SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19483
SOUTHWEST SECURITIES GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-2040825
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 Elm Street, Suite 3500, Dallas, Texas 75270
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 859-1800
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
As of February 9, 2000, there were 11,807,788 shares of the registrant's common
stock, $.10 par value, outstanding.
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition
December 31, 1999 and June 25, l999
Consolidated Statements of Income and Comprehensive Income (Loss)
For the three and six months ended December 31, 1999 and 1998
Consolidated Statements of Cash Flows
For the six months ended December 31, 1999 and 1998
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
December 31, 1999 and June 25, 1999
(In thousands, except par values and shares amounts)
December June
(Unaudited)
----------- -----------
Assets
Cash $ 13,891 $ 11,334
Assets segregated for regulatory purposes 186,536 225,736
Marketable equity securities, at market value 131,656 172,928
Receivable from brokers, dealers and clearing organizations 3,366,799 3,088,005
Receivable from clients, net 995,717 679,652
Securities owned, at market value 76,154 74,486
Other assets 46,975 41,133
----------- -----------
$ 4,817,728 $ 4,293,274
=========== ===========
Liabilities and Stockholder's Equity
Short-term borrowings $ 103,800 $ 2,700
Payable to brokers, dealers and clearing organizations 3,292,047 3,000,096
Payable to clients 958,287 812,559
Securities sold, not yet purchased, at market value 7,554 24,350
Drafts payable 45,564 37,013
Other liabilities 99,621 104,222
Exchangeable subordinated notes 57,500 50,000
----------- -----------
4,564,373 4,030,940
Minority interest in consolidated subsidiary 100 50
Stockholders' equity:
Preferred stock of $1.00 par value. Authorized 100,000
shares; none issued - -
Common stock of $.10 par value. Authorized 60,000,000 shares,
11,822,537 issued and 11,809,310 outstanding shares at
December 31, 1999; authorized 20,000,000 shares,
11,805,925 issued and outstanding at June 25, 1999 1,182 1,180
Additional paid-in capital 127,972 127,278
Accumulated other comprehensive income - unrealized
holding gain, net of tax of $45,951 at December 31, 1999
and $60,374 at June 25, 1999 85,391 112,123
Retained earnings 38,783 21,896
Receivable from employees under the Employee Stock Purchase Plan - (7)
Deferred compensation, net 488 (186)
Treasury stock (13,227 shares, at cost) (561) -
----------- -----------
Total stockholders' equity 253,255 262,284
Commitments and contingencies
----------- -----------
$ 4,817,728 $ 4,293,274
=========== ===========
See accompanying Notes to the Consolidated Financial Statements.
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income (Loss)
For the three and six months ended December 31, 1999 and 1998
(In thousands, except per share and share amounts)
(Unaudited)
For the three months ended For the six months ended
1999 1998 1999 1998
------------------------------------------------------------------
Net revenues from clearing operations $ 14,546 $ 9,415 $ 24,754 $ 17,509
Commissions 18,621 16,109 33,853 30,518
Interest 53,639 35,816 98,224 71,663
Investment banking, advisory and administrative fees 8,327 7,237 15,113 14,821
Net gains on principal transactions 25,729 7,166 30,032 10,928
Other 3,959 3,553 7,456 7,054
-----------------------------------------------------------------
124,821 79,296 209,432 152,493
-----------------------------------------------------------------
Commissions and other employee compensation 40,202 28,223 66,806 54,086
Interest 37,454 24,111 68,789 48,140
Occupancy, equipment and computer service costs 5,649 4,805 12,263 9,544
Communications 4,015 3,451 7,995 6,363
Floor brokerage and clearing organization charges 2,001 1,354 3,991 2,819
Advertising and promotional 4,265 1,426 8,693 2,214
Other 6,054 6,575 11,921 12,620
-----------------------------------------------------------------
99,640 69,945 180,458 135,786
-----------------------------------------------------------------
Income before income taxes 25,181 9,351 28,974 16,707
Income taxes 8,754 3,209 10,055 5,882
-----------------------------------------------------------------
Net income 16,427 6,142 18,919 10,825
Other comprehensive income (loss) - unrealized
holding gain (loss) arising during period, net of tax 23,826 15,921 (26,786) 25,778
-----------------------------------------------------------------
Comprehensive income (loss) $ 40,253 $ 22,063 $ (7,867) $ 36,603
=================================================================
Earnings per share - basic $ 1.39 $ .52 $ 1.60 $ .92
=================================================================
Earnings per share - diluted $ 1.38 $ .52 $ 1.58 $ .92
=================================================================
Weighted average shares outstanding - basic 11,808,867 11,746,247 11,811,775 11,746,247
=================================================================
Weighted average shares outstanding - diluted 11,900,814 11,755,886 11,940,885 11,756,644
=================================================================
See accompanying Notes to Consolidated Financial Statements.
