FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 001-13731
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
(Exact name of Registrant as specified in its charter)
Virginia 54-1837743
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1001 Nineteenth Street North
Arlington, VA 22209
(Address of principal executive offices) (Zip code)
(703) 312-9500
(Registrant's telephone number including area code)
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 the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date:
Title Outstanding
Class A Common Stock 12,417,029 as of October 31, 1998
Class B Common Stock 36,577,579 as of October 31, 1998
1
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
INDEX
Page Number(s)
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets-
December 31, 1997 and September 30, 1998 3-4
Consolidated Statements of Operations-
Three Months Ended September 30, 1997 and 1998 5
Nine months Ended September 30, 1997 and 1998 6
Consolidated Statements of Cash Flows-
Nine months Ended September 30, 1997 and 1998 7
Notes to Consolidated Financial Statements 8-15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 16-26
ITEM 3. CHANGES IN INFORMATION ABOUT MARKET RISK 26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 26-27
ITEM 6. EXHIBITS AND REPORTS ON 8-K 27
SIGNATURES 28
EXHIBIT INDEX 28
2
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
(AUDITED) (UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
ASSETS
Cash and cash equivalents.................................................... $205,709 $ 58,714
Short-term investments, at market value...................................... 1,982 --
Receivables:
Investment banking......................................................... 7,232 4,568
Asset management fees...................................................... 4,426 5,005
Income taxes............................................................... -- 8,795
Affiliates................................................................. 479 6,398
Other...................................................................... 1,986 329
Due from clearing organization............................................... 15,650 8,273
Marketable trading securities, at market value:
Corporate equities......................................................... 60,299 16,332
Corporate bonds............................................................ 18,485 6,483
Deferred tax asset........................................................... 2,402 2,402
Long-term investments, at fair value......................................... 36,352 94,639
Furniture, equipment and leasehold improvements, net of accumulated
depreciation and amortization of $2,198, and $3,048, respectively.......... 3,471 6,832
Prepaid expenses and other assets............................................ 854 3,089
-------- --------
Total assets........................................................... $359,327 $221,859
======== ========
The accompanying notes are an integral part of these consolidated statements.
3
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
(AUDITED) (UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Trading account securities sold but not yet purchased, at market value:
Corporate equities............................................................. $ 10,726 $ 2,381
Corporate and U.S. government bonds............................................ 5,947 1,037
Accounts payable and accrued expenses............................................. 30,423 11,530
Accrued compensation and benefits................................................. 19,023 11,047
Dividends payable................................................................. 24,000 --
Short-term subordinated revolving loan............................................ 40,000 --
Long-term secured loans........................................................... 2,416 2,037
Other............................................................................. 146 394
-------- --------
Total liabilities........................................................... 132,681 28,426
-------- --------
Commitments and contingencies (Note 9) -- --
Shareholders' equity:
Preferred Stock, $.01 par value, 15,000,000 shares authorized, none
issued and outstanding......................................................... -- --
Class A Common Stock, $.01 par value, 150,000,000 shares authorized,
13,451,421 issued.............................................................. 134 134
Class B Common Stock, $.01 par value, 100,000,000 shares authorized,
36,577,579 issued and outstanding.............................................. 366 366
Additional paid-in capital........................................................ 208,843 208,843
Treasury stock, at cost, 533,092 shares as of September 30, 1998.................. -- (5,925)
Accumulated other comprehensive income (loss)..................................... -- (14,888)
Retained earnings................................................................. 17,303 4,903
-------- --------
Total shareholders' equity.................................................. 226,646 193,433
-------- --------
Total liabilities and shareholders' equity.................................. $359,327 $221,859
======== ========
The accompanying notes are an integral part of these consolidated statements.
4
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS
ENDED SEPTEMBER 30,
---------------------------
1997 1998
------------ ------------
Revenues:
Investment banking-
Underwriting................................................ $24,489 $ 4,040
Corporate finance........................................... 29,065 4,417
Institutional brokerage-
Principal sales credits..................................... 7,593 7,619
Agency commissions.......................................... 3,355 3,862
Gains and losses, net-
Trading..................................................... (1,073) (39,542)
Investment.................................................. 2,139 (7,480)
Asset management.............................................. 1,297 2,119
Interest, dividends, and other................................ 1,368 3,456
------- --------
Total revenues............................................. 68,233 (21,509)
------- --------
Expenses:
Compensation and benefits..................................... 40,595 10,870
Business development and sales support........................ 3,095 6,212
Professional services......................................... 2,546 4,026
Clearing and brokerage fees................................... 1,224 1,603
Occupancy and equipment....................................... 747 1,284
Communications................................................ 540 834
Interest expense.............................................. 571 1,553
Other operating expenses...................................... 1,367 2,838
------- --------
Total expenses............................................. 50,685 29,220
------- --------
Net income (loss) before taxes................................ 17,548 (50,729)
Income tax provision (benefit)................................ -- (15,317)
------- --------
Net income (loss)............................................. $17,548 $(35,412)
======= ========
Basic and diluted net income (loss) per share................. $ .44 $ (.71)
======= ========
Weighted average shares outstanding........................... 40,029 49,780
======= ========
Pro forma statement of operations data (Note 4):
Net income before tax......................................... $17,548
Pro forma income tax provision................................ 7,019
-------
Pro forma net income.......................................... $10,529
=======
Pro forma basic and diluted net income per share.............. $ .26
=======
The accompanying notes are an integral part of these consolidated statements.
5
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------
1997 1998
------------ ------------
Revenues:
Investment banking-
Underwriting................................................ $ 67,091 $ 68,063
Corporate finance........................................... 38,618 37,693
Institutional brokerage-
Principal sales credits..................................... 20,460 24,292
Agency commissions.......................................... 7,898 11,906
Gains and losses, net-
Trading..................................................... (8,466) (53,779)
Investment.................................................. 3,074 (4,718)
Asset management.............................................. 3,182 7,594
Interest, dividends and other................................. 3,061 12,758
-------- --------
Total revenues............................................. 134,918 103,809
-------- --------
Expenses:
Compensation and benefits..................................... 85,138 68,112
Business development and sales support........................ 8,018 15,762
Professional services......................................... 5,377 9,541
Clearing and brokerage fees................................... 3,138 4,596
Occupancy and equipment....................................... 1,934 2,947
Communications................................................ 1,536 2,537
Interest expense.............................................. 2,301 4,680
Other operating expenses...................................... 3,646 8,034
-------- --------
Total expenses............................................. 111,088 116,209
-------- --------
Net income (loss) before taxes................................ 23,830 (12,400)
Income tax provision.......................................... -- --
-------- --------
Net income (loss)............................................. $ 23,830 $(12,400)
======== ========
Basic and diluted net income (loss) per share................. $ .60 $ (.25)
======== ========
Weighted average shares outstanding........................... 40,029 49,945
======== ========
Pro forma statement of operations data (Note 4):
Net income before tax......................................... $ 23,830
Pro forma income tax provision................................ 9,532
--------
Pro forma net income.......................................... $ 14,298
========
Pro forma basic and diluted net income per share.............. $ .36
========
The accompanying notes are an integral part of these consolidated statements.
