FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 001-13731
Friedman, Billings, Ramsey Group, Inc.
(Exact name of Registrant as specified in its charter)
Virginia 54-1837743
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1001 Nineteenth Street North
Arlington, VA 22209
(Address of principal executive offices) (Zip code)
(703) 312-9500
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date:
Title Outstanding
Class A Common Stock 13,416,421 as of July 31, 1998
Class B Common Stock 36,577,579 as of July 31, 1998
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1998
INDEX
Page Number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements - (unaudited)
Consolidated Balance Sheets-
December 31, 1997 and June 30, 1998 3
Consolidated Statements of Operations-
Three Months Ended June 30, 1997 and 1998 5
Six Months Ended June 30, 1997 and 1998 6
Consolidated Statement of Cash Flows-
Six Months Ended June 30, 1997 and 1998 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Changes in Information About Market Risk 24
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 6. Exhibits and Reports on 8-K 26
SIGNATURES 26
EXHIBIT INDEX 26
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Audited) (Unaudited)
December 31, June 30,
1997 1998
----------- ----------
Assets
Cash and cash equivalents................................................ $ 205,709 $ 71,246
Short-term investments, at market value.................................. 1,982 --
Receivables:
Investment banking...................................................... 7,232 9,565
Asset management fees................................................... 4,426 5,898
Other................................................................... 2,465 10,654
Due from clearing organization........................................... 15,650 51,621
Marketable trading securities, at market value:
Corporate equities...................................................... 60,299 118,092
Corporate bonds......................................................... 18,485 19,899
Deferred tax asset....................................................... 2,402 390
Long-term investments, at fair value..................................... 36,352 57,008
Furniture, equipment and leasehold improvements, net of accumulated
depreciation and amortization of $2,198, and $2,681, respectively..... 3,471 6,193
Prepaid expenses and other assets........................................ 854 2,878
----------- ----------
Total assets.................................................... $ 359,327 $ 353,444
=========== ==========
The accompanying notes are an integral part of these consolidated statements.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Audited) (Unaudited)
December 31, June 30,
1997 1998
-------------- -----------
Liabilities and Shareholders' Equity
Liabilities:
Trading account securities sold but not yet purchased, at market value:
Corporate equities........................................................ $ 10,726 $ 13,656
Corporate and U.S. government bonds....................................... 5,947 5,508
Due to issuer- underwriting................................................. -- 23,183
Accounts payable and accrued expenses....................................... 30,423 23,621
Accrued compensation and benefits........................................... 19,023 30,222
Dividends payable........................................................... 24,000 --
Income taxes payable........................................................ -- 4,509
Short-term subordinated revolving loan...................................... 40,000 --
Long-term secured loans..................................................... 2,416 2,169
Other ....................................................................
146 917
------------- -----------
Total liabilities...................................................... 132,681 103,785
------------- -----------
Commitments and contingencies (Note 8)........................................... -- --
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 issued and outstanding................................................ 135 135
Class B Common Stock $.01 par value, 100,000,000 shares authorized,.........
36,577,579 shares issued and outstanding..................................... 366 366
Additional paid-in capital.................................................. 208,843 208,843
Retained earnings........................................................... 17,302 40,315
------------- -----------
Total shareholders' equity............................................. 226,646 249,659
------------- -----------
Total liabilities and shareholders' equity............................. $ 359,327 $ 353,444
============= ===========
The accompanying notes are an integral part of these consolidated statements.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
(Unaudited)
For the Three Months
Ending June 30,
1997 1998
--------- --------
Revenues:
Investment banking-
Underwriting................................................ $ 29,424 $ 16,314
Corporate finance........................................... 769 28,935
Institutional brokerage-
Principal sales credits..................................... 5,954 7,639
Agency commissions.......................................... 1,740 4,335
Gains and losses, net-
Trading (3,040) (7,490)
Investment.................................................. 805 (274)
Asset management.............................................. 1,072 2,283
Interest, dividends, and other................................ 917 5,592
Total revenues......................................... 37,641 57,334
Expenses:
Compensation and benefits................................... 24,848 28,898
Business development and sales support...................... 2,823 5,260
Professional services....................................... 1,546 2,984
Clearing and brokerage fees................................. 897 1,649
Occupancy and equipment..................................... 679 899
Communications.............................................. 559 877
Interest expense............................................ 1,006 1,468
Other operating expenses.................................... 1,263 2,705
--------- --------
Total expenses......................................... 33,621 44,740
--------- --------
Net income before taxes .................................... 4,020 12,594
Income tax provision........................................ -- 5,161
--------- --------
Net income.................................................. $ 4,020 $ 7,433
========= ========
Basic and diluted net income per share...................... $ 0.10 $ 0.15
========= ========
Weighted average shares outstanding......................... 40,029 50,029
========= ========
Pro forma statements of operations data (Note 3):
Net income before tax....................................... $ 4,020
Pro forma income tax provision.............................. 1,608
---------
Pro forma net income........................................ $ 2,412
=========
Pro forma basic and diluted net income per share............ $ 0.06
=========
Weighted average shares outstanding......................... 40,029
=========
The accompanying notes are an integral part of these consolidated statements.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
(Unaudited)
For the Six Months
Ending June 30,
1997 1998
-------- --------
Revenues:
Investment banking-
Underwriting................................................ $ 42,603 $ 64,024
Corporate finance........................................... 9,552 32,596
Institutional brokerage-
Principal sales credits..................................... 12,867 16,673
Agency commissions.......................................... 4,543 8,043
Gains and losses, net-
Trading .................................................... (13,411) (7,393)
Investment.................................................. 935 2,730
Asset management.............................................. 1,885 5,452
Interest, dividends and other................................. 1,693 9,210
-------- --------
Total revenues......................................... 66,685 125,317
-------- --------
Expenses:
Compensation and benefits................................... 44,543 57,241
Business development and sales support...................... 4,923 9,534
Professional services....................................... 2,831 5,516
Clearing and brokerage fees................................. 1,914 2,992
Occupancy and equipment..................................... 1,187 1,663
Communications.............................................. 995 1,703
Interest expense............................................ 1,730 3,127
Other operating expenses.................................... 2,280 5,212
-------- --------
Total expenses......................................... 60,403 86,988
-------- --------
Net income before taxes .................................... 6,282 38,331
Income tax provision........................................ -- 15,319
-------- --------
Net income.................................................. $ 6,282 $ 23,012
======== ========
Basic and diluted net income per share...................... $ 0.16 $ 0.46
======== ========
Weighted average shares outstanding......................... 40,029 50,029
======== ========
Pro forma statements of operations data (Note 3):
Net income before tax....................................... $ 6,282
Pro forma income tax provision.............................. 2,513
--------
Pro forma net income........................................ $ 3,769
========
Pro forma basic and diluted net income per share............ $ 0.09
========
Weighted average shares outstanding......................... 40,029
========
The accompanying notes are an integral part of these consolidated statements.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
For the Six Months
Ending June 30,
1997 1998
------- --------
Cash flows from operating activities:
Net income ............................................................. $ 6,282 $ 23,012
Adjustments to reconcile net income to net cash used in operating
activities--
