[ARTWORK APPEARS HERE]
F R I E D M A N B I L L I N G S R A M S E Y
Annual Report 1998
[LOGO OF FRIEDMAN BILLINGS
RAMSEY APPEARS HERE]
[ARTWORK APPEARS HERE]
Friedman Billings Ramsey delivers
superior industry knowledge coupled
with capital markets expertise. FBR is a
leading provider of investment research,
institutional brokerage, investment
banking and asset management services.
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CORPORATE INFORMATION
BOARD OF DIRECTORS
Emanuel J. Friedman
Chairman and Chief Executive Officer; Director
Eric F. Billings
Vice Chairman and Chief Operating Officer; Director
W. Russell Ramsey
President and Secretary; Director
Wallace L. Timmeny
Director
Mark R. Warner
Director
AUDIT COMMITTEE
Wallace L. Timmeny
Director
Mark R. Warner
Director
COMPENSATION COMMITTEE
Wallace L. Timmeny
Director
Mark R. Warner
Director
EXECUTIVE COMMITTEE
Emanuel J. Friedman
Chairman and Chief Executive Officer; Director
Eric F. Billings
Vice Chairman and Chief Operating Officer; Director
W. Russell Ramsey
President and Secretary; Director
EXECUTIVE OFFICERS
Emanuel J. Friedman
Chairman and Chief Executive Officer; Director
Eric F. Billings
Vice Chairman and Chief Operating Officer; Director
W. Russell Ramsey
President and Secretary; Director
Eric Y. Generous
Executive Vice President and Chief Financial Officer
Nicholas J. Nichols
Executive Vice President and Director of Compliance
Robert S. Smith
Executive Vice President and General Counsel
Kurt R. Harrington
Treasurer and Chief Accounting Officer
OFFICE LOCATIONS
FBR maintains headquarter offices in the Washington, D.C. area at Potomac Tower,
1001 Nineteenth Street North, Arlington, Virginia 22209; the telephone number is
(703) 312-9500. The Company also maintains offices in Irvine, California;
Boston, Massachusetts; and London, England. FBR's website is located at
www.fbr.com.
INVESTOR RELATIONS
David A. R. Allan
Director of Investor Relations
phone (703) 469-1080, fax (703) 469-1081
TRANSFER AGENT AND REGISTRAR
American Stock Transfer & Trust Co.
40 Wall Street, 46th Floor
New York, New York 10005
INDEPENDENT PUBLIC ACCOUNTANTS
Arthur Andersen LLP
8000 Towers Crescent Drive
Vienna, Virginia 22182-2725
STOCK LISTINGS
New York Stock Exchange: FBG
Common stock trading range in 1998:
3 5/8 to 21 1/4
SHAREHOLDER COMMUNICATION
Annual Meeting of shareholders will be held on May 20, 1999. Notice of Annual
Meeting, Proxy Statement and Proxy Form will be mailed prior to the Annual
Meeting.
ANNUAL REPORT ON FORM 10K
A copy of the Company's annual report on Form 10K, which is filed with the
Securities and Exchange Commission, is available, at no charge, by sending a
written request to: David A. R. Allan, Director of Investor Relations, Friedman
Billings Ramsey Group, Inc., 1001 Nineteenth St. North, Arlington, VA 22209, fax
(703) 469-1081. The Company's Form 10K and other financial information
concerning the Company is available at FBR's website, www.fbr.com.
At FBR, a culture of innovation is our single most important asset. As the
challenges of 1998 give way to the FRESH OPPORTUNITIES of 1999, we will use this
culture and the vision behind it to drive greater success for our clients. We
will use our STRONG CAPITAL POSITION to expand and diversify our revenue base.
And we will focus on the underserved and undervalued market niches where our
exceptional research and ability to move quickly help us create NEW VALUE for
our shareholders.
A Strategy for Growth
Financial Overview 2
Letter to Our Shareholders 3
Diversified Business Segments 6
Investment Research 11
Institutional Brokerage 13
Investment Banking 15
Asset Management 17
Financial Review 19
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FINANCIAL OVERVIEW
All dollars in thousands, except per share data 1996 1997 1998
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Financial & Operating Data
Revenues $109,903 $256,135 $122,868
Net Income (Loss) $ 24,838 $ 59,539 $(16,209)
Pro Forma Net Income(1) $ 14,878 $ 34,282 N/A
Total Assets $125,438 $359,327 $205,116
Total Capital $ 49,059 $226,646 $186,902
Per Share Data
Basic and Diluted Earnings (Loss) $ 0.67 $ 1.48 $ (0.33)
Pro Forma Basic and Diluted Earnings(1) $ 0.40 $ 0.85 N/A
Book Value $ 1.31 $ 4.53 $ 3.81
Other Information
Weighted Average Shares Outstanding 37,079,130 40,275,575 49,723,514
Number of Shareholders(2) 24 3,885 4,674
Total Employees 176 265 358
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(1) Reflects Federal and state income taxes based on estimated applicable tax
rates as if the Company had not elected subchapter S corporation status
prior to December 21, 1997.
(2) Number of shareholders is an estimate by the Company of its beneficial
shareholders, since many of the shareholders of record are brokers that
hold shares on behalf of their customers.
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LETTER TO OUR SHAREHOLDERS
In retrospect, 1998 was a year of distinct contrasts in the capital markets
and in our company. It was a successful year in many ways as we accomplished an
important objective: to use the proceeds of our initial public offering to
expand our business. We added talented new investment bankers and research
analysts to the FBR team, expanded our industries of focus and formed new
investment vehicles.
At the same time, 1998 was a challenging year for FBR and everyone in our
business as the second half of the year brought some of the toughest times in
the capital markets since 1987. Global market uncertainty caused steep declines
in the U.S. capital markets in the third quarter and the small-and mid-cap
stocks in our areas of focus were greatly affected.
The contrasts in underwriting activity are particularly striking. In the
first quarter, FBR ranked as the number one lead IPO underwriter in the U.S. By
the third quarter, underwriting activity had all but stopped for most investment
banks, including FBR.
Faced with these dramatic swings in the market, FBR made changes to the way
we approach the business and to our cost base. Notably, we reduced our trading
inventory, which, in turn, reduced our exposure to market volatility. We also
reduced total compensation and eliminated many non-revenue-producing expenses.
In the last quarter of the year, we saw the benefit of this strategy -- our
results proved that we were able to cover our fixed costs in the event of little
or no underwriting activity.
Due largely to trading losses sustained during the year, however, we
reported a net loss for 1998 of $16.2 million or $0.33 per share compared with
pro forma net income of $34.3 million or $0.85 pro forma per share for 1997.
Before all trading losses for the year, our income was $20.6 million or $0.41
per share, which includes adjustments for compensation and income taxes.
While we are not satisfied with these results -- even in a turbulent year
- -- it is important for me to stress that our people pulled together during this
challenging time to preserve what we have built over the last 10 years. We made
progress in further building the firm and in positioning FBR for the future.
Here is a look at some of the accomplishments of the year:
BUILDING THE FRANCHISE In 1998, we bolstered an already strong research
department by adding 22 new research analysts, bringing our total to 60. We also
added new industries of focus: energy, which includes exploration and production
and utilities, as well as insurance and healthcare information technology.
FBR now publishes research reports on 439 publicly traded companies. In the
fourth quarter alone, we initiated research coverage on 69 new companies.
WE ENDED THE YEAR WITH $187 MILLION OF EQUITY AND VIRTUALLY NO DEBT. THIS
CAPITAL STRUCTURE REPRESENTS TRUE STRENGTH ON THE BALANCE SHEET AND PUTS US IN
AN EXCELLENT POSITION TO PURSUE NEW OPPORTUNITIES IN 1999.
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In the investment banking area, we ended the year as the 10th-ranked lead
IPO underwriter in the United States and the 7th for the 24-month period.
While we are best known as an IPO underwriter, we made great strides during
1998 in other areas of our investment banking business, including private
placements, merger and acquisitions (M&A) and other advisory services.
We raised more than $870 million in private capital last year and advised
on $3.7 billion in M&A and other advisory transactions that closed last year.
We also enjoyed an excellent relationship with PNC Bank Corp., which
afforded us new investment banking opportunities.
GROWING THE ASSET BASE In 1998, we continued to grow our total base of assets
under management. These assets include: managed accounts, proprietary investment
partnerships, an offshore fund, private equity and venture capital funds and
mutual funds.
FBR ended the year with $689 million in total assets under management, a
7.4 percent increase since the end of 1997. Approximately $496 million, or about
72 percent, of these assets are incentive-based assets, which enable FBR to earn
incentive income.
In a year when many fund managers were down for the year, three of our four
proprietary investment partnerships and both of our active private equity funds
posted net positive returns.
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Our private equity and venture capital funds recorded almost $100 million
in new capital commitments last year, ending the year with total investments of
$156.2 million -- a 162 percent increase.
Included in this total are new funds raised last year by FBR Technology
Venture Partners, LP. This venture capital fund financed seven new companies
last year and has funded 16 early-stage companies to date. Most of these
companies are directly or indirectly involved with the Internet, which we expect
will bring new opportunities for investors in the future.
Our managed REIT, FBR Asset Investment Corp., ended the year with
shareholders' equity of $151 million and net asset value of $17.66 per share.
THE FIRST DECADE AND LOOKING FORWARD Without question, 1998 was a difficult year
for FBR, as the extraordinary events of last summer marred a strong first half
of the year for the Company. Our sectors of focus were hit disproportionately
hard by market volatility, affecting each area of our business: sales and
trading, investment banking and asset management.
We ended the year with $187 million of equity and virtually no debt. This
capital structure represents true strength on the balance sheet and puts us in
an excellent position to pursue new opportunities in 1999.
June 29, 1999 will mark 10 years to the day that Eric Billings, Russ Ramsey
and I -- along with 15 founding partners -- started Friedman Billings Ramsey &
Co., Inc. As we enter our second decade together, we are proud of what we have
built and the unique culture we have created. We must now prove ourselves as a
public company and we're confident that we have the right team to do exactly
that -- for the benefit of our people, our clients and our shareholders.
I thank you for your support of Friedman Billings Ramsey.
Sincerely,
/s/ Emanuel J. Friedman
Emanuel J. Friedman
Chairman and Chief Executive Officer
Friedman Billings Ramsey Group, Inc.
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EXPERTISE IN DIVERSIFIED BUSINESS SEGMENTS
FINANCE
FBR's extensive bank, thrift and specialty finance research makes it a leader in
servicing the financial industry.
In June, FBR assembled an investor group of approximately 160 institutional
and accredited investors and sole managed a $237 million private placement of
EAST WEST BANK, one of the largest Chinese-American commercial banks in the
United States.
Subsequently, FBR acted as financial advisor to East West Bank in its
announced purchase of First Central Bank, a Los Angeles-based, Chinese-American
commercial bank. FBR also assisted the bank in forming a public holding company
and listing its shares on NASDAQ.
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REAL ESTATE
FBR advised PRIME RETAIL, INC., the largest owner/operator and
developer of factory outlet centers in the world, in its $906
million acquisition of Horizon Group, Inc. Prime Retail merged
with Horizon Group by acquiring only its best factory outlet
centers. The combined company, operating under the name Prime
Retail, Inc., has a market capitalization of more than $2 billion.
FBR had a strong year underwriting REAL ESTATE INITIAL PUBLIC
OFFERINGS. For 1998, the firm ranked nationally as the number one
lead manager of REIT U.S. Issuer IPOs, having raised more than
$980 million in capital for real estate investment banking
clients. (Source: CommScan Equidesk)
INDUSTRIAL GROWTH & BUSINESS SERVICES
CONSOLIDATION among publicly traded and private companies has increased as
companies look to accelerate revenue growth and enhance operating profitability.
The strong equity markets in the 1990s have contributed to this acceleration by
providing greater access to capital. FBR analysts issue research reports on
business services, consumer products, industrial companies, homebuilders and
other industries affected by consolidation.
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TECHNOLOGY
During 1998, FBR's TECHNOLOGY GROUP grew to 32 professionals
with research coverage of almost 50 companies within the
software, services and Internet sectors. FBR provides value-
added insights and services to its clients because its
technology team includes professionals with direct experience
in these technology industries. FBR has completed $900
million in technology transactions since the group's
inception in 1996, including the 1998 IPO for MicroStrategy,
a leading decision support software company that has grown 98
percent on a compounded annual basis since 1991.
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HIGH- YIELD DEBT
Since 1993, FBR has raised over $6.2 billion in high-yield debt and preferred
transactions for its investment banking clients.