6
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------
1997 1998
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)....................................................................... $ 23,830 $ (12,400)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities--
Income (loss) and incentive income on long-term investments........................... (4,256) 2,570
Depreciation and amortization......................................................... 684 971
Changes in operating assets:
Receivables--
Due from clearing organization.................................................... (12,247) 7,377
Investment banking................................................................ 1,131 2,664
Asset management fees............................................................. (318) (1,272)
Income taxes...................................................................... -- (8,795)
Affiliates........................................................................ -- (5,919)
Other............................................................................. (60) 1,657
Marketable trading securities....................................................... 29,294 20,151
Prepaid expenses and other assets................................................... 244 (1,532)
Changes in operating liabilities:
Trading account securities sold but not yet purchased............................... (28,570) (13,255)
Net repayments on short-term subordinated loans..................................... (15,000) (40,000)
Proceeds from short-term line of credit............................................. 7,500 --
Accounts payable and accrued expenses............................................... 1,832 (19,842)
Accrued compensation and benefits................................................... 19,220 (7,976)
Other............................................................................... (19) 248
-------- ---------
Net cash provided by (used in) operating activities............................... 23,265 (75,353)
-------- ---------
CASH FLOWS FROM INVESTMENT ACTIVITIES:
Purchases of fixed assets............................................................... (1,044) (4,332)
Long-term investments................................................................... (212) (39,234)
Sales of short-term investments......................................................... (105) 1,982
-------- ---------
Net cash used in investing activities............................................. (1,361) (41,584)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term secured loans................................................... (246) (379)
Purchases of treasury stock............................................................. -- (5,679)
Proceeds from issuance of common stock, including
repayments of stock subscriptions receivable........................................... 3,624 __
Capital contributions................................................................... 176 --
Dividends............................................................................... (18,570) (24,000)
-------- ---------
Net cash used in financing activities............................................. (15,016) (30,058)
-------- ---------
Net increase (decrease) in cash and cash equivalents..................................... 6,888 (146,995)
Cash and cash equivalents, beginning of period........................................... 20,681 205,709
-------- ---------
Cash and cash equivalents, end of period................................................. $ 27,569 $ 58,714
======== =========
Non-cash transactions: The Company accrued $246,125 for the purchase of
treasury stock that settled subsequent to September 30, 1998. The Company also
accrued $702,700 for lease buy-out costs that were capitalized and are amortized
over the life of a lease.
The accompanying notes are an integral part of these consolidated statements.
7
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS:
Organization
Friedman, Billings, Ramsey Group, Inc., a Virginia corporation (the
"Company"), is the sole parent holding company for two subsidiary holding
companies, Friedman, Billings, Ramsey Capital Markets, Inc. ("FBRCM") and FBR
Capital Management, Inc. ("FBRAM"). The principal subsidiary of FBRCM is
Friedman, Billings, Ramsey & Co., Inc. ("FBRC"), a registered broker-dealer.
The principal subsidiary of FBRAM is Friedman, Billings, Ramsey Investment
Management, Inc. ("FBRIM"), a registered investment advisor. All of the
subsidiaries of FBRCM and FBRAM are hereafter collectively referred to as the
"Operating Entities".
FBRC is a member of the National Association of Securities Dealers, Inc.
FBRC acts as an introducing broker executing securities transactions primarily
for institutional customers and forwards all such transactions to clearing
brokers on a fully disclosed basis. FBRC does not hold funds or securities for,
or owe funds or securities to, customers.
FBRC receives underwriting revenues from underwriting public offerings of
debt and equity securities. These revenues are comprised of selling concessions,
management fees and underwriting fees. FBRC also receives corporate finance
fees from private placement offerings and from providing merger and acquisition,
financial restructuring, and other advisory services. FBRC concentrates its
underwriting and corporate finance activities primarily on bank, thrift and
specialty finance institutions, technology companies and real estate investment
trusts ("REITS").
FBRIM acts as general partner of private investment limited partnerships and
also manages investment accounts and FBR Asset Investment Corporation ("FBR-
Asset"), a REIT.
Nature of Operations
The Company is primarily engaged in a single line of business as a
securities firm, which comprises several types of services, such as
underwriting, principal and agency securities trading transactions, asset
management and long-term investing, primarily in the United States. The
operations related to the Company's foreign entities are not material to these
consolidated financial statements.
The securities industry generally, and specifically in volatile or illiquid
markets, is subject to numerous risks, including the risk of losses associated
with the underwriting, ownership, and trading of securities and the risks of
reduced revenues in periods of reduced demand for security offerings and
activity in secondary trading markets. Changing or negative economic trends,
such as inflation, deflation or interest rate volatility, political trends, such
as regulatory and legislative changes, and overall or specific market trends can
influence the liquidity and value of the Company's investments, and impact the
level of security offerings underwritten by the Company, all of which could
adversely affect the Company's revenues and profitability.
8
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS, CONTINUED:
Nature of Operations, continued
Many aspects of the Company's business involve substantial risks of
liability. An underwriter is exposed to substantial liability under Federal and
state securities laws, other Federal and state laws and court decisions,
including decisions with respect to underwriters' liability and limitations on
indemnification of underwriters by issuers. Underwriters may be held liable for
material misstatements or omissions of fact in a prospectus used in connection
with the securities being offered or for statements made by its securities
analysts or other personnel. In recent years there has been an increasing
incidence of litigation involving the securities industry, including class
actions that seek substantial damages. The Company is also subject to the risk
of litigation, including litigation that may be without merit. As the Company
intends actively to defend such litigation, significant legal expenses could be
incurred. An adverse resolution of any future lawsuits against the Company could
materially affect the Company's operating results and financial condition.
Concentrations of Risk
Historically, the Company's revenues have been derived primarily from
investment banking transactions in the financial services and real estate
industries and the industry consolidation sector. As a result of the Company's
dependence on these industries and the consolidation sector, downturns in the
market for securities in these areas have adversely impacted and could continue
to adversely impact the Company's results of operations and financial condition.
A substantial portion of the Company's revenues in a year may be derived from
a small number of underwriting transactions or may be concentrated in a
particular industry. Revenues derived from two unrelated investment banking
transactions accounted for 25% of the Company's revenues for the nine months
ended September 30, 1997. Two unrelated investment banking transactions
accounted for 39% of the Company's revenues for the nine months ended September
30, 1998.
FBR-Asset accounted for $24.7 million or 26% of the Company's long-term
investment securities as of September 30, 1998.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The Company's financial statements have been prepared in accordance with the
rules and regulations of the Securities and Exchange Commission ("SEC") with
respect to Form 10-Q and reflect all normal recurring adjustments which are, in
the opinion of management, necessary for a fair presentation of the results for
the interim periods presented. Pursuant to such rules and regulations, certain
footnote disclosures which are contained in the Company's Annual Report on Form
10-K for the year ended December 31, 1997 ("1997 Annual Report") have been
omitted. It is recommended that these consolidated financial statements be read
in conjunction with the audited consolidated financial statements included in
the 1997 Annual Report. The consolidated balance sheet as of December 31, 1997
was derived from the audited financial statements. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Certain amounts in the consolidated financial statements for prior periods
have been reclassified to conform to the current period presentation.
9
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
Securities and Other Investments
Securities owned by the Company's broker-dealer subsidiaries are valued at
market and resulting unrealized gains and losses are reflected in earnings.
Other marketable securities held in non-broker dealer entities are classified as
available-for-sale, in accordance with Financial Accounting Standard ("SFAS")
No. 115, and are valued at market with resulting unrealized gains and losses
reflected in other comprehensive income (loss). However, other than temporary
declines in the value of available-for-sale securities would be recorded in
earnings. Investments in private investment partnerships and FBR-Asset are
accounted for under the equity method and the Company's proportionate share of
income or loss is reflected in earnings.