Income and special allocations on investments in limited partnerships. (1,688) (4,751)
Depreciation and amortization......................................... 394 484
Changes in operating assets:
Receivables--
Due to/from clearing organization................................. (10,944) (35,971)
Investment banking................................................ 5,709 (2,333)
Asset management fees............................................. (55) (1,472)
Other............................................................. 167 (8,189)
Marketable trading account securities............................... (5,415) (59,207)
Prepaid expenses and other assets................................... 436 (2,024)
Deferred tax asset.................................................. -- 2,012
Changes in operating liabilities:
Due to issuer- underwriting......................................... -- 23,183
Trading account securities sold but not yet purchased............... (33,604) 2,491
Borrowings (repayments) on short-term subordinated loans............ 20,000 (40,000)
Repayments on short-term revolving loan and line of credit.......... (1,000) --
Accounts payable and accrued expenses............................... (85) (6,802)
Income taxes payable................................................ -- 4,509
Accrued compensation and benefits................................... 10,969 11,199
Other............................................................... (12) 771
------- -------
Net cash used in operating activities............................. (8,846) (93,088)
------- -------
Cash flows from investment activities:
Purchases of fixed assets............................................... (892) (3,205)
Long-term investments................................................... (225) (15,905)
Sale (purchase) of short-term investments............................ (12) 1,982
------- -------
Net cash used in investing activities............................. (1,129) (17,128)
------- -------
Cash flows from financing activities:
Repayments of long-term secured loans................................... (162) (247)
Distributions........................................................... (10,146) --
Capital contributions................................................... 272 --
Dividend payments....................................................... -- (24,000)
------- -------
Net cash used in financing activities............................. (10,036) (24,247)
------- -------
Net decrease in cash and cash equivalents................................. (20,011) (134,463)
Cash and cash equivalents, beginning of period............................ 20,681 205,709
------- -------
Cash and cash equivalents, end of period................................. $ 670 $71,246
======= =======
Supplemental Cash Flow Information:
Income taxes paid...................................................... $ -- $ 8,795
======= =======
The accompanying notes are an integral part of these consolidated statements.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Nature of Operations:
Organization
Friedman, Billings, Ramsey Group, Inc., a Virginia corporation (the
"Company"), is the sole parent holding company for three subsidiary holding
companies, Friedman, Billings, Ramsey Capital Markets, Inc. ("FBRCM"), FBR
Capital Management, Inc. ("FBRAM", formerly Friedman, Billings, Ramsey Asset
Management, Inc.) and FBR Holdings, Inc. The principal subsidiary of FBRCM is
Friedman, Billings, Ramsey & Co., Inc. ("FBRC"), a registered broker-dealer. The
principal subsidiary of FBRAM is Friedman, Billings, Ramsey Investment
Management, Inc. ("FBRIM"), a registered investment advisor. FBR Holdings, Inc.
is an investment holding company formed to make and hold long-term investments.
All of the subsidiaries of FBRCM and FBRAM are hereafter collectively referred
to as the "Operating Entities".
FBRC is a member of the National Association of Securities Dealers, Inc.
FBRC acts as an introducing broker executing transactions primarily for
institutional customers and forwards all such transactions to clearing brokers
on a fully disclosed basis. FBRC does not hold funds or securities for, or owe
funds or securities to, customers.
FBRC receives underwriting revenues from underwriting public offerings of
debt and equity securities. These revenues are comprised of selling concessions
and management and underwriting fees. FBRC also receives corporate finance fees
from private placement offerings and from providing merger and acquisition,
financial restructuring, and other advisory services. FBRC concentrates its
underwriting and corporate finance activities primarily on bank, thrift and
specialty finance institutions, technology companies and real estate investment
trusts ("REITS").
FBRIM acts as general partner of investment limited partnerships and also
manages investment accounts and a REIT, and is the principal owner in two
investment holding companies organized as limited liability companies.
Reincorporation Merger
In December 1997, Friedman, Billings, Ramsey Group, Inc., a Delaware
corporation (the "Old Holding Company") and its operating entities terminated
their status as subchapter S corporations and converted to subchapter C
corporations as defined under the Internal Revenue Code (the "Conversion").
Prior to the Conversion, the Old Holding Company declared a distribution to its
shareholders of $54 million representing previously undistributed subchapter S
corporation earnings. As of December 31, 1997, $30 million of the distribution
had been paid. The Old Holding Company was then merged with and into the
Company, with the Company as the surviving corporation. As a result of the
merger, shareholders of the Company received 330 shares of Class B Common Stock
of the Company for each share in the Old Holding Company.
The effects of the reincorporation merger have been given retroactive
application in the consolidated financial statements for all periods presented.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Initial Public Offering
Subsequent to the reincorporation merger, the Company issued 10,000,000 new
Class A common shares and certain selling shareholders sold 1,000,000 Class A
common shares in an initial public offering (the "Offering"). The net proceeds
to the Company from the Offering approximated $185,000,000. Simultaneously with
the Offering, certain selling shareholders sold 2,451,421 shares of Class B
common stock to PNC Bank Corp. These shares were automatically converted to
Class A common shares upon the sale.
Nature of Operations
The Company is primarily engaged in a single line of business as a
securities firm, which comprises several types of services, such as
underwriting, principal and agency securities trading transactions, asset
management and long-term equity investing, primarily in the United States. The
operations related to the Company's foreign entities are not material to these
consolidated financial statements.
The securities industry generally, and specifically in volatile or illiquid
markets, is subject to numerous risks, including the risk of losses associated
with the underwriting, ownership, and trading of securities and the risks of
reduced revenues in periods of reduced demand for security offerings and
activity in secondary trading markets. Changing or negative economic trends,
such as inflation or interest rate volatility, political trends, such as
regulatory and legislative changes, and overall or specific market trends can
influence the liquidity and value of the Company's investments, and impact the
level of security offerings underwritten by the Company, all of which could
adversely affect the Company's revenues and profitability.
Many aspects of the Company's business involve substantial risks of
liability. An underwriter is exposed to substantial liability under Federal and
state securities laws, other Federal and state laws and court decisions,
including decisions with respect to underwriters' liability and limitations on
indemnification of underwriters by issuers. Underwriters may be held liable for
material misstatements or omissions of fact in a prospectus used in connection
with the securities being offered or for statements made by its securities
analysts or other personnel. While the Company has never been subject to such
litigation, in recent years there has been an increasing incidence of litigation
involving the securities industry, including class actions that seek substantial
damages. The Company is also subject to the risk of litigation, including
litigation that may be without merit. As the Company intends actively to defend
such litigation, significant legal expenses could be incurred. An adverse
resolution of any future lawsuits against the Company could materially affect
the Company's operating results and financial condition.
Concentrations of Risk
The Company's historical 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 specific industries and the consolidation sector, any downturn in
the market for securities in these areas could 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 approximately 38 percent of the Company's revenues
for the six months ended June 30, 1997. Two unrelated investment banking
transactions accounted for 32 percent of the Company's revenues in the six
months ended June 30, 1998.
Trading positions in two marketable securities, both corporate equities of
issuers classified as REITs, accounted for $57.6 million or 48.7 percent of the
Company's equity trading securities positions as of June 30, 1998.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Summary of Significant Accounting Policies:
Basis of Presentation
The Company's financial statements have been prepared in accordance with
the rules and regulations of the Securities and Exchange Commission ("SEC") with
respect to Form 10-Q and reflect all normal recurring adjustments which are, in
the opinion of management, necessary for a fair presentation of the results for
the interim periods presented. Pursuant to such rules and regulations, certain
footnote disclosures which are contained in the Company's Annual Report on 10-K
for the year ended December 31, 1997 ("1997 Annual Report") have been omitted.
