in private placements and public offerings of
securities we manage or underwrite.
INSTITUTIONAL BROKERAGE. As a result of the Sanders merger, we gained
institutional equity brokerage capabilities. Our institutional stock brokerage
strategy is to provide equity research coverage and trading services focused on
companies that have a presence in the southwestern United States. Our clients
are a broad array of institutions throughout North America, Europe and Asia.
Areas of concentration include the construction industry, environmental
services, biotechnology and healthcare, oil and gas exploration and production,
oilfield services, pipelines, restaurants and food-related providers, specialty
retailing, telecommunication and technology. We provide our institutional
clients with research and execution trading services in both exchange-listed
equity securities and equity securities quoted on Nasdaq. We also distribute to
institutional clients equity securities from offerings that we co-manage or
underwrite.
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SMH's institutional clients include banks, retirement funds, mutual funds,
endowments, investment advisors and insurance companies. At February 29, 2000,
SMH had 14 institutional brokers and 16 analysts. SMH entered the institutional
brokerage business in 1996 through the acquisition of Williams MacKay Jordan &
Co., Inc., a Houston-based registered broker-dealer specializing in
institutional sales and securities analysis.
Our officers and directors have in the past, and expect in the future, to
invest in the same securities as our retail and institutional clients, where
suitable and permitted by applicable law and regulations. We believe
co-investment creates an identity of interest that is generally beneficial,
particularly in investments we develop or where we play a major ongoing role.
Other than the Environmental Opportunities Funds, Corporate Opportunities Funds
and Sanders Opportunities Funds, our accounts are conducted on an individual
client basis. In many cases, one of our registered broker employees holds a
limited power of attorney permitting discretionary agency and certain other
transactions on a client's behalf.
INVESTMENT RESEARCH. The Sanders merger significantly increased our
proprietary investment research capabilities. At February 29, 2000, our
research department consisted of 16 professionals. We use our proprietary
equity research analysis to drive or assist a large portion of our business.
This analysis is based on economic fundamentals, using tools such as
price-to-earnings multiples, price-to-book value comparisons, both absolute
and relative to historic norms, and our research department's own earnings
forecasts. We intend to rely primarily on our own research rather than on
research products purchased from outside research organizations. We believe
that the services provided by our research department have a significant
impact on our revenue-generating activities, including retail and
institutional brokerage, market-making, and investment banking.
INVESTMENT BANKING AND UNDERWRITING ACTIVITIES. Our investment banking
strategy is to build a balanced mix of corporate securities underwriting,
private financings, and financial advisory services. As a result of the Sanders
merger, we added significant expertise in corporate securities underwriting and
private financings. We believe that the number and dollar amount of
underwritings and private placements in which Sanders Morris Mundy has
participated will contribute significantly to increased public and industry
awareness of our company, and will result in increased demand for our investment
banking and corporate advisory services. Through February 29, 2000, we acted as
placement agent in 77 private placements, 61 of which were attributable to the
former Sanders firm, with gross proceeds totaling approximately $580 million,
and acted as a co-managing underwriter in 30 public offerings with gross
proceeds totaling approximately $1.6 billion, all of which were attributable to
the former Sanders firm. We have a total of 17 professionals performing
investment banking services in Houston and New York.
We regularly participate in corporate securities distributions as a member
of an underwriting syndicate or of a selling group in public offerings managed
by other underwriters, including national and regional firms. Our syndicate
department coordinates the distribution of co-managed equity underwritings,
accepts invitations to participate in underwritings managed by other investment
banking firms and allocates our selling allotments to our various sales units.
Participation in an underwriting syndicate or selling group involves both
economic and regulatory risks. An underwriter or selling group member may incur
losses if it is forced to resell the securities it is committed to purchase at
less than the agreed purchase price. In addition, under the federal securities
laws, other statutes and court decisions with respect to underwriters'
liabilities and limitations on indemnification of underwriters by issuers, an
underwriter is subject to substantial potential liability for material
misstatements or omissions in prospectuses and other communications with respect
to underwritten offerings.
We also serve as placement agent or financial advisors in private
placements of securities under a variety of fee structures depending on the
amount and type of capital raised, including cash and equity contingent fees,
cash and equity non-contingent fees, adjustable cash and equity fees or a
combination of two or more of the foregoing. In 1999, SMH initiated 12 private
placements with gross proceeds totaling $89 million, and in the months of
January and February 2000, SMH initiated 3 private placements with gross
proceeds totaling $43 million. Our officers and directors have in the past, and
expect in the future, to invest in the securities involved in the private
placement on the same basis as other investors, where suitable and permitted by
applicable law and regulations. We believe these co-investments create an
identity of interest with our investors, and thus benefit them.
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Our financial advisory services include advising on mergers, acquisitions
and divestitures, fairness opinions, and financing strategies. We also provide
valuations, litigation support and financial consulting services. These
financial advisory services are typically provided to emerging or middle market
companies in the southwestern United States.
PROPRIETARY FUNDS. In January 1996, SMH organized Environmental
Opportunities Fund, L.P. and Environmental Opportunities Fund (Cayman), L.P.,
raising $38 million for investments primarily in private and public companies
providing environmental or industrial services and related products, an area in
which SMH has developed a specialty practice. In 1998, SMH organized a second
investment fund, Environmental Opportunities Fund II, L.P. and Environmental
Opportunities Fund II (Institutional), L.P., raising an additional $75 million
for investments in the environmental services area. SMH then formed Corporate
Opportunities Fund, L.P. and Corporate Opportunities Fund (Institutional), L.P.
in 1998 with capital commitments of $48 million for investment principally in
private companies and small public companies with enterprise values of less than
$250 million, particularly those in the healthcare, technology, and medical
industries. In late 1999, SMH organized and commenced sales of interests in the
Sanders Opportunities Funds, which are intended to invest primarily in small to
medium capitalization companies, both public and private, that are significantly
undervalued.
We hold an interest in these funds and also earn management and advisory
fees based on a fixed percentage per annum of total commitments during the
investment period of the fund (generally four years) and a fixed percentage
of the limited partnership profit above specified hurdle rates. For the two
Environmental Opportunities Funds and the Corporate Opportunities Fund, we
receive 2% per annum of total commitments, and 20% of the limited partnership
profits above specified hurdle rates. We receive 1% per annum of total
commitments during the investment period (generally four years), and of total
capital contributions thereafter, and 10% of the limited partnership profit
above specified hurdle rates for the Sanders Opportunity Fund, which
initially closed on $7.4 million in February 2000. We have agreed to allocate
to the managers of the funds and employees designated by the managers from
40% to 45% of our 20% and 10% back-in interests in the profits of these
limited partnership funds. Over time, the Sanders fund is expected to receive
additional funds. We account for all of these funds at the fair value of the
underlying securities.
MERCHANT BANKING. Our merchant banking activities focus on providing
private equity capital for middle-market growth companies within a broad range
of industries, including, among others, business services, communications,
computing, distribution, direct marketing of electronic financial services,
energy, information technology, Internet, media entertainment, retail, specialty
chemicals and biotechnology. These transactions may take a variety of forms,
such as buyouts, growth buildups, consolidation of several private companies in
conjunction with public and private offerings, expansion capital and venture
capital financings. In addition, PGG Capital, our subsidiary and sister company
to SMH, holds a significant equity position in BioCyte Therapeutics, Inc., an
early stage biotechnology company focusing on diagnostics and therapeutics for
cancer-related diseases.
MARKET MAKING AND PRINCIPAL TRANSACTIONS. We make markets, buying and
selling as principal, in securities quoted on Nasdaq or other over-the-counter
markets. In lieu of commissions, we create revenue in return for the risk we
assume based on the markup or markdown of each transaction. Principal
transactions with clients are generally effected at a net price within or equal
to the current interdealer price plus or minus a markup or markdown. The trading
department's objective is to facilitate sales to clients and to other dealers,
not to generate profits based on trading for our own account.
Revenues from principal transactions depend on the general trend of prices
and the level of activity in the securities market, employee skill in
market-making activities and inventory size. Trading activities carried out as a
principal require a commitment of capital, and create an opportunity for profit
and risk of loss due to market fluctuations. At February 29, 2000, through SMH,
we made markets in the common stock or equity securities of 70 companies that
were quoted on Nasdaq, and 10 companies that were traded in the over-the-counter
market.
The level of positions carried in our trading accounts fluctuates
significantly depending on the firm's assessment of economic and market
conditions, the allocation of capital among various stocks, client demand,
underwriting commitments, and market trading volume. The aggregate value of our
inventories is limited by certain net capital requirements under the Exchange
Act. At February 29, 2000, trading inventories at SMH totaled $1.8 million.
We have established procedures designed to reduce the systemic risks of our
proprietary trading activities. Our trading inventory positions and profit and
loss statements are reviewed daily by senior management of SMH and monthly by
its board of directors. However, these procedures may not prevent losses, which
could have a material adverse effect on SMH's business, financial condition,
results of operations or cash flows.
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PMT
TRUST, ASSET MANAGEMENT AND RELATED SERVICES. Through PMT, we provide a
variety of trust services, including investment management, estate settlement,
retirement planning, mineral interest management, funeral and cemetery trust
administration, real estate, retirement plan and other administrative services,
such as custody of assets and record keeping. We meet with each client to
develop asset management strategies that are consistent with the client's needs
and investment objectives. Consideration is given to the client's financial and
investment objectives, risk tolerance, investment restrictions and time horizon.
We believe this total investment management approach provides clients with
increased diversification, reduced risk and greater control over their
portfolios.
We license trust accounting software that provides our clients with many
additional benefits, including flexible statement packages and access to account
information on the Internet through a link established between PMT's "home page"
and the licensor of the software's database.
Our revenues are derived mainly from asset management and fiduciary fees
based on a percentage of assets under administration. At December 31, 1999, PMT
had approximately $488 million of assets under administration. The management
fee charged is based on a rate schedule which is changed from time to time.
Rates vary depending on the services being provided and the amount of assets
involved. We believe that this structure, as opposed to transactional
commissioned-based arrangements, more closely aligns our interests with our
clients and helps develop long-term client relationships. We also believe that
the Sanders merger broadened cross-selling opportunities within SMH's client
base.
SPIRES
INSTITUTIONAL BROKERAGE. Through Spires, we provide brokerage services
to institutional clients relating primarily to fixed-income securities, such
as municipal securities, U.S. government and agency securities,
mortgage-related securities, including those issued through Government
National Mortgage Association, Federal National Mortgage Association and
Federal Home Loan Mortgage Corp., and corporate investment-grade and
high-yield bonds. Commissions are charged on all institutional securities
transactions based on rates formulated by Spires.
TRADING. Rather than trading a wide variety of securities in direct
competition with Wall Street firms, we have developed a niche strategy to
proprietarily trade certain fixed-income securities, including U.S. government
securities, certain mortgage related securities and collateralized mortgage
obligations. In our trading activities, we generally act as a wholesaler. We buy
round-lot and odd-lot positions, sell round-lot and odd-lot positions and act as
market-maker in round-lot and odd-lot positions. Many of our counterparties in
these transactions are other broker-dealers. Our trading operations generally
seek to generate profits based on trading spreads, rather than through
speculation on the direction of the market. The size of the securities positions
varies substantially depending on economic and market conditions, the allocation
of capital among types of inventories, customer demands and trading volume. The
aggregate value of inventories we carry is limited by the net capital
requirements of the Exchange Act.
We have established procedures designed to reduce the risks of our trading
activities. We employ a hedging strategy designed to insulate the net value of
our trading inventory from fluctuations in the general level of interest rates.
However, it is not possible to hedge completely the risks of interest rate
fluctuations for some of the fixed-income securities that we trade, primarily
because the price movements of financial instruments typically used to hedge
long positions in such securities may not precisely mirror the price movements
of the hedged securities under all market conditions. In addition to our hedging
procedures, we seek to mitigate the risks associated with our proprietary
trading activities by subjecting our trading inventory positions and profit and
loss statements to daily review by Spires' senior management. However, such
procedures may not prevent losses, which could adversely affect Spires'
business, financial condition, results of operations or cash flows.
OTHER ACTIVITIES. To promote its business with the institutional investor,
Spires developed its own proprietary portfolio management and trading system,
Spires Financial Network, which is made up of databases, search engines, and
analytics delivered to the client via the internet. See "- Intellectual
Property."
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We are also active as a secondary market broker for residential, consumer
and commercial loans, and derive revenue from the placement of mortgage
servicing and newly "securitized" mortgaged collateral on a nationwide basis.
CLIENTS
Clients of our broker dealer subsidiaries, SMH and Spires, vary according
to the nature of the services provided. SMH's retail brokerage services are
generally focused on high net worth individuals. SMH's investment banking,
underwriting, investment research and principal transaction activities are
targeted at emerging and middle market companies throughout the United States.
At February 29, 2000, SMH had over 500 institutional clients throughout the
United States, Europe and Asia, and Spires had over 800 institutional clients
throughout the United States, Europe and Japan. These institutional clients
consist mostly of pension funds, money managers, mutual and hedge funds,
insurance companies, commercial banks and thrift companies.
Our trust subsidiary, PMT, provided trust services to approximately 396
accounts at December 31, 1999. These clients consist mainly of high net worth
individuals and their estates and trusts, 401(k) and other employee-directed
company sponsored retirement plans and charitable and other non-profit
corporations. PMT also provides trust services relating to trust funds of owners
and operators of funeral homes, cemeteries and related businesses.
INTELLECTUAL PROPERTY
Through Spires, we have developed proprietary trading tools in connection
with our fixed-income securities business. As the structures of fixed-income
securities have become increasingly complex, successful investors need reliable,
accurate and timely information to make prudent investment decisions. To satisfy
this need, we have invested significantly in an integrated proprietary trading
tool known as the "Spires Financial Network," or "SFN." SFN is delivered to
Spires' clients by direct dial-up or over the Internet. Through the Internet,
Spires' employees and clients access proprietary databases, search engines and
analytics of Spires through its "home page." Minimal investment is required by
the client since all computing is performed on Spires' servers in Houston,
Texas. Only mouse clicks and screen graphics are transmitted over the Internet.
SFN proprietary databases provide current and 14-year historical market
information relating to mortgage-backed securities, collateralized mortgage
obligations and other matters. The system stores and maintains detailed
information on the $2.7 trillion mortgage-backed securities market. SFN also
provides detailed databases of dealer inventories, client portfolios, and
third-party supplied institutional portfolio positions, giving customers a
value-added view of these markets. The company's unique virtual inventory of
mortgage securities offerings is maintained daily on the internet. SFN's
proprietary search engines and analytics include:
- Portfolio Pro - reduces the client's entire portfolio to a single
security by blending cash flows of each position in the portfolio
according to selected interest rate scenarios; and
- Bond Locator - permits database-searching capabilities by CUSIP,
description or profile and enables clients to better achieve liquidity
and execution by matching buyers and sellers of similar securities.
These databases also accelerate securities selection and improve overall
yield and total rate of return by isolating the best investment alternatives
based on the client's investment criteria. In December 1997, Spires obtained
a Bloomberg-Registered Trademark- Data License allowing Spires to consolidate
its data source requirements with one premier provider. As a result, Spires
can redistribute selected Bloomberg data through SFN to its clients.
SFN is supported by a staff of six full-time system development,
programming and support personnel. These people are responsible for system
maintenance and support and development of proprietary software tools based on
information provided by Spires' brokerage and trading professionals and its
institutional clients. Our management believes that SFN is a key element in the
success of Spires' institutional brokerage and trading activities.
7
MARKETING
The marketing efforts of our broker-dealer subsidiaries, SMH and Spires,
are conducted by an in-house staff of approximately 30 individuals at
Spires' five offices and 90 at SMH's five offices. SMH and Spires target
their client groups through mailings, telephone calls, in-person
presentations and firm-sponsored workshops. Due to the nature of SMH's
business, its regional name recognition and the reputation of its management,
business is obtained through referrals from other investment bankers or
initiated directly by the client, as well as through senior level calling
programs. We also believe that Spires' SFN proprietary technology has been
critical to its client development success.