Other Comprehensive Income (Loss)
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 is effective for financial
statements issued after December 15, 1997. SFAS No. 130 establishes new rules
for the reporting and display of comprehensive income and its components,
however, it has no impact on the Company's net income (loss) or total
shareholders' equity. For all reporting periods prior to June 30, 1998, the
Company did not have any components of comprehensive income (loss) other than
net income (loss). For the quarter ended September 30, 1998, the Company's
comprehensive income (loss), net of tax, totaled $50.3 million and included net
loss of $35.4 million and net unrealized loss on available-for-sale securities
of $14.9 million. For the nine months ended September 30, 1998, the Company's
comprehensive income (loss), net of tax, totaled $27.3 million and included net
loss of $12.4 million and net unrealized loss on available-for-sale securities
of $14.9 million.
Accumulated other comprehensive income (loss) presented on the accompanying
consolidated balance sheet consists of the accumulated net unrealized loss on
available-for-sale investments.
Net Income Per Share
In March 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings per Share." SFAS No. 128 is effective for financial statements
issued after December 15, 1997. SFAS No. 128 requires dual presentation of
basic and diluted income per share. Basic income per share includes no dilution
and is computed by dividing net income or loss available to common stockholders
by the weighted-average number of common shares outstanding for the period.
Diluted income per share includes the impact of potentially dilutive options,
warrants, or convertible debt and convertible preferred equity securities.
Options to purchase 4,231,650 shares of common stock were outstanding as of
September 30, 1998, but were not included in calculating diluted net income per
share as their effect would have been anti-dilutive. Therefore, there is no
difference between the amounts of basic and diluted net income per share in
these statements.
In February 1998, the SEC issued Staff Accounting Bulletin ("SAB") No. 98,
concerning the computation of earnings per share. SAB 98 amends previous
guidance concerning the impact of equity interests issued in proximity to an
initial public offering on the computation of weighted average shares
outstanding. SAB 98 also amends the requirements to present historical earnings
per share information when a company converts from a non-taxable, to a taxable
entity. SAB 98 has been applied in the accompanying consolidated financial
statements.
10
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Compensation
A significant component of compensation expense relates to incentive
bonuses. Incentive bonuses are accrued based on the contribution of key business
units using certain pre-defined formulas. Since the bonus determinations are
also based on aftermarket security performance and other factors, amounts
originally accrued may not ultimately be paid. Pursuant to this policy, the
Company reduced $9.5 million of current and prior year bonus accruals in the
six-month period ended June 30, 1998. All of the Company's compensation plans
are reviewed and evaluated on a quarterly basis.
3. RECEIVABLES FROM AFFILIATES:
During the nine months ended September 30, 1998, the Company made periodic
advances totaling $6 million to certain executive officers of the Company
against the 1997 Stock and Annual Incentive Plan ("the 1997 Plan").
Compensation, under the 1997 Plan, is based on the Company's annual pre-tax net
income. For the nine months ended September 30, 1998, the Company experienced a
net loss, therefore, the advances were converted to loans and are classified as
receivables from affiliates as of September 30, 1998. The loans earn interest
at a 5.41% annual rate and are due on December 31, 1999.
4. INCOME TAXES:
Through December 20, 1997, the Company and its U.S. Operating Entities, with
the exception of its subsidiaries which are limited liability corporations
("LLCs"), had elected to be taxed as subchapter S corporations under the
Internal Revenue Code. Subchapter S corporations and LLCs are not taxed on
their income; rather their income or loss passes directly through to their
shareholders (or members in the case of LLCs). As a result, there is no
provision for income taxes in these financial statements for the periods prior
to December 20, 1997.
The accompanying consolidated statements of operations for the quarter ended
and nine months ended September 30, 1997 include pro forma adjustments for
income tax expense, which would have been recorded had the Company been subject
to federal and state corporate income taxes, for all periods presented.
The Company reduces deferred tax assets by a valuation allowance if, based
on the weight of available evidence, it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
11
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. INCOME TAXES, CONTINUED:
As of September 30, 1998, the Company had a deferred tax asset of
$5.4 million primarily related to unrealized depreciation on investment
securities accounted for under SFAS No. 115. The Company recorded a valuation
allowance for 100% of this asset with the corresponding charge recorded
directly to other comprehensive income (loss). As of September 30, 1998, the
Company had net operating loss ("NOL") carry-forwards of $15.7 million which
expire through 2013. The deferred tax asset related to the NOL carry-forwards
was $6.3 million. The Company recorded a valuation allowance of $3.9 million
for the 1998 increase in the NOL.
5. LONG-TERM INVESTMENTS:
As of December 31, 1997 and September 30, 1998, long-term investments
consisted of the following (in thousands):
December 31, 1997 September 30, 1998
----------------- ------------------
FBR-Asset $15,051 $24,675
FBR Business Development investments -- 24,500
Private investment partnerships 21,301 24,352
Available-for-sale securities -- 19,112
Other debt 2,000
------- -------
$36,352 $94,639
======= =======
FBR-Asset is a privately held REIT formed in 1997. As of September 30, 1998,
FBR-Asset's investments consisted primarily of mortgage-backed securities and
corporate equities. FBR-Asset classifies its investments as available-for-sale
in accordance with SFAS No. 115. Accordingly, unrealized gains and losses
related to these securities are reflected as other comprehensive income (loss)
in FBR-Asset's equity. The Company accounts for its investment in FBR-Asset
under the equity method. As a result, for the nine month period ended September
30, 1998, the Company recorded $1 million in net investment gains in the
statement of operations for its proportionate share of FBR-Asset's net income.
The Company also recorded, in other comprehensive income (loss), $1.3 million of
net unrealized loss on investments which represented its proportionate share of
the net unrealized loss related to FBR-Asset's available-for-sale securities, as
of September 30, 1998.
FBR Business Development Capital ("FBR-BDC"), a wholly-owned subsidiary of
the Company, was organized in May 1998 as an interim loan fund designed to
extend financing to "middle-market" businesses in need of subordinated debt or
mezzanine financing. In connection therewith, the Company loaned $24.5 million
to three unrelated businesses at an annual interest rate of 12%. The loans
mature as follows: $7 million in July 2001, $7.5 million in June 2003 and
$10 million in December 2005. Within the next six to twelve months, the Company
intends to raise additional capital for FBR-BDC through a private or public
offering. Following the offering, the Company would manage the assets of FBR-
BDC and would earn a corresponding management fee.
12
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. LONG-TERM INVESTMENTS, CONTINUED:
During prior periods, the Company accumulated over $35 million of long-term
investment positions in its broker-dealer trading accounts. The amount of
shares held substantially exceeded the four-week trading volume and the sale of
certain of these securities is restricted. In addition, under SEC Rule 15c3-1,
FBRC is subject to large market blockage and haircut charges when calculating
regulatory net capital. These charges, related to the aforementioned
securities, reduced FBRC's regulatory net capital by up to $31 million.
Consequently, the Company transferred $35.8 million of investment securities, at
fair value, from its broker-dealer trading accounts to a long-term investment
account of an FBRAM subsidiary. In accordance with SFAS No. 115, these
securities are classified as available-for-sale and are valued at market with
resulting unrealized gains and losses reflected as other comprehensive income
(loss). Following the transfer, $3.1 million of the securities were sold
resulting in a realized investment loss of $.8 million reflected in the
Company's earnings. As of September 30, 1998, the unrealized loss related to
these securities was $13.6 million.
6. ASSET MANAGEMENT REVENUE:
Certain of the Company's subsidiaries, as investment advisers, receive
management fees for the management of the business and affairs of limited
partnerships or investment companies, based upon the amount of assets under
management, as well as incentive income based upon the operating results.
Incentive income is calculated on at least an annual period, which generally
coincides with the calendar year. As of December 31, 1997, September 30,
1997 and September 30, 1998, unrecorded incentive income was $1.5 million,
$12.9 million, and $.6 million, respectively. As the ultimate amount of such
income may vary with future performance, this income is not recorded as revenue
until such time as it becomes due and payable.