In March 1998, FBR co-managed the $75 million offering of high-yield notes
contemporaneously with the $40 million offering of common stock by SHOP AT HOME,
INC., a Nashville, Tennessee-based home shopping network. The transaction
allowed the company to acquire three broadcast stations and build a
state-of-the-art programming facility.
Launched in late 1997, FBR's Energy Group ended the year with four research
analysts dedicated to the energy sector. Within its first year, the FBR ENERGY
GROUP initiated coverage on 12 energy companies, including 10 exploration and
production (E&P) companies in the oil industry and two independent power
producers. A focus on this sector provides FBR clients with access to and
expertise in a dynamic industry where billions of dollars are invested each
year.
ENERGY
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INSURANCE
An important component of FBR's business strategy is to alert clients to
opportunities in industries that are experiencing dramatic change.
Insurance is such an industry, currently undergoing consolidation, corporate
restructuring, demutualization and regulatory change. In 1998, FBR launched its
INSURANCE RESEARCH GROUP and initiated coverage on 11 companies in the life
insurance, and property and casualty (P&C) industry segments.
EXPERTISE IN DIVERSIFIED BUSINESS SEGMENTS
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HEALTHCARE
In 1998, FBR initiated research coverage of the HEALTHCARE
INFORMATION TECHNOLOGY (HIT) industry as a new sector of
focus for the firm. To date, FBR has initiated coverage on
six companies (including two HIT consulting firms and four
enterprise-wide software vendors). In January 1999, FBR was
named as a co-manager of an important HIT underwriting,
indicating the firm's recognition in this competitive area.
INTERNATIONAL
FRIEDMAN, BILLINGS, RAMSEY INTERNATIONAL, LTD. (FBRIL) is located in London,
giving the Company a base for investment banking and institutional brokerage
services in the United Kingdom and elsewhere in Europe. FBRIL gained FSA (SFA)
approval to conduct business as an ISD category "A" firm in September 1997. A
member of EASDAQ, FBRIL has built on FBR's significant relationships with
numerous institutional investors in Europe, in addition to developing its own.
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INTERNET
The Washington, D.C. region is the birthplace of the Internet
and home to an abundance of intellectual capital and
entrepreneurial activity currently shaping the Internet. FBR
is participating in this growth through its research,
investment banking and private equity activities.
Specifically, FBR's venture capital partnership is helping to
grow the region's technology capabilities by funding some of
the nation's leading private Internet companies. FBR has
successfully invested its first venture capital fund, FBR
TECHNOLOGY VENTURE PARTNERS, LP, in companies such as
CareerBuilder, LifeMinders.com, Proxicom and webMethods.
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COMMUNICATIONS
Proximity to some of today's telecommunications giants and technological leaders
gives FBR's Communications Group a distinct advantage when evaluating the
current trends affecting the communications industry. FBR's communications group
focuses on the convergence of voice, data and the Internet. In 1998, FBR's
transactions in the communications arena included high-yield and equity
offerings for IDT CORPORATION, SHOP AT HOME, INC. AND XYPOINT CORPORATION.
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ACCESS
Clients have Internet access to a complete and current library of FBR investment
research. By submitting a registration form on the Company's website, clients
receive a user name and password and can view online research 24 hours a day. In
1999, FBR plans to enhance this service by adding "push" technology, which will
send clients a customized alert as soon as new research is posted.
EXPERT OPINION
FBR research analysts have a "voice" in the industries they cover. Every week,
FBR analysts take part in industry roundtables, industry conferences and
conference calls on companies under coverage. FBR analysts also offer frequent
comment and insight to the media. As a result, FBR was mentioned in The
Washington Post 74 times last year.
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INVESTMENT RESEARCH
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In 1998, FBR expanded its investment research capabilities and deepened its
focus in existing areas.
First, we added muscle to the new industry sectors we launched toward the
end of 1997: Energy, Insurance and Healthcare Information Technology. We now
cover 30 companies within these new sectors and continue to initiate coverage on
new companies at a steady pace.
Second, we have added new talent across the board. FBR now has 60 research
professionals working in teams and focused on some of the fastest-growing and
most rapidly changing sectors of the economy. These sectors include
banking/thrifts, communications services, energy, healthcare, industrial growth
and business services, insurance, real estate, specialty finance and technology.
The firm issues full research reports on 439 publicly traded companies.
In 1998, FBR began publishing several investment reports on a regular
basis, including a complete FBR Coverage List (monthly), Technology Perspectives
(quarterly) and U.S. Money Center and Super-Regional Banks (quarterly). These
reports are in addition to the many individual trend reports published on an
as-needed basis, as well as annual reports such as the FBR Thrift Focus List and
the FBR Wish List (of "best idea" stock picks).
ONLINE INVESTMENT RESEARCH In November, FBR launched its Online Investment
Research product, providing clients with Internet access to all FBR research
briefs, notes and trend reports, as well as daily economic and bond commentary.
FBR INVESTOR CONFERENCE FBR's Fifth Annual Investor Conference brought together
management from leading companies, portfolio managers and analysts to discuss
the latest industry trends and investment strategies. Attended by more than
1,200 people, the three-day program featured presentations by 188 companies and
a keynote address by General Colin L. Powell. FBR is continuing its focus on
innovative, growth-oriented companies with the Sixth Annual Investor Conference
in Washington, D.C., September 7 through 10, 1999.
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VOLUME
FBR's institutional sales desk traded more than 650 million shares in 1998*, and
FBR's institutional brokerage revenue increased 11 percent over the prior year.
As part of the Company's continued emphasis on institutional sales, FBR plans to
increase its professional sales force in 1999.
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*(Source:Autex/Blockdata)
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INSTITUTIONAL BROKERAGE
FBR executes securities transactions for institutional investors including
mutual funds, hedge funds, money managers, insurance companies and pension
funds, as well as high net worth investors. As of December 31, 1998, the Company
had more than 100 sales, trading and syndicate personnel.
SALES & TRADING FBR's Sales & Trading professionals provide services to the
trading desks of major financial institutions in the United States and Europe.
FBR is a market-maker in more than 400 NASDAQ and other OTC equity securities,
as well as high-yield debt, and actively trades exchange listed securities on an
agency basis.
At the end of the year, FBR undertook a special effort to organize its
Sales & Trading professionals into teams. Each team includes brokers that
specialize in one or two industries. This specialized approach gives FBR's
institutional clients the benefit of sector-focused Sales & Trading personnel
who can provide critical and time-sensitive information.
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PRIVATE CLIENT SERVICES
FBR's Private Client Group (PCG) works with high net worth investors to design
sophisticated investment strategies that can maintain and grow wealth. The group
advises clients on a broad range of investments, including growth and value
equity securities, fixed income securities, derivatives and direct private
investments. In addition, the PCG designs investment strategies around
restricted and control stock positions of corporate executives and employees.
All PCG clients have access to innovative investment vehicles and
proprietary investment partnerships that are developed in-house by FBR.
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ALLIANCE
During 1998, FBR enjoyed an excellent relationship with PNC Bank Corp., a 4.9
percent equity owner of FBR. In November, FBR worked together with PNC's retail
brokerage subsidiary, Hilliard-Lyons, to raise capital in a trust preferred
stock offering for KBK Capital Corporation, the holding company for KBK
Financial, an independent financial services company.
RELATIONSHIPS
This year, as in years past, FBR served as the advisor or underwriter in several
transactions for existing clients, including companies that FBR first brought
public or previously raised capital for, such as Brookdale Living Communities,
Inc., First Washington Realty Trust and Miami Computer Supply Corporation.
Long-term client relationships such as these are an important component of FBR's
growth and success.
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INVESTMENT BANKING
Taking into account all capital raising activity -- IPOs, other public
equity transactions, private placements and debt offerings -- FBR served as lead
or co-manager for $5.0 billion raised in 1998.
Of that total, approximately $1.8 billion was raised in initial public
offerings, enabling FBR to end the year as the 10th-ranked lead IPO underwriter
in the United States and the 7th for the 24-month period (Source: American
Banker, CommScan Equidesk).
High-yield debt offerings represented approximately 34 percent of total
capital raised in 1998. High-yield debt offerings included Pacific Aerospace &
Electronics, Inc., Schuff Steel Company, Shop at Home, Inc. and Styling
Technology Corporation.
In addition to raising capital, FBR made strides in M&A and advisory
services in 1998. Revenue from M&A and advisory services increased from $9.7
million in 1997 to $15.6 million in 1998, a 59 percent increase.
MERGERS AND ACQUISITIONS (M&A) FBR advised on $3.7 billion in M&A and other
advisory transactions that closed in 1998. M&A and advisory clients of note
include Capital One Financial Corp., George Mason Bankshares, Inc., Local
Financial Corporation, PNC Bank Corp. and Prime Retail, Inc.
PRIVATE PLACEMENTS FBR raised more than $870 million in private capital last
year. This expertise in private placements provides the firm's investment
banking clients with a range of financing options prior to -- or as an
alternative to -- entering the public capital markets.
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NEW VENTURES
In October, FBR Technology Venture Partners LP announced its final close of $50
million in capital commitments. The partnership funded seven technology
companies in 1998: Entevo Corporation, Call Technologies, Inc., CareerBuilder,
Inc., Network Access Solutions Inc., Empyrean Group, Inc.--all located in
Northern Virginia, as well as IntraNetics, Inc. of Boston and XYPOINT
Corporation of Seattle.
INCENTIVE-BASED VEHICLES
In May, FBR added a new proprietary investment vehicle to its line of asset
management products that can provide incentive income to the Company, further
illustrating the Company's emphasis on developing incentive-based proprietary
investment products.
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ASSET MANAGEMENT
BR ended the year with $688.8 million in total assets under management.
Incentive-based assets, which enable FBR to earn incentive income, represented
$496.3 or 72 percent of these assets.
The Company's assets under management include:
PROPRIETARY INVESTMENT PARTNERSHIPS AND OFFSHORE FUND FBR manages proprietary
investment partnerships and a parallel offshore fund for accredited investors.
In 1998, three of the Company's four proprietary investment partnerships posted
positive returns for the year despite exceptional market volatility in the
second half of the year. At December 31, 1998, FBR had $189.6 million under
management in this category of funds.
MUTUAL FUNDS FBR offers four open-end mutual funds, which comprise the FBR
Family of Funds: the FBR Financial Services Fund, the FBR Small Cap Financial
Services Fund, the FBR Small Cap Value Fund and the FBR Realty Growth Fund. All
four of these funds are offered on a "no-load" basis.
In September, FBR acquired GrandView Advisors Inc. and renamed its
affiliated fund the FBR Realty Growth Fund.
At year end, assets in the FBR Family of Funds totaled $118.6 million.
VENTURE CAPITAL AND PRIVATE EQUITY The Company's venture capital partnership,
FBR Technology Venture Partners LP, which is focused on telecommunications,
e-commerce and Internet-related companies, funded seven technology companies in
1998, adding to the portfolio of six companies funded in 1997.
FBR also manages two private equity funds. The Company's Private Equity
Fund, L.P. is fully invested with an internal rate of return of 19.8 percent
through December 31, 1998.
The Company's private equity funds and venture capital partnership had
$156.2 million in assets under management at the end of 1998, a 162 percent
increase over the prior year.
REAL ESTATE INVESTMENT TRUST (REIT) Formed in 1997, FBR Asset Investment Corp.,
is a REIT managed by the Company, 16 percent of which is owned by FBR. The REIT
invests in real estate-related assets, including mortgage loans and
mortgage-backed securities, as well as the securities of companies engaged in
real estate-related activities. At the end of 1998, FBR Asset Investment Corp.
had total assets of $296 million and shareholders' equity of $151 million. Book
value per share at December 31, 1998 was $17.66 per share.