It is recommended that these consolidated financial statements be read in
conjunction with the audited consolidated financial statements included in the
1997 Annual Report. The Consolidated Balance Sheet as of December 31, 1997 was
derived from the audited financial statements. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
Net Income Per Share
In March 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share." SFAS No. 128 is effective for financial statements
issued after December 15, 1997. SFAS No. 128 requires dual presentation of basic
and diluted income per share. Basic income per share includes no dilution and is
computed by dividing net income or loss available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
income per share includes the impact of potentially dilutive options, warrants,
or convertible debt and convertible preferred equity securities. Options to
purchase 4,269,900 shares of common stock at $20 per share were outstanding as
of June 30, 1998, but were not included in calculating diluted net income per
share as their effect would have been anti-dilutive. Therefore, there is no
difference between the amounts of basic and diluted net income per share in
these statements.
In February 1998, the SEC issued Staff Accounting Bulletin ("SAB") No. 98,
concerning the computation of earnings per share. SAB 98 amends previous
guidance concerning the impact of equity interests issued in proximity to an
initial public offering on the computation of weighted average shares
outstanding. SAB 98 also amends the requirements to present historical earnings
per share information when a company converts from a non-taxable, to a taxable
entity. SAB 98 has been applied in the accompanying consolidated financial
statements.
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.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. All of the Company's compensation
plans are reviewed and evaluated on a quarterly basis. Pursuant to this policy,
the Company reduced $9.5 million of previously accrued bonuses in the six month
period ending June 30, 1998.
3. Income Taxes:
Through December 20, 1997, the Company and its U.S. Operating Entities,
with the exception of its subsidiaries which are limited liability corporations
("LLC"s), had elected to be taxed as subchapter S corporations under the
Internal Revenue Code. Subchapter S corporations and LLCs are not taxed on their
income; rather their income or loss pass directly through to their shareholders
(or members in the case of LLCs). As a result, there is no provision for income
taxes in these financial statements for the periods prior to December 20, 1997.
The accompanying consolidated statements of operations include pro forma
adjustments for income tax expense, which would have been recorded had the
Company been subject to federal and state corporate income taxes, for all
periods presented.
4. Long-Term Investments:
Long-term investments primarily include non-readily marketable investments
in limited investment partnerships and other equity investments, including
privately held companies. Long-term investments also include illiquid warrants
for stock of corporations to which the Company has provided investment banking
services, carried at nominal values. Long-term investments are reported at their
estimated fair values.
The principal private company investment consists of a $25 million
investment in FBR Asset Investment Corporation ("FBR-Asset"), a privately held
real estate investment trust formed in 1997. FBR-Asset's investments as of June
30, 1998 consist of corporate equities- 21% (79% of these are publicly traded
REITs), mortgage-backed securities-59%, corporate bonds-5%, and cash and
equivalents-15%.
5. Asset Management Revenue:
Certain of the Company's subsidiaries, as investment advisers, receive
management fees for the management of the business and affairs of limited
partnerships or investment companies, based upon the amount of assets under
management, as well as incentive performance fees or special allocations of net
income based upon the operating results.
Incentive performance fees and special allocations are calculated on at
least an annual period, which generally coincides with the calendar year. As of
December 31, 1997, and June 30, 1997 and June 30, 1998, unrecorded special
allocations were $1.5 million, $3.4 million, and $4.2 million, respectively. As
the ultimate amount of such fees and allocations may vary with future
performance, these fees and allocations are not recorded as revenue until such
time as they become due and payable.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Borrowings:
Subordinated Revolving Loans
As of June 30, 1998, the Company had two unsecured revolving subordinated
loan agreements with its clearing broker and an affiliate of its clearing
broker. Available credit lines under these agreements were $15 million and $10
million. As of June 30, 1998 there were no amounts outstanding under these
lines. Borrowing capacity under the credit lines expire as follows: $15 million
in July 1998, and $10 million in October 1998. The Company did not renew the
line that expired in July, 1998.
7. Net Capital Computation:
FBRC is subject to the Net Capital Rule, which requires the maintenance of
minimum net capital and requires that the ratio of aggregate indebtedness to net
capital, both as defined, shall not exceed 15 to 1. At June 30, 1998, FBRC had
net capital of $65.4 million, which was $61.4 million in excess of its required
net capital of $4.0 million. FBRC's aggregate indebtedness to net capital ratio
was .92 to 1 at June 30, 1998.
8. 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, (in Thousands)
1999................................................ 2,546
2000................................................ 2,609
2001................................................ 2,789
2002................................................ 2,766
2003................................................ 2,696
Thereafter.......................................... 225
-------
$13,631
=======
FBR Business Development Capital ("FBR-BDC")
In May 1998, the Company organized an interim loan fund designed to extend
financing to "middle-market" businesses in need of subordinated debt or
mezzanine financing that is not readily available from traditional banks or in
the capital markets. In connection therewith, the Company provided FBR-BDC with
a loan for its operations and commitments of $6.6 million as of June 30, 1998.
Subsequent to June 30, 1998, the Company made three additional loans to FBR-BDC
totaling $17.9 million, and expects to provide loans up to $15 million in the
aggregate during the remainder of 1998, to be used by the fund.
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Distributions:
In 1997, prior to its initial public offering, the Company declared
distributions to its shareholders totaling $72,570,582. There were no dividends
declared during the six months ended June 30, 1998. However, $24 million of
distributions declared in 1997 were paid in the first quarter of 1998 to S
corporation shareholders.
10. Shareholders' Equity
At June 30, 1998, the Company has three stock-based compensation and
benefit plans discussed below. In July 1998, the Company's Board of Directors
approved a plan to repurchase up to 2.5 million shares of the Company's Class
"A" Common Stock from time to time. In accordance with the repurchase plan, a
portion of the stock acquired in the repurchase plan will be used in the three
stock-based compensation and benefit plans. As of July 31, 1998, the Company had
repurchased 35,000 shares of its class A common stock pursuant to this plan.
1997 Stock and Annual Incentive Plan
Under the 1997 Stock and Annual Incentive Plan the Company may grant
options, stock appreciation rights, "performance" awards and restricted and
unrestricted stock (collectively, the "Awards") to purchase up to 9.9 million
shares of Class A Common Stock to participants in the 1997 Plan. As of December
31, 1997, 4,384,400 stock options were granted to employees. The options were
granted at the initial public offering price of $20 per share and become
exercisable as follows: 10 percent, 40 percent, and 50 percent at the end of
three, four, and five years, respectively. As of June 30, 1998 no options had
been exercised or had expired. As of June 30, 1998, 114,500 options had been
cancelled upon the departure of employees, and 75,000 additional options have
been committed to new employees.
Non-Employee Director Stock Compensation Plan
Under the Non-Employee 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. There were no awards made under
this plan during the six months ending June 30, 1998.
Employee Stock Purchase Plan
Under the 1997 Employee Stock Purchase Plan (the "Purchase Plan") 1,000,000
shares of Class A Common Stock were reserved for future issuance of stock. The
Purchase Plan will permit eligible employees to purchase common stock through
payroll deductions at a price equal to 85 percent of the fair market value as
determined by the plan. The plan will not result in compensation expense in
future periods. As of June 30, 1998, the Purchase Plan had not yet been offered
to employees; therefore, no stock had been purchased under the Purchase Plan.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
NOTE: The following discussion should be read in conjunction with the unaudited
Consolidated Financial Statements as of June 30, 1998 and 1997, and the Notes
thereto included elsewhere herein. In addition to historical information, the
following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. Such statements include, but are not limited to, those relating
to the effects of growth, the Company's principal investment activities and its
current equity capital levels. The risks and uncertainties relate to, among
other factors: general economic and market conditions, changes in interest
rates, loan delinquency rates, stock market volume and prices, mutual fund and
401(k) and pension plan inflows or outflows, changes in the real estate
investment trust ("REIT"), technology and financial services industries and
other industries in which the Company is active, changes in demand for
investment banking and securities brokerage services, competitive conditions
within the securities industry, the Company's ability to recruit and retain key
employees, changes in the securities and banking laws and regulations, trading
and principal investment activities, and litigation. For a more detailed
explanation of these and other risks and uncertainties, refer to "Factors
Affecting the Company's Business, Operating Results and Financial Condition" in
the Company's Form 10-K for 1997, incorporated herein by reference. As a result
of these risks and uncertainties, there can be no assurance that operating
results for any future period will be comparable to those attained in the prior
periods. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information, future
events, or otherwise.