Our trust subsidiary, PMT, conducts its marketing and business development
efforts on a company-wide basis. All PMT employees are encouraged to be actively
involved in business development efforts through maintenance of professional and
personal relationships and active involvement in community events. PMT markets
to specific client groups through mailings, telephone calls, multi-media client
presentations and company-sponsored or co-sponsored workshops and seminars.
We believe cross-selling opportunities existing among SMH, PMT and Spires
based on the relationships developed by the individual companies.
Existing and potential clients can also gain a variety of information
about our firm and services we provide through our internet websites at
www.pinnacleglobal.com, www.smhhou.com, www.pinnacletrust.com and
www.spiresfin.com.
RELATIONSHIP WITH CLEARING BROKERS
Our broker-dealer subsidiaries, SMH and Spires, both use the services of
clearing brokers. Currently, SMH clears all transactions, and carries accounts
for clients, with the Pershing Division of Donaldson, Lufkin & Jenrette
Securities Corporation under a fully disclosed clearing arrangement. Spires
clears its transactions, and carries client accounts, primarily through Banc of
America Securities LLC and other clearing brokers. Both Pershing and Banc of
America Securities LLC serve as principal and clearing broker in all
transactions. Spires uses other clearing brokers in addition to Banc of America
Securities LLC. These clearing brokers also provide SMH and Spires with
information necessary to generate commission runs, transaction summaries, data
feeds for various reports including compliance and risk management, execution
reports, trade confirmations, monthly account statements, cashiering functions
and handling of margin accounts. We believe these arrangements produce clearing
costs that are competitive within the industry.
Each of SMH and Spires has an uncommitted financing arrangement with its
clearing broker which finances its customer accounts, certain broker-dealer
balances and firm trading positions. Although these customer accounts and
broker-dealer balances are not reflected on our balance sheet for financial
accounting reporting purposes, both SMH and Spires have generally agreed to
indemnify these clearing brokers for losses it may sustain in connection with
the accounts. Therefore we retain risk on these accounts. SMH and Spires are
each required to maintain certain cash or securities on deposit with its
clearing broker.
EFFECTS OF INTEREST RATES
Our financial service business is affected by general economic conditions,
including movements of interest rates. As interest rates increase, the prices of
equity securities may decline, partially reflecting the increased competition
posed by more attractive rates on fixed-income securities and partially
reflecting the fact that interest rate increases may tend to dampen economic
activity by increasing the cost of capital for investment and expansion, thereby
reducing corporate profits and the value of equity securities. As interest rates
decline, equity securities may tend to rise in value. The impact of these
fluctuations and changes may affect the profitability of our brokerage,
investment banking and market-making activities. Commission revenue may also be
affected by changes in interest rates and any resulting indirect impact on the
value of equity securities. Our interest income and interest expense may
likewise change as interest rates change.
Our revenues relating to asset-based advisory services and managed accounts
are typically from fees generally based on the market value of assets under
management. Consequently, significant fluctuations in the values of securities,
which can occur with changes in interest rates or changes in other economic
factors, may materially affect the amount of assets under management, and thus,
our revenues and profitability.
8
Our inventory of fixed-income securities may fluctuate as interest rates
change. As interest rates decrease, the prices of fixed-income securities may
increase, partially reflecting the increased demand for securities with higher
coupon rates. As interest rates increase, fixed-income securities may tend to
decrease in value reflecting the availability of newer securities with higher
coupon rates. Commission revenue may also be affected by changes in interest
rates and any resulting indirect impact on the value of fixed-income securities.
COMPETITION
Our financial services business and the securities business in general are
highly competitive. The principal competitive factors influencing our financial
services business is our:
- professional staff
- reputation in the marketplace
- existing client relationships
- ability to commit capital to client transactions and mix of market
capabilities
Our ability to compete effectively in our securities brokerage and
investment banking activities will also be influenced by the adequacy of our
capital levels and by our ability to raise additional capital. We compete
directly with national and regional full service broker-dealers and, to a
lesser extent, with discount brokers, dealers, and other investment banking
firms, investment advisors and commercial banks. We also compete for asset
management and fiduciary services with commercial banks, private trust
companies, mutual fund companies, insurance companies and others. Domestic
commercial banks and large international banks have recently entered the
securities business, including markets in which we compete. We expect
competition from domestic and international banks to increase as a result of
recent legislative and regulatory initiatives in the United States to remove
or relieve restrictions on commercial banks relating to the sale of
securities.
The financial services industry has become considerably more
concentrated as many securities firms have either ceased operations or been
acquired by or merged into other firms. Many of these larger firms have
significantly greater financial and other resources than we do and can offer
their customers more product offerings, lower pricing, broader research
capabilities, access to international markets and other products and services
we do not offer, which may give these firms a competitive advantage over us.
We also face competition from a rapidly developing discount or
electronic brokerage services industry. These competitors may have lower
costs and may offer their customers more attractive pricing or other terms
than we do. We also anticipate competition from underwriters who attempt to
affect public offerings using non-traditional means of distribution,
including through electronic media like the Internet. In addition, issuers
may try to sell their securities directly to purchasers, including through
electronic media such as the Internet. If issuers and purchasers of
securities can transact business without financial intermediaries, such as
our company, our financial condition and operating results could be adversely
affected.
GOVERNMENT REGULATION
The securities industry is one of the nation's most extensively regulated
industries. The SEC is responsible for carrying out the federal securities laws
and serves as a supervisory body over all national securities exchanges and
associations. The regulation of broker-dealers has to a large extent been
delegated by the federal securities laws to Self Regulatory Organizations,
called "SROs". These SROs include, among others, all the national securities and
commodities exchanges and the NASD. Subject to approval by the SEC and certain
other regulatory authorities, SROs adopt rules that govern the industry and
conduct periodic examinations of the operations of our broker-dealer
subsidiaries - SMH and Spires. SMH and Spires are also subject to regulation
under the laws of the states, Puerto Rico and certain foreign countries in which
they are registered to conduct securities, investment banking, insurance or
commodities business. Broker-dealers are subject to regulations which cover all
aspects of the securities business, including:
- sales methods,
- trade practices among broker-dealers,
9
- use and safekeeping of clients' funds and securities,
- capital structure of securities firms,
- record-keeping,
- reporting requirements,
- supervisory and organizational procedures intended to ensure compliance
with securities laws, including the prevention of unlawful trading on
material nonpublic information,
- employee-related matters, including qualification and licensing of
supervisory and sales personnel,
- limitations on extensions of credit in securities transactions,
- clearance and settlement procedures,
- requirements for the registration, underwriting, sale and distribution
of securities, and
- compliance with the rules of the self regulatory organizations
designed to promote high standards of commercial honor and just and
equitable principles of trade.
Many of these regulations involve the relationship between broker-dealers
and their clients including, in some instances, "suitability" determinations as
to certain client transactions, limitations on the amounts that may be charged
to clients, timing of proprietary trading in relation to clients' trades and
disclosures to clients. Violations of any of these customer regulations or other
applicable regulations can lead to revoking broker-dealer licenses, imposing
censures or fines or suspending, or terminating a firm, its officers or
employees.
As a registered broker-dealer, our brokerage subsidiaries are subject to
certain net capital requirements of Rule 15c3-1 under the Exchange Act. The net
capital rules, which specify minimum net capital requirements for registered
broker-dealers, are designed to measure the financial soundness and liquidity of
broker-dealers. Failure to maintain the required net capital may subject a firm
to suspension or revocation of registration by the SEC and suspension or
expulsion by other regulatory bodies, and ultimately may require its
liquidation. Further, a decline in a broker-dealer's net capital below certain
"early warning levels," even though above minimum capital requirements, could
cause material adverse consequences to the broker-dealer. For example, the net
capital requirements prohibit payments of dividends, redemption of stock, the
prepayment of subordinated indebtedness and payments in respect of subordinated
indebtedness principal if thereafter net capital would be less than required
levels.
The net capital rules also:
(1) require that broker-dealers notify the SEC, in writing, two
business days before making withdrawals or other distributions of
equity capital or lending money to certain related persons if the
withdrawals would exceed, in any 30-day period, 30% of the
broker-dealer's excess net capital, and that they notify the SEC
within two business days after any such withdrawal or loan that
would exceed, in any 30-day period, 20% of the broker-dealer's
excess net capital;
(2) prohibit a broker-dealer from withdrawing or otherwise
distributing equity capital or making related party loans if
after the distribution or loan, the broker-dealer has net capital
of less than $300,000 or if the aggregate indebtedness of the
broker-dealer's consolidated entities would exceed 1,000% of the
broker-dealer's net capital and in certain other circumstances;
and
(3) provide that the SEC may, by order, prohibit withdrawals from
capital of a broker-dealer for a period of up to 20 business
days, if the withdrawals would exceed, in any 30-day period, 30%
of the broker-dealer's excess net capital and if the SEC believes
the withdrawals would be detrimental to the financial integrity
of the firm or would unduly jeopardize the broker-dealer's
ability to pay its customer claims or other liabilities.
Compliance with the SEC's net capital requirements could limit those
operations of our brokerage subsidiaries that require intensive use of capital,
such as underwriting and trading activities, and also could restrict our ability
to withdraw capital, which, in turn, could limit our ability to pay dividends,
and redeem or purchase shares of our outstanding common stock.
We are in compliance with the net capital requirements. However, in the
past, when Sanders Morris Mundy had required additional net capital in order to
participate as an underwriter in a securities offering, one or more of its
10
shareholders advanced funds on a subordinated basis to Sanders Morris Mundy to
satisfy the net capital requirements. We do not expect that shareholders will
advance any future funds necessary to satisfy any net capital requirements.
Under the National Securities Markets Improvement Act of 1996 and the
Investment Advisors Supervision Coordination Act, investment advisors, such as
SMH, with less than $25 million of investment advisory assets under management
(excluding discretionary accounts and separate partnerships), are regulated by
the securities administrators of the states in which they offer investment
advisory services. SMH is currently registered as an investment advisor in Texas
and Georgia.
Our brokerage subsidiaries are also subject to "Risk Assessment Rules"
imposed by the SEC which require that certain broker-dealers maintain and
preserve certain information, prescribe risk management policies and procedures
and report on the financial condition of certain affiliates whose financial and
securities activities are reasonably likely to have a material impact on the
financial and operational condition of the broker-dealers. Certain "Material
Associated Persons" (as defined in the Risk Assessment Rules) of the
broker-dealers and the activities conducted by such Material Associated Persons
may also be subject to SEC regulation. In addition, the possibility exists that,
on the basis of the information it obtains under the Risk Assessment Rules, the
SEC could seek authority over our unregulated subsidiaries either directly or
through its existing authority over our regulated subsidiaries.
Our trust subsidiary, PMT, operates in a highly regulated environment and
is subject to extensive supervision and examination by Texas regulatory
agencies. As a Texas chartered trust company, PMT is subject to the Texas Trust
Company Act, the rules and regulations promulgated under that act and
supervision by the Texas Banking Commissioner. These laws are intended primarily
for the protection of PMT's clients, rather than for the benefit of investors.
The Texas Trust Company Act provides for, and regulates, a variety of matters,
such as:
- periodic examinations by the office of the Texas Banking
Commissioner;
- furnishing periodic financial statements to the Commissioner;
- minimum net capital maintenance requirements;
- fiduciary record-keeping requirements;
- bonding requirements for the protection of clients;
- restrictions on investments of restricted capital;
- lending and borrowing limitations;
- prohibitions against engaging in certain activities;
- prior regulatory approval for certain corporate events (e.g.,
mergers, sale/purchase of all or substantially all of the assets
and transactions transferring control of the trust company);
- broad regulatory powers if the trust company violates certain
provisions of Texas Trust Company Act or is determined to be in a
"hazardous condition" (as the law defines that term); and
- other matters.
While we believe PMT is in material compliance with these laws, rules and
regulations, PMT may not be able to continue compliance in the future, or these
laws, rules or regulations may change adversely, either of which could have a
material adverse effect on PMT. Our ability to comply with laws relating to our
financial service business depends upon establishing and maintaining an
effective compliance system to monitor compliance, and our ability to attract
and retain qualified compliance personnel. While we believe that we are in
material compliance with these laws and regulations, we may not be able to
comply in the future. Any noncompliance could have a material adverse effect on
us.
RISKS ASSOCIATED WITH DISCONTINUED OPERATIONS
From 1995 through 1997, we disposed of all of TEI's operating businesses
other than its liquid waste business. In the December 1997 sale of assets of a
former subsidiary, the purchaser agreed to complete customer contracts of the
subsidiary in process at the time of sale. We remain primarily liable to
complete the contracts, and agreed to reimburse the purchaser if its aggregate
completion costs exceeded the aggregate contract price. During the fourth
quarter of 1998, we recorded a loss of about $1.3 million (net of tax) for
potential liability associated with these contracts, principally from the
cancellation of a major customer contract. During the third quarter of 1999, the
purchaser informed us that additional costs would be incurred to complete the
customer contracts. As a result, we recorded an additional loss of about $73,000
(net of tax) during the third quarter of 1999. In March 2000, we were informed
by the customer that
11
while the projects under the contracts were substantially complete, payment on
the contracts would not be made. Under the purchase agreement, we are liable to
the purchaser for contract payments not made by the customer, and thus, we
recorded an additional liability of $1,200,000. In March 2000, we paid the
purchaser $420,000 with respect to our obligations.
As a result of our decision to focus on the financial services industry,
we discontinued our liquid waste business effective December 31, 1998. During
the fourth quarter of 1998, we recorded an estimated loss on disposition of
this business of about $2.2 million (net of tax). We recorded an additional
loss of $230,000 (net of tax) during the third quarter of 1999 based on
estimated operating losses from the liquid waste business through the
anticipated sale date. In the fourth quarter of 1999, based in part on
discussions with a third party, we recorded an additional estimated loss
provision of $1,000,000. We may not be able to sell this business at a price
we consider adequate, or if sold, recover our current investment. Our liquid
waste business may also incur operating losses in the future in excess of the
recorded amount, and we may have to record additional losses in future
periods based on the eventual sales price of the discontinued business.
In addition, our discontinued liquid waste operation is subject to numerous
and continually evolving federal, state, and local laws, regulations and
policies that govern environmental protection, zoning and other matters,
including the Clean Water Act, Resource Conservation and Recovery Act and the
Clean Air Act. While we do not accept, and do not intend to accept, hazardous
substances at our facilities, if our liquid waste operations result in the
release or improper disposal of hazardous substances, we could incur liability
under the Comprehensive Environmental Response and Compensation and Liability
Act. Although we believe our liquid waste operations are in material compliance
with applicable laws and regulations, we may not continue in compliance in the
future. Any failure to comply with these laws, regulations and policies could
have a material adverse effect on our business, results of operations or
financial condition and could result in continuing risk of liability to us for
these failures under any proposed sale of the liquid waste business.
EMPLOYEES
At December 31, 1999, we had 108 employees, excluding employees of
discontinued operations. Of these employees, 19 were engaged in retail
brokerage, 30 in institutional sales, 14 in investment banking, 2 in securities
analysis and research, 12 in trust services, 6 in systems development and
support and 18 in accounting, administration and support operations. As a result
of the Sanders merger, we added an additional 108 employees as of February 29,
2000, of which 30 were engaged in retail and institutional sales, 12 in
investment banking, 16 in securities analysis and research and 50 in accounting,
administration and support operations. None of our employees are subject to
collective bargaining agreements. We believe our relations with our employees
generally are good.
RISK MANAGEMENT
Our financial services business involves substantial risks of liability.