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Selected Consolidated Financial Information 19
Management's Discussion and Analysis of Financial Condition and
Results of Operations 20-29
Consolidated Balance Sheets 30
Consolidated Statements of Operations 31
Consolidated Statements of Changes in Shareholders' Equity 32
Consolidated Statements of Cash Flows 33
Notes to Consolidated Financial Statements 34-43
Report of Independent Public Accountants 44
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SELECTED CONSOLIDATED FINANCIAL INFORMATION(1)
(in thousands, except per share amounts)
Year Ended December 31, 1994 1995 1996 1997 1998
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Consolidated Statements of Operations
Revenues:
Underwriting $ 30,579 $ 16,075 $ 55,159 $ 142,506 $ 70,791
Corporate finance 14,427 7,224 10,362 60,649 41,356
Principal sales credits 14,881 21,869 31,734 29,276 30,976
Agency commissions 1,935 4,483 7,554 12,395 15,308
Trading gains and losses, net (4,978) (1,791) (6,268) (12,630) (59,168)
Investment gains and losses, net 55 774 3,974 3,228 (3,943)
Asset management 389 5,973 3,834 15,766 11,397
Interest and dividends 1,713 2,558 3,554 4,945 16,151
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Total revenues 59,001 57,165 109,903 256,135 122,868
Expenses:
Compensation and benefits 42,811 33,481 61,504 156,957 82,599
Clearing and brokerage fees 1,474 2,350 3,484 4,961 5,078
Occupancy and equipment 944 1,187 1,683 2,638 4,225
Communications 764 823 1,109 2,325 3,592
Interest expense 1,773 1,523 2,665 3,770 4,927
Other (2) 13,049 8,362 14,620 28,348 38,656
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Total expenses 60,815 47,726 85,065 198,999 139,077
Income (loss) before taxes (1,814) 9,439 24,838 57,136 (16,209)
Income tax expense (benefit) (589)(3) 3,457(3) 9,960(3) 22,854(3) --
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Net income (loss) $ (1,225) $ 5,982 $ 14,878 $ 34,282 $ (16,209)
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Consolidated Balance Sheet Data
Assets:
Cash & cash equivalents $ 612 $ 10,391 $ 20,681 $ 207,691 $ 46,827
Marketable trading securities 14,670 32,521 55,013 78,784 13,150
Long-term investments 753 1,579 6,424 36,351 97,157
Other 4,883 34,420 43,320 36,501 47,982
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Total assets $ 20,918 $ 78,911 $ 125,438 $ 359,327 $ 205,116
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Liabilities:
Accounts payable and
other liabilities $ 3,844 $ 36,018 $ 14,565 $ 52,008 $ 15,322
Short-term subordinated
revolving loans 350 13,250 22,000 40,000 --
Accrued dividends -- -- -- 24,000 --
Trading account securities
sold short 2,836 6,372 39,814 16,673 2,892
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Total liabilities 7,030 55,640 76,379 132,681 18,214
Shareholders' equity 13,888 23,271 49,059 226,646 186,902
Total liabilities and
shareholders' equity $ 20,918 $ 78,911 $ 125,438 $ 359,327 $ 205,116
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Statistical Data
Basic & diluted earnings
(loss) per share $ (0.05) $ 0.27 $ 0.67 $ 1.48 $ (0.33)
Pro forma basic & diluted
earnings (loss) per share (3) $ (0.04) $ 0.17 $ 0.40 $ 0.85 N/A
Book value per share (4) $ 0.40 $ 0.66 $ 1.31 $ 4.53 $ 3.81
Total employees (4) 92 112 176 265 358
Revenue per employee $ 752 $ 580 $ 766 $ 1,162 $ 394
Pre-tax return on average equity 144% 82% 87% 41% (8)%
Compensation & benefits
expense as a percentage of revenues 40% 48% 50% 61% 67%
Basic & diluted weighted
average shares outstanding 34,557 34,916 37,079 40,276 49,724
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(1) See Notes 1 and 2 of Notes to Consolidated Financial Statements for an
explanation of the basis of presentation.
(2) Includes business promotion, investment banking and other expenses.
(3) Reflects Federal and state income taxes based on estimated applicable tax
rates as if the Company had not elected subchapter S corporation status
prior to December 21, 1997.
(4) As of end of the period reported.
19
Management's Discussion and Analysis of
Financial Condition and Results of Operations
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.
("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, proprietary investment
partnerships, an offshore fund, private equity and venture capital funds and
mutual funds. The Asset Management Group also holds 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 second half of 1998, the financial markets in the U.S.
experienced considerable volatility due to, among other things, investor
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 slowed considerably in the second half of 1998, especially in
the small- and mid-cap companies that are the Company's area of focus. 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 below) as well as by other factors that apply to
particular industries. This environment has adversely affected the Company's
revenues for 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 at least the first part of 1999 and may continue to adversely affect the
Company's revenue.
OPERATING GROUPS
ASSET MANAGEMENT GROUP Asset management revenue has increased 197% over the
last three years from $3.8 million in 1996 to $11.4 million in 1998. This
revenue has been derived from an increasing variety of investment vehicles.
Assets under management ("AUM") have increased 477% from $119.3 million at
January 1, 1996 to $688.8 million at December 31, 1998. The Company plans to
grow these AUM by continuing to make minority investments in new vehicles as
appropriate in the future.
Asset management revenue consists of base management fees and incentive
income.
Base management fees are earned on all of 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 0.25% for FBR
Asset Investment Corp.'s ("FBR-Asset") mortgage-backed securities to 2.5% for
the venture capital fund). As of December 31, 1998, the weighted average base
management fees of the Company approximated 1.1% annually on the AUM. The
Company recorded $7.6 million in base management fees for the year ended
December 31, 1998.
In addition to the base management fees, the Company may earn incentive
income on 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
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 first anniversary of each contribution occurs.
For the year ended December 31, 1998, the Company recorded $3.8 million of
incentive income. Assets on which the Company has the potential to earn
incentive income have increased 5%, from $470 million at December 31, 1997 to
$496 million as of December 31, 1998.
The Company's investments in investment partnerships increased to $26.7
million as of December 31, 1998 from $21.3 million as of December 31, 1997. The
Company recorded net investment losses of $4.0 million during the year ended
December 31, 1998 related to these partnerships.
FBR Business Development Fund ("FBR-BDF"), a wholly-owned subsidiary of the
Company, was organized in May 1998 as a loan fund designed to extend financing
to "middle-market" businesses in need of subordinated
20
debt and bridge financing. In connection therewith, in July 1998, the Company
made two loans with warrants and an equity investment totaling $24.5 million to
three unrelated businesses. The loans bear interest at an annual rate of 12.7%.
The Company's investment vehicles have historically been concentrated in
the financial services industry. However, two of the Company's proprietary
investment partnerships and FBR-Asset, as well as two of the Company's mutual
funds, are primarily invested in other sectors.
CAPITAL MARKETS GROUP FBRC's investment banking and corporate finance
activities consist of a broad range of services, including public and private
transactions of a wide variety of securities and financial advisory services in
merger, acquisition and strategic partnering transactions. During 1998, FBRC
completed or advised on 63 investment banking and corporate finance transactions
representing $8.7 billion, with $5.0 billion in public underwritings and private
placements and $3.7 billion in merger and acquisition ("M&A") and advisory
transactions.
During the year ended December 31, 1998, FBRC managed or co-managed nine
initial public offerings ("IPOs") and twenty-one secondary offerings raising
over $4.1 billion. The average size of securities transactions managed was
$138.0 million. In addition, the Company increased the number of personnel in
the investment banking and research departments by 33% and 58%, 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 concentrated exposure to cyclical declines in sectors in which
the Company operates.
Corporate finance revenues include private placement fees and M&A and
advisory service fees. During the year ended December 31, 1998, FBRC acted as
placement agent or co-placement agent in eight non-public transactions, raising
$872 million and earning $25.7 million in revenues. Over the last eight
quarters, private placements have generated $9.2 million of revenue per quarter
(on average), ranging from none in one quarter to as much as $22.7 million in
another.
INVESTMENT BANKING REVENUES
(Unaudited, in thousands) 1994 1995 1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------------
Initial Public Offerings $ 6,954 $ 3,790 $ 25,997 $115,403 $ 50,502
Secondary Public Offerings 4,535 7,840 7,214 20,690 15,623
High Yield Debt & Preferred 19,090 4,445 21,948 6,413 4,666
- ---------------------------------------------------------------------------------------------------------------------
Subtotal Underwriting 30,579 16,075 55,159 142,506 70,791
High Yield Debt & Preferred 9,435 4,470 4,058 7,442 6,427
M&A and Advisory Services 1,690 2,754 3,637 9,716 15,608
Private Equity Placements 3,302 -- 2,667 43,491 19,321
- ---------------------------------------------------------------------------------------------------------------------
Subtotal Corporate Finance 14,427 7,224 10,362 60,649 41,356
- ---------------------------------------------------------------------------------------------------------------------
Total $ 45,006 $ 23,299 $ 65,521 $203,155 $112,147
- ---------------------------------------------------------------------------------------------------------------------
FBRC conducts market-making activities in more than 400 securities. During
the years ended December 31, 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 $7.3 million of prior year investment banking and
other bonus compensation accruals during the first half of the year ended
December 31, 1998.
During the year ended December 31, 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 $38.0
million of investment securities from
21
its broker-dealer trading accounts to an investment account of an asset
management subsidiary. The Company considers these securities to be investment
securities because the amount of shares held substantially exceeds the four-week
trading volume and the sale of certain of these securities is restricted.
INSTITUTIONAL BROKERAGE REVENUES
(Unaudited, in thousands) 1994 1995 1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------------
Principal Sales Credits $ 14,881 $ 21,869 $ 31,734 $ 29,276 $ 30,976
Trading Gains and Losses, Net (4,978) (1,791) (6,268) (12,630) (59,168)
Agency Commissions 1,935 4,483 7,555 12,395 15,308
- ---------------------------------------------------------------------------------------------------------------------
Total $ 11,838 $ 24,561 $ 33,021 $ 29,041 $(12,884)
- ---------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS
REVENUES Total revenues consist primarily of underwriting revenue,
corporate finance fees, principal sales credits, agency commissions, asset
management revenue and net gains and losses. Management believes that revenue
from underwriting and corporate finance is substantially dependent on the market
for public and private offerings of equity and debt securities 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 and investment gains and losses are dependent on the
market performance of securities held, as well as 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 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-dealer included in the selling
group.
Corporate finance revenues consist of M&A, 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 completed by the Company.
Principal sales credits consist of a portion of dealer spreads attributed
to 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.
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 and the level of
sales credits.
Investment gains and losses are combined and reported on a net basis. Gains
and losses primarily represent the Company's proportionate share of income or
loss related to investments in proprietary investment partnerships and
FBR-Asset, in addition to realized gains and losses resulting from the sale of
available-for-sale securities. As of December 31, 1998, the Company had $16.1
million of unrealized losses on available-for-sale securities and FBR-Asset
recorded in accumulated other comprehensive loss. Upon the sale of these
securities or in the event the decline in value is deemed other than temporary,
the resulting difference between the cost and market value will be recorded in
investment gains and losses.
Agency commissions revenue includes revenue resulting from executing stock
exchange-listed securities and OTC transactions as agent.
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 have invested
primarily in the securities of companies engaged in the financial services and
real estate investment trust ("REIT") sectors. Incentive income is likely to
fluctuate with the performance of securities in these sectors. A growing base of
AUM in incentive vehicles coupled with positive returns can provide significant
revenues with a high net margin for the Company.
EXPENSES Compensation and benefits expense includes base salaries as well as
incentive compensation paid to sales, trading, asset management, 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
22
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 adjusted net income before taxes. The
Company recorded no compensation expense related to the 1997 Plan for the year
ended December 31, 1998. 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 for the
years presented:
Year Ended December 31, 1994 1995 1996 1997 1998
- -----------------------------------------------------------------------------------------------------------------------
REVENUES:
Underwriting 51.8% 28.1% 50.2% 55.6% 57.6%
Corporate finance 24.5% 12.6% 9.4% 23.7% 33.7%
Principal sales credits 25.2% 38.3% 28.9% 11.4% 25.2%
Agency commissions 3.3% 7.8% 6.9% 4.8% 12.5%
Gains and losses, net-
Trading (8.5)% (3.1)% (5.7)% (4.9)% (48.2)%
Investment 0.1% 1.3% 3.6% 1.3% (3.2)%
Asset management 0.7% 10.5% 3.5% 6.2% 9.3%
Interest and dividends 2.9% 4.5% 3.2% 1.9% 13.1%
Total revenues 100.0% 100.0% 100.0% 100.0% 100.0%
EXPENSES:
Compensation and benefits 72.6% 58.6% 56.0% 61.3% 67.2%
Clearing and brokerage fees 2.5% 4.1% 3.2% 1.9% 4.2%
Occupancy and equipment 1.6% 2.1% 1.5% 1.0% 3.4%
Communications 1.3% 1.4% 1.0% 0.9% 2.9%
Interest expense 3.0% 2.7% 2.4% 1.5% 4.0%
Other (1) 22.1% 14.6% 13.3% 11.1% 31.5%
TOTAL EXPENSES 103.1% 83.5% 77.4% 77.7% 113.2%
INCOME (LOSS) BEFORE INCOME TAXES (3.1)% 16.5% 22.6% 22.3% (13.2)%
(1) Includes business development and sales support, professional services and
other expenses.