7. BORROWINGS:
Subordinated Revolving Loans
As of September 30, 1998, the Company had two unsecured revolving
subordinated loan agreements with its clearing broker and an affiliate of its
clearing broker. Available credit lines under these agreements were $25 million
and $10 million, respectively. As of September 30, 1998, there were no amounts
outstanding under these lines. Borrowing capacity under the $25 million credit
line expires in August 1999. Borrowing capacity under the $10 million credit
line expired in October 1998. The Company is in the process of renewing the loan
that expired.
8. NET CAPITAL COMPUTATION:
FBRC is subject to the Net Capital Rule, 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. At September 30, 1998, FBRC
had net capital of $41.4 million, which was $40.0 million in excess of its
required net capital of $1.4 million. FBRC's aggregate indebtedness to net
capital ratio was .50 to 1 at September 30, 1998.
13
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases premises under long-term lease agreements requiring
minimum annual rental payments with annual adjustments based upon increases in
the consumer price index, plus the pass-through of certain operating and other
costs above a base amount.
Future minimum aggregate annual rentals payable under these non-cancelable
leases and rentals for certain equipment leases for the years ended December 31,
1999 through 2003 and the aggregate amount thereafter, are as follows:
YEAR ENDED DECEMBER 31, (IN THOUSANDS)
- ----------------------- --------------
1999.................................................... $ 2,546
2000.................................................... 2,609
2001.................................................... 2,789
2002.................................................... 2,766
2003.................................................... 2,696
Thereafter.............................................. 225
-------
$13,631
=======
10. DIVIDENDS:
In 1997, prior to its initial public offering, the Company declared
distributions to its shareholders totaling $73 million. There were no
dividends declared during the nine months ended September 30, 1998. However,
$24 million of distributions declared in 1997 were paid in the first quarter of
1998 to S corporation shareholders.
11. SHAREHOLDERS' EQUITY:
At September 30, 1998, the Company has three stock-based compensation and
benefit plans discussed below. In July 1998, the Company's Board of Directors
approved a plan to repurchase up to 2.5 million shares of the Company's Class
A common stock from time to time. In accordance with the repurchase plan, a
portion of the stock acquired in the repurchase plan will be used in the three
stock-based compensation and benefit plans. As of September 30, 1998, the
Company had repurchased 533,092 shares of its Class A common stock pursuant to
this plan.
1997 Stock and Annual Incentive Plan
Under the 1997 Plan, the Company may grant options, stock appreciation
rights, "performance" awards and restricted and unrestricted stock to purchase
up to 9.9 million shares of Class A common stock to participants in the 1997
Plan. In addition, executive officers and certain other employees are eligible
to participate in a bonus pool, based on net income before taxes. For the nine
months ended September 30, 1998, the Company recorded no compensation expense
related to the bonus pool because the Company experienced a net loss for this
period. As of December 31, 1997, 4,383,400 stock options were granted to
employees in accordance with the 1997 Plan. The options were granted at the
initial public offering price of $20 per share and become exercisable as
follows: 10%, 40%, and 50% at the end of three, four, and five years,
respectively. As of September 30, 1998, no options were exercised or expired. As
of September 30, 1998, 207,000 options were cancelled upon the departure of
employees and 55,250 additional options were granted to new employees at fair
market value on the date of the grant.
14
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. SHAREHOLDERS' EQUITY, CONTINUED:
Non-Employee Director Stock Compensation Plan
Under the Non-Employee Director Stock Compensation Plan, the Company may
grant options or stock (in lieu of annual director fees) up to 100,000 shares of
Class A common stock to all non-employee directors as a group. There were no
awards made under this plan during the nine months ended September 30, 1998.
Employee Stock Purchase Plan
On September 1, 1998, the 1997 Employee Stock Purchase Plan (the "Purchase
Plan") became operational. Under this Purchase Plan, 1,000,000 shares of Class
A common stock are reserved for future issuance of stock. The Purchase Plan
permits eligible employees to purchase common stock through payroll deductions
at a price equal to 85% of the fair market value as determined by the Purchase
Plan. The Purchase Plan does not result in compensation expense. As of
September 30, 1998, payroll deductions for stock to be purchased on December 31,
1998 totaled $141,566.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
NOTE: The following discussion should be read in conjunction with the unaudited
Consolidated Financial Statements as of September 30, 1998 and 1997, and the
Notes thereto included elsewhere herein, and the Company's 1997 Form 10-K. In
addition to historical information, the following Management's Discussion and
Analysis of Financial Condition and Results of Operations contains forward-
looking statements that involve risks and uncertainties. Such statements
include, but are not limited to, those relating to the effects of growth, the
Company's principal investment activities and its current equity capital levels.
The risks and uncertainties relate to, among other factors: general economic and
market conditions, changes in interest rates, availability of long and short-
term credit, loan delinquency rates, stock market volume and prices, mutual fund
and 401(k) and pension plan inflows or outflows, changes in the REIT, technology
and financial services industries and other industries in which the Company is
active, changes in demand for investment banking and securities brokerage
services, competitive conditions within the securities industry, the Company's
ability to recruit and retain key employees, changes in the securities and
banking laws and regulations, trading and principal investment activities, and
litigation. For a more detailed explanation of these and other risks and
uncertainties, refer to "Factors Affecting the Company's Business, Operating
Results and Financial Condition" in the Company's Form 10-K for 1997,
incorporated herein by reference. As a result of these risks and uncertainties,
there can be no assurance that operating results for any future period will be
comparable to those attained in the prior periods. The Company undertakes no
obligation to update publicly any forward-looking statements whether as a result
of new information, future events, or otherwise.
OVERVIEW
Friedman, Billings, Ramsey Group, Inc. ("the Company") is a holding company
for Friedman, Billings, Ramsey Capital Markets, Inc. ("Capital Markets Group")
and FBR Capital Management, Inc. ("Asset Management Group"). The Capital
Markets Group is a holding company, whose primary subsidiary, Friedman,
Billings, Ramsey & Co., Inc. ("FBRC"), is a U.S. investment banking firm and
securities broker-dealer. The Capital Markets Group's other subsidiaries,
Friedman, Billings, Ramsey International, Ltd. ("FBRIL") and FBR Investment
Services, Inc. (formerly FBR Direct, Inc., "FBRIS"), are also broker-dealers in
targeted markets. The Asset Management Group is a holding company whose
subsidiaries are engaged in investment management and advisory services to
managed accounts, hedge and offshore funds, private equity and venture capital
funds, mutual funds, and holding principal investments. The Company's
operations are primarily in the United States, and the Company has very limited
direct exposure to foreign market activity.
BUSINESS ENVIRONMENT
During the third quarter of 1998, the financial markets in the U.S. have
continued to experience considerable volatility due to, among other things,
investors concerns about world-wide market conditions and the potential
weakening of the domestic economy. As a result of this volatility and investor
concerns, capital raising activities have slowed considerably in the second half
of 1998. The Company's business is linked to the activity in the capital
markets, particularly capital raising, and to the markets for securities of
companies that are affected by many of the same risks and uncertainties relating
to the Company itself (discussed above) as well as by other factors that apply
to particular industries. This environment has adversely affected the Company's
revenues for the third quarter of 1998 both because of a slow down in capital
raising activity and trading losses incurred by the Company. The Company
expects that this environment will continue to be a challenging one in which to
raise capital during the fourth quarter of 1998 and may continue to cause
trading losses and otherwise adversely affect the Company's revenue for the
remainder of 1998 and at least part of 1999.