Overview
Friedman, Billings, Ramsey Group, Inc. ("FBR" or the "Company") is a
holding company for Friedman, Billings, Ramsey Capital Markets, Inc. ("Capital
Markets Group"), FBR Capital Management, Inc. ("Asset Management Group") and FBR
Holdings, Inc., an investment holding company. The Capital Markets Group is a
holding company, whose primary subsidiary, Friedman, Billings, Ramsey & Co.,
Inc. ("FBRC"), is a U.S. investment banking firm and securities broker-dealer.
The Capital Markets Group's other subsidiaries, Friedman, Billings, Ramsey
International, Ltd. ("FBRIL") and FBR Investment Services, Inc. (formerly FBR
Direct, Inc., "FBRIS"), are also broker-dealers in targeted markets. The Asset
Management Group is a holding company whose subsidiaries are engaged in
investment management and advisory services to managed accounts, hedge and
offshore funds, private equity and venture capital funds, mutual funds, and
holding principal investments. The Company's operations are primarily in the
United States, and the Company has very limited exposure to foreign market
activity.
Business Environment
The financial markets in the U.S. have been turbulent as U.S. investors
continued to focus on worldwide market conditions, especially on events in Asia
and Japan, as well as heightened anxiety over the direction of interest rates
and potential weakening in the domestic economy, and the securities markets have
exhibited considerable volatility. The Company's business depends on the markets
for the securities of companies that are affected by many of the same risks and
uncertainties relating to the Company itself (discussed above) as well as by
other factors that apply to particular industries. However, the Company expects
that the environment will continue to be a challenging one in which to raise
capital, for at least the remainder of 1998, which may adversely affect the
Company's revenues.
OPERATING GROUPS
Asset Management Group
Revenue from the Asset Management Group has increased more than 180%
from the first six months of 1997 to the first six months of 1998. This revenue
has been derived from an increasing variety of investment products, which the
Company plans to continue to diversify over the next two years. Assets under
management ("AUM") have increased 35%, from $641 million at year-end to $865
million as of June 30, 1998. Asset management revenue consists of "base
management fees" (which are calculated based on the market value of clients'
assets under management), and performance fees or special (incentive-based)
allocations.
Base management fees are earned on all the Company's AUM, and are
determined based on a percentage of the market value of net assets, excluding
FBR's and certain other investors' assets. The percentages used to determine the
Company's fee vary within each product category (from 0.9% for mutual fund
assets to 2.5% for venture capital funds). As of June 30, 1998, the weighted
average base management fees of the Company approximate 1.2% annually on the
AUM.
In addition to the base management fees, the Company earns incentive
compensation or receives special allocations on private equity and venture
capital funds, hedge and offshore funds, and FBR Asset Investment Corp.
("FBR-Asset"). The Company receives 20% of the net investment gains (if any) on
the hedge and offshore fund assets contributed by third parties, and is also
entitled to incentive fees or special allocations on other investment products.
Generally, the incentive fees and special allocations are calculated annually
every December 31. However, the Company receives initial incentive fees or
special allocations at the end of the quarter in which the one-year anniversary
of each contribution occurs. Assets on which the Company has the potential to
earn incentive compensation have increased 32%, from $470 million at year-end to
$620 million as of June 30, 1998.
The Company's investment products have historically been concentrated
in the financial services industry. However, one of the Company's hedge funds
and FBR-Asset, as well as one of the Company's mutual funds, are primarily
invested in other sectors. In addition, in July 1998, the Company entered into a
definitive agreement to purchase GrandView Advisors, Inc. ("Grandview"), an
investment advisor based in Boston, Massachusetts. Grandview manages two mutual
funds totaling $3 million in net assets. Both Grandview funds are sector funds
specializing in the REIT sector. The Grandview funds' shareholders are currently
undertaking a vote on a proposed merger into a newly created FBR mutual fund
named the FBR Realty Fund. This new fund will broaden and complement FBR's
current mutual fund products.
The Company has investments in proprietary investment vehicles of $32.0
million as of June 30, 1998 compared to $21.4 million as of December 31, 1997
(excluding the Company's investment in FBR-Asset). FBR has recorded gains of
$2.7 million in the first six months of 1998 on these investments, which
represents a total return on investment of 10.1% for the first half of the year
(20.2% on an annualized basis).
The Company will endeavor to grow its assets under management and
continue to make minority investments in new investment vehicles as appropriate
during 1998. As part of that strategy, during the second quarter of 1998, the
Company formed FBR Business Development Capital ("FBR-BDC"), a business
development company intended to complement the Company's capabilities in
mezzanine and bridge financing for growing businesses. The Company made loans to
FBR-BDC totaling $24.5 million as of July 31, 1998, and currently expects to
provide $15 million of additional loans in the aggregate during the remainder of
1998. A significant source of loan volume for FBR-BDC is expected to originate
from PNC Bank, the Company's strategic business partner.
The Company has begun marketing four investment products that it
intends to continue to develop during the remainder of the year. These new
products involve; (i) asset allocation services for high net worth individuals;
(ii) corporate treasury advisory services for middle-market business clients;
(iii) a "fund of funds", to provide investors an opportunity to invest in all of
the Company's hedge funds, and certain outside funds; and (iv) an arbitrage
hedge fund. Although these additional products are not expected to contribute
significantly to revenues in the second half of 1998, the Company believes they
will produce more meaningful results in 1999.
OPERATING GROUPS (Continued)
Capital Markets Group
During the first six months of 1998, the Capital Markets Group
completed a greater number of transactions for existing investment banking
clients (by volume measures) than it completed in initial public offerings for
new clients. During the six months ended June 30, 1998, FBR managed or
co-managed seven IPO's and twelve secondary offerings. During the first half of
1998, the Company increased the number of personnel in the investment banking
group and the research department by 48 percent and 34 percent, respectively, in
order to increase its focus on a number of industry sectors that management
believes offer favorable opportunities for FBR to gain market share, as well as
reduce exposure to cyclical declines in sectors in which the Company currently
operates.
Corporate finance activities accelerated in the second quarter of 1998,
as FBR acted as sole or o-placement agent on five non-public capital raising
transactions, totaling $508 million in capital. The largest of these
transactions involved a competitive bidding process through which the Company
was contracted as the sole placement agent for the acquisition of East-West
Bank, a mid-cap financial institution based in California. In addition to
private placements, corporate finance revenue growth was also attributed to an
increase in M&A and advisory service fees which comprise 7.5% of total revenues
for the six months ended June 30, 1998 versus 1.6% in the first six months of
1997. FBRC has acted as placement agent or co-placement agent raising $808
million in eight non-public, capital-raising transactions in the first six
months of 1998 versus four such transactions in the same period in 1997. Over
the last six quarters (beginning with the first quarter of 1997), private
placements have generated more than $11 million of revenue per quarter (on
average), ranging from none in one quarter, to as much as $22.7 million in
another.
Institutional brokerage revenues increased 42% from $17.4 million to
$24.7 million, for the six months ending June 30, 1997 and 1998, respectively.