The Company estimates that its fixed costs as a percentage of revenue
increased from 15% for the year ended December 31, 1997 to 38% for the year
ended December 31, 1998. This increase is attributed to a 571% increase in net
trading and investment losses from $9.4 million in 1997 to $63.1 million in
1998, a 35% increase in the total number of full-time employees and
approximately 40% increase in office facilities.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Total revenues decreased 52% from $256.1 million in 1997 to $122.9 million
in 1998 due primarily to increased trading and investment losses and decreased
underwriting and corporate finance activity in the second half of 1998 as a
result of volatile markets and changing economic and market trends.
Underwriting revenue decreased 50% from $142.5 million in 1997 to $70.8
million in 1998. This decrease in revenue was due primarily to a decrease in the
average revenue earned per transaction from $4.9 million in 1997 to $2.4 million
in 1998. Most of the 1998 transactions occurred in the first half of 1998.
Corporate finance revenue decreased 32% from $60.6 million in 1997 to $41.4
million in 1998. This decrease was due to a 49% decrease in private placement
revenue from $50.9 million in 1997 to $25.8 million in 1998, offset by a 59%
increase in M&A and other advisory activities, which generated $9.7 million in
1997, compared to $15.6 million in 1998.
Principal sales credits increased 6% from $29.3 million in 1997 to $31.0
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, offset by lower spreads.
Agency commissions increased 24% from $12.4 million in 1997 to $15.3
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 and sales traders, an increase in listed equity trading
capabilities, as well as an increase in the issuance of research reports.
Net trading and investment losses increased 571% from $9.4 million in 1997
to $63.1 million in 1998. This increase is attributed to larger and more
concentrated corporate securities inventories in 1998, specifically in the
23
REIT and mortgage company sectors and the market decline related to these
sectors in the second half of 1998. The Company's largest losses in 1998 are
principally from holding positions in stocks in which the Company acted as an
underwriter. Net losses were also incurred from the Company's investment in one
proprietary investment partnership.
Asset management revenue decreased 28% from $15.8 million in 1997 to $11.4
million in 1998. This decrease was due to a 70% decrease in incentive income
from $12.6 million in 1997 to $3.8 million in 1998 related to the market decline
of investments in one proprietary investment partnership, offset by a 139%
increase in base management fees from $3.2 million in 1997 to $7.6 million in
1998. Base management fees increased due to a 7% increase in assets under
management from $641.6 million as of December 31, 1997 to $688.8 million as of
December 31, 1998 and a change in the mix of AUM toward higher base fee
vehicles.
Interest and dividends increased 227% from $4.9 million in 1997 to $16.2
million in 1998. This increase is due primarily to an increase in the Company's
invested net assets.
Total expenses decreased 30% from $199.0 million in 1997 to $139.1 million
in 1998 due primarily to lower variable compensation expense.
Compensation and benefits expense decreased 47% from $157.0 million in 1997
to $82.6 million in 1998. The decrease was due primarily to lower executive
officer bonus compensation, which starting in 1998 is determined as a percentage
of adjusted net income, partially offset by an increase in the number of the
Company's personnel. In addition, $7.3 million of prior year investment banking
incentive compensation accruals were reduced in 1998 due to the losses
attributable to capital raising transactions. Average employee headcount was 220
in 1997 compared to 350 in 1998. In the second half of 1998, the Company
implemented a cost reduction program that included certain staff reductions,
primarily in support positions. The effect of these reductions was to reduce
employee headcount and to reduce costs associated with the eliminated positions
going forward. The Company continues to hire employees in areas that it believes
can lead to business development.
Clearing and brokerage fees increased 2% from $5.0 million in 1997 to $5.1
million in 1998 due to the increase in sales and trading activities. As a
percentage of institutional brokerage revenue, clearing and brokerage fees
decreased from 12% in 1997 to 11% in 1998 due to a decrease in clearance fees
and transaction charges paid to the Company's clearing broker.
Occupancy and equipment expense increased 60% from $2.6 million in 1997 to
$4.2 million in 1998. This increase is due to additional office leases, an
increase in equipment rental to accommodate growth in personnel and an increase
in depreciation expense due to acquisitions of computer and telecommunications
equipment for expanded staff.
Communications expense increased 55% from $2.3 million in 1997 to $3.6
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 31% from $3.8 million in 1997 to $4.9 million in
1998 due primarily to increased margin interest expense, which is a result of
increased securities position levels in 1998.
Business development and other operating expenses increased 36% from $28.3
million in 1997 to $38.7 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
and fourth quarters of 1998 due to the volatile capital markets. Other expenses
also increased due to expenses associated with expanded office space and
increased business promotion expenses.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1997 AND 1996
Total revenues increased 133% from $109.9 million in 1996 to $256.1 million
in 1997 due primarily to increased underwriting and corporate finance activity.
Revenues from capital markets activities in 1997 far exceeded any year in the
Company's history.
Underwriting revenue increased 158% from $55.2 million in 1996 to $142.5
million in 1997. This increase was due primarily to an increase in the average
size of the security transactions managed from $43.7 million in 1996 to $122.1
million in 1997.
Corporate finance fees increased 485% from $10.4 million in 1996 to $60.6
million in 1997. This increase was due primarily to the increased size in dollar
terms of the Company's private placement activities as well as increased M&A
activities fostered by the addition of a team of professionals dedicated to such
activities.
Principal sales credit revenue decreased 8% from $31.7 million in 1996 to
$29.3 million in 1997. Although trading volumes were higher in 1997, the amount
of sales credits revenue per transaction decreased from 1996 to 1997.
24
Agency commissions increased 64% from $7.6 million in 1996 to $12.4 million
in 1997. 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, as well as the addition of a listed equity trader.
Asset management fees increased 311% from $3.8 million in 1996 to $15.8
million in 1997. The increase was due primarily to an increase in assets under
management and an increase in incentive income, principally in the Company's
largest proprietary investment partnership, which focuses its investments in the
financial services industry sector.
Total expenses increased 134% from $85.1 million in 1996 to $199.0 million
in 1997 due primarily to the Company's growth.
Compensation and benefits expense increased 155% from $61.5 million in 1996
to $157.0 million in 1997. The increase was due primarily to an increase in
incentive compensation paid to sales, trading, underwriting and corporate
finance professionals and executive management. Average employee headcount was
143 in 1996 compared to 220 in 1997.
Clearing and brokerage fees increased 42% from $3.5 million in 1996 to $5.0
million in 1997 due to the increase in sales and trading activities.
Occupancy and equipment expense increased 57% from $1.7 million in 1996 to
$2.6 million in 1997. This increase was due to additional office leases and
related expenditures and an increase in depreciation expense due to acquisitions
of computer and telecommunications equipment and furniture and fixtures for the
expanded staff and facilities.
Communications expense increased 110% from $1.1 million in 1996 to $2.3
million in 1997. This increase was due primarily to increases in
telecommunications expenses resulting from the increase in employees and
expansion of facilities in 1996 and 1997, and the enhancement of network
technology.
Interest expense increased 41% from $2.7 million in 1996 to $3.8 million in
1997, primarily due to increases in subordinated loan borrowings to meet the
regulatory capital requirements of the increased investment banking activities
and increased margin interest expense due to increased securities position
levels.
Business development and other operating expenses increased 94% from $14.6
million in 1996 to $28.3 million in 1997. This increase was due primarily to
increased investment banking expenses and increased expenses associated with
expanded office space.
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, its
clearing broker and that broker's affiliates. The Company has frequently
required the use, and may continue the use, of temporary subordinated loans in
connection with regulatory capital requirements to support its underwriting
activities. The Company has no material long-term debt.
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 managing partner,
available-for-sale securities, an investment in FBR-Asset and long-term debt and
equity investments in privately held companies. Although the investments in
limited partnerships are for the most part illiquid, the underlying investments
of such partnerships are mostly in publicly traded, liquid equity and debt
securities.
As of December 31, 1998, the Company had liquid assets consisting primarily
of cash and cash equivalents of $46.8 million. Cash equivalents consist
primarily of money market funds invested in debt obligations of the U.S.
government. The Company also held $13.1 million in marketable securities in its
trading accounts. The Company had borrowing capacity (borrowing against security
positions) from its clearing broker of approximately $7.0 million as of December
31, 1998.
As of December 31, 1998, the Company had available a total of $40.0 million
in a committed subordinated revolving loan from an affiliate of its clearing
broker that is allowable for net capital purposes. As of December 31, 1998, the
Company had no outstanding borrowings under this facility. The agreement expires
in December 1999.
As of December 31, 1998, the Company had net operating losses ("NOL") for
tax purposes of $25.6 million that expire through 2013. As a result of recording
a valuation allowance related to the NOL, the Company estimates that no income
tax provision will be recorded in the Consolidated Statement of Operations until
the Company records more than $13.9 million in taxable net income.
25
FBRC, as a broker-dealer, is registered with the Securities and Exchange
Commission ("SEC") and is a member of the National Association of Securities
Dealers, Inc. 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 December 31, 1998, FBRC was required to
maintain minimum regulatory net capital of $1.0 million and had total regulatory
net capital of $37.0 million which was $36.0 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. The Company's other broker-dealer subsidiaries were in
compliance with all applicable regulatory capital adequacy requirements as of
December 31, 1998.
Management believes that the Company's current level of equity capital and
committed line of credit, combined with funds anticipated to be generated from
operations, are adequate to meet its liquidity and regulatory capital
requirements associated with broker-dealer activities. The Company may, however,
seek debt or equity 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 during 1998, 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
1,036,092 shares as of December 31, 1998. 126,055 of the purchased shares were
reissued to employees pursuant to the Company's Employee Stock Purchase Plan.
HIGH YIELD AND NON-INVESTMENT GRADE DEBT SECURITIES
The Company underwrites, trades, invests in, and makes markets in
high-yield corporate debt securities and preferred stock of below investment
grade-rated companies. For purposes of this discussion, non-investment grade
securities are defined as preferred securities or debt rated BB+ or lower, or
equivalent ratings by recognized credit rating agencies, as well as non-rated
securities or debt. Investments in non-investment grade securities generally
involve greater risks than investment grade securities due to the issuer's
creditworthiness and the comparative illiquidity of the market for such
securities. The Company's portfolio of such securities at December 31, 1997 and
1998 are included in trading securities and long-term investments and had an
aggregate fair value of approximately $19.8 million and $31.7 million,
respectively. The Company's trading and investment portfolios may, from time to
time, contain concentrated holdings of selected issues. The Company's largest,
unhedged non-investment grade securities position was $5.7 million and $10.0
million at December 31, 1997 and 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 restrictions
on the warrants and the underlying securities, the Company currently carries the
warrants at a nominal value in its financial statements, and will recognize any
potential, future revenues and profits, if any, when realized. In 1999, the
Company will transfer up to 40% of these warrants to certain key employees,
subject to vesting provisions that require continued employment with the Company
for a period of time. As of December 31, 1998, the Company had received warrants
in client companies as set forth below:
Closing Price Expiration
Number of Exercise on December Date of
Warrants Price 31, 1998 Warrants
- -------------------------------------------------------------------------------------------------------------------
American Capital Strategies, Ltd 442,751 $ 15.000 $ 17.2500 08/29/02
Capital Automotive REIT 1,277,794 15.000 14.8750 02/12/03
Building One Services Corporation 1,130,000 20.000 20.8750 11/25/01
East West Bank 475,500 10.000 *9.8750 06/12/03
Local Financial Corporation 591,000 10.000 9.0000 09/08/02
Styling Technology Corporation 101,500 12.000 9.2500 11/21/01
FBR Asset Investment Corporation 970,805 20.000 *14.5000 12/11/07
Xypoint Corporation 285,107 2.100 *2.0000 07/10/03
UOL Publishing, Inc. 36,500 4.625 5.9375 09/16/03
Resource Asset Investment Trust 141,667 15.000 11.0000 01/08/03
* Represents the market price of the underlying unregistered security in
recent Rule 144A transaction trading.
26
MARKET AND BUSINESS RISK
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, 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.
The Company's primary risk exposure is to equity and debt price changes and
the resulting impact on the Company's marketable trading and long-term
investments. Direct market risk exposure to changes in foreign exchange rates is
not material. Equity and debt price risk is managed primarily through the daily
monitoring of capital committed to various issuers and industry segments.
TRADING SECURITIES During the first half of 1998, the Company accumulated
substantial trading positions in securities for which it acted as underwriter.
Many of these securities experienced declines in market values during 1998,
resulting in net trading losses of $59.2 million in 1998. Management has reduced
the Company's exposure to such market risk through partial or complete
liquidation of the Company's positions in many of these same securities and the
adoption of a new position limits policy. The Company's trading securities
inventory was decreased from $138.0 million at the beginning of the third
quarter to $13.1 million as of December 31, 1998, including a $38.0 million
transfer of long-term investment securities from the Company's trading accounts
to its investment portfolio. Under its new policy, the Company generally
attempts to limit exposure to market risk on securities held as a result of its
daily trading activities by limiting its intra-day and overnight inventory of
trading securities to that needed to provide the appropriate level of liquidity
in the securities for which it is a market maker.