16
OPERATING GROUPS
Asset Management Group
Revenue from the Asset Management Group has increased 139% from the first
nine months of 1997 to the first nine months of 1998. This revenue has been
derived from an increasing variety of investment vehicles, which the Company
plans to seek to diversify in the future. Assets under management ("AUM") have
increased 13%, from $641.6 million at year-end to $723.5 million as of September
30, 1998. Asset management revenue consists of base management fees and
incentive income.
Base management fees are earned on all the Company's AUM, and are determined
based on a percentage of actual or committed net assets, excluding the Company's
and certain other affiliated assets. The percentages used to determine the
Company's base fee vary within each vehicle (from .25% for FBR-Asset Investment
Corp.'s ("FBR-Asset") mortgage-backed securities to 2.5% for venture capital
funds). As of September 30, 1998, the weighted average base management fees of
the Company approximate 1.1% annually on the AUM. The Company recorded $5.5
million in management fees for the nine months ended September 30, 1998.
In addition to the base management fees, the Company may earn incentive
income on private investment partnerships and FBR-Asset. The Company receives
20% of the net investment gains (if any) on the assets contributed by third
parties to the private investment partnerships. Generally, the incentive income
is calculated annually every December 31. However, the Company receives initial
incentive income at the end of the quarter in which the one-year anniversary of
each contribution occurs. For the nine months ended September 30, 1998, the
Company recorded $2.1 million of incentive income. Assets on which the Company
has the potential to earn incentive income have increased 14%, from $470 million
at year-end to $536 million as of September 30, 1998.
The Company's investments in private investment partnerships increased to
$24.4 million as of September 30, 1998 from $21.3 million as of December 31,
1997. The Company recorded net investment losses of $4.9 million during the
first nine months of 1998 related to these partnerships.
FBR Business Development Capital ("FBR-BDC"), a wholly-owned subsidiary of
the Company, was organized in May 1998 as an interim loan fund designed to
extend financing to "middle-market" businesses in need of subordinated debt and
bridge financing. In connection therewith, in July 1998, the Company made loans
with warrants totaling $24.5 million to three unrelated businesses at an annual
interest rate of 12%.
The Company's investment vehicles have historically been concentrated in the
financial services industry. However, one of the Company's private investment
partnerships and FBR-Asset, as well as two of the Company's mutual funds, are
primarily invested in other sectors. In July 1998, the Company added a real
estate mutual fund through the acquisition of GrandView Advisors, Inc., and its
namesake mutual fund, which now operates as the FBR Realty Growth Fund.
The Company has begun marketing four investment vehicles that it intends to
continue to develop. These new vehicles involve; (i) asset allocation services
for high net worth individuals; (ii) corporate treasury advisory services for
middle-market business clients; (iii) a "fund of funds", to provide investors an
opportunity to invest in all of the Company's private investment partnerships,
and certain outside funds; and (iv) an arbitrage private investment partnership.
Although these additional vehicles are not expected to contribute significantly
to revenues in 1998, the Company believes they may become more meaningful in
1999.
17
OPERATING GROUPS, CONTINUED
Capital Markets Group
During the nine months ended September 30, 1998, Friedman, Billings, Ramsey
& Co., Inc. ("FBRC") managed or co-managed eight IPO's and sixteen secondary
offerings raising over $3.5 billion. During the nine months ended September 30,
1998, the Company increased the number of personnel in the investment banking
group and the research department by 47% and 66%, respectively, in order to
increase its focus on a number of industry sectors that management believes
offer favorable opportunities for the Company to gain market share, as well as
reduce exposure to cyclical declines in sectors in which the Company currently
operates. In response to decreased revenues in the current market environment,
the Company implemented a cost cutting program that is estimated to reduce
annual expenses by approximately $2.5 million. These cost cutting measures
included staff reductions, however, they are not expected to adversely impact
the Company's ability to focus on an increased number of industry sectors.
Corporate finance revenues include private placement fees and M&A and
advisory service fees. During the nine months ended September 30, 1998, FBRC
acted as placement agent or co-placement agent in eight non-public transactions,
raising $872 million. Over the last seven quarters (beginning with the first
quarter of 1997), private placements have generated approximately $11 million of
revenue per quarter (on average), ranging from none in one quarter, to as much
as $22.7 million in another.
FBRC conducts market-making activities in more than 400 securities. During
the first nine months of 1997 and 1998, in connection with these activities,
FBRC experienced net trading losses on positions held in securities inventories
and primarily in those securities for which FBRC had acted as underwriter. FBRC
has an investment banking incentive compensation policy which takes into account
the risk of trading and other losses related to market-making activity and other
transactions conducted to support investment banking transactions. This policy
provides for a deferral of a portion of the incentive compensation payable to
investment banking and other personnel. Any losses or liabilities of the
Company attributable to capital raising transactions may result in a reduction
of accrued incentive compensation to investment banking personnel. Pursuant to
this policy, the Company reduced $9.5 million of accrued investment banking and
other bonus compensation during the six months ended June 30, 1998.
During the quarter ended September 30, 1998, the Company liquidated a
substantial amount of its trading positions in order to mitigate the risk of
future trading losses caused by a volatile market. The Company also
significantly reduced its trading inventory positions by transferring $35.8
million of securities from its broker-dealer trading accounts to an investment
account of a non-broker-dealer subsidiary.
The Company continues to be approached by existing clients and potential new
clients concerning possible capital raising transactions. However, given the
uncertainties involved in completing such transactions under current market
conditions, the Company is unable to predict when or whether any such
transactions will be successfully completed.
The Company monitors its market and counter-party risk on a daily basis
through a number of control procedures designed to identify and evaluate the
various risks to which the Company is exposed. The Company 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. The Company 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.
18
OPERATING GROUPS, CONTINUED
Capital Markets Group, continued
In addition to the risks associated with investment banking transactions,
the Company may be exposed to significant after-market risks with these
companies, as the Company may hold substantial positions in the securities of
these companies as underwriter or market maker. The Company often acts as
principal in customer-related transactions in financial instruments that expose
the Company to market risks. The Company also engages in proprietary trading and
arbitrage activities and makes dealer markets in equity securities and high-
yield securities. These trading activities generally result in the creation of
inventory positions. Position and exposure reports are prepared and circulated
to management of the Company on a daily basis. The Company seeks to manage the
exposure to market risks by establishing position limits, and from time to time
may limit its net long or short position by selling or buying similar
instruments.
The Securities and Exchange Commission has developed new market risk
disclosure rules. The Company is required to adopt these rules with the filing
of its annual report on Form 10-K for the year ended December 31, 1998. The
Company has risk management policies and procedures related to its trading
activities designed to reduce its exposure to market risk. The Company will
adopt additional policies or procedures during 1998 that may be necessary to
meet compliance with the new SEC rules; however, the Company will continue to
use other risk management measures, such as trading limits and daily position
summary reports.
RESULTS OF OPERATIONS
Revenues
Total revenues are comprised primarily of underwriting revenue, corporate
finance fees, principal sales credits, agency commissions, asset management
revenue, and net gains and losses. The Company believes that revenue from
underwriting and corporate finance is substantially dependent on the market for
public and private offerings of equity and debt securities by the companies in
the sectors within which the Company focuses its efforts. Principal sales
credits are dependent on NASDAQ trading volume and spreads in the securities of
such companies. Net trading gains and losses are dependent on the market
performance of securities in which the Company holds trading positions in its
inventory, as well as on the decisions of management as to the level of market
exposure in these securities. Accordingly, the Company's revenues have
fluctuated, and are likely to continue to fluctuate, based on these factors.