From time to time we or our operating subsidiaries may be named as a defendant
in civil litigation and arbitration arising from our business activities as a
broker-dealer, fiduciary or in connection with our investment management
functions. The plaintiffs in such litigation or arbitration may allege
misconduct on the part of our investment or trust executives, claiming, for
example, that investments sold to the plaintiffs were unsuitable for their
portfolios, or that the investment executives engaged in excessive trading in
the plaintiffs' accounts. While historically we have not incurred material
liability in litigation or arbitration, substantial liabilities in connection
with such matters may occur in the future.
In recent years, there has been a substantial amount of litigation
involving the securities industry, including class action lawsuits that
generally seek substantial damages and other suits seeking punitive damages.
Companies engaged in the underwriting of securities, including our company,
through SMH, are subject to substantial potential liability, including material
misstatements or omissions in prospectuses and other communications in
underwritten offerings of securities or statements made by securities analysts,
under federal laws, such as Rule 10b-5 under the Exchange Act and Section 11 of
the Securities Act and similar state statutes and common law doctrines. The risk
of liability may be higher for an underwriter which, like SMH, is active in the
underwriting of securities offerings for emerging and middle-market companies
due to the higher degree of risk and volatility associated with the securities
of those companies.
12
The defense of these or any other lawsuits or arbitrations may divert
the efforts and attention of management and staff and those of our
subsidiaries from other responsibilities, and we may incur significant legal
expense in defending such litigation or arbitration.
ITEM 2. PROPERTIES
We lease office facilities in Houston (five locations) and Austin, Texas;
New York, New York; Morris Plains, New Jersey; Chicago, Illinois; Denver,
Colorado and Westport, Connecticut, aggregating approximately 50,000 square
feet. Two of our Houston leases expire in 2004, two Houston leases in 2002, one
Houston lease in 2003, the Austin and Morris Plains leases in 2000, the Denver
and Chicago leases in 2001, and the Westport lease in 2003. The leases are on
rental and other terms that we believe are commercially reasonable. We believe
our existing facilities are well maintained and adequate for existing and
planned operations.
As part of our plan to discontinue the liquid waste operations, we intend
to sell our real property located in Charlotte, North Carolina, consisting of
about six acres of land, related office space and a 14,800 square foot
processing plant built in 1997. We anticipate the sale to occur in 2000, but due
to unforeseen circumstances a sale may not be completed within that time frame.
ITEM 3. LEGAL PROCEEDINGS
We are a party to various legal proceedings which 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 financial condition or results of operations.
In October 1999, a brokerage customer initiated an arbitration proceeding
against HWG alleging wrongdoing in the execution of a trade. The customer is
seeking damages of $532,000, and a hearing date has not been scheduled. We are
contesting the allegations vigorously, however, due to the uncertainty involved
in actions of this nature, we are unable to determine the likelihood of an
unfavorable outcome in the proceeding.
In November 1999, SMH received a letter from the chairman of the audit
committee of Waste Management, Inc. asking for information concerning
investments by SMH, its clients, and the Environmental Opportunities Funds in a
number of private and public companies that either purchased assets from Waste
Management or were acquired by Waste Management while John E. Drury was both
employed by Waste Management and associated with Sanders Morris Mundy. Mr. Drury
is a current shareholder and former executive officer and director of Waste
Management, is a former shareholder and director of Sanders Morris Mundy and as
a result of the Sanders merger is a 2.2% shareholder of our company. SMH has
provided information in response to the Waste Management request.
Waste Management has not made any formal claim against SMH. However, Waste
Management's investigation is continuing. Based on our own investigation and
discussions with management of SMH, we believe there is no factual basis or
legal basis for any Waste Management claim against SMH. While we believe that
neither the existence nor the ultimate resolution of the Waste Management
investigation will have a material adverse effect on the financial condition of
SMH, we cannot predict the outcome of the investigation and if a claim is made
we cannot determine the significance of the related costs and management
attention required to defend it.
We may also be exposed to certain liabilities and claims associated with
our discontinued liquid waste business. See "Item 1. Business-Risks Associated
with Discontinued Operations."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 29, 1999, we held a special meeting of our shareholders for the
following purpose:
- To consider and vote on a proposal to approve the issuance of
7,125,220 shares of our common stock to the shareholders of
Sanders Morris Mundy Inc. as part of a merger of the Sanders firm
with Harris Webb & Garrison, Inc., our investment banking
subsidiary.
- To transact other business related to the first proposal that may
have properly come before the special meeting.
13
Holders, present in person or represented by proxy, of 3,973,420 of our
common shares were present at the special meeting, which shares represented
55.76% of our total issued and outstanding shares entitled to vote at the
special meeting. While the meeting was legally convened and called to order, due
to last minute developments involving both our company and Sanders Morris Mundy,
the meeting was adjourned until January 28, 2000, at 10:00 a.m. Central Standard
Time. The adjournment of the meeting was made on a motion by Robert E. Garrison
II, the Chairman of the special meeting, which was seconded by one of our
shareholders present at the meeting. The motion was then submitted to an oral
vote and approved.
The last minute developments causing the adjournment involved:
- One of our directors withdrawing his support for the Sanders
merger, and
- An information request by the audit committee of Waste Management
directed to Sanders Morris Mundy concerning investments by the
Sanders firm, its clients, and the Environmental Opportunities
Funds in a number of private and public companies that either
purchased assets from Waste Management or were acquired by Waste
Management while John Drury was both employed by Waste Management
and associated with Sanders Morris Mundy. Mr. Drury is a
shareholder and former executive officer and director of Waste
Management and a former shareholder and director of the Sanders
firm, and a current shareholder of our company. See "Item 3.
Legal Proceedings."
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock trades on the Nasdaq National Market tier of The Nasdaq
Stock Market under the symbol "PING." Our common stock began trading on January
29, 1999. Prior to that time, there was no established public trading market for
our common stock. As a result of the January 1999 combination, we became the
successor issuer to TEI, Inc. whose common stock was traded on the Nasdaq
National Market under the symbol "TANK." The TEI common stock began trading on
June 19, 1991 and was removed from quotation on the Nasdaq National Market on
January 28, 1999. In connection with the combination, each outstanding share of
TEI common stock was converted into 0.25 of a share of our common stock, with
just over 50% of our outstanding common shares being issued to TEI's former
shareholders. A total of 3,562,500 of common shares, representing slightly less
than 50% of our outstanding shares, were issued to the former owners of HWG, PMT
and Spires. The following table sets forth the quarterly high and low sale
prices of our common stock during 1999 for the calendar quarters indicated, and
the quarterly high and low sale prices of the TEI common stock through January
29, 1999 for the calendar quarters indicated and after giving effect to the one
for .25 share exchange of the TEI common stock effected in connection with the
combination, each as reported on the Nasdaq National Market:
CALENDAR PERIOD HIGH LOW
--------------- ---- ----
1999:
First Quarter........................................9 5 1/16
Second Quarter.......................................6 1/4 4 1/2
Third Quarter........................................6 4 1/2
Fourth Quarter.......................................5 3/4 3 7/8
1998:
First Quarter........................................7 3/4 5 5/8
Second Quarter.......................................10 7
Third Quarter........................................10 1/2 6
Fourth Quarter.......................................9 5 1/4
14
At March 24, 2000, there were 342 record holders of our common stock. To
date, we have not paid cash dividends on our common stock. It is our policy to
continue retaining earnings for use in our operations and to fund our future
activities.
ITEM 6. SELECTED FINANCIAL DATA
The following data for 1995 through 1998 reflects our historical operating
results and financial condition prior to the January 1999 combination and the
January 2000 Sanders merger, and does not include any historical operating
results or financial condition data of any of the financial service firms for
those periods. The following data for 1999 reflects (1) our results of
operations, including the operations of the three financial services firms
acquired in the January 1999 combination, HWG, PMT and Spires, from January 31,
1999 through December 31, 1999 and (2) our financial condition after giving
effect to the January 1999 combination. This data does not include any of the
historical operating results or financial condition of Sanders Morris Mundy,
which was combined with our operations in January 2000.
As more fully described in Notes 1, 2 and 10 to the Consolidated Financial
Statements, all of our businesses owned through TEI have been sold or are
accounted for as discontinued operations.
The statement of operations data for all periods reflects Energy
Recovery Resources' liquid waste operations as discontinued. Periods prior to
1997 reflect the operations of the Tank Testing Group, Engineered Systems,
Inc. and Mankoff, Inc. as discontinued. Accordingly, the historical selected
financial data is not indicative of future operations.
The following data should be read together with the Consolidated
Financial Statements and their related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included later in
this Annual Report.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------
1999 1998 1997 1996 1995
--------------- --------------- ---------------- ---------------- ---------------
STATEMENT OF OPERATIONS DATA:
Total revenues .................. $18,972,765 $ 1,524,405 $ 1,530,264 $ 910,142 $ 740,013
Income (loss) from
continuing operations ........ (2,897,711) 106,260 3,621 (456,379) (552,775)
Income (loss) from
discontinued operations,
net of tax ................... (1,797,227) (4,077,020) (2,785,237) 1,211,479 (8,036,330)
--------------- --------------- ---------------- ---------------- ---------------
Net income (loss) ............... $ (4,694,938) $ (3,970,760) $ (2,781,616) $ 755,100 $(8,589,105)
=============== =============== ================ ================ ===============
Basic and diluted earnings (loss)
per share:
From continuing
operations ................ $ (0.43) $ 0.03 $ 0.00 $ (0.13) $ (0.16)
From discontinued
operations ................ (0.26) (1.14) (0.78) 0.34 (2.26)
--------------- --------------- ---------------- ---------------- ---------------
Net earnings (loss)
per share .................... $ (0.69) $ (1.11) $ (0.78) $ 0.21 $ (2.42)
=============== =============== ================ ================ ===============
Weighted average common
shares outstanding ........... 6,828,378 3,562,753 3,561,003 3,559,253 3,557,503
=============== =============== ================ ================ ===============
AS OF DECEMBER 31,
----------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------- --------------- ---------------- ---------------- ---------------
BALANCE SHEET DATA:
Cash and cash equivalents........... $10,494,979 $13,292,644 $ 12,810,100 $ 11,421,710 $ 14,967,107
Securities owned and securities
available for sale............... 89,051,079 14,637,575 15,335,619 18,425,979 3,694,873
Total assets........................ 298,466,181 34,995,239 39,042,721 43,033,894 42,276,610
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read together with the Consolidated
Financial Statements and their related notes and "Selected Financial Data"
included later in this Annual Report.
GENERAL
We provide diversified financial services through our subsidiaries,
including institutional and retail brokerage, investment banking, merchant
banking, secondary market loan and loan servicing placement, trust related
services and investment management. 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 of any individual period should not be
considered representative of future performance.
On January 29, 1999, we completed the combination of HWG, PMT and Spires.
In the combination, just over 50% of our outstanding common shares were issued
to TEI's former shareholders and slightly less than 50%, or 3,562,500 of our
common shares, were issued to the former owners of the financial services firms.
The combination was accounted for as separate purchases of each of the three
financial services firms.
In March 1999, the Company's new management decided to discontinue the
operations of TEI's liquid waste subsidiary effective December 31, 1998. These
operations, which are conducted primarily in Charlotte, North Carolina and
surrounding areas, involve the treating, recycling, and handling of waste-water,
waste oil and other non-hazardous fluid waste for owners and operators of under
and above ground storage tanks and other commercial and industrial waste
generators. Management believes the sale of the liquid waste business and
related Charlotte, North Carolina facility will be consummated in 2000.
On January 31, 2000, we completed the merger of HWG with Sanders Morris
Mundy Inc. Sanders Morris Mundy survived the merger, was renamed "Sanders
Morris Harris Inc." and became our wholly owned subsidiary. In the Sanders
Merger, we issued 7,125,220 of our common shares to the former shareholders
of the Sanders firm, increasing our total outstanding shares to approximately
14.25 million.
During the last several years, strong equity markets and record returns
have stimulated our brokerage business. Additionally, the strong markets and
economy have driven an increase in our investment banking business. Stock market
volatility generally affects our brokerage division more than our investment
banking division If stock market volatility dictates a general shift away from
our brokerage business, we believe that we have the ability to shift our focus
to more investment banking activities, such as public or private underwritings,
mergers and acquisitions and other types of financial advisory services. We
believe that the Sanders merger will contribute significantly to increased
public and industry awareness of our company and will result in increased demand
for our investment banking and corporate advisory services.
While recent markets have been strong, they have also been volatile. Given
the uncertainty in the market, we anticipate the trend toward investors seeking
professional asset management expertise to manage their portfolios to continue.
Our philosophy, through PMT, is focused toward long-term management and growth
of assets, regardless of client's asset mix.
Due to strong equity markets, rising interest rates, a flat yield curve,
and significant interest rate volatility, our fixed-income business at Spires'
experienced declining margins in 1999. Based on equity market gains in 1999,
institutional investor focused their attention primarily on equity markets. As a
result, investment manager allocations were heavily weighted toward equity
securities. Interest rate volatility, a key factor in bond transaction volume,
was significant during 1999, with rates fluctuating more than 170 basis points
during the period. While fixed-income yields became more attractive, the
relatively flat yield curve between shorter term fixed-income securities as
compared to those with longer maturities created little incentive for investors
to purchase the longer maturity fixed-income products that are more profitable
for Spires. For example, at December 31, 1999 only approximately 25 basis points
separated the yield on two-year notes from the 30-year bond. As a result,
Spires' average transaction margin, the difference between the sales price of a
bond and its cost, remained low during 1999. Spires' financial results have been
and may continue to be subject to fluctuations due to these factors and others.
16
The following discussion of the results of operations for 1998 reflects our
historical operating results prior to the January 1999 combination and the
January 2000 Sanders merger, and does not include any historical operating
results of any of the financial service firms for that period. The discussion of
the results of operations for 1999 reflects the operations of the three
financial services acquired in the January 1999 combination, HWG, PMT and
Spires, from January 31, 1999 through December 31, 1999. This discussion does
not include any of the operating results of Sanders Morris Mundy, which was
combined with our operations in January 2000.
COMPONENTS OF REVENUES AND EXPENSES
REVENUES. Our revenues are comprised primarily of (1) commission revenue
from retail and institutional brokerage transactions, fees from asset-based
advisory services, and principal and agent transactions at HWG and Spires, and
(2) investment banking revenue from corporate finance fees, mergers and
acquisitions fees and merchant banking fees at HWG and (3) fees from asset
management and fiduciary services at PMT. We also earn interest on the cash held
and dividends received from the equity securities held by PMT for its corporate
capital account and have gains (or losses) in Spires' inventory account.
Interest income results from interest earned on Spires' inventories of
fixed-income securities prior to sale and from interest and dividends earned on
investments in HWG's capital account. Other sources of revenue include revenue
earned from gains on the sale of securities held in PMT's corporate account, and
from realized and unrealized gains (or losses), net of hedging, on fixed-income
securities in Spires' possession.
EXPENSES. Our expenses consist of (1) compensation and benefits and (2)
brokerage and clearing costs, (3) interest expense and (4) other expenses.
Compensation and benefits is our largest expense item and includes wages,
salaries, commissions to retail and institutional brokers and investment and
merchant bankers, and benefits. During 1999, compensation and benefits
represented 59% as a percentage of total expenses, and 57% as a percentage of
total revenues. 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, trading desk
incentives, and management compensation. 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.
Brokerage and clearance expenses include clearing and settlement costs
associated with the retail and institutional brokerage business at HWG and
Spires. HWG clears its transactions through the Pershing Division of Donaldson,
Lufkin and Jenrette Securities Corporation, and Spires clears transactions
primarily through Banc of America Securities LLC and other clearing brokers.