FBRC conducts market-making activities in more than 400 securities. During the
first six months of 1997 and 1998, in connection with these activities, FBRC
experienced net trading losses on positions held in securities inventories and
primarily in those securities for which FBR had acted as underwriter. FBR has an
investment banking incentive compensation policy which takes into account the
risk of trading and other losses related to market-making activity and other
transactions conducted to support investment banking transactions. This policy
provides for a deferral of a portion of the incentive compensation payable to
investment banking and other personnel. Any losses or liabilities of the Company
attributable to capital raising transactions may result in a reduction of
accrued incentive compensation to investment banking personnel. Pursuant to this
policy, the Company reduced $9.5 million of accrued investment banking and other
bonus compensation during the six months ended June 30, 1998.
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.
RESULTS OF OPERATIONS
Revenues
Total revenues are comprised primarily of underwriting revenue,
corporate finance fees, principal sales credits, agency commissions, asset
management revenue, and net gains and losses. The Company believes that revenue
from underwriting and corporate finance is substantially dependent on the market
for public and private offerings of equity and debt securities by the companies
in the sectors within which FBR focuses its efforts. Principal sales credits are
dependent on Nasdaq trading volume and spreads in the securities of such
companies. Net trading gains and losses are dependent on the market performance
of securities in which the Company holds trading positions in its inventory, as
well as on the decisions of management as to the level of market exposure in
these securities. Accordingly, the Company's revenues have fluctuated, and are
likely to continue to fluctuate, based on these factors.
Underwriting revenue consists of underwriting discounts, selling
concessions, management fees and other underwriting fees and reimbursed expenses
associated with underwriting activities. The Company acts in varying capacities
in its underwriting activities, which, based on the underlying economics of each
transaction, determines its ultimate revenues from these activities. When the
Company is engaged as lead-manager of an underwriting, the Company generally
bears more risk and earns higher revenues than if engaged as a co-manager, an
underwriter ("syndicate member"), or a broker included in the "selling group".
In general, when FBRC acts as lead manager or co-manager, the Company may
receive 20 to 80 percent of the total underwriters' discount; however if FBRC
acts as a syndicate member, or has a reduced role as a co-manager, the Company
may receive 3 to 20 percent of the total underwriters' discount.
Corporate finance revenues are comprised of the Company's merger and
acquisition, private placement, mutual-to-stock conversion, and other corporate
finance advisory fees and reimbursed expenses associated with such activities.
Corporate finance fees have fluctuated, and are likely to continue to fluctuate,
based on the number and size of transactions, including private placements, by
the Company
Principal sales credits consist of a portion of dealer spreads from the
securities trading activities of the Company as principal in Nasdaq-listed and
other over-the-counter ("OTC") securities, and is primarily derived from the
Company's activities as a market-maker.
Trading gains are combined with trading losses and the resulting amount
is reported on an aggregate basis. Gains and losses result primarily from market
price fluctuations that occur while holding positions in the Company's trading
security inventory, while losses also reflect the internally allocated costs of
sales associated with principal transactions ("principal sales credits"). The
Company has established policies (including compensation policies) to reduce the
risk and economic impact of trading and other losses resulting from underwriting
activities.
Agency commissions revenue includes revenue resulting from executing
Nasdaq-listed and other OTC transactions as agent, and executing trades through
a stock exchange.
The Company receives asset management revenue in its capacity as the
investment manager to advisory clients and as general partner of several
investment partnerships. Management fees, performance fees, and special
allocations on investment partnerships historically have been earned from
vehicles that invest primarily in the securities of companies engaged in the
financial services sector. Incentive fees and special allocations are likely to
fluctuate with performance of securities in the sectors in which managed funds
invest. A growing asset base coupled with a stable or rising equity market
(including equity of financial services companies) can provide significant
revenues with a high net margin for the Company. The Company's ultimate
objective is to establish an asset base with sufficient revenue to cover the
fixed cost of the Company's business.
RESULTS OF OPERATIONS
Expenses
Compensation and benefits expense includes base salaries as well as
incentive compensation paid to sales, trading, underwriting and corporate
finance professionals and to executive management. Incentive compensation (other
than under the 1997 Plan, below) varies primarily based on revenue production.
Salaries, payroll taxes and employee benefits are relatively fixed in nature.
During the first six months of 1997, the incentive compensation paid to the top
three of the Company's Executive Officers, who also serve as Directors of the
Company, was based primarily on gross revenues, from certain of the Company's
business lines. In December 1997, the Company adopted the 1997 Stock and Annual
Incentive Plan ("1997 Plan"), under which the Executive Officers and certain
other employees are eligible to participate in a bonus pool, based on net income
before taxes, rather than on gross revenues. In particular, the cash bonus
payments made pursuant to the 1997 Plan will be made from a pool equal to up to
30% of FBR's annual pre-tax net income (before annual cash bonus payments under
the 1997 Plan). The pool will be reduced to the extent the Company's aggregate
compensation and benefits expense for the year (including annual cash bonus
payments under the 1997 Plan) would exceed 55% of revenues. The Company's Board
of Directors is responsible for determining the percentage of pre-tax net income
remunerated under the 1997 Plan and intends to do so based on quantitative and
qualitative performance criteria. FBR intends to review and evaluate all of its
compensation plans on a quarterly basis.
The following table sets forth certain financial data as a percentage
of revenues:
For the quarter For the six months
ended June 30, ended June 30,
1997 1998 1997 1998
------- ------- ------- -------
Revenues:
Investment banking-
Underwriting 78.17% 28.45% 63.89% 51.09%
Corporate finance 2.04% 50.47% 14.32% 26.01%
------- ------- ------- -------
Total investment banking 80.21% 78.92% 78.21% 77.10%
------- ------- ------- -------
Institutional brokerage-
Principal (OTC) sales credits 15.82% 13.32% 19.30% 13.30%
Agency commission 4.62% 7.56% 6.81% 6.42%
------- ------- ------- -------
Total institutional brokerage 20.44% 20.88% 26.11% 19.72%
------- ------- ------- -------
Gains and losses, net-
Trading (8.08%) (13.06%) (11.09%) (10.70%)
Investment 2.14% (0.48%) 1.40% 2.18%
------- ------- ------- -------
Total gains and losses, net (5.94%) (13.54%) (9.69%) (8.52%)
------- ------- ------- -------
Asset management 2.85% 3.98% 2.83% 4.35%
Interest and dividends 2.44% 9.76% 2.54% 7.35%
------- ------- ------- -------
Total revenues 100.00% 100.00% 100.00% 100.00%
------- ------- ------- -------
Expenses:
Compensation and benefits 66.01% 50.40% 66.80% 45.68%
Brokerage and clearance 2.38% 2.88% 2.87% 2.39%
Occupancy and equipment 1.80% 1.57% 1.78% 1.33%
Communications 1.49% 1.53% 1.49% 1.36%
Interest 2.67% 2.56% 2.59% 2.50%
Other (1) 14.97% 19.09% 15.05% 16.15%
-------- ------- ------- -------
Total expenses 89.32% 78.03% 90.58% 69.41%
-------- ------- ------- -------
Net income before taxes 10.68% 21.97% 9.42% 30.59%
======== ======= ======= =======
1) Includes business promotion, investment banking and other expenses.
The Company estimates its fixed costs as a percentage of historical
revenue have increased to 15% for the year ended December 31, 1997 to 22% for
the six months ended June 30, 1998. This increase is attributed to a 32%
increase in total full-time employees, and approximately 40% increase in office
facilities in the first half of 1998, which can take several months to become
productively utilized.
RESULTS OF OPERATIONS
Three months ended June 30, 1998 compared to three months ended June 30, 1997
Total revenues increased 52% from $37.6 million in 1997 to $57.3
million in 1998 due primarily to increased investment banking revenues and
interest and dividend income.