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the six months ended December 31, 1999 and 1998
(In thousands)
(Unaudited)
1999 1998
----------- -----------
Cash flows operating activities:
Net income $ 18,919 $ 10,825
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 1,482 1,681
Provision for doubtful accounts 257 (307)
Deferred income taxes 878 (205)
Deferred compensation expense 516 -
Gain on sale of marketable equity securities (21,291) -
Decrease (increase) in assets segregated for regulatory purposes 39,200 (181,988)
Net change in broker, dealer and clearing organization accounts 13,157 (32,462)
Net change in client accounts (170,594) 204,405
Increase in securities owned (1,614) (19,890)
Increase in other assets (5,972) (4,203)
Increase (decrease) in securities sold, not yet purchased (16,796) 3,891
Decrease in drafts payable 8,551 8,353
Increase (decrease) in other liabilities 10,280 (359)
----------- -----------
Net cash used in operating activities (123,027) (10,259)
----------- -----------
Cash flows from investing activities:
Purchase of furniture, equipment and leasehold improvements (1,940) (1,169)
Proceeds from sale of marketable equity securities 21,354 -
----------- -----------
Net cash provided by (used in) investing activities 19,414 (1,169)
----------- -----------
Cash flows from financing activities:
Proceeds from short term borrowings 101,100 14,900
Proceeds from issuance of exchangeable subordinated notes 7,500 -
Debt issue costs (242) -
Net change in receivable from employees for Employee
Stock Purchase Plan 7 (23)
Proceeds from employees for Stock Purchase Plan 250 -
Proceeds from exercise of stock options 162 -
Proceeds related to Deferred Compensation Plan 561 -
Purchase of treasury stock (561) -
Payment of cash dividend on common stock (2,657) (2,107)
Proceeds from issuance of stock of consolidated subsidiary 50 100
----------- -----------
Net cash provided by financing activities 106,170 12,870
----------- -----------
Net increase in cash 2,557 1,442
Cash at beginning of period 11,334 13,706
----------- -----------
Cash at end of period $ 13,891 $ 15,148
=========== ===========
See accompanying Notes to the Consolidated Financial Statements.
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
GENERAL AND BASIS OF PRESENTATION
The interim consolidated financial statements include the accounts of Southwest
Securities Group, Inc. ("Parent") and its consolidated subsidiaries listed below
(collectively, the "Company"):
Broker/Dealer Group
Southwest Securities, Inc. "Southwest"
SWS Financial Services, Inc. "SWSFS"
Mydiscountbroker.com, Inc. "MDB"
Southwest Clearing Corporation "Clearing"
Asset Management Group
Westwood Management Corporation "Westwood"
Westwood Trust "Trust"
SW Capital Corporation "Capital"
Southwest Investment Advisors, Inc. "Advisors"
Other
SWS Technologies Corporation "Technologies"
Southwest, SWSFS, MDB and Clearing are registered broker/dealers under the
Securities Exchange Act of 1934 ("1934 Act"). Clearing has not yet begun
operations. Advisors and Westwood are registered investment advisors under the
Investment Advisors Act of 1940. Trust is chartered and regulated by the Texas
Department of Banking.
The consolidated financial statements as of December 31, 1999, and for the three
and six month periods ended December 31, 1999 and 1998, are unaudited; however,
in the opinion of management, these interim statements include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the financial position, results of operations and cash flows.
These financial statements should be read in conjunction with the audited
consolidated financial statements and related notes as of and for the year ended
June 25, 1999 filed on Form 10-K. Amounts included for June 25, 1999 are from
the audited consolidated financial statements as filed on Form 10-K.
All significant intercompany balances and transactions have been eliminated.
CASH FLOW REPORTING
Cash paid for interest was $63,919,000 and $49,114,000 for the six month periods
ended December 31, 1999 and 1998, respectively. Cash paid for income taxes was
$4,800,000 and $7,425,000 for the six months ended December 31, 1999 and 1998,
respectively.
ASSETS SEGREGATED FOR REGULATORY PURPOSES
At December 31, 1999, the Company had U.S. Treasury securities with a market
value of $186,536,000 segregated in a special reserve bank account for the
exclusive benefit of customers under Rule 15c3-3 of the 1934 Act. At June 25,
1999, the Company had U.S. Treasury securities with a market value of
$28,465,000 and reverse repurchase agreements of $197,271,000 in this account.
The reverse repurchase agreements were collateralized by U.S. Government
securities with a market value of approximately $198,298,000 at June 25, 1999.