Other expenses include (1) occupancy and equipment expenses, such as
rent and utility charges for facilities, (2) communications and data
processing expense, such as third-party systems, data, and software program
providers and development and maintenance expenses associated with SFN and
(3) interest expense paid by Spires to finance its inventory of fixed-income
securities, either through loans or repurchase agreements.
Amortization expense reflects the amortization of the goodwill created
through the combination of the three financial services firms, HWG, PMT and
Spires.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Total revenues for the year ended December 31, 1999 were $18,973,000
compared to $1,524,000 in 1998. The increase in revenues was due to the
acquisition of the three financial services firms on January 29, 1999. Total
expenses for the period were $18,600,000 compared to $1,365,000 in the previous
year. Income from continuing operations before taxes was $373,000 compared to
$160,000 in the previous year.
Provision for income taxes was $3,575,000 compared to $54,000 in the
previous year. The provision in 1999 included a 2,807,000 charge to provide a
valuation allowance for deferred tax assets that do not meet the more likely
than not criteria for recognition. While the charge is included in continuing
operations, these deferred tax assets resulted from losses and tax basis
differences from the Company's discontinued operations. Loss from continuing
operations, net of tax, was $3,203,000 compared to income of $106,000 in the
previous year. Loss from discontinued operations, net of tax declined to
$933,000 from $2,733,000 in 1998. Loss on disposition of discontinued
operations, net
17
of tax, was $1,797,000 in 1999 compared to $4,077,000 in 1998. Basic and diluted
income (loss) per share from continuing operations was $(0.43) in 1999 compared
to $0.03 per share for the year ended December 31, 1998.
Commissions revenue in 1999 was $8,268,000 primarily from retail and
institutional brokerage operations at Spires and HWG. Principal transactions
revenue was $3,649,000 consisting primarily of trading gains, net of hedging
costs. Investment banking revenue was $1,609,000 primarily from investment
banking fees earned from advisory services and private security offerings.
Fiduciary, custodial and advisory fees were $2,027,000 primarily from fee-based
account business at PMT. Interest and dividend income rose to $2,810,000 from
$1,524,000 in 1998, primarily due to interest earned on our securities.
Employee compensation and benefits increased $10,425,000 from $453,000 in
1998 to $10,878,000 in 1999 primarily due to additional employees in connection
with the January 1999 combination. Employee compensation and benefits includes
commissions paid to retail and institutional brokers and investment bankers at
HWG and Spires. Communications and data processing costs were $1,134,000 in
1999, compared to $22,000 in 1998. The increase of $1,112,000 was primarily
related to upgrades in technology and services, including quotes and market data
services. Occupancy costs increased from $75,000 in 1998 to $1,118,000 in 1999,
primarily due to rent expense for office and equipment leases of the financial
services firms.
The effective tax rate from continuing operations during the year ended
December 31, 1999 was 877% compared to 34% for the year ended December 31,
1998. The rate in 1999 was affected by nondeductible goodwill amortization
and an increase in the valuation allowance for deferred tax assets that do
not meet the more likely than not criteria for recognition as discussed above.
DISCONTINUED OPERATIONS
Losses from discontinued operations, net of tax, were $1,797,000 in 1999
compared to a loss of $4,077,000 in 1998. The loss from discontinued operations
in 1999 consists of $933,000, net of tax, related to a revision of the estimated
loss on the disposition of Energy Recovery Resources, Inc., and $865,000 related
to the a revision of our obligation to fund the cost to complete customer
contracts in connection with the December 1997 sale of Engineered Systems, Inc.
and an increase in the related reserve against amounts due from customers that
may not be collected. Although we made our best estimate of losses, discontinued
operations may incur additional operating losses and we may need to record
additional loss provisions on the disposition of discontinued operations in
future periods.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Interest and dividend income declined by $6,000 to $1,524,000 during 1998
from $1,530,000 during 1997, as a result of a decrease in the average balance of
cash and investments of approximately $1,500,000. This decrease was partially
offset by an increase of approximately 0.5% in the average rate earned on such
investments.
Employee compensation and benefits decreased by $73,000 to $453,000 in 1998
as a result of reductions in staff. Occupancy expenses decreased from $128,000
in 1997 to $75,000 in 1998 due to reduced rent expense at our corporate offices.
General and administrative expenses decreased by $38,000 to $814,000 during
1998 from $852,000 during 1997, primarily from a decrease in property taxes
resulting from the sale of our former corporate headquarters.
Losses from discontinued operations, net of tax, were $4,077,000 in 1998
compared to a loss of $2,785,000 in 1997. The loss from discontinued operations
in 1998 reflects a $569,000 net after tax loss of Energy Recovery Resources,
Inc. for the year and a write down of our investment in Energy Recovery
Resources, Inc. of $2,164,000, net of tax, based on the estimated net realizable
value of the business. Under the terms of our sale of Engineered Systems, Inc.,
the purchaser is responsible for completing customer contracts in place as of
the sale date. However, we remain liable for costs incurred by the purchaser in
excess of amounts collected from customers. Through the third quarter of 1998,
we believed, based in part on information provided by the purchaser, that we had
no additional liability under the contracts in process. Subsequent to December
31, 1998, the purchaser notified us that a major customer cancelled its contract
and other contracts in process have or are expected to result in costs in excess
of amounts recoverable from customers. As a result, we recorded a charge to
discontinued operations, net of tax, of $1,344,000 for the estimated contract
losses. The
18
loss from discontinued operations in 1997 consisted of a $188,000 loss on
disposition of Engineered Systems Inc., $2,194,000 from estimated contract
losses at Engineered Systems Inc. and $403,000 of net losses from the operations
of Energy Recovery Resources, Inc.
LIQUIDITY AND CAPITAL RESOURCES
A substantial portion of our assets is highly liquid and short-term in
nature, consisting of cash and assets readily convertible into cash. Securities
borrowed and securities loaned, along with receivables from customers and
payables to customers, fluctuate as a result of the changes in the level of
positions held to facilitate customer transactions and changes in market
conditions. Receivables from others and payables to others fluctuate primarily
due to the change in adjustment to securities owned on a trade date basis.
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 held before the January 1999 combination. Cash, cash
equivalents and liquid assets, consisting of receivables from broker-dealers and
clearing organizations, deposits with clearing brokers, securities owned, and
securities available for sale represented about 90% of our total assets at
December 31, 1999. At December 31, 1999, we had approximately $14.5 million in
cash and cash equivalents and securities available for sale. We had $21.4
million in intangible assets at December 31, 1999 as a result of the
acquisitions of HWG, PMT and Spires in the January 1999 combination. Total
assets increased $263.5 million from $35.0 million at December 31, 1998 to
$298.5 million at December 31, 1999.
Increases in securities owned and securities sold, not yet purchased arise
out of Spires' ordinary course of business. At December 31, 1999, Spires had
just issued a new collateralized mortgage obligation which increased our long
positions in securities that had not been sold and accompanying short positions,
or hedges. Increases in receivables from and payable to clearing brokers and
dealers were related to Spires' policy of financing long and short inventory
positions for leverage. Spires' clearing arrangement with Banc of America
Securities, LLC required an increase in deposits held by clearing brokers and
dealers.
At December 31, 1999, HWG and Spires, our then registered broker-dealer
subsidiaries, were in compliance with the net capital requirements of the
Securities and Exchange Commission's Uniform Net Capital Rule 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.
During July 1999, we signed a letter of intent to acquire a financial
services firm for $6.6 million in cash and 733,333 shares of our common
stock. The proposed transaction was subject to approval by our Board of
Directors, the receipt of approvals by various regulatory agencies, the
absence of adverse changes in the financial condition of the parties
involved, and the execution of a definitive agreement for the transaction. On
August 24, 1999, we announced that merger discussions had been terminated.
On October 12, 1999, we entered into a definitive agreement to merge HWG
with Sanders Morris Mundy, a privately owned investment bank based in Houston,
Texas. The parties amended and restated the merger agreement on November 12,
1999. The new firm, Sanders Morris Harris, resulting from the merger became our
wholly owned subsidiary. Under the merger, we issued 7,125,220 common shares to
the former Sanders Morris Mundy shareholders. The merger, which was subject to
approval by our shareholders, governmental approvals and other typical
conditions, closed on January 31, 2000.
We are involved in litigation and routine claims from time to time. Certain
of our litigation and claims are covered by insurance with a maximum deductible
of $50,000. Until recently, we were contingently liable for up to $600,000 for
liabilities relating to services performed by Tanknology Corporation
International, Tanknology Canada, Inc. (1988) and USTMAN Industries, Inc. prior
to October 25, 1996. We had fully reserved for that contingency and in February
2000 we paid the purchaser $600,000 in exchange for a complete release of our
remaining obligations.
Management believes that cash generated from operations, existing cash
balances and available borrowing capacity will be sufficient to meet our
anticipated cash requirements for 2000.
19
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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 terms of the safe
harbor, we caution readers that a variety of factors could cause our actual
results to differ materially from the anticipated results or other expectations
expressed in the forward-looking statements. These risks and uncertainties, many
of which are beyond our 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 our services or the cost of doing business; (4) general economic
conditions, both domestic and foreign, especially in the regions where we do
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 and (9) demand for our services. We do not undertake any
obligation to publicly update or revise any forward-looking statements.
EFFECTS OF INFLATION
Historically, inflation has not had a material effect on our financial
condition, results of operations or cash flows; however, the rate of inflation
can be expected to affect our expenses, such as employee compensation, occupancy
and equipment. Increases in these expenses may not be readily recoverable in the
prices that we charge for our services. Inflation can have significant effects
on interest rates that in turn can affect prices and activities in the financial
services market. These fluctuations could have an adverse impact on our
financial services operations.
YEAR 2000 IMPACT
We developed a company-wide initiative to detect and resolve potential Year
2000 issues that might adversely impact our computer systems and facilities. Our
broker-dealer subsidiaries, HWG and Spires, were required to complete a review
of the potential impact and report their findings to the NASD and the SEC no
later than August 31, 1998. An updated report by both subsidiaries was due no
later than April 30, 1998. HWG filed its initial report with the NASD and the
SEC on August 6, 1998, and Spires filed its initial report with both agencies on
August 31, 1998.
PMT, our trust subsidiary, was required to conduct a complete review of the
potential impact of Year 2000 issues and report its findings to the Texas
Banking Commissioner. PMT filed its initial report with the Bank Commissioner on
August 3, 1998.
We also developed a multi-phase plan to resolve potential problems relating
to our information technology at all of our operations and embedded chip
technology at our Energy Recovery Resources, Inc. liquid waste facility.
The contingency plan developed for resolution of Year 2000 issues detailed
the course of action to follow at various stages of readiness. There were no
problems encountered that warranted implementation of the contingency plan. Our
operations continued with no noticeable disruptions of service.
Costs to prepare our systems for the Year 2000 were approximately $142,294,
comprised of $21,085 for capital expenditures and $121,209 for non-capital
expenditures.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The following discussion relates to our market risk sensitive instruments
as of December 31, 1999, and thus, no discussion has been included regarding
such instruments held by Sanders Morris Mundy since the Sanders merger was not
consummated until January 31, 2000.
20
HWG
HWG's market making, investing, and underwriting activities often involve
the purchase, sale, or short sale of securities and expose its capital to
significant risks, including market risk, equity price risk, and credit risk.
Market risk represents the potential loss we may incur as a result of absolute
and relative price movements, price volatility, and changes in liquidity in
financial instruments due to many factors over which we have virtually no
control. HWG's primary market risk arises from the fact that it owns a variety
of investments that are subject to changes in value and could result in material
gains or losses. HWG also engages in proprietary trading and makes dealer
markets in equity securities. In doing this, HWG may be required to maintain
certain amounts of inventories in order to facilitate customer order flow. HWG
is exposed to equity price risk due to changes in the level and volatility of
equity prices primarily in Nasdaq and over-the-counter markets. Changes in
market conditions could limit HWG's ability to resell securities purchased or to
purchase securities sold short. Direct market risk exposure to changes in
foreign exchange rates is not material.
HWG seeks to cover its exposure to market and equity price risk by limiting
its net long and short positions and by selling or buying similar instruments.
In addition, trading and inventory accounts are monitored on an ongoing basis,
and HWG has established position limits. Position and exposure reports are
prepared at the end of each trading day and are reviewed by traders, trading
managers, and management personnel. These reports show the amount of capital
committed to various issuers and industry segments. Securities held in HWG's
investment portfolio are guided by an investment policy and are reviewed on a
regular basis.
Credit risk represents the amount of accounting loss HWG would incur should
counterparties to its proprietary transactions fail to perform their contractual
obligations, such as delivery of securities or payment of funds. This risk
depends primarily on the credit worthiness of the counterparty. HWG seeks to
control credit risk by following an established credit approval process,
monitoring credit limits and requiring collateral where appropriate.
HWG monitors its market and counterparty risk on a daily basis through a
number of control procedures designed to identify and evaluate the various risks
to which it is exposed. HWG has established various committees to assess and to
manage risk associated with its investment banking and other activities. The
committees review, among other things, business and transactional risks
associated with potential clients and engagements. HWG seeks to control the
risks associated with its investment banking activities by review and approval
of transactions by the relevant committee, prior to accepting an engagement or
pursuing a material investment transaction.
HWG's trading equity securities are marked to market on a daily basis.
At December 31, 1999, HWG's trading equity securities were recorded at a fair
market value of $85,000. These trading equity securities are subject to
equity price risk. This risk would amount to $8,500 base on a potential loss
in fair market value from a hypothetical 10% decrease in the year end market
value of such equity securities. The actual equity price risk related to the
trading equity securities may differ substantially.
At December 31, 1999, HWG's investment portfolio was recorded at a fair
market value of $2.3 million. Since this portfolio is invested primarily in
cash and short-term U.S. treasuries, it is exposed to limited equity price risk.
As a result of the closing of the Sanders merger on January 31, 2000, we
expect our market risk sensitive instrument portfolio held by our newly
combined investment banking subsidiary, SMH, to be significantly larger, but
within the same general risk categories.
PMT
PMT revenues are primarily from asset management and fiduciary fees based
on a percentage of assets under administration. As a result, PMT is subject to
equity price risk since its fees are directly affected by changes in the equity
prices of the assets under its management. Similarly, PMT's fee income is
subject to interest rate risk to the extent changes in interest rates affect the
carrying value of assets under management. While these market risks are present,
quantification remains difficult due to the number of other variables that
affect PMT's fee income.
21
At December 31, 1999, PMT had equity securities under management with a
fair market value of $429 million. PMT's fee income for 1999 would have been
reduced by approximately $23,000 assuming a hypothetical 10% decrease in the
year end market value of its equity securities under management. PMT's fee
income could also be reduced from changes in interest rates to the extent it
reduces the carrying value of securities under management.
SPIRES
Exposure to risk and the ways we manage the various types of risks on the
day-to-day basis are critical to Spires' survival and financial success. Spires
monitors its market, credit and liquidity risks on a daily basis through a
number of control procedures designed to identify and evaluate the various risks
to which we are exposed. However, Spires' risk management procedures and
internal controls may not prevent all losses from occurring as a result of such
risks.
Spires' primary market risk is that it owns a variety of investments that
are subject to changes in value and could result in material gains or losses.
Spires also engages in proprietary trading and makes dealer markets in
securities which include, among others, mortgage related securities (e.g.
mortgage-backed securities and collateralized mortgage obligations), U.S.
government and agency obligations, indexed debt instruments, interest-only and
principal-only obligations, and other debt obligations. Spires maintains
inventory in these and other securities for market making, customer order flow,
and arbitrage purposes. To invest in these opportunities and to properly
leverage its capital, Spires borrows funds. This leverage and the price
volatility in these positions arising from changes in interest rates, market
volatility, and prepayment expectations create risk. Spires also acts as
principal in customer-related transactions in financial instruments, which
exposes it to risks of default by customers and counterparties.