Underwriting revenue decreased 45% from $29.4 million in 1997 to $16.3
million in 1998. This decrease was due primarily to a change in the mix of
capital raising activities completed in the quarter from public to non-public.
The number of completed transactions increased, from 5 in 1997 to 10 in 1998,
while the average size of the capital raising transactions in the quarter
decreased from $129 million per transaction in 1997 to $62 million per
transaction in 1998.
Corporate finance fees increased over 35-fold from $769 thousand in
1997 to $28.9 million in 1998. This increase was due to a shift in capital
raising activities from public underwritings to private placements, as well as
increased advisory, merger, and acquisition activities, which generated $769
thousand in 1997, compared to $7.3 million in 1998.
Principal sales credit revenue increased 28% from $6.0 million in 1997
to $7.6 million 1998. This increase is a result of higher volumes of activity in
the Company's Nasdaq trading overall, as well as increased trading activity
derived from the Company's expansion of its equity sales and trading personnel
and capabilities.
Agency commissions increased 149% from $1.7 million in 1997 to $4.3
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, an increase in listed equity trading capabilities, as
well as an increase in issuance of research reports covering securities listed
on national exchanges.
Trading and investment gains, net of losses contributed to a 247%
larger net loss in 1998 compared to 1997. Net losses increased from $3.0 million
in 1997 to $7.5 million in 1998. This increase is attributed to larger corporate
securities inventories in 1998, specifically in the REIT sector. The Company's
largest 10 corporate securities positions account for 26% of total assets and
66% of the Company's total corporate securities positions as of June 30, 1998.
The Company's largest losses in the second quarter of 1998 are attributed to
these positions and are more heavily weighted in the REIT and mortgage company
sectors.
Asset management revenue increased by 113% from $1.1 million in 1997 to
$2.3 million in 1998. The increase was due primarily to an increase in assets
under management, which increased from $286 million as of June 30, 1997 to $865
million as of June 30, 1998.
Interest, dividends and other revenue increased by 510% from $917
thousand in 1997 to $5.6 million in 1998. This increase is due primarily to a
five-fold increase in the Company's invested assets, net of liabilities at June
30, 1998 compared to June 30, 1997.
Total expenses increased 33% from $33.6 million in 1997 to $44.7
million 1998 primarily due to the Company's growth in number of personnel (52%
increase in full-time employees as of June 30, 1998 compared to June 30, 1997).
In addition to personnel increases, the Company's spending has increased on
business promotion and investment banking efforts.
Compensation and benefits expense increased 16% from $24.8 million in
1997 to $28.9 million in 1998. The increase was due primarily to an increase in
the number of the Company's personnel. Compensation and benefits expense as a
percentage of total revenues decreased from 66% to 50%. This decrease was
attributable to a number of factors, including the change in revenue mix towards
asset management revenue and investment gains and implementation of the 1997
Plan, which includes incentive compensation for the Company's Executive
Officers. The decrease in compensation as a percent of revenues was also due to
a reduction of accrued bonus compensation in the first six months of 1998. This
compensation adjustment is discussed more fully in the Capital Market Group
section on page 16 herein. Average employee headcount was 222 in the 2nd quarter
of 1997 compared to 327 in the 2nd quarter of 1998.
RESULTS OF OPERATIONS
Three months ended June 30, 1998 compared to three months ended June 30, 1997
(Continued)
Brokerage and clearance expense increased 84% from $897 thousand in
1997 to $1.6 million in 1998 due to the increase in sales and trading
activities. As a percentage of institutional brokerage revenue, brokerage and
clearance expense increased from 11.7% in 1997 to 13.8% in 1998, due to a
greater increase in the volume of listed business relative to the increase in
principal transaction volume. Listed trading carries higher expenses related to
order execution than does principal transaction activity.
Occupancy and equipment expense increased 32% from $679 thousand in
1997 to $899 thousand in 1998. This increase is due to additional office leases
at the corporate headquarters, which began in May 1998, and office equipment
rental to accommodate its growth in personnel.
Communications expense increased 57% from $559 thousand in 1997 to $877
thousand in 1998. This increase was due primarily to increases in
telecommunications expenses resulting from the increase in employees and
expansion of facilities in 1998, and the enhancement of network technology.
Interest expense increased by 46% from $1.0 million in 1997 to $1.5
million in 1998, primarily due to increased margin interest expense, which is a
result of increased securities position levels.
Other expenses increased 94% from $5.6 million in 1997 to $10.9 million
in 1998. This increase was due primarily to increased investment banking
activity, increased expenses associated with expanded office space, and
increased business promotion expenses.
Six months ended June 30, 1998 compared to six months ended June 30, 1997
Total revenues increased 88% from $66.7 million in 1997 to $125.3
million in 1998 due primarily to increased investment banking revenue and
institutional brokerage revenue.
Underwriting revenue increased 50% from $42.6 million in 1997 to $64.0
million in 1998 but decreased as a percentage of revenues from 64% to 51%,
respectively. This increase in revenue was due primarily to an increase in the
number of the security transactions managed from 11 in 1997 to 21 in 1998, and
slightly offset by a decrease in the average size of the capital raising
transactions in the first half of 1998, from $137 million per transaction in
1997 to $102 million per transaction in 1998. The increase was also offset by
reduced FBRC participation in some co-managed deals. The reduction as a
percentage of revenues was due primarily to a shift in revenue mix from public
to non-public capital raising activities, and to a lesser extent to a shift from
investment banking to asset management revenues.
Corporate finance revenue increased 241% from $9.6 million in 1997 to
$32.6 million in 1998. This increase was due to a shift in capital raising
activities from public underwritings to private placements, and was somewhat
magnified by increased advisory, merger, and acquisition activities, which
generated $1.0 million in 1997, compared to $9.4 million in 1998.
Principal sales credits increased 30% from $12.9 million in 1997 to
$16.7 million 1998. This increase is a result of higher volumes of activity in
the Company's Nasdaq trading overall, as well as increased trading activity
derived from the Company's expansion of its equity sales and trading personnel
and capabilities.
Agency commissions increased 77% from $4.5 million in 1997 to $8.0
million in 1998. This increase was due to the expansion of the Company's
institutional listed equity business fostered by an increase in the number of
institutional brokers, an increase in listed equity trading capabilities, as
well as an increase in issuance of research reports covering securities listed
on national exchanges.
Trading and investment gains, net of losses, contributed to a 65%
larger loss in 1998 compared to 1997. Net losses increased from $6.5 million in
1997 to $10.7 million in 1998. This increase is attributed to larger and more
concentrated corporate securities inventories in 1998, specifically in the REIT
and mortgage company sectors. The Company's largest losses in 1998 are
principally from holding positions in stocks in
RESULTS OF OPERATIONS
Six months ended June 30, 1998 compared to six months ended June 30, 1997
(Continued)
which the Company has acted in an underwriting capacity. Net losses were
partially offset by an increase in net gains from proprietary investment
products.
Asset management revenue increased by 189% from $1.9 million in 1997 to
$5.5 million in 1998. The increase was due primarily to an increase in assets
under management, as well as an increase in incentive based allocations
principally in the Company's largest hedge fund, which focuses its investments
in the financial services industry sector.
Interest, dividends and other revenue increased by 444% from $1.7
million in 1997 to $9.2 million in 1998. This increase is due primarily to a
five-fold increase in the Company's invested assets, net of liabilities at June
30, 1998 compared to June 30, 1997.
Total expenses increased 44% from $60.4 million in 1997 to $87.0
million 1998 primarily due to the Company's growth in number of personnel (52%
increase in full-time employees as of June 30, 1998 compared to June 30, 1997).