MARKETABLE EQUITY SECURITIES
The investment in Knight/Trimark Group, Inc. ("Knight") common stock is
classified as marketable equity securities available for sale, and the
unrealized holding gains (losses), net of tax, are recorded as a separate
component of stockholders' equity on the Consolidated Statements of Financial
Condition. The Knight shares are subject to the provisions of Securities and
Exchange Commission Rule 144. The following table summarizes the cost and market
value of the investment in Knight at December 31, 1999 and June 25, l999 (in
thousands):
Gross Gross
Unrealized Unrealized Market
Cost Gains Losses Value
-------------------------------------------------------------------
December
Marketable equity securities $ 369 131,287 - $ 131,656
===================================================================
June
Marketable equity securities $ 432 172,496 - $ 172,928
===================================================================
The "specific identification" method is used to determine the cost of marketable
securities sold. In the three and six month periods ended December 31, 1999, the
Company sold 417,600 and 487,600 shares of Knight, respectively, with proceeds
from the sales totaling $18,358,000 and $21,354,000, respectively. Realized
gains on these sales totaled approximately $18,304,000 and $21,291,000 for the
three and six month periods ended December 31, 1999, respectively.
The other comprehensive income (loss) - unrealized holding gain (loss) arising
during period presented on the Consolidated Statements of Income and
Comprehensive Income (Loss) is shown net of tax of $12,805,000 and ($14,423,000)
for the three and six month periods ended December 31, 1999, respectively. For
the three and six months ended December 31, 1998, other comprehensive income
(loss) - unrealized holding gain (loss) arising during period is presented net
of tax of $8,573,000 and $13,881,000, respectively.
RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
At December 31, 1999 and June 25, l999, the Company had receivable from and
payable to brokers, dealers and clearing organizations related to the following
(in thousands):
December June
---------------- ---------------
Receivable
Securities failed to deliver $ 123,711 $ 27,505
Securities borrowed 3,151,883 2,987,910
Correspondent broker/dealers 52,785 47,805
Clearing organizations 5,757 1,444
Other 32,663 23,341
---------------- ---------------
$ 3,366,799 $ 3,088,005
================ ===============
Payable
Securities failed to receive $ 64,970 $ 23,634
Securities loaned 3,158,078 2,945,007
Correspondent broker/dealers 23,561 15,273
Other 45,438 16,182
---------------- ---------------
$ 3,292,047 $ 3,000,096
================ ===============
SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
At December 31, 1999 and June 25, l999, the Company held securities owned and
securities sold, not yet purchased as follows (in thousands):
December June
---------------- ---------------
Securities owned
Corporate equity securities $ 15,572 $ 35,671
Municipal obligations 17,659 19,391
U.S. Government and Government agency obligations 11,852 9,470
Corporate obligations 19,658 4,114
Other 11,413 5,840
---------------- ---------------
$ 76,154 $ 74,486
================ ===============
Securities sold, not yet purchased
Corporate equity securities $ 3,716 $ 14,972
Municipal obligations 35 6,184
U.S. Government and Government agency obligations 902 2,491
Corporate obligations 1,277 372
Other 1,624 331
---------------- ---------------
$ 7,554 $ 24,350
================ ===============
SHORT-TERM BORROWINGS
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $250,000,000. These lines of credit are used primarily to
finance securities owned, securities held for Correspondent broker/dealer
accounts and receivables in customers' margin accounts. These lines may also be
used to release pledged collateral against day loans. These credit arrangements
are provided on an "as offered" basis and are not committed lines of credit.
These arrangements can be terminated at any time by the lender. Any outstanding
balance under these credit arrangements is due on demand and bears interest at
rates indexed to the federal funds rate. At December 31, 1999, the amount
outstanding under these secured arrangements was $103,800,000 which was
collateralized by clients' securities valued at $126,401,000. There was
$2,700,000 outstanding at June 25, 1999 on these credit arrangements which was
collateralized by securities held for firm accounts valued at $29,724,000.
In addition to the broker loan lines, the Company has a $20,000,000 unsecured
line of credit that is due on demand and bears interest at rates indexed to the
federal funds rate. There were no amounts outstanding under this line of credit
at December 31, 1999 and June 25, l999.
At December 31, 1999 and June 25, l999, the Company had no repurchase agreements
outstanding.
NET CAPITAL REQUIREMENTS
The broker/dealer subsidiaries are subject to the Securities and Exchange
Commission's Uniform Net Capital Rule (the "Rule"), which requires the
maintenance of minimum net capital. Southwest has elected to use the alternative
method, permitted by the Rule, which requires that it maintain minimum net
capital, as defined in Rule 15c3-1 under the 1934 Act, equal to the greater of
$1,500,000 or 2% of aggregate debit balances, as defined in Rule 15c3-3 under
the 1934 Act. At December 31, 1999, Southwest had net capital of $127,873,000,
or approximately 10.82% of aggregate debit balances, which is $104,238,000 in
excess of its minimum net capital requirement of $23,635,000 at that date.