Spires' management is responsible for maintaining inventory, managing risk
position, establishing acceptable risk tolerances and hedging strategies,
setting inventory position limits, and overseeing the purchasing/selling
activities of the firm's trading personnel. Trading and inventory accounts are
monitored on an ongoing basis, and Spires has established written position
limits. Position and exposure reports are prepared at the end of each trading
day. The reports are reviewed independently by Spires' senior management and
corporate accounting group. Spires' management also reviews and monitors
inventory pricing, concentration, and credit ratings.
Market risk represents the potential loss Spires may incur as a result of
absolute and relative price movements in financial instruments due to changes in
interest rates, credit spreads, liquidity spreads, foreign exchange rates, and
other political factors. Spires is not subject to direct market risk due to
changes in foreign exchange rates. However, Spires is subject to market risk as
a result of changes in interest rates as they are affected by global economic
conditions. The principal source of this risk arises from maintaining
inventories in and trading and market-making in securities which include
mortgage related securities (e.g. mortgage-backed securities and collateralized
mortgage obligations), U.S. government and agency obligations, indexed debt
instruments, interest-only and principal-only obligations, and other debt
obligations. Inventory positions are carried for resale to institutional
brokerage clients and other broker-dealers. All inventories are held for trading
purposes.
Spires seeks to cover its exposure to market risk by limiting its net long
or short positions and by hedging strategies that involve selling or buying
similar instruments. These strategies seek to insulate Spires from changes in
interest rates, prepayment expectations, and market volatility. Hedges are
constructed to manage the price volatility risk of Spires' inventory by
offsetting the price volatility of the inventory position with an instrument
whose price change moves in the opposite direction to the inventory position but
with equal magnitude. Spires understands that hedging is not a perfect insurance
policy and that there is always "basis risk" between the performance of the
hedge and the inventory over time. This basis risk is discussed in greater
detail below and remains one of the business risks of doing business in
fixed-income securities. Spires does not employ derivative financial instruments
(e.g. swaps, caps, floors) in its hedging strategies.
The following table shows the quoted market values of Spires' securities
inventory owned ("long"), its inventory hedge in the form of securities sold,
not yet purchased ("short"), net positions, and overall gains and losses as of
December 31, 1999:
Security Type Long Short Net Gain (Loss)
- ----------------------------------------------- --------------- ------------------ ----------------- -------------
Mortgage-backed securities $ - $ (120,173,984) $(120,173,984) $ 77,363
Collateralized mortgage obligations (CMO) 80,215,739 - 80,215,739 (31,989)
--------------- ----------------- ----------------- -------------
Totals $ 80,215,739 $ (120,173,984) $ (39,958,245) $ 45,374
=============== ================== ================= =============
22
Spires has also prepared a sensitivity analysis to estimate its exposure
to interest rate risk from its inventory position. The net potential change
in fair value of the inventory long positions at December 31, 1999, assuming
all other factors remained constant except for a hypothetical 50 basis point
change in interest rates, would be $125,000, after offsetting corresponding
effect of the interest rate change on the inventory short positions. The
actual interest rate risk related to Spires' inventory position may differ
substantially.
The ratio of 1.495 mortgage-backed securities/CMOs is used to fully
hedge long inventory. Unless management approval is given, long inventory
must be hedged.
The information regarding Spires' market risk included above does not
consider basis risk. Basis risk is the risk that the change in market value of
Spires' inventory and the change in market value of the items used to hedge that
inventory may not always be offsetting. For example, an unfavorable basis change
could result in an inventory gain that is less than the loss in Spires' hedge,
or an inventory loss that is greater than the gain in Spires' hedge. Basis risk
is one of the business risks of doing business in fixed-income securities.
Factors that influence Spires' basis risk include credit spread risk,
liquidity spread risk, prepayment risk on mortgage securities/CMOs, and changes
in the shape of the yield curve. Credit spread risk arises from the potential
that changes in an issuer's credit rating or credit perception could affect the
value of financial instruments. Liquidity spread risk arises from the potential
that changes in the liquidity (ease of marketability) of a financial instrument
or market sector could affect the value of a financial instrument. Prepayment
risk arises from the potential that changes in the prepayment speed of a
mortgage security or CMO could affect the value of that security. Yield curve
risk arises from the potential that shifts in the yield curve could affect the
value of a financial instrument.
Spires' management believes that its securities inventory at December 31,
1999, consisting entirely of securities of high quality, exposed Spires to
little risk associated with changes in either credit or liquidity spreads.
However, unpredictable prepayment rates on mortgage-backed securities/CMOs and
changes in the shape of the yield curve were key components contributing to
Spires' basis risk.
As of December 31, 1999, Spires' inventory of securities sold under
agreements to repurchase was $37,091,000 at an average rate of 6.25% and Spires
had no borrowed or loaned securities.
A derivative financial instrument represents a contractual agreement
between counterparties and has value that is derived from changes in the value
of some other underlying asset such as the price of another security, interest
rates (such as the Prime Rate, or LIBOR), indices (i.e. S&P 500), or the value
referenced in the contract.
We do not act as dealer, trader, or end-user of complex derivative
contracts such as swaps, collars, and caps. However, Spires does act as a dealer
and trader of mortgage-derivative securities, called collateralized mortgage
obligations (CMOs or REMICs). Mortgage-derivative securities redistribute the
risks associated with their underlying mortgage collateral, by redirecting cash
flows according to specific formulas or algorithms, to various tranches or
classes, designed to meet specific investor objectives.
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants .......................................................... 25
Consolidated Balance Sheet as of December 31, 1999 and 1998 ................................ 26
Consolidated Statement of Operations for the three years in the period ended
December 31, 1999 ....................................................................... 27
Consolidated Statement of Shareholders' Equity for the three years in the period ended
December 31, 1999 ....................................................................... 28
Consolidated Statement of Cash Flows for the three years in the period ended
December 31, 1999 ....................................................................... 29
Notes to Consolidated Financial Statements ................................................. 30
24
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Pinnacle Global Group, Inc.:
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, shareholders' equity and cash flows
present fairly, in all material respects, the financial position of Pinnacle
Global Group, Inc. and Subsidiaries as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Houston, Texas
March 17, 2000
25
PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, December 31,
1999 1998
---------------- ---------------
ASSETS
Cash and cash equivalents ........................................................ $ 10,494,979 $ 13,292,644
Receivable from brokers-dealers and clearing organizations ....................... 162,423,140 -
Deposits with clearing brokers ................................................... 8,463,479 -
Securites owned .................................................................. 85,001,572 -
Securities available for sale .................................................... 4,049,507 14,637,575
Intangible assets, net of accumulated amortization of $815,865 ................... 21,413,644 -
Furniture and equipment .......................................................... 1,090,313 25,116
Deferred income taxes ............................................................ - 2,656,777
Other assets ..................................................................... 3,081,748 1,308,167
Net assets of discontinued operations ............................................ 2,447,799 3,074,960
---------------- ---------------
Total assets ............................................................ $ 298,466,181 $ 34,995,239
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued liabilities ..................................... $ 1,954,092 $ 1,295,476
Payable to clearing brokers-dealers .......................................... 117,921,940 -
Securities sold, not yet purchased ........................................... 120,275,441 -
Deferred income taxes ........................................................ 737,339 -
---------------- ---------------
Total liabilities ....................................................... 240,888,812 1,295,476
---------------- ---------------
Commitments and Contingencies
Shareholders' Equity:
Preferred stock, $.10 par value; 10,000,000 shares authorized;
no shares issued and outstanding ............................................ - -
Common stock, $.01 par value; 100,000,000 shares authorized;
7,125,292 and 3,801,559 shares issued at December 31, 1999
and 1998, respectively ...................................................... 71,253 38,016
Additional paid-in capital.................................................... 58,928,713 33,248,729
Receivables for shares issued ................................................ (1,311,675) -
Retained earnings (deficit)................................................... (88,249) 4,606,689
Accumulated other comprehensive loss ......................................... (22,673) (6,000)
Treasury stock at cost, 238,806 shares at December 31, 1998................... - (4,187,671)
---------------- ---------------
Total shareholders' equity .............................................. 57,577,369 33,699,763
---------------- ---------------
Total liabilities and shareholders' equity .............................. $ 298,466,181 $ 34,995,239
================ ===============
The accompanying notes are an integral part of the
consolidated financial statements.
26
PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
1999 1998 1997
--------------- --------------- ---------------
Revenues:
Commissions .............................................. $8,268,088 $ - $ -
Principal transactions ................................... 3,649,195 - -
Investment banking ....................................... 1,608,993 - -
Fiduciary, custodial and advisory fees ................... 2,026,938 - -
Interest and dividends ................................... 2,810,370 1,524,405 1,530,264
Other income ............................................. 609,181 - -
--------------- --------------- ---------------
Total revenues ...................................... 18,972,765 1,524,405 1,530,264
--------------- --------------- ---------------
Expenses:
Employee compensation and benefits ....................... 10,878,451 453,235 526,412
Floor brokerage, exchange and clearance fees ............. 784,849 - -
Communications and data processing ....................... 1,133,659 21,701 30,873
Interest ................................................. 1,369,061 - -
Occupancy ................................................ 1,117,939 75,312 128,397
Amortization of intangible assets ........................ 815,865 - -
Other general and administrative ......................... 2,500,100 814,365 851,694
--------------- --------------- ---------------
Total expenses ...................................... 18,599,924 1,364,613 1,537,376
--------------- --------------- ---------------
Income from continuing operations before income taxes .......... 372,841 159,792 (7,112)
Provision (benefit) for income taxes ........................... 3,270,552 53,532 (10,733)
--------------- --------------- ---------------
Income (loss) from continuing operations ....................... (2,897,711) 106,260 3,621
Loss from discontinued operations, net of tax .................. (932,627) (2,732,626) (2,597,383)
Loss on disposition of discontinued operations, net of tax ..... (864,600) (1,344,394) (187,854)
--------------- --------------- ---------------
Net income (loss) .............................................. $(4,694,938) $(3,970,760) $(2,781,616)
=============== =============== ===============
Basic and diluted income (loss) per share:
From continuing operations ............................... $ (0.43) $ 0.03 $ 0.00
From discontinued operations ............................. (0.26) (1.14) (0.78)
--------------- --------------- ---------------
Net income (loss) per share .................................... $ (0.69) $ (1.11) $ (0.78)
=============== =============== ===============
Weighted average common shares outstanding ..................... 6,828,378 3,562,753 3,561,003
=============== =============== ===============
The accompanying notes are an integral part of the
consolidated financial statements.
27
PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
COMMON STOCK TREASURY STOCK ADDITIONAL
----------------------------------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
------------ ----------------------- ---------------- -----------------
Balance, December 31, 1996 .......... 3,798,059 $ 37,981 (238,806) $ (4,187,671) $ 33,223,598
Issuance of common stock to
nonemployee directors ............... 1,750 18 - - 13,772
Comprehensive income (loss):
Net loss ....................... - - - - -
Net change in unrealized
appreciation on securities
available for sale ............. - - - - -
Total comprehensive loss ........ - - - - -
------------ ----------------------- ---------------- -----------------
Balance, December 31, 1997 .......... 3,799,809 37,999 (238,806) (4,187,671) 33,237,370
Issuance of common stock to
nonemployee directors ........... 1,750 17 - - 11,359
Comprehensive income (loss):
Net loss......................... - - - - -
Net change in unrealized
depreciation on securities
available for sale net of
deferred taxes of $3,091........ - - - - -
Total comprehensive loss ........ - - - - -
------------ ----------------------- ---------------- -----------------
Balance, December 31, 1998 .......... 3,801,559 38,016 (238,806) (4,187,671) 33,248,729
Issuance of common stock for
acquisitions..................... 3,562,539 35,625 - - 29,865,267
Retirement of treasury stock......... (238,806) (2,388) 238,806 4,187,671 (4,185,283)
Comprehensive income (loss):
Net loss ....................... - - - - -
Net change in unrealized
depreciation on securities
available for sale net of
deferred taxes of $8,589....... - - - - -
Total comprehensive loss ........ - - - - -
----------- ----------------------- ---------------- ------------------
Balance, December 31, 1999 7,125,292 $ 71,253 - $ - $ 58,928,713
============ ======================= ================ =================
ACCUMULATED
RECEIVABLES OTHER
FOR SHARES RETAINED COMPREHENSIVE
ISSUED EARNINGS(DEFICIT) INCOME(LOSS) TOTAL
-------------- ---------------- ---------------- --------------
Balance, December 31, 1996 .......... $ - $ 11,359,065 $ - $ 40,432,973
Issuance of common stock to - - - 13,790
nonemployee directors ..........
Comprehensive income (loss):
Net loss ....................... - (2,781,616) - (2,781,616)
Net change in unrealized
appreciation on securities - - - -
available for sale ............. --------------
Total comprehensive loss ........ - - - (2,781,616)
-------------- ---------------- ---------------- --------------
Balance, December 31, 1997 .......... - 8,577,449 - 37,665,147
Issuance of common stock to
nonemployee directors ...........
Comprehensive income (loss): - - - 11,376
Net loss.........................
Net change in unrealized - (3,970,760) - (3,970,760)
depreciation on securities
available for sale net of - - (6,000) (6,000)
deferred taxes of $3,091........ --------------
Total comprehensive loss ........ - - - (3,976,760)
-------------- ---------------- ---------------- --------------
Balance, December 31, 1998 .......... - 4,606,689 (6,000) 33,699,763
Issuance of common stock for
acquisitions..................... (1,311,675) - - 28,589,217
Retirement of treasury stock......... - - - -
Comprehensive income (loss):
Net loss ....................... - (4,694,938) - (4,694,938)
Net change in unrealized
depreciation on securities
available for sale net of - - (16,673) (16,673)
deferred taxes of $8,589....... --------------
Total comprehensive loss ........ - - - (4,711,611)
------------- ---------------- ---------------- --------------
Balance, December 31, 1999 $ (1,311,675) $ (88,249) $ (22,673) $ 57,577,369
============== ================ ================ ==============
The accompanying notes are an integral part of the
consolidated financial statements.
28
PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
1999 1998 1997
----------------- --------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .............................................. $ (4,694,938) $ (3,970,760) $ (2,781,616)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Gain on sale of securities available for sale................ (311,530) - -
Provision for loss on discontinued operations ............... 2,660,000 5,234,085 2,375,064
Depreciation................................................. 270,374 910,631 674,538
Gain on disposal of assets................................... - (7,701) (63,664)
Net amortization of premiums and discounts on
securities available for sale.............................. - (201,526) (246,537)
Deferred income taxes........................................ 2,370,170 (1,964,783) 1,205,456
Amortization of intangible assets............................ 815,865 - -
Changes in assets and liabilities, including discontinued
operations:
Increase in receivable from clearing brokers
and dealers.......................................... (160,818,209) - -
Increase in securities owned........................... (66,887,198) - -
Increase in deposits held by clearing brokers
and dealers.......................................... (7,335,776) - -
Increase in securities sold, not yet purchased......... 118,735,363 - -
(Increase) decrease in income tax receivable........... - 1,512,115 (1,512,115)
Increase in other assets............................... (1,092,814) (263,344) (313,242)
Increase in payable to clearing brokers and dealers.... 114,420,730 - -
Increase (decrease) in accounts payable and
accrued liabilities.................................. (316,463) - (1,227,408)
Operating losses and payments charged (1,471,148) 194,025 (2,193,860)
to reserve for discontinued operations............... ----------------- --------------- ---------------
Net cash provided by (used in) operating activities.... (3,655,574) 1,442,742 (4,083,384)
----------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................................ (897,281) (879,876) (682,192)
Acquisition costs............................................... (648,244) (995,625) -
Proceeds from sale of assets.................................... 5,406 15,733 2,492,284
Purchase of securities available for sale....................... (10,219,125) (28,856,556) (35,693,443)
Proceeds from maturities of securities available for sale....... 8,258,300 29,756,126 39,355,125
----------------- --------------- ---------------
Net cash provided by (used in) investing activities.... (3,500,944) (960,198) 5,471,774
----------------- --------------- -------------
CASH OF BUSINESSES ACQUIRED.......................................... 4,358,853 - -
----------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents... (2,797,665) 482,544 1,388,390
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR....................... 13,292,644 12,810,100 11,421,710
----------------- --------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF YEAR............................. $ 10,494,979 $13,292,644 $ 12,810,100
================= =============== ===============
The accompanying notes are an integral part of the
consolidated financial statements.