Underwriting revenue consists of underwriting discounts, selling
concessions, management fees and other underwriting fees and reimbursed expenses
associated with underwriting activities. The Company acts in varying capacities
in its underwriting activities, which based on the underlying economics of each
transaction, determines its ultimate revenues from these activities. When the
Company is engaged as lead-manager of an underwriting, the Company generally
bears more risk and earns higher revenues than if engaged as a co-manager, an
underwriter ("syndicate member"), or a broker included in the "selling group".
In general, when FBRC acts as lead manager or co-manager, the Company may
receive 20 to 80 percent of the total underwriters' discount; however if FBRC
acts as a syndicate member, or has a reduced role as a co-manager, the Company
may receive 3 to 20 percent of the total underwriters' discount.
Corporate finance revenues are comprised of the Company's merger and
acquisition, private placement, mutual-to-stock conversion, and other corporate
finance advisory fees and reimbursed expenses associated with such activities.
Corporate finance fees have fluctuated, and are likely to continue to fluctuate,
based on the number and size of transactions, including private placements, by
the Company.
Principal sales credits consist of a portion of dealer spreads from the
securities trading activities of the Company as principal in NASDAQ-listed and
other over-the-counter ("OTC") securities, and is primarily derived from the
Company's activities as a market-maker.
19
RESULTS OF OPERATIONS, CONTINUED
Revenues, continued
Trading gains and losses are combined and reported on a net basis. Gains and
losses result primarily from market price fluctuations that occur while holding
positions in the Company's trading security inventory.
Agency commissions revenue includes revenue resulting from executing NASDAQ-
listed and other OTC transactions as agent, and executing trades through a stock
exchange.
The Company receives asset management revenue in its capacity as the
investment manager to advisory clients and as general partner of several
investment partnerships. Management fees and incentive income on investment
partnerships historically have been earned from vehicles that invest primarily
in the securities of companies engaged in the financial services and REIT
sectors. Incentive income is likely to fluctuate with the performance of
securities in these sectors. A growing asset base coupled with a stable or
rising equity market (including equity of financial services companies) can
provide significant revenues with a high net margin for the Company. The
Company's ultimate objective is to establish an asset base with sufficient
revenue to cover the Company's fixed costs.
Expenses
Compensation and benefits expense includes base salaries as well as
incentive compensation paid to sales, trading, underwriting and corporate
finance professionals and to executive management. Incentive compensation (other
than under the 1997 Plan, below) varies primarily based on revenue production.
Salaries, payroll taxes and employee benefits are relatively fixed in nature. In
December 1997, the Company adopted the 1997 Stock and Annual Incentive Plan
("the 1997 Plan") under which the executive officers and certain other employees
are eligible to participate in a bonus pool, based on net income before taxes,
rather than on gross revenues. The Company recorded no compensation expense
related to this Plan, for the nine months ended September 30, 1998, because the
Company experienced a net loss for this period. The Company intends to review
and evaluate all of its compensation plans on a quarterly basis.
The following table sets forth expenses as a percentage of revenues before
net trading and investment gains and losses for the periods presented:
FOR THE NINE
FOR THE QUARTER MONTHS ENDED
ENDED SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1997 1998
---- ---- ---- ----
Revenues before net trading and
investment gains and losses, in
thousands $67,167 $25,513 $140,310 $162,306
Expenses:
Compensation and benefits 60% 43% 61% 42%
Clearing and brokerage fees 2% 6% 2% 3%
Occupancy and equipment 1% 5% 1% 2%
Communications 1% 3% 1% 1%
Interest 1% 6% 2% 3%
Other(1) 10% 51% 12% 21%
------------------ --------------------
Total expenses 75% 114% 79% 72%
------------------ --------------------
(1) Includes business development and sales support, professional services and
other expenses.
20
RESULTS OF OPERATIONS, CONTINUED
Expenses, continued
The Company estimates that its fixed costs as a percentage of revenue
increased from 15% for the year ended December 31, 1997 to 36% for the nine
months ended September 30, 1998. This increase is attributed to a 522% increase
in net trading and investment losses from $9.4 million for the year ended
December 31, 1997 to $58.5 million for the nine months ended September 30, 1998,
a 48% increase in total full-time employees and approximately 40% increase in
office facilities in the first nine months of 1998. Had the Company not
experienced net trading and investment losses, fixed costs as a percentage of
revenues would have been 23% for the nine months ended September 30, 1998 and
14% for the year ended December 31, 1997.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
Total revenues changed from $68.2 million in 1997 to $(21.5) million in
1998 due primarily to trading and investment losses and decreased investment
banking revenues.
Underwriting revenue decreased 84% from $24.5 million in 1997 to
$4.0 million in 1998. This decrease was due primarily to a near cessation of
underwriting transactions throughout the securities industry associated with the
turmoil in the global capital markets during August and September of 1998. The
number of completed transactions decreased from eight in 1997 to four in 1998,
while the average revenue earned per each transaction in the quarter decreased
from $3 million per transaction in 1997 to $1 million per transaction in 1998.
Corporate finance fees decreased from $29.1 million in 1997 to $4.4 million
in 1998. This decrease was also reflective of the reduced private placement
capital raising activities during the third quarter of 1998 and the completion
of one very large private placement transaction in the third quarter of 1997
with revenues totaling $18 million.
Principal sales credit revenue was constant at $7.6 million in both 1997 and
1998.
Agency commissions increased 15% from $3.4 million in 1997 to $3.9 million
in 1998. This increase was due to the expansion of the Company's institutional
listed equity business fostered by an increase in the number of institutional
brokers, an increase in listed equity trading capabilities, as well as an
increase in the issuance of research reports covering securities listed on
national exchanges.
Net trading and investment gains/(losses) changed from $1.1 million in 1997
to $(47.0) million in 1998. This change is attributed to larger corporate
securities inventories in 1998, specifically in the specialty finance and REIT
sectors. The Company's losses in the third quarter of 1998 are also attributed
to its investment in private investment partnerships that are invested primarily
in financial service companies.
Asset management revenue increased by 62% from $1.3 million in 1997 to
$2.1 million in 1998. The increase was due primarily to an increase in assets
under management, which increased from $414.1 million as of September 30, 1997
to $723.5 million as of September 30, 1998.
Interest, dividends and other revenue increased by 150% from $1.4 million in
1997 to $3.5 million in 1998. This increase is due primarily to an increase in
the Company's invested net assets.
Total expenses decreased 42% from $50.7 million in 1997 to $29.2 million
1998 due primarily to lower variable compensation expense associated with lower
investment banking revenue.
Compensation and benefits expense decreased 73% from $40.6 million in 1997
to $10.9 million in 1998. The decrease was due primarily to lower variable
investment banking compensation and lower executive officer bonus compensation,
which in 1998 is determined as a percentage of net income. Average employee
headcount was 221 in the 3rd quarter of 1997 compared to 370 in the
3rd quarter of 1998.
21
RESULTS OF OPERATIONS, CONTINUED
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997, CONTINUED
Clearing and brokerage fees increased 31% from $1.2 million in 1997 to
$1.6 million in 1998 due to the increase in sales and trading activities. As a
percentage of institutional brokerage revenue, clearing and brokerage fees
increased from 11% in 1997 to 14% in 1998, due to an increase in the volume of
listed business relative to the increase in principal transaction volume. Listed
trading carries higher expenses related to order execution than does principal
transaction activity.
Occupancy and equipment expense increased 72% from $.8 million in 1997 to
$1.3 million in 1998. This increase is due to additional office leases at the
corporate headquarters, which began in May 1998, and office equipment rental to
accommodate its growth in personnel.