Additionally, the net capital rule of the New York Stock Exchange, Inc. (the
"Exchange") provides that equity capital may not be withdrawn or cash dividends
paid if resulting net capital would be less than 5% of aggregate debit items. At
December 31, 1999, Southwest had net capital of $68,785,000 in excess of 5% of
aggregate debit items.
Clearing also follows the alternative method. At December 31, 1999, Clearing had
net capital of $1,276,000, which is $1,026,000 in excess of its minimum net
capital requirement of $250,000 at that date.
SWSFS and MDB follow the primary (aggregate indebtedness) method under Rule
15c3-1, which requires the maintenance of minimum net capital of $250,000. At
December 31, 1999, the net capital and excess net capital were $318,000 and
$68,000, respectively, for SWSFS and $428,000 and $178,000, respectively, for
MDB.
Trust is subject to the capital requirements of the Texas Department of Banking,
and has a minimum capital requirement of $1,000,000. Trust had total
stockholder's equity of approximately $2,762,000, which is $1,762,000 in excess
of its minimum capital requirement at December 31, 1999.
EARNINGS PER SHARE
A reconciliation between the weighted average shares outstanding used in the
basic and diluted EPS computations is as follows (in thousands, except share and
per share amounts):
Three Months Ended Six Months Ended
December 31, December 31,
1999 1998 1999 1998
---------------------------------- --------------------------------
Net income $ 16,427 $ 6,142 $ 18,919 $ 10,825
================================== ================================
Weighted average shares outstanding - basic 11,808,867 11,746,247 11,811,775 11,746,247
Effect of dilutive securities:
Assumed exercise of stock options 91,947 9,639 129,110 10,397
---------------------------------- --------------------------------
Weighted average shares outstanding - diluted 11,900,814 11,755,886 11,940,885 11,756,644
================================== ================================
Earnings per share - basic $ 1.39 $ .52 $ 1.60 $ .92
================================== ================================
Earnings per share - diluted $ 1.38 $ .52 $ 1.58 $ .92
================================== ================================
At December 31, 1999, the Company had two stock option plans, the Southwest
Securities Group, Inc. Stock Option Plan (the "1996 Plan") and the Southwest
Securities Group, Inc. 1997 Stock Option Plan (the "1997 Plan"). At December 31,
1999, there were approximately 713,000 options outstanding under the 1996 Plan
and approximately 26,000 options outstanding under the 1997 Plan. The Company
also had approximately 17,000 options outstanding that were granted in
conjunction with the acquisition of Barre & Company, Inc. ("Barre Options"). As
of December 31, 1999, all outstanding options were dilutive and were included in
the calculation of weighted average shares outstanding - diluted, except
approximately 285,000 shares under the 1996 Plan and 264 shares under the 1997
Plan.
SEGMENT REPORTING
The Company operates two principal segments within the financial services
industry: the Broker/Dealer Group and the Asset Management Group. There have
been no changes in the basis of segmentation or in the basis of measurement of
segment profit or loss since last reported.
Consolidated
Asset Other Southwest
Broker/Dealer Management Consolidated Securities
(in thousands) Group Group Entities Group, Inc.
- -------------------------------------------------- ------------------ ---------------- ------------------ ----------------
Three months ended December 31, 1999
Net revenues from external sources $ 121,089 $ 3,392 $ 340 $ 124,821
Net intersegment revenues -- 227 1,271 --
Income before income taxes 31,118 1,017 (6,954) 25,181
Consolidated
Asset Other Southwest
Broker/Dealer Management Consolidated Securities
(in thousands) Group Group Entities Group, Inc.
- -------------------------------------------------- ------------------ ---------------- ------------------ ----------------
Six months ended December 31, 1999
Net revenues from external sources $ 202,069 $ 6,627 $ 736 $ 209,432
Net intersegment revenues -- 468 2,491 --
Income before income taxes 34,808 1,730 (7,564) 28,974
Three months ended December 31, 1998
Net revenues from external sources $ 75,815 $ 3,274 $ 207 $ 79,296
Net intersegment revenues -- 253 597 --
Income before income taxes 9,534 996 (1,179) 9,351
Six months ended December 31, 1998
Net revenues from external sources $ 145,943 $ 6,028 $ 522 $ 152,493
Net intersegment revenues -- 459 1,138 --
Income before income taxes 17,131 1,584 (2,008) 16,707
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
From time to time, Southwest Securities Group, Inc. (the "Parent") and
subsidiaries (collectively, the "Company") may publish "forward-looking
statements" within the meaning of section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended,
(the "Acts") or make oral statements that constitute forward-looking statements.