29
PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Through a series of transactions on January 29, 1999, the shareholders of
TEI, Inc. ("TEI") exchanged all common shares of TEI for 3,562,753 common shares
of Pinnacle Global Group, Inc. (the "Company"), then a newly formed public
holding company. The Company simultaneously acquired three financial services
firms: Harris Webb & Garrison, Inc. ("HWG"), Pinnacle Management & Trust Company
("PMT"), and Spires Financial, L.P. ("Spires"), by exchanging 3,562,500 of its
common shares (slightly less than 50% of outstanding common shares) for all of
the ownership interests of the three financial services firms. TEI is now a
wholly owned subsidiary of the Company. As a result of the acquisitions, the
Company now provides a broad range of financial services including institutional
and retail brokerage, investment banking, merchant banking, secondary market
loan and loan servicing placement, trust related services and asset management.
PRINCIPLES OF CONSOLIDATION
The 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.
MANAGEMENT'S ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
consolidated assets and liabilities and disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting periods. Actual
results could differ from those estimates.
CASH EQUIVALENTS
Highly liquid investment instruments with original maturities of three
months or less when purchased are considered to be cash equivalents.
SECURITIES TRANSACTIONS
Securities owned, securities sold not yet purchased, and deposits held by
clearing brokers and dealers are valued at market value. Securities not readily
marketable are valued at fair value as determined by management. Realized and
unrealized gains and losses are included in income from operations.
Principal securities transactions are recorded on the trade date, as if
they had settled. Profit and loss arising from securities transactions entered
into for the account and risk of the Company are recorded on a trade date basis.
Customers' securities transactions are reported on a settlement date basis with
related commission income and expenses reported on a trade date basis.
SECURITIES AVAILABLE FOR SALE
Securities available for sale include marketable equity securities and debt
instruments owned by the Company`s PMT subsidiary with maturities greater than
three months when purchased. These securities are recorded at cost and are
adjusted for unrealized holding gains and losses due to market fluctuations.
These unrealized gains or losses, net of taxes, are recorded as a separate
component of other comprehensive income (loss). Gains and losses are recorded
upon sale based on the specific identification method.
30
FURNITURE AND EQUIPMENT
Furniture and equipment are carried at cost. Depreciation is computed using
the straight-line method over five to ten years. Depreciation expense included
in continuing operations was $270,374, $11,417, and $33,533 for the years ended
December 31, 1999, 1998, and 1997, respectively. When assets are retired or
otherwise disposed of, the cost and related accumulated depreciation are removed
from the accounts and any resulting gain or loss is reflected in income for the
period. The cost of maintenance and repairs is charged to expense as incurred;
significant renewals and betterments are capitalized.
INTANGIBLE ASSETS
Intangible assets, principally goodwill, are amortized using the
straight-line method over 25 years. Amortization expense was $815,865 for the
year ended December 31, 1999. The Company evaluates intangible assets for
impairment if events or changes in circumstances occur which indicate the
carrying amount may not be recoverable. If impairment is determined to exist,
the asset is written down to reflect the estimated future discounted cash flows
expected to be generated by the underlying business.
RESALE AND REPURCHASE AGREEMENTS
Transactions involving purchases of securities under agreement to resell
(reverse repurchase agreements or reverse repos) or sales of securities under
agreement to repurchase (repurchase agreements or repos) are accounted for as
collateralized financings. It is the policy of the Company to obtain the
possession of collateral with a market value equal to or in excess of the
principal amount loaned under resale agreements. Collateral is valued daily, and
the Company may require counterparties to deposit additional collateral or
return collateral pledged when appropriate.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation under the intrinsic value
method. Under this method, the Company recognizes no compensation expense for
stock options granted when the number of underlying shares is known and exercise
price of the options granted is greater than or equal to the fair value of the
stock on the date of grant.
INCOME TAXES
The Company utilizes the liability method for deferred income taxes. The
liability approach requires recognition of deferred tax assets and liabilities
for the expected future tax consequences of events recognized in the Company's
financial statements or tax returns. All expected future events other than
changes in the law or tax rates, are considered in estimating future tax
consequences. A valuation allowance is provided for deferred tax assets when, in
management's judgment, such assets do not meet the more likely than not
recognition criteria.
The provision for income taxes includes federal, state, and local income
taxes currently payable and those deferred because of temporary differences
between the financial statements and tax bases of assets and liabilities.
COMMISSIONS
Commissions and related clearing expenses are recorded on the trade date as
securities transactions occur.
INVESTMENT BANKING
Investment banking revenues include gains, losses, and fees, net of
syndicate expenses, arising from securities offerings in which the Company acts
as an underwriter or agent. Investment banking revenues also include fees earned
from providing merger-and-acquisition and financial restructuring advisory
services. Investment banking management
31
fees are recorded on offering date, sales concessions on settlement date, and
underwriting fees at the time the underwriting is completed and the income is
reasonably determinable. Other investment banking fees are recognized when the
services have been performed.
FIDUCIARY, CUSTODIAL AND ADVISORY FEES
Fiduciary, custodial and advisory fees are recorded based on a percentage
of each individual account's market value on the last day of the month.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1998 and 1997 consolidated
financial statements to conform them with the 1999 presentation. The
reclassifications had no effect on retained earnings, net loss or cash flows.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," ("SFAS No. 133"). SFAS No. 133 as amended establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133 is effective beginning January 1, 2001. The Company has not
determined the impact of adoption of this statement.
2. ACQUISITIONS
On January 29, 1999, the Company acquired HWG, PMT, and Spires. The former
owners of HWG, PMT, and Spires received consideration consisting of 3,562,500
shares of the Company's common stock, which represented 49.98% of the
outstanding common stock. The acquisitions were accounted for as purchases and,
accordingly, the financial information of HWG, PMT, and Spires is included in
the Company's consolidated financial statements from the date of acquisition.
The purchase price of approximately $31 million exceeded the fair value of
identifiable net assets acquired by approximately $22 million which has been
recorded as goodwill and is being amortized on a straight-line basis over 25
years. The following summarized unaudited pro forma financial information
assumes the acquisitions of HWG, PMT and Spires had occurred on January 1, 1998:
1999 1998
---------------- ----------------
Revenues................................................. $ 20,289,000 $ 19,552,000
Income (loss) from continuing operations................. (2,780,000) 1,758,000
Basic and diluted earnings (loss) per share
from continuing operations............................ (0.39) 0.25
32
On January 31, 2000, the Company acquired Sanders Morris Mundy Inc.
("SMM"), a privately owned investment banking firm. The former owners of SMM
received consideration consisting of 7,125,220 shares of the Company's common
stock, which represents approximately 50% of the outstanding common stock. The
acquisition was accounted for as a purchase and, accordingly, the financial
information of SMM will be included in the Company's consolidated financial
statements from February 1, 2000. The purchase price of approximately $37
million exceeded the fair value of identifiable net assets acquired by
approximately $21 million which will be recorded as goodwill and amortized on a
straight-line basis over 25 years. The purchase price has been allocated to the
individual assets acquired and liabilities assumed based upon preliminary
estimated fair value. The actual allocation may be different from the
preliminary allocation due to refinements in the estimates of the fair values of
the net assets acquired; however, such differences are not expected to be
material. The following summarized unaudited pro forma financial information
assumes the acquisition of SMM had occurred on January 1, 1999:
1999
-----------------
Revenues ......................................... $ 53,500,000
Loss from continuing operations .................. (240,000)
Basic and diluted earnings per share
from continuing operations.................... (0.02)
These unaudited pro forma amounts are derived from the historical financial
information of the acquired businesses and reflect adjustments for amortization
of intangible assets and for income taxes. The unaudited pro forma financial
information does not necessarily represent results that would have occurred if
the acquisitions had taken place on the basis assumed above, nor are they
indicative of the results of future combined operations.
3. SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
Securities owned and securities sold, not yet purchased at December 31,
1999 were as follows:
Sold, Not Yet
Owned Purchased
Marketable: ----------------- -----------------
Obligations of U.S. government................ $ 80,963,444 $ 120,173,985
Corporate stocks.............................. 93,630 101,456
Corporate bonds and commercial paper.......... 2,484,161 -
----------------- -----------------
83,541,235 120,275,441
Not readily marketable:
Corporate stocks and warrants................. 1,460,337 -
----------------- -----------------
$ 85,001,572 $ 120,275,441
================= =================
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.
33
4. SECURITIES AVAILABLE FOR SALE
Securities available for sale at December 31, 1999 and 1998 were as
follows:
GROSS UNREALIZED
AMORTIZED ------------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------------- ------------ ----------- ---------------
1999:
U.S. Government and agency obligations...... $ 972,895 $ - $ (14,527) $ 958,368
Corporate bonds ............................ 99,540 - (9,304) 90,236
Marketable equity securities ............... 3,013,059 - (12,156) 3,000,903
--------------- ------------ ----------- ---------------
$ 4,085,494 $ - $ (35,987) $ 4,049,507
=============== ============ =========== ===============
1998:
U.S. Government and agency obligations...... $ 607,190 $ - $ (188) $ 607,002
Corporate bonds ............................ 9,216,698 22,757 (31,691) 9,207,764
Commercial paper ........................... 4,722,809 - - 4,722,809
Certificates of deposit..................... 99,969 31 - 100,000
--------------- ------------ ----------- ---------------
$14,646,666 $ 22,788 $ (31,879) $ 14,637,575
=============== ============ =========== ===============
The contractual maturities of securities available for sale at December 31,
1999 were as follows:
Due after 1 year through 5 years .................. $ 777,094
Due after 5 years through 10 years ................ 271,510
Marketable equity securities ...................... 3,000,903
------------------
$ 4,049,507
==================
In connection with the acquisition of the financial service firms, the
Company transferred approximately $10,805,000 of securities available for sale
to Spires.
5. RECEIVABLE FROM AND PAYABLE TO BROKERS AND DEALERS AND CLEARING
ORGANIZATIONS
Amounts receivable from and payable to brokers and dealers and clearing
organizations at December 31, 1999 were as follows:
RECEIVABLE PAYABLE
------------------- -----------------
Receivable/payable to clearing brokers-dealers................. $ - $ 117,921,940
Receivable from clearing organizations ........................ 161,991,671 -
Fees and commissions receivable ............................... 431,469 -
------------------- -----------------
$ 162,423,140 $ 117,921,940
=================== =================
6. DEPOSITS HELD BY CLEARING BROKERS AND DEALERS
Under its clearing agreements, HWG and Spires are required to maintain a
certain level of cash or securities on deposit with clearing brokers and
dealers. Should the clearing brokers and dealers suffer a loss due to the
failure of a customer of the Company to complete a transaction, the Company is
required to indemnify the clearing brokers and dealers. The Company has funds
invested in U.S. Treasury bills with a market value of $8,118,563 and in money
market
34
accounts with a market value of $344,916 as of December 31, 1999, which are on
deposit with clearing brokers and dealers to meet this requirement.
7. FURNITURE AND EQUIPMENT
Furniture and equipment at December 31, 1999 and 1998 was as follows:
DECEMBER 31,
--------------------------------
1999 1998
--------------- ---------------
Equipment............................................... $ 747,117 $ -
Furniture and fixtures.................................. 248,265 52,455
Leasehold improvements.................................. 392,644 -
Accumulated depreciation and amortization............... (297,713) (27,339)
--------------- ---------------
Furniture and equipment............................. $ 1,090,313 $ 25,116
=============== ===============
8. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities at December 31, 1999 and 1998 were
as follows:
DECEMBER 31,
--------------------------------
1999 1998
-------------- ---------------
ACCRUED LIABILITIES:
Accounts payable................... $ 407,367 $ 595,412
Compensation....................... 798,427 32,836
Other.............................. 748,298 667,228
-------------- ---------------
Total accounts payable and
accrued liabilities......... $1,954,092 $ 1,295,476
============== ===============
9. INCOME TAXES
The components of the income tax provision (benefit) for the years ended
December 31, 1999, 1998, and 1997 were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1999 1998 1997
-------------- ---------------- --------------
Continuing operations:
Current.................... $ 37,609 $ - $ (3,136)
Deferred................... 3,232,943 53,532 (7,597)
-------------- ---------------- --------------
Total continuing
operations........... 3,270,552 53,532 (10,733)
Discontinued operations........ (862,773) (2,018,315) (142,202)
-------------- ---------------- --------------
Total.................. $2,407,779 $ (1,964,783) $ (152,935)
============== ================ ==============
35
The difference between the effective tax rate reflected in the income tax
provision for continuing operations and the statutory federal rate is analyzed
as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------
1999 1998 1997
--------------- -------------- ---------------
Tax computed using the statutory rate..... $ 126,766 $ 54,329 $ (2,418)
Nondeductible amortization of goodwill.. 277,395 - -
State income taxes...................... 37,609 - -
Change in valuation allowance........... 2,806,708 - -
Other................................... 22,074 (797) (8,315)
--------------- -------------- ---------------
Total................................. $ 3,270,552 $ 53,532 $ (10,733)
=============== ============== ===============
The effective tax rates for continuing operations for the years ended
December 31, 1999, 1998, and 1997 were 877.2%, 33.5%, and 50.9%, respectively.
The effective tax rate for discontinued operations was approximately 17.1%,
33.1%, and 5.9%, for the years ended December 31, 1999, 1998, and 1997,
respectively.
As a result of the changes in ownership due to the acquisitions of the
three financial services firms in January 1999 and the planned disposition of
discontinued operations, the Company's ability to utilize its net operating loss
carryforward and realize its deferred tax assets was limited. These limitations
were not expected to prevent the Company from realizing its deferred tax assets.
However, as a result of further changes in ownership due to the SMM merger in
January 2000 and the treasury shares purchased in March 2000, the Company now
believes that the deferred tax assets do not meet the more likely than not
criteria for recognition. Accordingly, a valuation allowance has been recorded
as of December 31, 1999.
The components of the deferred income tax assets and liabilities were as
follows:
1999 1998
-------------- ---------------
Deferred income tax assets:
Net operating loss carry forward ......................................... $ 1,030,949 $ 755,059
Difference in recognition of asset impairment ............................ 1,609,383 1,150,383
Difference in recognition of accrued liabilities ......................... 573,393 828,769
Difference in recognition of inventory reserve ........................... 36,663 36,663
Difference in recognition of allowance for doubtful accounts ............. 169,353 131,367
Other .................................................................... 27,757 199,867
-------------- ---------------
Total deferred tax assets ............................................. 3,447,498 3,102,108
-------------- ---------------
Deferred income tax liabilities:
Difference in recognition of accumulated depreciation..................... (771,915) (445,331)
Difference in recognition due to change in tax method..................... (42,829) -
Difference in recognition of unrealized gains on securities............... (563,385) -
-------------- ---------------
Total deferred tax liabilities......................................... (1,378,129) (445,331)
-------------- ---------------
Net deferred tax assets..................................................... 2,069,369 2,656,777
Valuation allowance.......................................................... (2,806,708) -
-------------- ---------------
Net deferred income tax asset(liability)............................ $ (737,339) $ 2,656,777
============== ===============
36
10. DISCONTINUED OPERATIONS
ENERGY RECOVERY RESOURCES, INC.