At December 31, 1998, the fair value of the Company's trading securities
was $13.1 million in long positions and $2.9 million in short positions. The net
potential loss in fair value at December 31, 1998, using a 10% hypothetical
decline in reported value of long positions (offset by a 10% hypothetical
increase in reported value of short positions) is $1.0 million.
LONG-TERM INVESTMENTS The Company's long-term investments consist of investments
in investment partnerships that are managed by the Company, an investment in a
REIT also managed by the Company, direct debt and equity investments in
privately held companies and direct equity securities of public companies.
A majority of the underlying assets of the proprietary investment
partnerships and the REIT are equity securities of domestic, publicly traded
companies or in the case of the REIT, publicly traded mortgage-backed
securities. These underlying investments are marked to market and the Company
records its proportionate share of gains and losses. To the extent the
underlying investments of the investment partnerships, REIT and direct
investments of the Company are not marketable securities, they are valued at
estimated fair values. The effects of equity and debt price risk on these
investments were evident in the volatility of the capital markets in 1998. In
1998, the Company recorded, in earnings, net losses from investments in the
partnerships, REIT and other direct investments of $3.9 million. The Company
also recorded, as a separate component of shareholders' equity, $16.1 million of
accumulated other comprehensive loss, representing $14.6 million of unrealized
losses on direct investments held by the Company and $1.5 million of unrealized
losses related to the Company's investment in the REIT.
As of December 31, 1998, the recorded value of the Company's long-term
investment securities was $97.2 million. The net potential loss in fair value,
using a 10% hypothetical decline in reported value, is $9.7 million.
MATTERS RELATED TO YEAR 2000
The following year 2000 discussion is a "Year 2000 Readiness Disclosure"
within the meaning of the Year 2000 Information and Disclosure Act.
The Company utilizes certain software and related information technologies
that may be affected by the date change in the year 2000. The Company is also
heavily reliant on certain third parties for critical information processing,
particularly its clearing broker, Bear Stearns Securities Corporation ("Bear
Stearns"). Additionally, the Company relies on certain non-information
technology systems such as communications and building operations systems that
could also be affected by the date change. The failure of these non-information
technology systems could interrupt or shut down business operations for some
period of time.
27
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, certain date-sensitive systems may recognize the year 2000 as
1900, or not at all. This inability to recognize or properly treat the year 2000
may result in a systems failure or cause systems to process critical financial
and operational information incorrectly.
The Company has assessed and continues to assess the level of the year 2000
readiness of its internal information technology systems, those of vendors on
which it places significant reliance and its non-information technology systems.
The year 2000 plan being finalized and followed by the Company contains four
phases: phase one is the inventorying and prioritization of in-house and third
party information technology and non-information technology systems; phase two
is the diagnostic assessment of critical information technology and
non-information technology systems for year 2000 compliance; phase three is the
implementation and testing of solutions, including necessary repair work,
modifications, and replacements to system software and hardware; and phase four
is the execution of the contingency plan created during phases one through three
for those areas where residual risk is identified.
The Company continues to refine its year 2000 plan and has substantially
completed phases one and two as of March 1999. The Company expects to complete
phases three and four by the third quarter of 1999. The total cost associated
with the Company's year 2000 plan is not expected to be material to the
Company's financial position. The estimated costs of and time frames related to
completion of the remaining phases of the Company's plan are based on estimates
of the Company's management.
The Company has inquired of and obtained certain information regarding Bear
Stearns' year 2000 plans and state of readiness. Bear Stearns has indicated that
it has established a task force to review and develop an action plan to address
the year 2000 issue. Bear Stearns has indicated that its action plan addresses
both information and non-information technology issues. Bear Stearns has
indicated that it believes that the activities that it is undertaking should
satisfactorily resolve year 2000 compliance exposure within its own worldwide
systems. Bear Stearns has also indicated that they actively participate in
various industry wide testing that exercises critical systems used to interface
with third party clients and service providers.
Bear Stearns and the Company also rely heavily on various third party
systems or services to conduct business, including NASDAQ, Inc., New York Stock
Exchange, Inc. and regional and national telecommunications and market data
services providers. The Company is presently monitoring the progress of these
and other entities' year 2000 compliance. Due diligence that the Company has and
is continuing to perform to evaluate the readiness of key third party vendors
includes point to point testing with mission critical vendors, such as NASDAQ,
Instinet and Bridge, conducting interviews with key third party vendors and
analysis of compliance letters received from third party vendors. To date the
Company has not encountered a vendor that does not expect to be fully compliant
by the end of the year. In addition, the Company intends to continue monitoring
the progress of its third party vendors through any combination of the following
activities: reviewing status updates whenever provided by third party vendors,
performing additional point to point testing when third party vendors provide
this capability, and reviewing results from the Securities Industries
Association testing when made available.
To mitigate material risks due to failure resulting from year 2000 issues,
the Company is preparing contingency plans for its mission critical systems.
These plans will be finalized by the end of the third quarter of 1999. The
failure of the Company to successfully complete any remaining phase of its own
year 2000 plan, the failure of Bear Stearns or other critical service providers
to satisfactorily address the year 2000 issue, or the failure of the Company's
contingency plans to mitigate any year 2000 failures, such as the Company's
inability to submit trade orders timely and Bear Stearns' inability to clear the
Company's trades, could have a material adverse effect on the Company's
operations, liquidity and financial condition.
There can be no assurance that actual year 2000 related costs will not
differ materially from the Company's current expectations or that the proposed
time frames can be maintained. Specific factors that might cause such material
differences include, but are not limited to, the success of the Company in
identifying systems and programs that are not year 2000 ready, the nature and
amount of programming required to upgrade or replace each of the affected
programs, the availability, rate and magnitude of related labor and consulting
costs; the success of the Company's business partners, vendors and clients in
addressing the year 2000 issue and the ability to formulate and successfully
implement contingency plans, if required, and similar uncertainties.
28
FORWARD-LOOKING INFORMATION
The above discussion should be read in conjunction with "Selected
Consolidated Financial Data" and the audited Consolidated Financial Statements
as of December 31, 1996, 1997, and 1998, and the Notes thereto included
elsewhere herein. In addition to historical information, the above 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, level of AUM, and its
current equity capital levels. The risks and uncertainties relate to, among
other factors: general economic and market conditions, changes in interest
rates, loan delinquency rates, stock market volume and prices, mutual fund and
401(k) and pension plan inflows or outflows, changes in the 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. 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. For a further discussion of these risks and
uncertainties, see the Company's Annual Report on Form 10K, Item 1.
Business-Factors Affecting the Company's Business, Operating Results and
Financial Condition.
29
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
December 31, 1997 1998
- -------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 207,691,111 $ 46,827,219
Receivables:
Investment banking 7,232,104 3,075,218
Asset management fees 4,425,900 5,108,380
Income taxes -- 8,794,712
Affiliates 478,693 6,870,953
Other 1,985,838 966,712
Due from clearing broker 15,649,552 10,721,353
Marketable trading securities, at market value 78,783,748 13,149,908
Long-term investments 36,351,567 97,156,904
Furniture, equipment and leasehold improvements,
net of accumulated depreciation and amortization
of $2,197,627, and $3,466,529, respectively 3,471,325 6,945,539
Deferred tax asset 2,402,369 2,402,369
Prepaid expenses and other assets 854,561 3,096,789
- ----------------------------------------------------------------------------------------------------------------
Total assets $ 359,326,768 $ 205,116,056
- ----------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Liabilities:
Trading account securities sold but not yet purchased,
at market value $ 16,673,138 $ 2,891,602
Accounts payable and accrued expenses 30,568,390 8,225,887
Accrued compensation and benefits 19,022,798 5,185,327
Short-term subordinated revolving loans 40,000,000 --
Accrued dividends payable 24,000,000 --
Long-term secured loans 2,416,078 1,911,182
- ----------------------------------------------------------------------------------------------------------------
Total liabilities 132,680,404 18,213,998
- ----------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 12) -- --
Shareholders' equity:
Preferred Stock, $0.01 par value, 15,000,000
shares authorized, none issued and outstanding -- --
Class A Common Stock, $0.01 par value, 150,000,000
shares authorized, 13,451,421 and 13,716,571
issued, respectively 134,514 137,166
Class B Common Stock, $0.01 par value, 100,000,000
shares authorized, 36,577,579 and 36,312,429
issued and outstanding, respectively 365,776 363,124
Additional paid-in capital 208,842,802 208,525,065
Treasury stock, at cost, 910,037 shares -- (7,081,203)
Accumulated other comprehensive loss -- (16,135,903)
Retained earnings 17,303,272 1,093,809
- ----------------------------------------------------------------------------------------------------------------
Total shareholders' equity 226,646,364 186,902,058
- ----------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 359,326,768 $ 205,116,056
- ----------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
30
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1996 1997 1998
- ----------------------------------------------------------------------------------------------------------------------------
Revenues:
Underwriting $ 55,158,579 $ 142,505,579 $ 70,790,850
Corporate finance 10,361,515 60,649,324 41,355,646
Principal sales credits 31,734,357 29,275,941 30,975,600
Agency commissions 7,554,520 12,394,593 15,308,436
Trading gains and losses, net (6,268,459) (12,630,150) (59,168,246)
Investment gains and losses, net 3,974,334 3,228,302 (3,942,647)
Asset management 3,834,283 15,765,810 11,397,486
Interest and dividends 3,553,933 4,945,283 16,150,959
- ----------------------------------------------------------------------------------------------------------------------------
Total revenues 109,903,062 256,134,682 122,868,084
Expenses:
Compensation and benefits 61,503,652 156,956,983 82,599,091
Business development and
professional services 11,481,557 22,406,180 29,313,653
Clearing and brokerage fees 3,484,063 4,961,176 5,077,929
Occupancy and equipment 1,682,526 2,638,104 4,225,633
Communications 1,109,001 2,324,534 3,591,984
Interest expense 2,665,171 3,770,045 4,927,112
Other operating expenses 3,139,007 5,941,364 9,342,145
- ----------------------------------------------------------------------------------------------------------------------------
Total expenses 85,064,977 198,998,386 139,077,547
Net income (loss) before taxes 24,838,085 57,136,296 (16,209,463)
Income tax benefit -- 2,402,369 --
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 24,838,085 $ 59,538,665 $ (16,209,463)
- ----------------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings (loss) per share $ 0.67 $ 1.48 $ (0.33)
- ----------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 37,079,130 40,275,575 49,723,514
- ----------------------------------------------------------------------------------------------------------------------------
Pro forma Statements of Operations data (unaudited) (Note 2):
Net income before tax $ 24,838,085 $ 57,136,296
Pro forma income tax provision (9,960,072) (22,854,518)
- --------------------------------------------------------------------------------------------------
Pro forma net income $ 14,878,013 $ 34,281,778
- --------------------------------------------------------------------------------------------------
Pro forma basic and diluted
earnings per share $ 0.40 $ 0.85
- --------------------------------------------------------------------------------------------------
Weighted average shares outstanding 37,079,130 40,275,575
- --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
31
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
Class A Class B
- ------------------------------------------------------------------------------------------------------------------------------------
Additional Accumulated
Number Number Paid-In Treasury Other Compre-
of Shares Amount of Shares Amount Capital Stock hensive Loss
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1995 -- $ -- 35,271,060 $352,711 $ 16,589,097 $ -- $ --
Net income -- -- -- -- -- -- --
Comprehensive income -- -- -- -- -- -- --
Issuance of common stock -- -- 2,183,940 21,839 1,156,243 -- --
Capital contributions -- -- -- -- 898,865 -- --
Repayment of stock
subscription receivable -- -- -- -- -- -- --
Distributions -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1996 -- -- 37,455,000 374,550 18,644,205 -- --
Net income -- -- -- -- -- -- --
Comprehensive income -- -- -- -- -- -- --
Issuance of common stock -- -- 2,574,000 25,740 3,658,123 -- --
Capital contributions -- -- -- -- 176,382 -- --
Repayment of stock
subscription receivable -- -- -- -- -- -- --
Issuance of common stock in
initial public offering,
net of offering costs 10,000,000 100,000 -- -- 184,947,378 -- --
Conversion of Class B
common stock upon