These forward-looking statements may relate to such matters as anticipated
financial performance, future revenues or earnings, business prospects,
projected ventures, new products, anticipated market performance and similar
matters. The Private Securities Litigation Reform Act of 1995 provides a safe
harbor for forward-looking statements. In order to comply with the terms of the
safe harbor, the Company cautions readers that a variety of factors could cause
the Company's actual results to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
These risks and uncertainties, many of which are beyond the Company's control,
include, but are not limited to (1) transaction volume in the securities
markets; (2) volatility of the securities markets; (3) fluctuations in interest
rates; (4) changes in regulatory requirements which could affect the cost of
doing business; (5) general economic conditions, both domestic and foreign; (6)
changes in the rate of inflation and related impact on securities markets; (7)
competition from existing financial institutions and other new participants in
the securities markets; (8) legal developments affecting the litigation
experience of the securities industry; and (9) changes in federal and state tax
laws which could affect the popularity of products sold by the Company. The
Company does not undertake any obligation to publicly update or revise any
forward-looking statements.
GENERAL
The Company is primarily engaged in securities execution and clearance,
securities brokerage, investment banking, securities lending and borrowing and
trading as a principal in equity and fixed income securities. All of these
activities are highly competitive and are sensitive to many factors outside the
control of the Company, including volatility of securities prices and interest
rates; trading volume of securities; economic conditions in the regions where
the Company does business; income tax legislation; and demand for investment
banking and securities brokerage services. While revenues are dependent upon the
level of trading and underwriting volume, which may fluctuate significantly, a
large portion of the Company's expenses remain fixed. Consequently, net earnings
can vary significantly from period to period.
RESULTS OF OPERATIONS
Net income for the three and six month periods ended December 31, 1999 totaled
$16,427,000 and $18,919,000, respectively, representing increases over
comparable prior year periods of $10,285,000, or 167%, and $8,094,000, or 75%,
respectively.
Included in net gains on principal transactions is a gain totaling $15,098,000
from the sale of 325,750 shares of Knight/Trimark Group, Inc. ("Knight") common
stock. Proceeds from the sale were added to the working capital of Southwest
Securities, Inc. and will be used for general corporate purposes.
Excluding the sale of the Knight shares discussed above, net income for the
second quarter totaled $8,424,000, representing an increase of $2,282,000, or
37%, from the second quarter of fiscal 1999. Net income for the six months ended
December 31, 1999 remained flat compared to the previous year excluding the sale
of Knight.
The following is a summary of increases (decreases) in categories of net
revenues and operating expenses for the three and six month periods ended
December 31, 1999 and 1998 (dollars in thousands):
Three Month Change Six Month Change
Amount Percent Amount Percent
---------------------------- --------------------------
Net revenues:
Net revenues from clearing operations $ 5,131 54% $ 7,245 41%
Commissions 2,512 16% 3,335 11%
Net interest 4,480 38% 5,912 25%
Investment banking, advisory and administrative fees 1,090 15% 292 2%
Net gains on principal transactions 18,563 259% 19,104 175%
Other 406 11% 402 6%
---------------------------- --------------------------
32,182 58% 36,290 35%
---------------------------- --------------------------
Operating expenses:
Commissions and other employee compensation 11,979 42% 12,720 24%
Occupancy, equipment and computer service costs 844 18% 2,719 28%
Communications 564 16% 1,632 26%
Floor brokerage and clearing organization charges 647 48% 1,172 42%
Advertising and promotional 2,839 199% 6,479 293%
Other (521) (8%) (699) (6%)
---------------------------- --------------------------
16,352 36% 24,023 27%
---------------------------- --------------------------
Income before income taxes $ 15,830 169% $ 12,267 73%
============================ ==========================
Net Revenues from Clearing Operations. Net revenues from clearing operations
increased primarily as a result of an increase in total transaction volumes in
the three and six month periods ended December 31, 1999 over the same periods in
the prior year. Total transactions processed in the second quarter of fiscal
2000 increased 206% to approximately 13.8 million from approximately 4.5 million
in the same quarter a year ago. For the six-month period, transactions increased
201% to approximately 23 million from 7.6 million in the same period of the
prior year. This increase is due to high trading volumes in the securities
markets during the past six months. The rate of increase in transactions
processed has outpaced the increase in revenues from clearing, because, in
recent years, the Company has increased the number of high-volume trading
Correspondents in its customer base, and a substantial portion of the increase
in transactions processed were related to these Correspondents. These customers
use a relatively low level of clearing services and, accordingly, are charged
substantially discounted clearing fees from the Company's standard clearing
schedule. As transaction volumes increase, revenue per clearing transaction
tends to decrease as Correspondents take advantage of volume discounts.