The Board of Directors adopted a plan to discontinue the operations of
Energy Recovery Resources Inc. ("ERRI") effective December 31, 1998.
Accordingly, the operating results of ERRI have been segregated from continuing
operations and reported as a discontinued operation in the statement of
operations. A provision for estimated loss on disposition of ERRI of $2,164,000
net of tax, consisting of a write down of goodwill and property and equipment,
was recorded during the fourth quarter of 1998. In the third quarter of 1999,
the Company revised its estimate of loss on disposition of ERRI and recorded a
provision of $230,000 net of tax, as a result of higher than anticipated
operating losses. During the fourth quarter of 1999, based in part on a purchase
offer anticipated from a third party, an additional provision of $1,000,000 was
recorded. The Company currently estimates that ERRI can be sold without the
Company incurring additional losses. However, the Company may not be able to
dispose of ERRI and recover its investment. Additionally, ERRI may incur
additional operating losses. It is reasonably possible that the Company would
need to record additional loss provisions on the disposition of ERRI in future
periods.
ENGINEERED SYSTEMS, INC.
Engineered Systems, Inc.'s ("ESI") operations were discontinued as of
December 31, 1995. The assets of ESI were disposed of on December 23, 1997, for
a $500,000 interest bearing note due in 2002. The purchaser also agreed to
complete customer contracts that were in process at the time of the sale.
However, the Company remains liable for costs incurred by the purchaser in
excess of amounts recoverable from customers. Through the third quarter of 1998,
the Company believed, based in part on information provided by the purchaser,
that it had no additional liability with respect to the contracts in process.
Subsequent to December 31, 1998, the Company was notified that a major customer
cancelled its contract and that the other contracts in process had incurred
costs in excess of amounts recoverable from customers. As a result, during the
fourth quarter of 1998 the Company recorded an additional loss related to ESI of
$1,344,000, net of tax. In the second quarter of 1999 the Company paid the
purchaser $1,000,000 to satisfy a portion of those liabilities. In the third
quarter of 1999 the Company was notified that additional costs would be incurred
to complete certain customer contracts and, therefore, the Company recorded an
additional loss of $73,000, net of tax. In March 2000 the Company was informed
by certain customers that payment would not be made based on delivery delays and
failure to perform under the terms of the contract. Therefore, the Company
recorded an additional loss of $1,200,000. Net liabilities recorded by ESI were
$1,720,000 at December 31, 1999. In March 2000 the Company paid the purchaser an
additional $420,000 to satisfy a portion of those liabilities. It is reasonably
possible that the Company could incur additional losses on the disposition of
ESI.
37
A summary of selected financial information of discontinued operations for
each of the three years in the period ended December 31, 1999 were as follows:
1999 1998 1997
-------------- --------------- ---------------
Revenues:
ERRI................................ $ 3,637,000 $ 2,953,000 $ 2,726,000
ESI................................. - - 1,954,000
Cost of sales:
ERRI................................ 3,208,000 2,497,000 2,190,000
ESI................................. - - 3,646,000
Gross margin (loss):
ERRI................................ 429,000 456,000 536,000
ESI................................. - - 1,692,000
Selling, general & administrative:
ERRI................................ 856,000 1,173,000 1,088,000
ESI................................. - - 502,000
Net income (loss), net of tax:
ERRI................................ (933,000) (2,733,000) (403,000)
ESI................................. - - (2,194,000)
Loss on disposition, net of tax:
ESI................................. (865,000) (1,344,000) (188,000)
11. STOCK OPTIONS
Under its 1998 Incentive Plan, the Board of Directors has reserved 15% of
the issued and outstanding Common Stock of the Company, or 1,100,000 shares of
Common Stock, whichever is greater for the purpose of issuing incentive awards
under the plan. The outstanding employee options generally vest over a period of
three years and have an exercise price equal to the closing price of the
Company's stock on the date of grant. The outstanding non-employee director
options vest immediately and have an exercise price equal to the closing price
of the Company's stock on the date of grant.
Under its 1991 Nonemployee Director Stock Option Plan, 200,000 authorized
shares were reserved for issuance, for the purpose of granting nonincentive
stock options to purchase Common Stock and restricted stock awards, subject to
certain restrictions for nonemployee directors. Under the original plan, each
eligible nonemployee director received (i) an option to purchase 1,500 shares of
common stock on January 1 of each year, beginning January 1, 1993, and (ii) 250
shares of restricted stock (collectively, an "Award"). Each director option was
for a term of five years. The purchase price for each share of restricted stock
was zero. Effective with the January 1, 1995 issue date, the 1991 Nonemployee
Director Stock Option Plan was amended to eliminate the annual issuance of the
director options for 1,500 shares of Common Stock to nonemployee directors. All
outstanding options authorized under the 1991 Nonemployee Director Stock Option
Plan were replaced with similar options under the 1998 Incentive Plan as part of
the January 1999 acquisition and restructure of the Company. All of these
replacement options have expired without exercise and no additional options,
restricted stock or other awards are to be granted under this plan.
Under its 1989 Stock Option Plan, the Board of Directors reserved 1,000,000
authorized shares of its Common Stock for the purpose of issuing nonincentive
stock options, incentive stock options, and restricted stock awards to key
employees. The exercise price for a nonincentive stock option could not be less
than 85% of the fair market value of the Common Stock on the date of grant. The
exercise price for each incentive stock option granted could not be less than
the fair market value of the Company stock on the date of grant. The purchase
price for restricted stock could be equal to or less than par value and may be
zero. The options under the plan vested on a graded schedule depending on the
Company's stock price. Fifteen percent of all options vested immediately as of
the date of grant and an additional 15% vested on the third anniversary of the
date of grant. An additional 70% vested within 3 years if the Company's stock
38
price equals or exceeds certain criteria. Otherwise, these options vested on the
tenth anniversary of the date of grant. All outstanding options authorized under
the 1989 Stock Option Plan were replaced with similar options under the 1998
Incentive Plan as part of the January 1999 acquisition and restructure of the
Company. No additional options, restricted stock or other awards are to be
granted under this plan.
The Company had 517,950, 246,474, and 235,974 shares of Common Stock
available for grant under existing stock option plans at December 31, 1999,
1998, and 1997, respectively.
The following table sets forth pertinent information regarding stock option
transactions for each of the three years in the period ended December 31, 1999:
WEIGHTED WEIGHTED
NUMBER AVERAGE AVERAGE
OF SHARES EXERCISE PRICE FAIR VALUE
------------ ----------------- ------------
Outstanding at January 1, 1997.... 242,775 $ 12.76 -
Granted............................. - - -
Cancelled/Forfeited................. (61,650) $ 17.20 -
------------
Outstanding at December 31, 1997.. 181,125 $ 11.32 -
Granted............................. - - -
Cancelled/Forfeited................. (10,500) $ 16.24 -
------------
Outstanding at December 31, 1998.. 170,625 $ 11.04 -
Granted............................. 532,050 $ 4.63 $ 2.85
Cancelled/Forfeited................. (120,625) $ 11.46 -
------------
Outstanding at December 31, 1999.. 582,050 $ 5.09 -
============
The following tables summarize information related to stock options
outstanding and exercisable at December 31, 1999:
OPTIONS OUTSTANDING OPTION EXERCISABLE
------------------------------------------------ ----------------------------------
NUMBER WGTD. AVG. NUMBER
OUTSTANDING REMAINING WGTD. AVG. EXERCISABLE AT WGTD. AVG.
AT 12/31/99 CONTR. LIFE EXERCISE PRICE 12/31/99 EXERCISE PRICE
--------------- -------------- ---------------- -------------- -----------------
$ 4.63................. 532,050 9.83 $ 4.63 133,013 $ 4.63
$ 10.00 ............... 50,000 5.0 10.00 50,000 10.00
------------- ------- ---------- ----------- ----------
582,050 9.42 $ 5.09 183,013 $ 6.10
============= ======= ========== =========== ==========
The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions: dividend yield of 0.00%; risk-free interest rate
of 6.3%; the expected life of options is 6.0 years; and volatility of 59.2% for
the grants. Had the compensation cost for the Company's stock-based compensation
plan been determined based on fair value of the options, results of operations
would approximate the pro forma amounts below:
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1999 1998 1997
----------------- --------------- -----------------
Income (loss) from continuing operations -- as reported ....... $ (2,897,711) $ 106,260 $ 3,621
Income (loss) from continuing operations -- pro forma ......... $ (3,220,906) $ 92,126 $ 12,575
Continuing operations income (loss) per share -- as reported .. $ (0.43) $ 0.03 $ -
Continuing operations income (loss) per share -- pro forma .... $ (0.47) $ 0.03 $ -
39
12. PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of Preferred Stock,
par value $.10 per share. Shares of Preferred Stock may be issued from time to
time by the Board of Directors, without action by the shareholders, in one or
more series with such designations, preferences and special rights and
qualifications, limitations, and restrictions as may be designated by the Board
of Directors prior to the issuance of such series.
13. TREASURY STOCK
In March 2000 the Company reacquired 139,211 shares of its common stock at
a weighted average price of $3.97 per share, totaling $552,930.
14. EARNINGS (LOSS) PER COMMON SHARE
Basic and diluted per-share computations for the periods indicated were as
follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------
1999 1998 1997
---------------- --------------- ---------------
Computation of basic and diluted earnings (loss) per common
share for the year ended December 31, 1999:
Net income (loss) applicable to common stock............................... $ (4,694,938) $ (3,970,760) $(2,781,616)
================ =============== ===============
Weighted average number of common shares outstanding....................... 6,828,378 3,562,753 3,561,003
Common shares issuable under stock option plan............................. - - -
Less shares assumed repurchased with proceeds.............................. - - -
---------------- --------------- ---------------
Weighted average common shares outstanding............................. 6,828,378 3,562,753 3,561,003
================ =============== ===============
Basic and diluted earnings (loss) per common share..................... $ (0.69) $ (1.11) $ (0.78)
================ =============== ===============
Stock options outstanding of 582,050, 170,625, and 181,125 at December 31,
1999, 1998 and 1997, respectively, have not been included in diluted earnings
per common share because to do so would have been antidilutive for the periods
presented.
15. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company enters into underwriting
commitments. Transactions relating to underwriting commitments that were open at
December 31, 1999, were subsequently settled, and had no material effect on the
consolidated financial statements as of that date.
Total rental expense for operating leases for the years ended December 31,
1999, 1998, and 1997 was approximately $1,303,000, $70,000, and $34,000,
respectively. The Company and its subsidiaries have obligations under operating
leases that expire by 2004 with initial noncancelable terms in excess of one
year. Aggregate annual rentals for office space and computer and office
equipment are as follows:
2000 .................................$ 1,387,000
2001 ................................. 1,304,000
2002 ................................. 796,000
2003 ................................. 717,000
2004 ................................. 138,000
-----------
$ 4,342,000
===========
40
The Company is involved in litigation and routine claims from time to time.
Certain of the Company's litigation and claims are covered by insurance with a
maximum deductible of $50,000. In 1999, the Company received an arbitration
proceeding from a brokerage customer alleging wrongdoing in execution of a
trade. The plaintiffs are seeking damages of $532,000. A hearing date has not
been scheduled. The Company is contesting the case vigorously, but because of
the inherent unpredictability of litigation, particularly arbitration,
management is unable to determine the likelihood of an unfavorable outcome.
In November 1999, SMM received a letter from the chairman of the audit
committee of Waste Management, Inc. asking for information concerning
investments by SMM, its clients, and the Environmental Opportunities Funds in a
number of private and public companies that either purchased assets from Waste
Management or were acquired by Waste Management while John E. Drury was both
employed by Waste Management and associated with SMM. Mr. Drury is a current
shareholder and former executive officer and director of Waste Management, is a
former shareholder and director of SMM and as a result of the SMM merger is a
2.2% shareholder of the Company. SMM has provided information in response to the
Waste Management request.
Waste Management has not made any formal claim against SMM. However, Waste
Management's investigation is continuing. Based on the Company's own
investigation and discussions with management of SMM, management believes there
is no factual basis or legal basis for any Waste Management claim against SMM.
While management believes that neither the existence nor the ultimate resolution
of the Waste Management investigation will have a material adverse effect on the
financial condition of SMM, they cannot predict the outcome of the investigation
and if a claim is made cannot determine the significance of the related costs
and management attention required to defend it.
As discussed in Note 10 to the consolidated financial statements, the
Company has contingent liabilities and potential loss exposures related to
discontinued operations.
16. CONCENTRATIONS OF CREDIT RISK
Financial investments that potentially subject the Company to
concentrations of credit risk consist of primarily cash and cash equivalents,
securities available for sale, securities owned, and all receivables, including
those from discontinued operations. Risks and uncertainties associated with
financial investments include credit exposure, interest rate volatility,
regulatory changes, and changes in market values of equity securities. Future
changes in market trends and conditions may occur which could cause actual
results to differ materially from the estimates used in preparing the
accompanying financial statements.
The Company and its subsidiaries are engaged in various trading and
brokerage activities with counterparties that primarily include broker-dealers,
banks, and other financial institutions. If counterparties do not fulfill their
obligations, the Company may be exposed to risk. The risk of default depends on
the creditworthiness of the counterparty or issuer of the instrument. It is the
Company's policy to review, as necessary, the credit standing of each
counterparty.
17. NET CAPITAL REQUIREMENTS OF SUBSIDIARIES
Certain of the Company's subsidiaries are subject to the Securities and
Exchange Commission Uniform Net Capital Rule (SEC rule 15c3-1), which requires
the maintenance of minimum net capital and requires that the ratio of aggregate
indebtedness to net capital, both as defined, shall not exceed 15 to 1 (and the
rule of the "applicable" exchange also provides that equity capital may not be
withdrawn or cash dividends paid if the resulting net capital ratio would exceed
10 to 1). At December 31, 1999, HWG and Spires had net capital of $15,369,462,
which was $7,360,140 in excess of their required net capital of $8,009,322. PMT
is required by the Texas Department of Banking to maintain minimum capital,
which was $1,500,000 as of December 31, 1999.
41
18. BUSINESS SEGMENT INFORMATION
The Company's continuing businesses operate in three reportable business
segments. HWG is an investment banking and brokerage services firm whose
activities primarily include securities underwriting, and retail and brokerage
services. Spires is a regional brokerage services firm whose activities
primarily include institutional brokerage services and trading of fixed income
and equity securities. PMT is a state chartered trust company providing a
variety of trust services including investment management, estate settlement,
and retirement planning. The following summarizes certain financial information
of each reportable segment for the year ended December 31, 1999:
HWG SPIRES PMT
----------------- ----------------- -----------------
Revenues........................ $ 5,346,332 $ 10,542,600 $ 2,370,745
Income before income taxes...... 85,473 1,838,565 884,352
Total assets.................... 3,692,132 255,631,564 5,033,268
The following table reconciles income before income taxes of the reportable
segments to the consolidated income from continuing operations before income
taxes reported in the consolidated statement of operations for the year ended
December 31, 1999:
Income before income taxes of reportable segments:
HWG........................................................ $ 85,473
Spires..................................................... 1,838,565
PMT........................................................ 884,352
----------------
2,808,390
Amortization of intangible assets.......................... (815,865)
Corporate revenues and expenses, net....................... (1,619,684)
----------------
Income from continuing operations before income taxes...... $ 372,841
================
19. SUPPLEMENTAL CASH FLOW INFORMATION
1999 1998 1997
--------------- --------------- ------------
Cash paid for interest............................... $ 1,369,061 $ - $ 6,700
Cash paid for income taxes........................... 184,500 52,000 846,000
Cash received from income tax refunds................ 1,600 1,508,000 72,000
Non-cash investing and financing activities:
Notes received in connection with disposition
of discontinued operation...................... - - 500,000
Issuance of common stock in acquisition.......... 28,589,217 - -
Retirement of treasury stock..................... 4,187,671 - -
42
20. RELATED PARTIES
PMT obtained legal services from a PMT Board member. Included in general
and administrative expense is legal fees of $2,282 paid to the PMT Board member
during 1999.