Communications expense increased 54% from $.5 million in 1997 to $.8 million
in 1998. This increase was due primarily to increases in telecommunications
expenses resulting from the increase in employees and expansion of facilities in
1998, and the enhancement of network technology.
Interest expense increased 172% from $.6 million in 1997 to $1.6 million in
1998, primarily due to increased margin interest expense, resulting from
increased securities position levels.
Other expenses increased 87% from $7.0 million in 1997 to $13.1 million in
1998. This increase was due primarily to increased investment banking pipeline
activity for transactions that were postponed or cancelled in the third quarter
due to the volatile capital markets. Expenses associated with expanded office
space and increased business promotion expenses also contributed to the
increase.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997
Total revenues decreased 23% from $134.9 million in 1997 to $103.8 million
in 1998 due primarily to increased trading and investment losses.
Underwriting revenue increased 1% from $67.1 million in 1997 to
$68.1 million in 1998. This increase in revenue was due primarily to an
increase in the number of the security transactions managed or co-managed from
seventeen in 1997 to twenty-four in 1998, but slightly offset by a decrease in
the average revenue size per transaction of $3.9 million in 1997 to
$2.8 million in 1998. Most of the 1998 transactions occurred in the first half
of 1998.
Corporate finance revenue decreased 2% from $38.6 million in 1997 to
$37.7 million in 1998. This decrease was due to lower private placement revenue,
offset by increased advisory, merger, and acquisition activities, which
generated $5.1 million in 1997, compared to $11.8 million in 1998.
Principal sales credits increased 19% from $20.5 million in 1997 to $24.3
million in 1998. This increase is a result of higher volumes of activity in the
Company's NASDAQ trading overall, as well as increased trading activity derived
from the Company's expansion of its equity sales and trading personnel and
capabilities.
Agency commissions increased 51% from $7.9 million in 1997 to $11.9 million
in 1998. This increase was due to the expansion of the Company's institutional
listed equity business fostered by an increase in the number of institutional
brokers, an increase in listed equity trading capabilities, as well as an
increase in the issuance of research reports covering securities listed on
national exchanges.
Net trading and investment losses, increased from $5.4 million in 1997 to
$58.5 million in 1998. This increase is attributed to larger and more
concentrated corporate securities inventories in 1998, specifically in the REIT
and mortgage company sectors. The Company's largest losses in 1998 are
principally from holding positions in stocks in which the Company has acted in
an underwriting capacity. Net losses were also incurred from the Company's
minority investment in its asset management entities.
22
RESULTS OF OPERATIONS, CONTINUED
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997, CONTINUED
Asset management revenue increased by 139% from $3.2 million in 1997 to
$7.6 million in 1998. The increase was due primarily to an increase in assets
under management.
Interest, dividends and other revenue increased by 317% from $3.1 million in
1997 to $12.8 million in 1998. This increase is due primarily to an increase in
the Company's invested net assets.
Total expenses increased 5% from $111.1 million in 1997 to $116.2 million in
1998 due primarily to the Company's growth in number of personnel (70% increase
in full-time employees as of September 30, 1998 compared to September 30, 1997).
In addition to personnel increases, the Company has been increasing expenditures
on business promotion and investment banking efforts.
Compensation and benefits expense decreased 20% from $85.1 million in 1997
to $68.1 million in 1998. The decrease was due primarily to lower executive
officer bonus compensation, which in 1998 is determined as a percentage of net
income, partially offset by an increase in the number of the Company's
personnel. Compensation and benefits expense as a percentage of total revenues
before trading losses decreased from 59% to 43%. This decrease was attributable
to a number of factors, including lower executive bonus compensation, the change
in revenue mix towards asset management revenue and the reduction of accrued
bonus compensation in the first six months of 1998. Average employee headcount
for the nine-month period was 203 in 1997 compared to 328 in 1998.
Clearing and brokerage fees increased 46% from $3.1 million in 1997 to
$4.6 million in 1998 due to the increase in sales and trading activities. As a
percentage of institutional brokerage revenue, clearing and brokerage fees
increased from 11% in 1997 to 13% in 1998, due to an increase in the volume of
listed business relative to the increase in principal transaction volume. Listed
trading carries higher expenses related to order execution than does principal
transaction activity.
Occupancy and equipment expense increased 52% from $1.9 million in 1997 to
$2.9 million in 1998. This increase is due to additional office leases, an
increase in equipment rental to accommodate its growth in personnel, and an
increase in depreciation expense due to acquisitions of computer and
telecommunications equipment for expanded staff.
Communications expense increased 65% from $1.5 million in 1997 to
$2.5 million in 1998. This increase was due primarily to increases in
telecommunications expenses resulting from the increase in employees and
expansion of facilities in 1998, and the enhancement of network technology.
Interest expense increased by 103% from $2.3 million in 1997 to $4.7 million
in 1998, primarily due to increased margin interest expense, which is a result
of increased securities position levels.
Other expenses increased 96% from $17.0 million in 1997 to $33.3 million in
1998. This increase was due primarily to increased investment banking activity,
including increased investment banking pipeline activity for transactions that
were postponed or cancelled in the third quarter due to the volatile capital
markets. Other expenses also increased due to expenses associated with expanded
office space and increased business promotion expenses.
23
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically satisfied its liquidity and regulatory capital
needs through three primary sources: (1) internally generated funds; (2) equity
capital contributions; and (3) credit provided by the Company's banks, and its
clearing broker and that broker's affiliates. The Company has frequently
required the use, and reasonably believes that it may continue to require the
use, of temporary subordinated loans in connection with regulatory capital
requirements to support its underwriting activities.
The Company's principal assets consist of cash and cash equivalents,
receivables from other broker-dealers, including its clearing broker, a
receivable for income taxes paid, securities held for trading purposes, and
long-term investments. Long-term investments consist primarily of investments in
limited partnerships in which the Company serves as the general partner,
available-for-sale securities, investment in FBR-Asset and long-term debt
investments in privately held companies. Although investments in limited
partnerships are for the most part illiquid, the underlying investments of such
partnerships are mostly in publicly traded, liquid debt and equity securities.
As of September 30, 1998, the Company had liquid assets consisting primarily
of cash and cash equivalents of $58.7 million. Cash equivalents consist
primarily of money market mutual funds invested in debt obligations of the U.S.
government. The Company also had $22.8 million in marketable securities in its
trading accounts. FBRC has available borrowing capacity (borrowing against
security positions) from its clearing broker of $4.1 million as of September 30,
1998.
FBRC, as a broker-dealer, is registered with the SEC and is a member of the
NASD. As such, it is subject to the minimum net capital requirements promulgated
by the SEC. FBRC's regulatory net capital has historically exceeded these
minimum requirements. As of September 30, 1998, FBRC was required to maintain
minimum regulatory net capital of approximately $1.4 million, and had total
regulatory net capital of approximately $40.0 million in excess of its
requirement. Regulatory net capital requirements increase when FBRC is involved
in underwriting activities based upon a percentage of the amount being
underwritten by FBRC.
Other broker-dealer subsidiaries were in compliance with all applicable
regulatory capital adequacy requirements as of September 30, 1998.
The Company has no material long-term debt. As of September 30, 1998, the
Company had available a total of $35.0 million in two committed subordinated
revolving loans from its clearing broker and an affiliate of its clearing broker
that are allowable for net capital purposes. One facility with a $25 million
credit line expires in August 1999. The other facility with a $10 million credit
line expired in October 1999; however, the Company is in the process of renewing
this loan. The Company characterizes its relationship with its lenders as very
good.