Commissions. Commissions from the Company's client transactions increased in the
three and six months ended December 31, 1999 over the comparable prior year
periods primarily as a result of increased production in the SWS Financial
Services, Inc. ("SWSFS") independent contractor network, as well as the
Company's retail brokerage network. Also contributing to the increase were
increased commissions from Mydiscountbroker.com, Inc. ("MDB"), the Company's
on-line investing subsidiary. Commissions at MDB for the three and six month
periods ending December 31, 1999 increased 156% and 139%, respectively, over in
the comparable prior year periods. MDB's on-line accounts have increased 223%
over prior year.
Net Interest Income. The Company's net interest income is dependent upon the
level of customer and stock loan balances as well as the spread between the rate
it earns on those assets compared with the cost of funds. The components of
interest earnings are as follows (in thousands):
Three Months Ended Six Months Ended
December 31, December 31,
1999 1998 1999 1998
----------------------------- ----------------------------
Interest revenue
Customer margin accounts $ 18,004 $ 10,931 $ 31,491 $ 22,743
Assets segregated for regulatory purposes 2,129 3,751 4,610 5,681
Stock borrowed 31,233 19,281 57,851 39,356
Other 2,273 1,853 4,272 3,883
----------------------------- ----------------------------
53,639 35,816 98,224 71,663
----------------------------- ----------------------------
Interest expense
Customer funds on deposit 8,853 8,524 16,644 16,026
Stock loaned 26,856 15,375 49,406 31,501
Other 1,745 212 2,739 613
----------------------------- ----------------------------
37,454 24,111 68,789 48,140
----------------------------- ----------------------------
Net interest $ 16,185 $ 11,705 $ 29,435 $ 23,523
============================= ============================
In the three and six-month periods ended December 31, 1999, net interest income
accounted for approximately 19% and 21% of the Company's net revenue,
respectively. Net interest income was 21% and 23% of the Company's net revenue
in the comparable time periods of the previous year.
Interest revenue from customer margin balances and interest expense from
customer funds on deposit have fluctuated in relation to average balances over
the three and six month periods ended December 31, 1999 and 1998. Average
customer balances and average balances from securities lending activities are as
follows (in thousands):
Three Months Ended Six Months Ended
December 31, December 31,
1999 1998 1999 1998
------------------------------- ------------------------------
Average customer margin balances $ 781,000 $ 523,000 $ 732,000 $ 561,000
Average customer funds on deposit 731,000 684,000 733,000 641,000
Average stock borrowed 2,979,000 2,030,000 2,853,000 2,044,000
Average stock loaned 2,968,000 1,990,000 2,843,000 2,015,000
Rates on customer margin balances and funds on deposit are influenced by changes
in leading market interest rates and competitive factors. Spreads on securities
lending transactions are influenced by the types of securities borrowed or
loaned, market conditions and counterparty risk. Securities lending activities
are conducted out of the Company's New York office using a highly specialized
sales force.
Competition for these individuals is intense and there can be no assurance that
the Company will be able to retain these individuals.
Investment Banking, Advisory and Administrative Fees. Investment banking,
advisory and administrative fees include revenues derived from the underwriting
and distribution of corporate and municipal securities, unit trusts and money
market and other mutual funds. Investment banking, advisory and administrative
fees increased in both the three and six months ended December 31, 1999 when
compared to the same period in the prior year due to increases in fees from
investment advisory services which were offset by decreases in municipal finance
business. Advisory fees earned on investment management increased as assets
under management ("AUM") averaged $3.8 billion for the quarter ended December
31, 1999 and averaged $3.4 billion for the same quarter a year ago. AUM averaged
$3.6 billion for the six months ended December 31, 1999 versus an average of
$3.2 billion for the comparable prior year period.
Net Gains on Principal Transactions. For the three and six months ended December
31, 1999, $3.2 million and $6.2 million, respectively, represent net gains
realized on the sale of Knight common stock to fund MDB's advertising
commitments (see Advertising and Promotional below). Excluding these gains, as
well as the previously mentioned $15.1 million gain on the sale of 325,750
shares of Knight stock, net gains on principal transactions were $7.4 million
and $8.7 million for the three and six month periods ended December 31, 1999.
Net gains were flat when comparing the second quarter of fiscal 2000 to second
quarter of fiscal 1999, but net gains on principal transactions decreased in the
first half of fiscal 2000 over fiscal 1999. These results are attributed to a
difficult trading environment in both the equity and fixed income markets in the
first quarter of fiscal 2000. Revenue in this area can fluctuate significantly
from quarter to quarter based on market conditions.