sale to third party 3,451,421 34,514 (3,451,421) (34,514) -- -- --
Compensation recorded
pursuant to book
value stock issued in 1997 -- -- -- -- 1,416,714 -- --
Distributions -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1997 13,451,421 134,514 36,577,579 365,776 208,842,802 -- --
Net loss -- -- -- -- -- -- --
Conversion of Class B shares to
Class A shares 265,150 2,652 (265,150) (2,652) -- -- --
Repurchase of treasury stock -- -- -- -- -- (8,061,911) --
Issuance of treasury stock -- -- -- -- (317,737) 980,708 --
Other comprehensive loss:
Unrealized loss on
investment securities -- -- -- -- -- -- (16,135,903)
Comprehensive loss -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1998 13,716,571 $137,166 36,312,429 $363,124 $208,525,065 $(7,081,203) $(16,135,903)
- ------------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
Stock Retained Comprehensive
Subscriptions Earnings Income
Receivable (Deficit) Total (Loss)
- ---------------------------------------------------------------------------------------------
Balances, December 31, 1995 $ (67,444) $ 6,397,104 $23,271,468
Net income -- 24,838,085 24,838,085 $ 24,838,085
------------
Comprehensive income -- -- -- $ 24,838,085
------------
Issuance of common stock (251,427) -- 926,655
Capital contributions -- -- 898,865
Repayment of stock
subscription receivable 23,976 -- 23,976
Distributions -- (900,000) (900,000)
- ---------------------------------------------------------------------------------------------
Balances, December 31, 1996 (294,895) 30,335,189 49,059,049
Net income -- 59,538,665 59,538,665 $ 59,538,665
------------
Comprehensive income -- -- -- $ 59,538,665
------------
Issuance of common stock (292,111) -- 3,391,752
Capital contributions -- -- 176,382
Repayment of stock
subscription receivable 587,006 -- 587,006
Issuance of common stock in
initial public offering,
net of offering costs -- -- 185,047,378
Conversion of Class B
common stock upon
sale to third party -- -- --
Compensation recorded
pursuant to book
value stock issued in 1997 -- -- 1,416,714
Distributions -- (72,570,582) (72,570,582)
- ------------------------------------------------------------------------------
Balances, December 31, 1997 -- 17,303,272 226,646,364
Net loss -- (16,209,463) (16,209,463) $(16,209,463)
Conversion of Class B shares to
Class A shares -- -- --
Repurchase of treasury stock -- -- (8,061,911)
Issuance of treasury stock -- -- 662,971
Other comprehensive loss:
Unrealized loss on
investment securities -- -- (16,135,903) (16,135,903)
-------------
Comprehensive loss -- -- -- $(32,345,366)
- ------------------------------------------------------------------------------ -------------
Balances, December 31, 1998 $ -- $ 1,093,809 $186,902,058
- ------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
32
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------------------------------------------------------------
Years Ended December 31, 1996 1997 1998
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ 24,838,085 $ 59,538,665 $ (16,209,463)
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities-
(Income) loss and incentive
income on long-term investments (3,974,352) (13,561,542) 101,192
Depreciation and amortization 625,167 883,508 1,390,355
Loss on disposition of assets 53,249 -- --
Compensation recorded pursuant to book
value stock issuance -- 1,416,714 --
Deferred income taxes -- (2,402,369) --
Changes in operating assets:
Receivables-
Investment banking (7,177,291) 69,270 4,156,886
Asset management fees 3,766,524 (2,989,063) (1,287,569)
Income taxes -- -- (8,794,712)
Affiliates (271,114) (207,579) (6,392,260)
Other (104,830) (1,754,286) 1,019,126
Due from clearing broker (18,721,627) (5,949,168) 4,366,826
Marketable trading securities (22,491,427) (23,770,900) 26,699,240
Prepaid expenses and other assets (129,289) 736,669 (1,621,273)
Insurance deposit (5,716,929) 9,416,929 --
Changes in operating liabilities:
Trading account securities sold
but not yet purchased 33,441,401 (23,140,673) (13,411,503)
Net proceeds from (repayments on)
short-term subordinated loans 5,000,000 25,000,000 (40,000,000)
Proceeds from (repayments on)
short-term line of credit 3,750,000 (7,000,000) --
Accounts payable and accrued expenses (3,823,630) 21,402,003 (22,963,458)
Accrued compensation and benefits 1,966,926 15,538,029 (13,837,471)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in)
operating activities 11,030,863 53,226,207 (86,784,084)
=======================================================================================================================
Cash flows from investing activities:
Purchases of fixed assets (1,798,153) (1,251,830) (4,864,569)
Purchases of long-term investments, net (500,000) (16,365,616) (37,311,403)
Sales of short-term investments, net 7,900 10,267,710 --
- -----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (2,290,253) (7,349,736) (42,175,972)
=======================================================================================================================
Cash flows from financing activities:
Borrowings of long-term secured loans 1,126,627 850,000 --
Repayments of long-term secured loans (155,510) (348,053) (504,896)
Proceeds from issuance of common stock,
net of repayments on stock
subscriptions receivable 950,631 189,026,136 --
Purchases of treasury stock -- -- (8,061,911)
Issuance of treasury stock -- -- 662,971
Capital contributions 527,615 176,382 --
Distributions (900,000) (48,570,582) (24,000,000)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in)
financing activities 1,549,363 141,133,883 (31,903,836)
=======================================================================================================================
Net increase (decrease) in cash and
cash equivalents 10,289,973 187,010,354 (160,863,892)
Cash and cash equivalents, beginning of year 10,390,784 20,680,757 207,691,111
- -----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 20,680,757 $ 207,691,111 $ 46,827,219
=======================================================================================================================
The accompanying notes are an integral part of these consolidated statements.
33
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION, NATURE OF OPERATIONS AND SEGMENT INFORMATION:
ORGANIZATION Friedman, Billings, Ramsey Group, Inc., a Virginia corporation (the
"Company"), is the sole parent holding company of two subsidiary holding
companies. The principal respective subsidiaries are Friedman, Billings, Ramsey
& Co., Inc. ("FBRC"), a registered broker-dealer, and Friedman, Billings, Ramsey
Investment Management Company ("FBRIM"), a registered investment adviser. All of
the operating subsidiaries of the Company 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 and forwards all such transactions to a
clearing broker on a fully disclosed basis. FBRC does not hold funds or
securities for, nor 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. During the periods
presented, FBRC's underwriting and corporate finance activities were
concentrated primarily on bank, thrift and specialty finance institutions,
technology companies and real estate investment trusts ("REITS").
FBRIM is a registered investment adviser that acts as the general partner
of proprietary investment limited partnerships and also manages separate
investment accounts and FBR Asset Investment Corporation ("FBR-Asset"), a REIT.
Effective January 1, 1997, the Company restructured to simplify the
ownership structure of the Operating Entities and to form groups of companies in
similar business activities. As a result, all of the shareholders of the then
existing Operating Entities exchanged their outstanding stock for ownership of
the Company. As there was no change in relative ownership or assets, the
exchange lacked economic substance. Therefore, the assets and liabilities of the
Company are recorded at their historical carrying amounts. As a result of the
common ownership both prior to and subsequent to the exchange, the financial
statements for the year ended December 31, 1996 include the combined operations
of the Operating Entities.
NATURE OF OPERATIONS The Company is 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, the risks of
reduced revenues in periods of reduced demand for security offerings and
activity in secondary trading markets and the risks of liability of litigation.
Changing economic and market trends have negatively impacted the liquidity and
value of the Company's investments and the level of security offerings
underwritten which in turn have adversely affected the Company's revenues and
profitability.
CONCENTRATION 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 24% of the Company's revenues for the year ended
December 31, 1997. Two unrelated investment banking transactions accounted for
33% of the Company's revenues for the year ended December 31, 1998.
The Company's investment in FBR-Asset of $23.7 million represented 24% and
12% of the Company's long-term investment securities and assets, respectively,
as of December 31, 1998. A debt investment in a privately held company totaling
$10 million represented 10% and 5% of the Company's long-term investment
securities and assets, respectively, as of December 31, 1998.
SEGMENT INFORMATION In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and
Related Information," the Company considers its capital markets and asset
management operations to be two separate reportable segments. Segment assets are
identifiable assets that can be directly associated with the segments. Parent
company assets, liabilities and income, such as cash equivalents, income taxes
and interest income are not allocated to the segments and, therefore, are
included in the
34
"other" column in the following tables. The accounting policies of these
segments are the same as those described in Note 2. There are no significant
revenue transactions between the two segments. The following tables illustrate
the financial information for both segments for the years indicated:
Capital Asset Consolidated
Markets Management Other Totals
- -------------------------------------------------------------------------------------------------------------------------
1996
- -------------------------------------------------------------------------------------------------------------------------
Total revenues $102,049,309 $ 7,853,753 $ -- $109,903,062
Compensation and benefits 59,429,762 2,073,890 -- 61,503,652
Total expenses 82,146,005 2,918,972 -- 85,064,977
Pre-tax income 19,903,304 4,934,781 -- 24,838,085
Total assets 115,547,486 9,890,661 -- 125,438,147
Total net assets 39,475,551 9,583,498 -- 49,059,049
Capital Asset Consolidated
Markets Management Other Totals
- -------------------------------------------------------------------------------------------------------------------------
1997
- -------------------------------------------------------------------------------------------------------------------------
Total revenues $236,998,214 $ 19,136,468 $ -- $256,134,682
Compensation and benefits 151,951,723 3,588,546 1,416,714(1) 156,956,983
Total expenses 192,451,489 5,130,183 1,416,714(1) 198,998,386
Pre-tax income (loss) 44,546,725 14,006,285 (1,416,714)(1) 57,136,296
Total assets 227,621,245 39,535,301 92,170,222 359,326,768
Total net assets 122,178,573 38,025,637 66,442,154 226,646,364
Capital Asset Consolidated
Markets Management Other Totals
- -------------------------------------------------------------------------------------------------------------------------
1998
- -------------------------------------------------------------------------------------------------------------------------
Total revenues $111,214,639 $ 8,388,581 $ 3,264,864 $122,868,084
Compensation and benefits 77,171,017 5,428,074 -- 82,599,091
Total expenses 131,019,704 6,690,463 1,367,380 139,077,547
Pre-tax income (loss) (19,805,065) 1,698,118 1,897,484 (16,209,463)
Total assets 83,044,119 97,512,795 24,559,142 205,116,056
Total net assets 66,746,921 95,810,138 24,344,999 186,902,058
(1) Compensation recorded pursuant to book value stock issued in 1997.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION All significant intercompany accounts and
transactions have been eliminated in consolidation.
CASH EQUIVALENTS AND SUPPLEMENTAL CASH FLOW INFORMATION Cash equivalents include
demand deposits with banks, money market accounts and highly liquid investments
with original maturities of three months or less that are not held for sale in
the ordinary course of business. Approximately 80% of the Company's cash
equivalents are invested in a money market fund that invests primarily in U.S.
Treasuries and other government securities, backed by the U.S. government. Cash
payments for interest approximated interest expense for the years ended December
31, 1996, 1997, and 1998. The Company paid $8,794,712 of estimated income tax
payments in 1998. The following table illustrates non-cash investing and
financing activities for the years indicated:
1996 1997 1998
- -------------------------------------------------------------------------------------------------------
Accrued distributions as of December 31, 1997, paid in 1998 $-- $24,000,000 $ --
Transfer of investment securities from marketable trading securities.
to long-term investments (Note 5) -- -- 38,034,656
35
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 trading gains and losses in the Statements of Operations. Other
marketable securities held in non-broker-dealer entities are classified as
available-for-sale investments, in accordance with SFAS No. 115, and are valued
at market with resulting unrealized gains and losses reflected in other
comprehensive loss. Declines in the value of available-for-sale investments that
are other than temporary would be recorded in earnings. No such declines have
been recorded in earnings. Investments in proprietary investment partnerships
and FBR-Asset are accounted for under the equity method and the Company's
proportionate share of income or loss ("income allocation") is reflected in
investment gains and losses in the Statements of Operations.
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Furniture and equipment are
depreciated using the straight-line method over their estimated useful lives of
three to ten years. Leasehold improvements are amortized using the straight-line
method over the shorter of the useful life or lease term. Amortization of
purchased software is recorded over the estimated useful life of three years.
OTHER COMPREHENSIVE LOSS In June 1997, the Financial Accounting Standards Board
issued SFAS No. 130, "Reporting Comprehensive Income." 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. Accumulated other comprehensive loss presented on
the accompanying consolidated balance sheets consists of the accumulated net
unrealized loss on available-for-sale investments.
INCOME TAXES Deferred tax assets and liabilities represent the differences
between the financial statement and income tax bases of assets and liabilities,
using enacted tax rates. The measurement of net deferred tax assets is adjusted
by a valuation allowance if, based on the weight of available evidence, it is
more likely than not that they will not be realized.