The Company believes that its current level of equity capital and committed
lines of credit, combined with funds anticipated to be generated from operations
and anticipated additional lines of credit, are adequate to meet its liquidity
and regulatory capital requirements associated with its broker-dealer
activities. The Company may, however, seek debt financing to provide capital for
corporate purposes and/or to fund strategic business opportunities, including
possible acquisitions, joint ventures, alliances or other business arrangements
which could require substantial capital outlays. The Company's policy is to
evaluate acquisition opportunities as they arise.
The Company constantly reviews its capital needs and sources, the cost of
capital and return on equity, and seeks strategies to provide favorable returns
on capital. In evaluating the Company's anticipated capital needs and current
cash resources, the Company's Board of Directors authorized a share repurchase
program of up to 2.5 million shares of the Company's Class A common stock. Since
announcing the share repurchase program, the Company purchased 533,092 shares as
of September 30, 1998. Subsequent to September 30, 1998, the Company purchased
501,300 shares resulting in 1,034,392 total treasury shares as of October 31,
1998.
24
LIQUIDITY AND CAPITAL RESOURCES, CONTINUED
In response to the third quarter 1998 decrease in investment banking
revenues caused by volatile and uncertain markets, the Company implemented a
comprehensive cost-reduction program including a seven percent reduction in
total headcount as well as significant reductions in operating expenses and
discretionary budgets.
High Yield and Non-Investment Grade Debt Securities
The Company underwrites, trades, invests, and makes markets in high-yield
corporate debt securities. The Company also syndicates, trades and invests in
loans and preferred stock of below investment grade-rated companies. For
purposes of this discussion, non-investment grade securities are defined as
securities or loans rated BB+ or lower, or equivalent ratings by recognized
credit rating agencies, as well as non-rated securities or loans. Investments in
non-investment grade securities generally involve greater risks than investment
grade securities due to the issuer's creditworthiness and the liquidity of the
market for such securities. High yield and other non-investment grade securities
are carried at fair market value and unrealized gains and losses for these
securities are reflected in the Company's Consolidated Statements of Income for
the periods presented. The Company's portfolio of such securities at December
31, 1997 and September 30, 1998, are included in trading and investment
securities and have an aggregate market value of approximately $19.8 million and
$34.6 million, respectively. The Company's portfolio may, from time to time,
contain concentrated holdings of selected issues. The Company's largest,
unhedged non-investment grade position (not including loans related to FBR-BDC)
was $5.7 million and $1.2 million at December 31, 1997 and September 30, 1998,
respectively.
Warrants
In connection with certain capital raising transactions, the Company has
received and holds warrants for stock of the issuing corporation generally
exercisable at the corporation's respective offering price. Due to the current
restrictions on the warrants and the underlying securities, the Company carries
the warrants at a nominal value in its financial statements, and will recognize
any potential, future revenues and profits, if any, only when realized. The
Company may use a portion of these warrants as incentive compensation for
certain key employees of the Capital Markets Group. As of September 30, 1998,
the Company had received warrants in client companies as set forth below:
Closing Price Expiration
Number of Exercise on September date of
Warrants Price 30, 1998 Warrants
-------------------------------------------------
American Capital Strategies, Ltd. .................. 442,751 $15.00 16.1875 08/29/02
Capital Automotive REIT............................. 1,277,794 15.00 11.6875 02/12/03
Building One Services Corporation................... 1,130,000 20.00 12.3750 11/25/01
East-West Bank...................................... 475,500 10.00 *8.0000 06/12/03
Local Financial Corporation......................... 591,000 10.00 8.6250 09/08/02
Styling Technology Corporation...................... 101,500 12.00 18.5000 11/21/01
FBR Asset Investment Corporation.................... 970,805 20.00 *13.0000 12/11/07
Xypoint Corporation................................. 270,107 2.10 *2.0000 07/10/03
Resource Asset Investment Trust..................... 141,667 15.00 14.25000 01/08/03
* Represents the market price of the underlying unregistered security in recent
Rule 144a transaction trading.
25
MATTERS RELATED TO THE COMPANY'S INFORMATION SYSTEMS:
The Company's software and information systems are year 2000 compliant;
however, the Company utilizes certain software and related technologies of its
clearing organization. The Company expects that it will be indirectly affected
by the date change in the year 2000 as it relates to the systems of its clearing
organization. The year 2000 issue exists because many computer systems and
applications currently use two-digit date fields to designate a year. When the
century date change occurs, date-sensitive systems will recognize the year 2000
as 1900, or not at all. This inability to recognize or properly treat the year
2000 may cause systems to process critical financial and operational information
incorrectly. The Company's clearing organization has a defined plan to address
and correct its year 2000 deficiencies. The Company does not expect to incur any
significant expenditure related to year 2000 problems with its primary
information systems. However, any failure by the Company's clearing organization
to adequately address the date change could have a material adverse effect on
the Company's financial condition and operations.
ITEM 3. CHANGES IN INFORMATION ABOUT MARKET RISK
None.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Many aspects of the Company's business involve substantial risks of
liability, litigation and arbitration. The Company has been named as a defendant
in an action against two of the Company's employees by the employees' former
employer. The outcome of litigation cannot be predicted with certainty. However,
based upon management's review of this action with counsel, management believes
that it has meritorious defenses to this action and intends to vigorously defend
the action. Management does not believe that this action will have a material
adverse effect on the results of operations or the consolidated financial
condition of the Company.
An underwriter is exposed to potential liability under federal and state
securities laws, other federal and state laws and court decisions, including
decisions with respect to underwriters' liability and limitation on
indemnification of underwriters by issuers. For example, a firm that acts as an
underwriter may be held liable for material misstatements or omissions of fact
in a prospectus used in connection with the securities being offered or for
statements made by its securities analysts or other personnel.
If plaintiffs in any future suits against the Company were to prosecute
their claims successfully, or if the Company were to settle such suits by making
significant payments to the plaintiffs, the Company's operating results and
financial condition could be materially and adversely affected. The Company
carries very limited insurance that may cover only a portion of any such
payments.
In addition to these financial costs and risks, the defense of litigation or
arbitration may divert the efforts and attention of the Company's management and
staff, and the Company may incur significant legal expenses in defending such
litigation and arbitration. This may be the case even with respect to claims and
litigation that management believes to be frivolous, and the Company intends to
defend vigorously any frivolous claims against it. The amount of time that
management and other employees may be required to devote in connection with the
defense of litigation could be substantial and might materially divert their
attention from other responsibilities within the Company.
The Company also may become a defendant in civil actions and arbitration
arising out of its other activities as a broker-dealer, as an investment
adviser, in other business activities, or as an employer. There can be no
assurance that substantial payments in connection with the resolution of
disputed claims will not occur in the future.
26
ITEM 1. LEGAL PROCEEDINGS, CONTINUED
In addition, the Company's charter documents allow indemnification of
the Company's officers, directors and agents to the maximum extent permitted
under Virginia law. The Company intends to enter into indemnification
agreements with these persons. The Company has been and in the future may be
the subject of indemnification assertions under these charter documents or
agreements by officers, directors or agents of the Company who are or may become
defendants in litigation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(27) Financial Data Schedule
(b) Reports on Form 8-K
On September 23, 1998, the Company filed a Form 8-K with respect
to its projected third quarter 1998 loss.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Friedman, Billings, Ramsey Group, Inc.
11/16/98 By: /s/ Eric Y. Generous
---------------- -----------------------------------------
Date Eric Y. Generous, Chief Financial Officer
(Principal Financial Officer),
11/16/98 By: /s/ Kurt R. Harrington
---------------- ----------------------
Date Kurt R. Harrington, Treasurer
(Principal Accounting Officer)
EXHIBIT INDEX
EXHIBIT 27.01 Financial Data Schedule.
28