HWG paid St. James Place Corp. ("St. James"), an affiliate providing
furniture and equipment, lease payments of $5,270. In connection with the
acquisition by the Company, HWG purchased the furniture and equipment it
previously leased from St. James for $285,131.
HWG earned insurance commissions of $250,502 from HWG Insurance Agency,
Inc. The sole shareholder of HWG Insurance Agency is an employee of HWG.
The Chairman of the Board of Directors is a member of the board of
directors of an investment banking client. Fee income of $66,394 and
reimbursable expenses of $16,074 were recorded from this client during 1999 and
remain outstanding at December 31, 1999.
The Company has an investment in BioCyte Therapeutics, Inc. ("BioCyte".)
The Company has a $500,000 note receivable from Biocyte and accrued interest
related to this note of $23,000 at December 31, 1999. In addition, the Company
had outstanding receivables from Biocyte of $128,061 at December 31, 1999. The
Company's president and chief executive officer also has an investment in
BioCyte and serves on its board of directors.
The Company issued Common Stock in lieu of cash to nonemployee directors
totaling $11,376 and $13,790 during 1998 and 1997, respectively.
The Company purchased diesel and boiler fuel and utilized freight services
from a company owned by the President of ERRI totaling $365,000, $207,000 and
$159,000 in 1999, 1998, and 1997, respectively.
43
21. UNAUDITED QUARTERLY FINANCIAL INFORMATION
Three Months Ended
------------------------------------------------------------------
Sept. 30,
March 31, June 30, 1999 Dec. 31,
1999 1999 Restated(1) 1999(2)
---------------- --------------- --------------- ----------------
1999:
Total revenues....................................... $ 4,608,000 $ 5,424,000 $ 5,077,000 $ 3,864,000
Income (loss) from continuing operations............. 565,000 76,000 197,000 (3,735,000)
Income (loss) from discontinued operations,
net of tax......................................... - - (303,000) (1,495,000)
---------------- --------------- --------------- ----------------
Net income (loss)............................. $ 565,000 $ 76,000 $ (106,000) $ (5,230,000)
================ =============== =============== ================
Basic and diluted earnings (loss) per share:
From continuing operations....................... $ 0.10 $ 0.01 $ 0.03 $ (0.52)
From discontinued operations..................... - - (0.04) (0.21)
---------------- --------------- --------------- ----------------
Net earnings (loss) per share.................... $ 0.10 $ 0.01 $ (0.01) $ (0.73)
================ =============== =============== ================
Weighted average common shares outstanding........... 5,937,753 7,125,253 7,125,253 7,125,253
================ =============== =============== ================
Three Months Ended
------------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
1998: ---------------- --------------- --------------- ----------------
Total revenues....................................... $ 385,000 $ 374,000 $ 393,000 $ 372,000
Income (loss) from continuing operations............. (51,000) 27,000 83,000 47,000
Income (loss) from discontinued operations,
net of tax....................................... (40,000) 54,000 (342,000) (3,749,000)
---------------- --------------- --------------- ----------------
Net income (loss)............................. $ (91,000) $ 81,000 $ (259,000) $ (3,702,000)
================ =============== =============== ================
Basic and diluted earning (loss) per share:
From continuing operations....................... $ (0.02) $ (0.00) $ 0.02 $ 0.01
From discontinued operations..................... (0.01) 0.02 (0.09) (1.05)
---------------- --------------- --------------- ----------------
Net earnings (loss) per share.................... $ (0.03) $ 0.02 $ (0.07) $ (1.04)
================ =============== =============== ================
Weighted average common shares outstanding........... 3,562,753 3,562,753 3,562,753 3,562,753
================ =============== =============== ================
(1) The quarterly information for the three months ended September 30, 1999
has been restated to reflect the reduction of investment banking revenues by
$74,150, income taxes by $25,211 and income from continuing operations by
$48,939. There was no effect on per share amounts.
(2) The quarterly information for the three months ended December 31, 1999
includes adjustments to record additional losses from discontinued operations of
$2.2 million and a valuation allowance on deferred tax assets of $2.8 million.
44
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company had no disagreements on accounting or financial disclosure
matters with its independent accountants to report under this Item 9.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required in response to this Item 10 is incorporated herein
by reference to the Company's Proxy Statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A, not later than 120 days
after the end of the fiscal year covered by this report.
ITEM 11. EXECUTIVE COMPENSATION
The information required in response to this Item 11 is incorporated herein
by reference to the Company's Proxy Statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A, not later than 120 days
after the end of the fiscal year covered by this report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required in response to this Item 12 is incorporated herein
by reference to the Company's Proxy Statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A, not later than 120 days
after the end of the fiscal year covered by this report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required in response to this Item 13 is incorporated herein
by reference to the Company's Proxy Statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A, not later than 120 days
after the end of the fiscal year covered by this report.
45
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The following financial statements of the Company and Report of
Independent Accountants are included under Part II Item 8 of this Form
10-K.
PAGE
Report of Independent Accountants ........................................................ 24
Consolidated Balance Sheet as of December 31, 1999 and 1998 .............................. 25
Consolidated Statement of Operations for the three years in the period ended
December 31, 1999 ...................................................................... 26
Consolidated Statement of Shareholders' Equity for the three years in the period ended
December 31, 1999 ...................................................................... 27
Consolidated Statement of Cash Flows for the three years in the period ended
December 31, 1999 ...................................................................... 28
Notes to Consolidated Financial Statements ............................................... 29
2. FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule should be read in
conjunction with the consolidated financial statements and notes
thereto.
Report of Independent Accountants ....................................................... S-1
Schedule II - Valuation and qualifying accounts ........................................ S-2
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions, are inapplicable, or the
required information is included elsewhere in the financial statements.
3. EXHIBITS
The exhibits filed in response to Item 601 of Regulation S-K are listed
in the Index to Exhibits contained elsewhere herein.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the three-month period
ended December 31, 1999.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 29, 2000.
PINNACLE GLOBAL GROUP, INC.
By: /s/ ROBERT E. GARRISON II
President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated and on the 29th day of March 2000.
SIGNATURE TITLE
/s/ TITUS H. HARRIS, JR. Chairman of the Board
----------------------------------
Titus H. Harris, Jr.
/s/ ROBERT E. GARRISON II President, Chief Executive Officer, and Director
---------------------------------- (Principal Executive Officer)
Robert E. Garrison II
/s/ DONALD R. CAMPBELL Vice Chairman, Director
---------------------------------- (Principal Financial and Accounting Officer)
Donald R. Campbell
/s/ PETER W. BADGER Director
----------------------------------
Peter W. Badger
/s/ T. CRAIG BENSON Director
----------------------------------
T. Craig Benson
/s/ TONY COELHO Director
----------------------------------
Tony Coelho
/s/ JAMES H. GREER Director
----------------------------------
James H. Greer
/s/ STEPHEN M. RECKLING Director
----------------------------------
Stephen M. Reckling
/s/ JOHN H. STYLES Director
----------------------------------
John H. Styles
/s/ W. BLAIR WALTRIP Director
----------------------------------
W. Blair Waltrip
/s/ RICHARD C. WEBB Director
----------------------------------
Richard C. Webb
47
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of Pinnacle Global Group, Inc.:
Our audits of the consolidated financial statements referred to in our
report dated March 17, 2000 of Pinnacle Global Group, Inc. and Subsidiaries
included on page 24 of this Form 10-K also included an audit of the financial
statement schedule listed in Item 14(a) of this Form 10-K. In our opinion, the
financial statement schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.
PricewaterhouseCoopers LLP
Houston, Texas
March 17, 2000
S-1
PINNACLE GLOBAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
- ------------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C (1) COL. C (2) COL. D COL. E
- ------------------------------------------------------------------------------------------------------------------------------
CHARGED
BALANCE AT TO OTHER BALANCE
BEGINNING ACCOUNTS- DEDUCTIONS- AT END OF
DESCRIPTION OF PERIOD ADDITIONS DESCRIBE DESCRIBE PERIOD
- ------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
Allowance for doubtful accounts and
notes................................ $ - $ - $ - $ - $ -
============== ============= ============= ================ =============
DECEMBER 31, 1998
Allowance for doubtful accounts and
notes................................ $ 430,510 $ - $ (9,945) (A) $ (420,565) (B) $ -
============== ============= ============= ================ =============
DECEMBER 31, 1997
Allowance for doubtful accounts and
notes................................ $ 849,427 $452,065 $ - $ (870,982) (B)(C) $430,510
============== ============= ============= ================ =============
(A) Amounts were reclassified to net assets of discontinued operations.
(B) Represents the charge off of receivables.
(C) Includes $178,425 attributable to discontinued operations.
S-2
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Articles of Incorporation of the Company, as amended (Filed as
Appendix F to the Proxy Statement/Prospectus of the Company dated
December 31, 1998 (Reg. No. 333-65417) and incorporated herein by
reference).
3.2 Amended and Restated Bylaws of the Company (Filed as an exhibit to the
Company's Form 10-K for the year ending December 31, 1998. (File No.
333-65417) and incorporated herein by reference).
10.1 Amended and Restated Agreement and Plan of Reorganization dated
November 12, 1999 among the Company, Harris Webb & Garrison, Inc.
("HWG"), Sanders Morris Mundy Inc. ("SMM") and the SMM shareholders
(Filed as Appendix A to the Definitive Proxy Statement on Schedule 14A
of the Company dated December 6, 1999 and incorporated herein by
reference).
10.2 Amended and Restated Plan of Merger dated November 12, 1999, among the
Company, HWG and SMM (Filed as Appendix B to the Definitive Proxy
Statement on Schedule 14A of the Company dated December 6, 1999 and
incorporated herein by reference).
10.3 Amended and Restated Agreement and Plan of Reorganization dated
October 2, 1998 among the Company, TEI, Inc. ("TEI"), HWG, Pinnacle
Management & Trust Company ("PMT"), Spires Financial, L.P. ("Spires")
and certain direct and indirect owners of HWG, PMT and Spires (Filed
as Appendix A to the Proxy Statement/Prospectus of the Company dated
December 31, 1998 (Reg. No. 333-65417) and incorporated herein by
reference).
10.4 Plan of Merger dated October 2, 1998, among TEI, TEI Combination
Corporation and the Company (Filed as Appendix B to the Proxy
Statement/Prospectus of the Company dated December 31, 1998 (Reg. No.
333-65417) and incorporated herein by reference).
10.5 Plan of Merger dated October 2, 1998, among HWG, HWG Combination
Corporation and the Company (Filed as Appendix C to the Proxy
Statement/Prospectus of the Company dated December 31, 1998 (Reg. No.
333-65417) and incorporated herein by reference).
10.6 Plan of Merger dated October 2, 1998, among PMT, PMT Combination
Corporation and the Company (Filed as Appendix D to the Proxy
Statement/Prospectus of the Company dated December 31, 1998 (Reg. No.
333-65417) and incorporated herein by reference).
10.7 1998 Incentive Plan of the Company (Filed as an exhibit to the Proxy
Statement/Prospectus of the Company dated December 31, 1998 (Reg. No.
333-65417) and incorporated herein by reference).
10.8 Consulting Agreement, dated December 10, 1991, between TEI and T.G.
Bogle (Filed as an exhibit to TEI's Form 10-K for the year ending
December 31, 1991 (File No. 0-18899) and incorporated herein by
reference).
10.9 Asset Purchase Agreement between Tanknology Environmental, Inc. and
Mankoff Equipment, Inc. dated September 23, 1993 (Filed as an exhibit
to TEI's Form 8-K dated October 1, 1993 (File No. 0-18899) and
incorporated herein by reference).
10.10 Noncompete Agreement between Tanknology Environmental, Inc. and Curt
J. Mankoff (Filed as an exhibit to TEI's Form 8-K dated October 1,
1993 (File No. 0-18899) and incorporated herein by reference).
10.11 Asset Purchase Agreement between Tanknology Environmental, Inc. and
Jack Holder Enterprises, Inc. dated January 31, 1994 (Filed as an
exhibit to TEI's Form 10-K for the year ending December 31, 1994 (File
No. 0-18899) and incorporated herein by reference).
10.12 Agreement to sell assets, dated December 22, 1995, between Mankoff,
Inc. and Donald Kooperman (Filed as an exhibit to TEI's Form 10-K for
the year ending December 31995 (File No. 0-18899) and incorporated
herein by reference).
10.13 Installment note between Mankoff, Inc. and Continental Environmental,
Inc., dated December 20, 1995 (Filed as an exhibit to TEI's Form 10-K
for the year ending December 31, 1995 (File No. 0-18899) and
incorporated herein by reference).
10.14 License Agreement between Tanknology Worldwide and Fulton Hogan
Limited, dated April 1, 1995 (Filed as an exhibit to TEI's Form 10-K
for the year ending December 31, 1995 (File No. 0-18899) and
incorporated herein by reference).
10.15 Stock Purchase Agreement between Tanknology Environmental, Inc. and
NDE Environmental Corporation dated October 7, 1996 (Filed as an
exhibit to TEI's Form 8-K dated October 25, 1996 (File No. 0-18899)
and incorporated herein by reference).
10.16 Asset Purchase Agreement between Tanknology/Engineered Systems, Inc.,
TEI, Inc. and Sorrento Electronics, Inc. dated December 23, 1997
(filed as an exhibit to TEI's Form 10-K for the year ending
December 23, 1997 (File No. 0-18899) and incorporated herein by
reference).
10.17 Sublease Agreement dated January 19, 1994 between Texas Commerce Bank
National Association and Harris Webb & Garrison, Inc., as amended by
that certain First Amendment to Sublease Agreement dated February 23,
1994, the Second Amendment to Sublease Agreement dated April 26, 1994,
and the Third Amendment to Sublease Agreement dated January 19, 1995
(Filed as an exhibit to the Proxy Statement/Prospectus of the Company
dated December 31, 1998 (Reg. No. 333-65417) and incorporated herein
by reference).
10.18 Office Lease Agreement dated February 1, 1998 between 5599 San
Felipe, Ltd. and Harris Webb & Garrison, Inc. (Filed as an exhibit to
the Proxy Statement/Prospectus of the Company dated December 31, 1998
(Reg. No. 333-65417) and incorporated herein by reference).
10.19 Office Lease Agreement dated January 19, 1999 between 5599 San
Felipe, Ltd. and the Company (Filed as an exhibit to the Company's
Fork 10-K for the year ending December 31, 1998 (File No. 333-65417)
and incorporated herein by reference).
*10.20 Letter Agreement dated April 7, 1999 between the Pershing Division
of Donaldson, Lufkin Jenrette Securities Corporation and Harris Webb &
Garrison, Inc.
10.21 Autotrust Agreement dated January 9, 1998 between SunGard Trust
Systems Inc. and Pinnacle Management & Trust Company (Filed as an
exhibit to the Proxy Statement/Prospectus of the Company dated
December 31, 1998 (Reg. No. 333-65417) and incorporated herein by
reference).
*10.22 Letter of Agreement dated August 31, 1999 between Montgomery
Correspondent Services, a division of Banc of America Securities LLC
and Spires Financial, L.P.
*10.23 Office Lease Agreement dated August 4, 1998 between Barnhart
Interests, Inc. and Spires Financial, L.P.
*21.1 List of Subsidiaries of the Registrant.
*23.1 Consent of PricewaterhouseCoopers LLP.
*27.1 Financial Data Schedule.
- -------------------------
* Filed herewith.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the three-month period
ended December 31,1999.