In addition to personnel increases, the Company has been increasing expenditures
on business promotion and investment banking efforts.
Compensation and benefits expense increased 29% from $44.5 million in
1997 to $57.2 million in 1998. The increase was due primarily to an increase in
the number of the Company's personnel. Compensation and benefits expense as a
percentage of total revenues decreased from 67% to 46%. This decrease was
attributable to a number of factors, including the change in revenue mix towards
asset management revenue and investment gains and implementation of the 1997
Plan, which includes incentive compensation for the Company's Executive
Officers. The decrease in compensation as a percent of revenues was also due to
a reduction of accrued bonus compensation in the first six months of 1998. This
compensation adjustment is discussed more fully in the Capital Markets Group
section on page 16 herein. Average employee headcount for the six-month period
was 204 in 1997 compared to 308 in 1998.
Brokerage and clearance expense increased 56% from $1.9 million in 1997
to $3.0 million in 1998 due to the increase in sales and trading activities. As
a percentage of institutional brokerage revenue, brokerage and clearance expense
increased from 11.0% in 1997 to 12.1% in 1998, due to a greater increase in the
volume of listed business relative to the increase in principal transaction
volume. Listed trading carries higher expenses related to order execution than
does principal transaction activity.
Occupancy and equipment expense increased 40% from $1.2 million in 1997
to $1.7 million in 1998. This increase is due to additional office leases, an
increase in equipment rental to accommodate its growth in personnel, and an
increase in depreciation expense due to acquisitions of computer and
telecommunications equipment for expanded staff.
Communications expense increased 71% from $995 thousand in 1997 to $1.7
million in 1998. This increase was due primarily to increases in
telecommunications expenses resulting from the increase in employees and
expansion of facilities in 1998, and the enhancement of network technology.
Interest expense increased by 81% from $1.7 million in 1997 to $3.1
million in 1998, primarily due to increased margin interest expense, which is a
result of increased securities position levels.
Other expenses increased 102% from $10.0 million in 1997 to $20.3
million in 1998. This increase was due primarily to increased investment banking
activity, increased expenses associated with expanded office space, and
increased business promotion expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically satisfied its liquidity and regulatory
capital needs through three primary sources: (1) internally generated funds; (2)
equity capital contributions; and (3) credit provided by the Company's banks,
and its clearing broker and that broker's affiliates. The Company has frequently
required the use, and reasonably believes that it may continue to require the
use, of temporary subordinated loans in connection with regulatory capital
requirements to support its underwriting activities.
The Company completed its initial public offering in December 1997. Net
proceeds from the offering were $185 million. After the offering, the Company
made capital contributions of $73 million to FBRC, distributed $54 million to
its S corporation shareholders, repaid $8.5 million on an outstanding line of
credit, invested $25 million in FBR Asset, made other investments in securities
of $6 million, made advances to affiliates of $7 million, and held the remaining
funds in short-term money market accounts. FBRC used $40 million of its existing
capital to repay its outstanding subordinated loans and retained the $73 million
contributed by FBR for working capital purposes. The Company has employed
approximately two-thirds of the IPO proceeds to date by making investments in
affiliated investment vehicles, and supporting increased underwriting and
related trading activity without drawing on external lines of credit.
The Company's principal assets consist of cash and cash equivalents,
receivables from other broker-dealers, including its clearing broker, securities
held for trading purposes, and long-term investments. Long-term investments
consist primarily of investments in limited partnerships in which the Company
serves as the general partner and its investment in FBR- Asset. Although
investments in limited partnerships are for the most part illiquid, the
underlying investments of such partnerships are mostly in publicly traded,
liquid debt and equity securities.
As of June 30, 1998, the Company had liquid assets consisting primarily
of cash and cash equivalents of $71.2 million. Cash equivalents consist
primarily of money market mutual funds invested in debt obligations of the U.S.
government. The Company also had $138.0 million in marketable securities in its
trading accounts. FBRC has available borrowing capacity (borrowing against
security positions) from its clearing broker of $71.6 million as of June 30,
1998. Due to the timing of an underwriting transaction on June 30, 1998, FBRC
had a payable to an investment banking client for the proceeds of a transaction
in the amount of $23.2 million and a corresponding receivable from its clearing
broker for the same amount.
Trading positions in two marketable securities, both corporate equities
of issuers classified as REITs, accounted for $57.6 million or 48.7% of the
Company's equity trading securities positions as of June 30, 1998. The largest
ten marketable corporate securities owned by the Company as of June 30, 1998
totaled $90.9 million, or 66% of the Company's total marketable trading
securities. While trading positions of this magnitude decrease available
regulatory capital of the Company's broker-dealer subsidiary, the Company does
not expect this to hinder FBRC's ability to underwrite securities offerings.
FBRC, as a broker-dealer, is registered with the SEC and is a member of
the NASD. As such, it is subject to the minimum net capital requirements
promulgated by the SEC. FBRC's regulatory net capital has historically exceeded
these minimum requirements. As of June 30, 1998, FBRC was required to maintain
minimum regulatory net capital of approximately $4.0 million, and had total
regulatory net capital of approximately $61.4 million in excess of its
requirement. Regulatory net capital requirements increase when FBRC is involved
in underwriting activities based upon a percentage of the amount being
underwritten by FBRC.
Other broker-dealer subsidiaries were in compliance with all applicable
regulatory capital adequacy requirements as of June 30, 1998.
FBR has no material long-term debt. As of June 30, 1998, the Company had
available a total of $25.0 million in two committed subordinated revolving loans
from its clearing broker and an affiliate of its clearing broker that are
allowable for net capital purposes. Certain of the Company's principal employee-
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
shareholders personally guaranteed these facilities. The facilities have not
been used during 1998, and expire in July and October of 1998. The Company is in
process of renewing the loan that expired in July, and will either renew the
second loan or seek alternative financing from other sources. The Company
characterizes its relationship with its lenders as very good, and does not
expect any impediments to obtaining credit, as needed, from available sources.
The Company believes that its current level of equity capital and
committed lines of credit, combined with funds anticipated to be generated from
operations and anticipated additional lines of credit, are adequate to meet its
liquidity and regulatory capital requirements associated with its broker-dealer
activities. The Company may, however, seek debt financing to provide capital for
corporate purposes and/or to fund strategic business opportunities, including
possible acquisitions, joint ventures, alliances or other business arrangements
which could require substantial capital outlays. The Company's policy is to
evaluate acquisition opportunities as they arise.
The Company constantly reviews its capital needs and sources, the cost of
capital and return on equity, and seeks strategies to provide favorable returns
on capital. In evaluating the Company's anticipated capital needs and current
cash resources, the Company's Board of Directors authorized a share repurchase
program of up to 2.5 million shares of the Company's class A common stock. As of
July 31, 1998, the Company had repurchased 35,000 shares of stock at market
prices.
Risk Management
FBR 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. FBR 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.
In addition to the risks associated with investment banking
transactions, the Company may be exposed to significant after-market risks with
these companies, as FBR may hold substantial positions in the securities of
these companies as underwriter or market maker. The Company often acts as
principal in customer-related transactions in financial instruments that expose
the Company to market risks. The Company also engages in proprietary trading and
arbitrage activities and makes dealer markets in equity securities and
high-yield securities. These trading activities generally result in the creation
of inventory positions. Position and exposure reports are prepared and
circulated to management of the Company on a daily basis. The Company seeks to
manage the exposure to market risks by establishing position limits, and from
time to time may limit its net long or short position by selling or buying
similar instruments.