Commissions and Other Employee Compensation. Commissions and other employee
compensation are generally affected by the level of operating revenues, earnings
and the number of employees. During the three and six months ended December 31,
1999, commissions and other employee compensation expense increased over the
same periods in the prior year. This was principally due to (1) increased
commissions and benefits paid to revenue-producing employees generating higher
levels of operating revenues; (2) increased production from the SWSFS
independent contractor network; and (3) the addition of 128 full-time employees,
primarily at MDB and in the information systems area. The number of full-time
employees increased to 954 at December 31, 1999 compared to 826 at December 31,
1998.
Occupancy, Equipment and Computer Service Costs. Occupancy, equipment and
computer service costs increased for three and six month periods as the Company
continued to increase the resources allocated to the implementation of its new
brokerage software, Comprehensive Software Systems, Ltd.
Communications. Communications expense increased primarily due to increased
quotations expense during the first quarter of fiscal 2000 due to the expansion
of the equity trading area, as well as the growth of MDB.
Floor Brokerage and Clearing Organization Charges. Floor brokerage and clearing
organization charges increased due to higher volume in the institutional trading
area.
Advertising and Promotional. Advertising and promotional expenses increased
primarily due to the national advertising campaign launched by MDB in the first
quarter of fiscal 2000. The Company sold 91,850 shares of its investment in
Knight to fund the advertising commitment for the second quarter and 161,850 to
fund the commitment for the first half of the fiscal year.
FINANCIAL CONDITION
The Parent owns approximately 2.9 million shares of Knight. The shares are
classified as marketable equity securities available for sale, and the
unrealized holding gain, net of tax, is recorded as a separate component of
stockholders' equity on the Consolidated Statements of Financial Condition in
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities."
LIQUIDITY AND CAPITAL RESOURCES
The Company's assets are substantially liquid in nature and consist mainly of
cash or assets readily convertible into cash. These assets are financed by the
Company's equity capital, short-term bank borrowings, interest bearing and
non-interest bearing client credit balances, Correspondent deposits and other
payables. The Company maintains an allowance for doubtful accounts which
represents amounts, in the judgment of management, that are necessary to
adequately absorb losses from known and inherent risks in receivables from
clients, clients of Correspondents and Correspondents.
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $250,000,000. These lines of credit are used primarily to
finance securities owned, securities held for Correspondent broker/dealer
accounts and receivables in customers' margin accounts. These credit
arrangements are provided on an "as offered" basis and are not committed lines
of credit. Outstanding balances under these credit arrangements are due on
demand, bear interest at rates indexed to the federal funds rate and are
collateralized by securities of the Company and its clients. At December 31,
1999, the amount outstanding under these secured arrangements was $103,800,000
which was collateralized by clients' securities valued at $126,401,000. In the
opinion of management, these credit arrangements are adequate to meet the
short-term operating needs of the Company.
In addition to the broker loans lines, the Company has a $20,000,000 unsecured
line of credit that is due on demand and bears interest at rates indexed to the
federal funds rate. There were no amounts outstanding under this line of credit
at December 31, 1999.
The Company has issued $57.5 million of 5% Exchangeable Subordinated Notes (the
"Notes") due June 30, 2004. At maturity, the principal of the notes will be paid
in shares of the Class A common stock of Knight or, at the option of the
Company, their cash equivalent. The Notes, which are in the form of DARTS/SM/
(or, "Derivative Adjustable Ratio Securities/SM/"), were issued in denominations
of $56.6875, the closing bid price of Knight on June 10, 1999. At maturity,
Noteholders are entitled to one share of Knight common stock for each DARTS if
the average price for the 20 days immediately preceding the Note's maturity is
equal to or less than the DARTS issue price. Noteholders are entitled to .833
shares of Knight common stock for each DARTS if the average price of Knight's
common stock is 20% or more greater than the DARTS' issue price. If the average
price of the Knight common stock is between the Note's issue price and 20%
greater than the issue price, the exchange rate will be determined by a formula.
Net cash used in operating activities during the three month period ended
December 31, 1999 was $123,027,000. The use of cash was due to the increase in
receivables from customers and was adequately financed by the short-term
borrowings mentioned above.
The Company's broker/dealer subsidiaries are subject to the requirements of the
Securities and Exchange Commission relating to liquidity, capital standards and
the use of client funds and securities. The Company has historically operated in
excess of the minimum net capital requirements.
MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in value of a financial instrument as a result of fluctuations
in interest rates, equity prices, and changes in credit ratings of the issuer.
The Company's exposure to market risk is directly related to its role as a
financial intermediary in customer-related transactions and to its proprietary
trading activities.