REVENUES Underwriting fees are recorded as revenue at the time the underwriting
is completed (generally trade date) and the income is reasonably determinable.
Corporate finance and advisory fees are recorded as revenue when the related
services have been rendered and the client is contractually obligated to pay.
Securities transactions and related commission income and expenses are
recorded on a trade date basis.
Certain of the Company's subsidiaries act as investment advisers and
receive management fees for the management of proprietary investment
partnerships, mutual funds and FBR-Asset, based upon the amount of assets under
management, as well as incentive income based upon the operating results of the
partnerships. Incentive income is calculated on at least an annual period that
generally coincides with the calendar year. Incentive income is recorded in
asset management revenues in the Statements of Operations.
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 $7.3 million of prior year bonus accruals during the
year ended December 31, 1998. All of the Company's compensation plans are
reviewed and evaluated on a quarterly basis.
STOCK OPTION PLANS The Company accounts for stock-based compensation in
accordance with SFAS No.123, "Accounting for Stock-Based Compensation." Pursuant
to SFAS No. 123, the Company continues to apply the provisions of Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees." Under APB No. 25, compensation expense is recorded for the
difference, if any, between the fair market value of the common stock on the
date of grant and the exercise price of the option. For the years ended December
31, 1997 and 1998, the exercise prices of all options granted equaled the market
prices on the dates of grants, therefore, the Company did not record any
compensation expense in 1997 and 1998 related to option grants.
The Company provides pro forma net income (loss) and pro forma earnings
(loss) per share disclosures for employee stock option grants as if the
fair-value-based method, defined in SFAS No. 123, had been applied.
EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share includes no dilution
and is computed by dividing net income or loss available to common shareholders
by the weighted-average number of common shares outstanding for the period.
Diluted earnings (loss) per share includes the impact of dilutive securities
such as options. For the years ended December 31, 1997 and 1998, there is no
difference between basic and diluted historical and pro forma earnings or loss
per share as the impact of options was anti-dilutive. As of December 31, 1996,
there were no options outstanding.
36
In February 1998, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 98 ("SAB 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.
PRO FORMA EARNINGS PER SHARE (UNAUDITED) In conjunction with the Company's
initial public offering in December 1997, the Company terminated its status as a
subchapter S corporation. Pro forma earnings per share for 1996 and 1997 is
based on the assumption that the Company's subchapter S corporation status was
terminated at the beginning of each year. Accordingly, the Company has provided
income taxes on a pro forma basis as if it were a subchapter C corporation for
1996 and 1997.
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.
RECLASSIFICATIONS Certain amounts in 1996 and 1997 have been reclassified to
conform to the 1998 presentation.
NOTE 3. RECEIVABLES FROM AFFILIATES:
Under the 1997 Stock and Annual Incentive Plan (the "1997 Plan"), executive
officers and certain other employees are eligible to participate in a bonus pool
based on net income before taxes. During the year ended December 31, 1998, the
Company made periodic advances totaling $6.0 million to certain executive
officers of the Company against the 1997 Plan. For the year ended December 31,
1998, the Company generated a net loss, therefore, the advances were converted
to notes and are classified as receivables from affiliates in the accompanying
consolidated balance sheets. The notes earn interest at a 5.41% annual rate and
are due on December 31, 1999.
NOTE 4. MARKETABLE TRADING SECURITIES OWNED AND SECURITIES SOLD BUT NOT YET
PURCHASED:
Marketable trading securities owned and trading account securities sold but
not yet purchased consist of securities at market values for the years
indicated:
December 31, 1997 1998
- --------------------------------------------------------------------------------------------
Sold But Not Sold But Not
Owned Yet Purchased Owned Yet Purchased
- --------------------------------------------------------------------------------------------
Corporate stocks $60,298,321 $10,725,928 $ 8,708,950 $ 2,526,482
Corporate bonds 18,485,427 5,947,210 4,440,958 365,120
- --------------------------------------------------------------------------------------------
$78,783,748 $16,673,138 $13,149,908 $ 2,891,602
- --------------------------------------------------------------------------------------------
Trading account securities sold but not yet purchased represent obligations
of the Company to deliver the specified security at the contracted price, and
thereby, creates a liability to purchase the security in the market at
prevailing prices. Accordingly, these transactions result in off-balance-sheet
risk as the Company's ultimate obligation to satisfy the sale of securities sold
but not yet purchased may exceed the current value recorded in the consolidated
balance sheets.
NOTE 5. LONG-TERM INVESTMENTS:
Long-term investments consisted of the following for the years indicated:
December 31, 1997 1998
- --------------------------------------------------------------------------
Proprietary investment partnerships $21,300,567 $26,671,380
FBR-Asset 15,051,000 23,690,112
FBR Business Development investments -- 24,878,813
Available-for-sale securities -- 19,916,599
Other debt -- 2,000,000
- --------------------------------------------------------------------------
$36,351,567 $97,156,904
- --------------------------------------------------------------------------
37
PROPRIETARY INVESTMENT PARTNERSHIPS FBRIM is the managing partner or member of
FBR Ashton, L.P., FBR Weston, L.P., FBR Braddock, L.P., FBR Future Financial
Fund, L.P., FBR Private Equity Fund, L.P., FBR Arbitrage, L.L.C. and through a
wholly-owned L.L.C., FBR Financial Fund II, L.P. FBR Venture Capital Managers,
Inc., a wholly-owned subsidiary of the Company, is the managing partner of FBR
Technology Venture Partners, L.P. All of these partnerships were formed for the
purpose of investing in public and private securities, therefore, their assets
principally consist of investment securities accounted for at fair value. The
Company accounts for its investments in these partnerships under the equity
method. The following table shows the Company's investments and ownership
interests:
December 31, 1997 1998
- ---------------------------------------------------------------------------------------
FBR Ashton, L.P. $15,425,834 10% $12,192,297 13%
FBR Weston, L.P. 1,024,954 10% 1,289,695 6%
FBR Braddock, L.P. 1,709,026 12% 3,204,071 9%
FBR Private Equity Fund, L.P. 1,664,972 8% 2,344,988 12%
FBR Arbitrage, L.L.C -- -- 5,949,259 41%
Other 1,475,781 -- 1,691,070 --
- ---------------------------------------------------------------------------------------
$21,300,567 $26,671,380
- ---------------------------------------------------------------------------------------
FBR-ASSET FBR-Asset is a REIT, formed in 1997, whose primary purpose is to
invest in mortgage loans, mortgage-backed securities and public and private real
estate companies. As of December 31, 1998, 55% and 24% of FBR-Asset's assets
were invested in mortgage-backed securities and equity securities, respectively.
FBR-Asset classifies its investments as available-for-sale in accordance with
SFAS No. 115. Accordingly, unrealized gains and losses related to securities are
reflected as other comprehensive loss in FBR-Asset's equity. The Company
accounts for its investment in FBR-Asset under the equity method. As a result,
the Company recorded $1,109,467 in net investment gains in the Statement of
Operations for its proportionate share of FBR-Asset's 1998 net income. In
addition, during 1998, the Company reduced its carrying basis of FBR-Asset for
declared dividends of $887,097. The Company also recorded, in other
comprehensive loss, $1,532,258 of net unrealized loss on investments which
represented its proportionate share of FBR-Asset's net unrealized loss related
to available-for-sale securities, as of December 31, 1998. The Company's
ownership percentage of FBR-Asset was 16% as of December 31, 1998. The following
table summarizes FBR-Asset's financial information:
December 31, 1997 1998
- -----------------------------------------------------------------------
Total assets $190,538,402 $295,930,620
Total liabilities 771,573 145,026,041
Gross revenues 721,277 17,927,502
Income before realized losses 646,921 9,958,042
Net income 646,921 1,588,235
FBR BUSINESS DEVELOPMENT FUND ("FBR-BDF") FBR-BDF, a wholly-owned subsidiary of
the Company, was organized in May 1998 as a business trust designed to extend
financing to "middle-market" businesses in need of subordinated debt or
mezzanine financing. In connection therewith, the Company loaned $17.5 million
to two unrelated businesses at an annual interest rate of 12.7%. The loans
mature as follows: $7.5 million in June 2003 and $10.0 million in December 2005.
The Company also invested $7.0 million in an unaffiliated private company. These
investments are carried at cost which approximates estimated fair values.
AVAILABLE-FOR-SALE SECURITIES The Company's available-for-sale securities
consist primarily of equity investments in publicly traded companies. During
1998, these securities were transferred from FBRC's trading accounts to an asset
management subsidiary of the Company at their then fair market value of
$38,034,656. The transfer was made because the Company plans to hold these
securities and the sale of certain of them is restricted. In addition, market
blockage and haircut charges related to these securities, as defined in SEC Rule
15c3-1, reduced FBRC's regulatory net capital by up to $33 million in the third
quarter of 1998. In accordance with SFAS No. 115, the securities are valued at
market with resulting unrealized gains and losses reflected as other
comprehensive loss. Following the transfer, $3,625,412 of the securities were
sold for $2,650,900 resulting in a realized investment loss of $974,512
reflected in the Company's earnings. As of December 31, 1998, the unrealized
loss related to these securities was $14,668,390 and is included in other
comprehensive loss.
38
- --------------------------------------------------------------------------------
NOTE 6. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
Furniture, equipment and leasehold improvements, summarized by major
classification, are as follows:
December 31, 1997 1998
- --------------------------------------------------------------------------------
Furniture and equipment $ 4,196,497 $ 5,934,155
Leasehold improvements 1,472,455 4,477,913
- --------------------------------------------------------------------------------
5,668,952 10,412,068
Less-Accumulated depreciation and amortization (2,197,627) (3,466,529)
- --------------------------------------------------------------------------------
$ 3,471,325 $ 6,945,539
- --------------------------------------------------------------------------------
NOTE 7. INCOME TAXES:
Through December 20, 1997, the Company and its primary subsidiaries had
elected to be taxed as subchapter S corporations under the Internal Revenue
Code. As a result, there is no provision for income taxes in these financial
statements for the period prior to December 21, 1997.
For the year ended December 31, 1998, the Company's pre-tax loss was
$16,209,463. As of December 31, 1998, the Company's deferred tax asset relating
to net operating loss ("NOL") carryforwards was $10,222,564. The Company
recorded a valuation allowance of $5,483,659 in 1998 resulting in a net NOL
balance of $4,738,905. The Company also had a deferred tax liability of
$2,336,536 primarily related to unrealized investment gains on proprietary
investment partnerships. As a result of recording a valuation allowance in 1998
for the NOL, the Company did not have any income tax expense or benefit in the
Statement of Operations for the year ended December 31, 1998.
The Company also recorded a $6,460,819 valuation allowance against the
deferred tax asset relating to unrealized losses on investment securities
accounted for under SFAS No. 115. This allowance was recorded in accumulated
other comprehensive loss, in accordance with SFAS No. 115.
The benefit for income taxes results in effective tax rates that differ
from the Federal statutory rates as follows:
December 31, 1997 1998
- --------------------------------------------------------------------------------
Statutory Federal income tax rate 35% (35)%
State income taxes, net of Federal benefit 5 (5)
Subchapter S corporation income not taxable to the Company (31) --
Recognition of deferred tax assets upon termination
of subchapter S corporation status (13) --
Nondeductible expenses -- 6
Valuation allowance -- 34
- --------------------------------------------------------------------------------
Effective income tax rate (4)% --
- --------------------------------------------------------------------------------
Significant components of the Company's deferred taxes are as follows:
December 31, 1997 1998
- -------------------------------------------------------------------------------------------------------------
Unrealized investment gains on proprietary investment partnerships $ (4,837,866) $ (2,336,536)
Unrealized investment losses on available-for-sale securities -- 6,460,819
Net operating losses 3,482,704 10,222,564
Accrued compensation 3,469,928 100,000
Other 287,603 (20,425)
- -------------------------------------------------------------------------------------------------------------
2,402,369 14,426,422
Less-Valuation allowance -- (12,024,053)
- -------------------------------------------------------------------------------------------------------------
Net deferred tax assets $ 2,402,369 $ 2,402,369
- -------------------------------------------------------------------------------------------------------------
39
- --------------------------------------------------------------------------------
The Company has NOL tax carryforwards of $25,633,311 that expire through
2013.
NOTE 8. PROFIT SHARING PLAN:
The Company maintains a qualified 401(k) profit sharing plan. Eligible
employees may defer a portion of their salary. At the discretion of the Board of
Directors, the Company may make matching contributions and discretionary
contributions from profits. There were no Company contributions made in 1996,
1997 or 1998.