The Securities and Exchange Commission has developed new market risk
disclosure rules. The Company is required to adopt these rules with the filing
of its annual report on Form 10-K for the year ended December 31, 1998. The
Company has risk management policies and procedures related to its trading
activities designed to reduce its exposure to market risk. The Company will
adopt additional policies or procedures during 1998 that may be necessary to
meet compliance with the new SEC rules; however, the Company will continue to
use other risk management measures, such as trading limits and daily position
summary reports.
High Yield and Non-Investment Grade Debt Securities
The Company underwrites, trades, invests, and makes markets in high-yield
corporate debt securities. The Company also syndicates, trades and invests in
loans to and preferred stock of below investment grade-rated companies. For
purposes of this discussion, non-investment grade securities are defined as
securities or
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
loans to companies rated BB+ or lower, or equivalent ratings by recognized
credit rating agencies, as well as non-rated securities or loans. Investments in
non-investment grade securities generally involve greater risks than investment
grade securities due to the issuer's creditworthiness and the liquidity of the
market for such securities. High yield and other non-investment grade securities
are carried at market value and unrealized gains and losses for these securities
are reflected in the Company's Consolidated Statements of Income. The Company's
portfolio of such securities at December 31, 1997 and June 30, 1998, are
included in long positions and have an aggregate market value of approximately
$19.8 million and $24.1 million, respectively. The Company's portfolio may, from
time to time, contain concentrated holdings of selected issues. The Company's
largest, unhedged non-investment grade position was $5.7 million and $4.5
million at December 31, 1997 and June 30, 1998, respectively.
Warrants
In connection with certain capital raising transactions, FBR has
received and holds warrants for stock of the issuing corporation generally
exercisable at the corporation's respective offering price. Due to the current
restrictions on the warrants and the underlying securities, FBR carries the
warrants at a nominal value in its financial statements, and will recognize any
potential, future revenues and profits, if any, only when realized. FBR may use
a portion of these warrants as incentive compensation for certain key employees
of the Capital Markets Group. As of July 31, 1998, FBR had received warrants in
client companies as set forth below:
Expiration
Number of Exercise Closing Price date of
Warrants Price on July 31, 1998 Warrants
----------- --------- ---------------- -----------
American Capital Strategies, Ltd................... 442,751 $15.00 $23.0000 08/29/02
Capital Automotive REIT............................ 1,277,794 15.00 13.6875 02/12/03
Consolidation Capital Corporation.................. 1,130,000 20.00 21.7500 11/25/01
East-West Bank..................................... 475,500 10.00 *10.0000 06/12/03
Local Financial Corporation........................ 591,000 10.00 12.3750 09/08/02
Styling Technology Corporation..................... 101,500 12.00 20.0000 11/21/01
FBR Asset Investment Corporation................... 970,805 20.00 *18.3250 12/11/07
Resource Asset Investment Trust.................... 141,667 15.00 18.5000 01/08/03
* Represents the market price of the underlying unregistered security in recent Rule 144a transaction trading.
MATTERS RELATED TO THE COMPANY'S INFORMATION SYSTEMS:
The Company's software and information systems are year 2000 compliant;
however, the Company utilizes certain software and related technologies of its
clearing organization. The Company expects that it will be indirectly affected
by the date change in the year 2000 as it relates to the systems of its clearing
organization. The year 2000 issue exists because many computer systems and
applications currently use two-digit date fields to designate a year. When the
century date change occurs, date-sensitive systems will recognize the year 2000
as 1900, or not at all. This inability to recognize or properly treat the year
2000 may cause systems to process critical financial and operational information
incorrectly. The Company's clearing organization has a defined plan to address
and correct its year 2000 deficiencies. The Company does not expect to incur any
significant expenditure related to year 2000 problems with its primary
information systems. However, any failure by the Company's clearing organization
to adequately address the date change could have a material adverse effect on
the Company's financial condition and operations.
Item 3. Changes in Information About Market Risk
None.
Part II. Other Information
Item 1. Legal Proceedings
While the Company is not currently a defendant or plaintiff in any
lawsuits or arbitrations, many aspects of the Company's business involve
substantial risks of liability, litigation and arbitration. An underwriter is
exposed to potential liability under federal and state securities laws, other
federal and state laws and court decisions, including decisions with respect to
underwriters' liability and limitation on indemnification of underwriters by
issuers. For example, a firm that acts as an underwriter may be held liable for
material misstatements or omissions of fact in a prospectus used in connection
with the securities being offered or for statements made by its securities
analysts or other personnel.
If plaintiffs in any future suits against the Company were to prosecute
their claims successfully, or if the Company were to settle such suits by making
significant payments to the plaintiffs, the Company's operating results and
financial condition could be materially and adversely affected. The Company
carries very limited insurance that may cover only a portion of any such
payments.
In addition to these financial costs and risks, the defense of
litigation or arbitration may divert the efforts and attention of the Company's
management and staff, and the Company may incur significant legal expenses in
defending such litigation and arbitration. This may be the case even with
respect to claims and litigation that management believes to be frivolous, and
the Company intends to defend vigorously any frivolous claims against it. The
amount of time that management and other employees may be required to devote in
connection with the defense of litigation could be substantial and might
materially divert their attention from other responsibilities within the
Company.
The Company also may become a defendant in civil actions and
arbitrations arising out of its other activities as a broker-dealer, as an
investment adviser, in other business activities, or as an employer. There can
be no assurance that substantial payments in connection with the resolution of
disputed claims will not occur in the future.
In addition, the Company's charter documents allow indemnification of
the Company's officers, directors and agents to the maximum extent permitted
under Virginia law. The Company intends to enter into indemnification agreements
with these persons. The Company has been and in the future may be the subject of
indemnification assertions under these charter documents or agreements by
officers, directors or agents of the Company who are or may become defendants in
litigation.
Item 4. Submission of Matters to a Vote of Security Holders
Friedman, Billings, Ramsey Group, Inc. held its Annual Meeting of
Shareholders on June 18, 1998 at which shareholders took the following actions:
1. The election of five directors nominated to serve until the next Annual
Meeting,
2. The approval of an amendment to the 1997 Stock and Annual Incentive
Plan increasing the number of Class A Common Stock available for grant
under the Plan by 5 million shares, bringing the total number of such
shares available for grant to 9,900,000, and
3. The ratification of the appointment of Arthur Andersen LLP as the
Company's independent public accountants for 1998.
The results of the voting in connection with the preceding items were as
follows:
1. Election of Directors: A total of 118,852,487 votes were received for this
item.
For Against Abstain
Emanuel J. Friedman 118,714,357 138,130 -0-
Eric F. Billings 118,714,357 138,130 -0-
W.Russell Ramsey 118,714,357 138,130 -0-
Wallace L. Timmeny 118,714,357 138,130 -0-
Mark R. Warner 118,714,357 138,130 -0-
2. Approval of Amendment to 1997 Stock and Annual Incentive Plan A total
of 115,318,597 votes were received for this item.
For Against Abstain
113,003,083 2,228,714 86,800
3. Ratification of the Appointment of Arthur Andersen LLP. A total of
118,852,487 votes were received for this item.
For Against Abstain
118,810,862 12,970 28,655
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(27) Financial Data Schedule
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Friedman, Billings, Ramsey Group, Inc.
08/13/98 By: /s/ Eric Y. Generous
---------- ---------------------------------------
Date Eric Y. Generous, Chief Financial Officer
(Principal Financial Officer),
08/13/98 By: /s/ Kurt R. Harrington
---------- ---------------------------------------
Date Kurt R. Harrington, Treasurer (Principal
Accounting Officer)
EXHIBIT INDEX
EXHIBIT 27.01 Financial Data Schedule.