Interest Rate Risk. Interest rate risk is a consequence of maintaining inventory
positions and trading in interest-rate-sensitive financial instruments. The
Company does not maintain material positions in interest-rate-sensitive
financial instruments. The Company's fixed income activities also expose it to
the risk of loss related to changes in credit spreads. Credit spread risk arises
from the potential that changes in an issuer's credit rating or credit
perception could affect the value of financial instruments.
Equity Price Risk. The Company is exposed to equity price risk as a result of
making markets in equity securities. Equity price risk results from changes in
the level or volatility of equity prices, which affect the value of equity
securities or instruments that derive their value from a particular stock, a
basket of stocks or a stock index.
Credit Risk. Credit risk arises from the potential nonperformance by
counterparties, customers or debt security issuers. The Company is exposed to
credit risk as a trading counterparty to dealers and customers, as a holder of
securities and as a member of exchanges and clearing organizations.
Managing Risk Exposure. The Company manages risk exposure through the
involvement of various levels of management. Position limits in trading and
inventory accounts are well established and monitored on an ongoing basis.
Current and proposed underwriting, banking and other commitments are subject to
due diligence reviews by senior management, as well as professionals in the
appropriate business and support units involved. Credit risk related to various
financing activities is reduced by the industry practice of obtaining and
maintaining collateral. The Company monitors its exposure to counterparty risk
through the use of credit exposure information, the monitoring of collateral
values and the establishment of credit limits.
Market Risk Analysis. The Company has performed an analysis of the Company's
financial instruments and has assessed the related risk and materiality in
accordance with the rules. Based on this analysis, in the opinion of management,
the market risk associated with the Company's financial instruments at December
31, 1999 will not have a material adverse effect on the consolidated financial
position or operating results of the Company.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is incorporated in Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations under
the caption Market Risk.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None Reportable (229.103)
Item 2. Changes in Securities and Use of Proceeds
None Reportable (Per Instructions to Form 10-Q)
Item 3. Defaults upon Senior Securities
None Reportable (Per Instructions to Form 10-Q)
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of shareholders was held on November 3, 1999. The following
directors were elected at the meeting:
Nominees For Withheld
--------------------------------------------------------------------
Don A. Buchholz 10,460,504 157,993
David Glatstein 10,458,328 160,169
Brodie L. Cobb 10,459,492 159,005
J. Jan Collmer 10,461,459 157,038
Robert F. Gartland 10,438,759 179,738
R. Jan LeCroy 10,461,309 157,188
Frederick R. Meyer 10,460,280 158,217
Jon L. Mosle, Jr. 10,460,928 157,569
There were no abstentions.
Other matters that were voted on:
For Against Abstain Not Voted
-------------- --------------- -------------- --------------
Issuance of 2,600,000 shares of the Company's common
stock in connection with the proposed acquisition of
ASBI Holdings, Inc. 7,606,641 116,171 36,084 2,859,601
Amendment of the Company's Certificate of Incorporation
to increase the number of shares of common stock from
20,000,000 to 60,000,000 shares 9,661,846 932,379 24,272 --
Item 5. Other Information
None Reportable (Per Instructions to Form 10-Q)
Item 6. Exhibits and Reports on Form 8-K
EXHIBITS
10.1 Executive Compensation
The information required by this item regarding Executive compensation is
incorporated by reference to the definitive Proxy Statement for the Company's
1999 Annual Meeting of Stockholders filed with the Commission pursuant to
Regulation 240.14a (6) (c) within 120 days after the Company's fiscal year end
is incorporated herein by reference.
27 Financial Data Schedule*
99 Press Release dated November 3, 1999 filed as an exhibit to the Current
Report on Form 8-K filed on November 9, 1999
* Filed herewith
REPORTS ON FORM 8-K
The Company filed a Current Report on Form 8-K on November 9, 1999. Item 5 of
the referenced Report refers to the Company's press release dated November 3,
1999 announcing the election of directors and the approval of the proposals at
the Annual Meeting of Shareholders. No financial statements were filed with the
Report.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Southwest Securities Group, Inc.
-------------------------------------
(Registrant)
February 14, 2000 /S/ David Glatstein
- ----------------- -------------------------------------
Date (Signature)
David Glatstein
President and Chief Executive Officer
(Principal Executive Officer)
February 14, 2000 /S/ Stacy M. Hodges
- ----------------- -------------------------------------
Date (Signature)
Stacy M. Hodges
Treasurer and Chief Financial Officer
(Principal Financial Officer)
February 14, 2000 /S/ Laura Leventhal
- ----------------- -------------------------------------
Date (Signature)
Laura Leventhal
Controller
(Principal Accounting Officer)