NOTE 9. BORROWINGS:
SUBORDINATED REVOLVING LOANS As of December 31, 1997, FBRC had three unsecured
revolving subordinated loan agreements, with total available credit of $40
million, with its clearing broker and an affiliate of its clearing broker. The
purpose of these lines was to make additional funds available to meet regulatory
net capital requirements for participation in underwriting public offerings. As
of December 31, 1997, $40 million was outstanding with an interest rate equal to
the broker call rate plus 2% or 8.5%. During 1998, the entire outstanding
balance was repaid. In addition, the three lines were converted to one agreement
("new line") with an affiliate of FBRC's clearing broker. The expiration date of
the new line is December 1999. There were no outstanding balances under the new
line as of December 31, 1998. Revolving subordinated loan agreements are
available in computing net capital under the SEC's Uniform Net Capital Rule
(Rule 15c3-1).
LONG-TERM LOANS The Company has four long-term secured loans requiring fixed
annual principal and interest payments totaling $673,000. Each loan bears
interest at an annual rate equal to the one-month commercial paper rate, as
published by the Federal Reserve Board, that equaled 7.97% and 7.48% at December
31, 1997 and 1998, respectively. The loans are collateralized by certain
furniture, equipment, and leasehold improvements of the Company. The loans are
scheduled to be entirely repaid in June 2001, October 2001, January 2002, and
November 2002, respectively.
NOTE 10. NET CAPITAL COMPUTATION:
FBRC is subject to the SEC's Uniform Net Capital Rule (Rule 15c3-1), that
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 December 31, 1998, FBRC had net capital of $37,015,102 which was
$36,015,102 in excess of its required net capital of $1,000,000. FBRC's
aggregate indebtedness to net capital ratio was 0.3 to 1 at December 31, 1998.
NOTE 11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CREDIT RISK:
FINANCIAL INSTRUMENTS The Company's Capital Markets segment trades securities
that are primarily traded in United States markets. The Company's Asset
Management segment also trades and invests in public and non-public securities.
As of December 31, 1998, the Company had not entered into any transactions
involving financial instruments, such as financial futures, forward contracts,
options, swaps or derivatives, that would expose the Company to significant
related off-balance-sheet risk.
Market risk is primarily caused by movements in market prices of the
Company's trading and investment account securities, in addition to interest
rate volatility and possible illiquidity in markets in which the Company trades.
The Company seeks to control market risk through monitoring procedures. The
Company's principal transactions are primarily short and long debt and equity
transactions.
Positions taken and commitments made by the Company, including those made
in connection with investment banking activities, have resulted in substantial
amounts of exposure to individual issuers and businesses, including
non-investment grade issuers and securities with low trading volumes. These
issuers and securities expose the Company to a higher degree of risk than
associated with investment grade instruments.
Credit Risk The Company's Capital Markets subsidiaries function as introducing
brokers that place and execute customer orders. The orders are then settled by
an unrelated clearing organization that maintains custody of customers'
securities and provides financing to customers.
Through indemnification provisions in agreements with clearing
organizations, customer activities may expose the Capital Markets segment to
off-balance-sheet credit risk. Financial instruments may have to be purchased or
sold at prevailing market prices in the event a customer fails to settle a trade
on its original terms or in the event cash and securities in customer margin
accounts are not sufficient to fully cover customer losses. The
40
- --------------------------------------------------------------------------------
Capital Markets segment seeks to control the risks associated with customer
activities through customer screening and selection procedures as well as
through requirements on customers to maintain margin collateral in compliance
with various regulations and clearing organization policies.
The Company's other equity and debt investments include non-investment
grade securities of privately held issuers with no ready markets. The
concentration and illiquidity of these investments expose the Company to a
higher degree of risk than associated with readily marketable securities.
NOTE 12. 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 ending December
31, 1999 through 2003 and the aggregate amount thereafter, are as follows:
Year Ending December 31,
- --------------------------------------------------------------------------------
1999 $ 2,651,932
2000 2,646,589
2001 2,605,932
2002 2,245,162
2003 2,134,260
Thereafter 870,490
- --------------------------------------------------------------------------------
$13,154,365
- --------------------------------------------------------------------------------
Equipment and office rent expense for 1996, 1997 and 1998 was $941,000,
$1,274,000 and $2,430,000, respectively.
LITIGATION 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 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.
Many aspects of the Company's business involve substantial risks of
liability. An underwriter is exposed to 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. Broker-dealers and asset managers may
also be held liable by customers and clients for losses sustained on
investments. The Company is also subject to the risk of litigation and
arbitration, including litigation and arbitration that may be without merit. As
the Company intends actively to defend such litigation and arbitration,
significant legal expenses could be incurred. An adverse resolution of any
future lawsuits and arbitration against the Company could materially affect the
Company's operating results and financial condition.
NOTE 13. SHAREHOLDERS' EQUITY:
The Company has authorized share capital of 100 million shares of Class B
Common Stock, par value $0.01 per share; 150 million shares of Class A Common
Stock, par value $0.01 per share; and 15 million shares of undesignated
preferred stock. Holders of the Class A and Class B Common Stock are entitled to
one vote and three votes per share, respectively, on all matters voted upon by
the shareholders. Shares of Class B Common Stock convert to shares of Class A
Common Stock at the option of the Company in certain circumstances including (i)
upon sale or other transfer, (ii) at the time the holder of such shares of Class
B Common Stock ceases to be affiliated with the Company and (iii) upon the sale
of such shares in a registered public offering. The Company's Board of Directors
has the authority, without further action by the shareholders, to issue
preferred stock in one or more series and to fix the terms and rights of the
preferred stock. Such actions by the Board of Directors could adversely affect
the voting power and other rights of the holders of common stock. Preferred
stock could thus be issued quickly with
41
- --------------------------------------------------------------------------------
terms that could delay or prevent a change in control of the Company or make
removal of management more difficult. At present, the Company has no plans to
issue any of the preferred stock.
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. Participants include employees and officers of
the Company and its subsidiaries. The 1997 Plan has a term of 10 years and
options granted have an exercise period of up to 10 years. Options may be
incentive stock options, defined by Section 422 of the Code, or nonqualified
stock options, although incentive stock options may be granted only to
employees. All incentive stock options are nontransferable other than by will or
the laws of descent and distribution. Details of stock options granted in 1997
and 1998 are as follows:
Number Exercise
of Shares Price
- --------------------------------------------------------------------------------
Outstanding as of December 31, 1996 -- --
Granted in 1997 4,383,400 $20.00
- --------------------------------------------------------------------------------
Outstanding as of December 31, 1997 4,383,400 $20.00
Granted in 1998 2,160,280 $5.875 - $19.625
Canceled in 1998 upon departure of employees (293,200) $5.875 - $20.00
- --------------------------------------------------------------------------------
Outstanding as of December 31, 1998 6,250,480 $5.875 - $20.00
- --------------------------------------------------------------------------------
All options granted in 1997 and 70,780 of the options granted in 1998
become exercisable as follows: 10%, 40%, and 50% at the end of three, four, and
five years, respectively. The remainder of the grants in 1998, 2,089,500
options, become exercisable ratably over the first three years. As of December
31, 1998, the weighted average exercise price and remaining contractual life of
options outstanding was $15.25 and 9.3 years, respectively.
The Company applies APB Opinion No. 25 in accounting for the 1997 Plan and,
accordingly, does not recognize any compensation cost associated with the 1997
Plan in the consolidated financial statements. Had the Company determined
compensation cost based on the fair value at the grant date for its options,
under SFAS No. 123, the Company's pro forma net loss and pro forma basic and
diluted loss per share for 1998 would have been $21,900,245 and $0.44,
respectively. Due to the proximity of 1997 grants to December 31, 1997, pro
forma basic and diluted earnings per share for 1997 is the same as that
reported.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for options granted during 1997 and 1998, respectively: no
dividend yield , expected volatility of 50% and 65%, risk-free interest rate of
5.7% and 4.5% and an expected life of five years for all grants. The weighted
average fair value of options granted during 1997 and 1998 was $10.09 and $3.57,
respectively, per share.
DIRECTOR STOCK COMPENSATION PLAN Under the Director Stock Compensation Plan (the
"Director 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. Options granted under the Director Plan will vest upon the
first anniversary of the grant and are exercisable up to 10 years from the date
of grant. All options and stock awarded under the Director Plan are
nontransferable other than by will or the laws of descent and distribution.
During 1997 and 1998, the Company granted 40,000 and 6,000 options,
respectively, under the Director Plan.
EMPLOYEE STOCK PURCHASE PLAN Employees began participating in the 1997 Employee
Stock Purchase Plan (the "Purchase Plan") on September 1, 1998. Under this
Purchase Plan, one million shares of Class A Common Stock are reserved for
issuance. The Purchase Plan permits eligible employees to purchase common stock
through payroll deductions at a price equal to 85% of the lower of the market
value of the common stock on the first day of the offering period or the last
day of the offering period. The Purchase Plan does not result in compensation
expense. As of December 31, 1998, 126,055 shares were issued under the Purchase
Plan for $662,971.
TREASURY STOCK 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 (the "Repurchase Plan"). In accordance with the Repurchase Plan, a
portion of the stock acquired may be used for the three stock-based compensation
plans described previously. As of December 31, 1998, the Company's treasury
stock consists of stock purchased in the
42
- --------------------------------------------------------------------------------
open market at cost. Treasury stock issuances relate to issuances of common
stock pursuant to the Employee Stock Purchase Plan. Differences between the
average cost of the treasury stock and the sales price of the shares issued are
charged to additional paid-in capital. During 1998, the Company's treasury stock
transactions were as follows:
Shares Cost
- --------------------------------------------------------------------------------
Outstanding at December 31, 1997 -- $ --
Open market purchases 1,036,092 8,061,911
Employee Stock Purchase Plan issuances (126,055) (980,708)
- --------------------------------------------------------------------------------
Outstanding at December 31, 1998 910,037 $ 7,081,203
- --------------------------------------------------------------------------------
NOTE 14. QUARTERLY DATA (UNAUDITED):
The following tables set forth selected information for each of the fiscal
quarters during the years ended December 31, 1997 and 1998 (dollars in
thousands, except per share data). The selected quarterly data is derived from
unaudited financial statements of the Company and has been prepared on the same
basis as the annual, audited financial statements to include, in the opinion of
management, all adjustments (consisting of only normal recurring adjustments)
necessary for fair presentation of the results for such periods.
Pro forma/(1)/
Basic and Basic and
Diluted Diluted
Total Pro forma/(1)/ Earnings Earnings
1997 Revenues Net Income Net Income Per Share/(2)/ Per Share/(2)/
- ----------------------------------------------------------------------------------------------------------
First Quarter $ 29,044 $ 2,262 $ 1,357 $ 0.06 $ 0.03
Second Quarter 37,641 4,020 2,412 0.10 0.06
Third Quarter 68,233 17,548 10,529 0.44 0.26
Fourth Quarter 121,217 35,708 19,984 0.87 0.49
- ----------------------------------------------------------------------------------------------------------
Total Year $256,135 $ 59,538 $ 34,282 $ 1.48 $ 0.85
- ----------------------------------------------------------------------------------------------------------
(1) Pro forma net income and pro forma earnings per share include taxes on S
corporation earnings at an effective rate of 40%.
(2) The sum of the quarters' pro forma earnings per share do not always equal
the total year amounts due to the effect of averaging the number of shares
of common stock throughout the year.
Basic and
Net Income Diluted
Total (Loss) Before Net Income Earnings (Loss)
1998 Revenues Income Taxes (Loss) Per Share
- ----------------------------------------------------------------------------------------
First Quarter $ 67,984 $ 25,736 $ 15,579 $ 0.31
Second Quarter 57,334 12,593 7,433 0.15
Third Quarter (21,509) (50,729) (35,412) (0.71)
Fourth Quarter 19,059 (3,809) (3,809) (0.08)
- ----------------------------------------------------------------------------------------
Total Year $122,868 $(16,209) $(16,209) $ (0.33)
- ----------------------------------------------------------------------------------------
43
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Friedman, Billings, Ramsey Group, Inc.:
We have audited the accompanying consolidated balance sheets of Friedman,
Billings, Ramsey Group, Inc. (a Virginia corporation) as of December 31, 1997
and 1998, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Friedman, Billings, Ramsey Group, Inc., as of December 31, 1997 and 1998, and
the results of its operations and its cash flows for each of the three years in
the period ended December 31, 1998 in conformity with generally accepted
accounting principles.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Vienna, Virginia
January 26, 1999
44
[ARTWORK APPEARS HERE]
Friedman Billings Ramsey
1001 Nineteenth Street North
Arlington, Virginia 22209
www.fbr.com
Washington, D.C. . Boston . Irvine . London