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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 March 26, 1999
or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-14243
RAGEN MACKENZIE GROUP INCORPORATED
(Exact name of registrant as specified in its charter)
Washington 91-1898738
(State or other jurisdiction of (IRS Employer
incorporation of organization) Identification Number)
999 Third Avenue, Suite 4300 Seattle, Washington 98104
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code (206) 343-5000
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 May 3, 1999 the Company had 12,871,994 shares of common stock outstanding.
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RAGEN MACKENZIE GROUP INCORPORATED
REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 26, 1999
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INDEX PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities and Use of Proceeds 15
Item 3. Defaults Upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
EXHIBIT INDEX 17
</TABLE>
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
RAGEN MACKENZIE GROUP INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except share amounts)
<TABLE>
<CAPTION>
March 26, September 25,
1999 1998
----------------- ------------------
(unaudited)
ASSETS
<S> <C> <C>
Cash $ 2,888 $ 2,143
Cash and market value of securities segregated for the exclusive benefit of customers 370,532 315,997
Deposits with clearing organizations 1,757 1,207
Receivable from:
Brokers, dealers, and clearing organizations 3,407 2,661
Customers 112,492 110,428
Securities owned, at market value 147,509 169,410
Securities purchased under agreements to resell 144,535 172,384
Securities borrowed 5,039 2,144
Furniture, equipment, and leasehold improvements - net 1,938 1,293
Other assets 4,845 4,182
-------- --------
Total $794,942 $781,849
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Borrowings $ 52,375 $ 47,225
Payable to:
Brokers, dealers, and clearing organizations 12,297 11,986
Customers 425,303 390,697
Securities sold but not yet purchased, at market value 138,361 164,095
Securities sold under agreements to repurchase 43,600 45,900
Accrued compensation and related benefits 7,904 8,300
Other liabilities and accrued expenses 3,798 4,707
-------- --------
Total liabilities 683,638 672,910
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value--Authorized 10,000,000
shares; no shares issued and outstanding
Common stock, $.01 par value--Authorized 50,000,000
shares; issued and outstanding, 13,457,390 shares 135 135
Additional paid-in capital 47,686 47,872
Common shares issuable under deferred compensation
arrangements, less unamortized purchase discount of $211 892
Treasury stock - 625,396 and 50,600 shares, at cost (7,146) (511)
Retained earnings 69,737 61,443
-------- --------
Total shareholders' equity 111,304 108,939
-------- --------
Total $794,942 $781,849
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
3
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RAGEN MACKENZIE GROUP INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
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Three-Month Period Ended Six-Month Period Ended
------------------------ ----------------------
March 26, March 27, March 26, March 27,
1999 1998 1999 1998
----------- ----------- ---------- ----------
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REVENUES:
Principal transactions, net $ 6,930 $ 6,479 $15,191 $12,912
Commissions 7,835 7,446 16,197 17,821
Other 950 1,326 2,440 3,034
------- ------- ------- -------
Total operating revenues 15,715 15,251 33,828 33,767
Interest Income 8,968 8,953 18,343 18,365
------- ------- ------- -------
Total revenues 24,683 24,204 52,171 52,132
Interest expense 5,228 5,910 10,999 12,154
------- ------- ------- -------
Net revenues 19,455 18,294 41,172 39,978
------- ------- ------- -------
NONINTEREST EXPENSES:
Compensation and benefits 9,351 9,516 20,172 20,728
Occupancy and equipment 1,504 1,256 2,743 2,641
Communications 980 866 1,927 1,774
Clearing and exchange fees 725 659 1,310 1,428
Other 1,270 587 2,459 1,634
------- ------- ------- -------
Total noninterest expenses 13,830 12,884 28,611 28,205
------- ------- ------- -------
INCOME BEFORE TAXES ON INCOME 5,625 5,410 12,561 11,773
TAXES ON INCOME 1,902 2,055 4,267 4,518
------- ------- ------- -------
NET INCOME $ 3,723 $ 3,355 $ 8,294 $ 7,255
======= ======= ======= =======
WEIGHTED-AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING:
Basic 13,090 10,574 13,221 10,426
Diluted 13,270 10,991 13,380 10,919
EARNINGS PER COMMON SHARE:
Basic $.28 $.32 $.63 $.70
Diluted .28 .31 .62 .66
</TABLE>
See Notes to Consolidated Financial Statements
4
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RAGEN MACKENZIE GROUP INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six-Month Period Ended
------------------------------------------
March 26, March 27,
1999 1998
-------------------- --------------------
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OPERATING ACTIVITIES:
Net income $ 8,294 $ 7,255
Adjustments to reconcile net income to net cash provided (used) by
operating activities:
Depreciation and amortization 374 238
Stock option expense 1,150
Deferred tax benefit (442) (37)
Deferred compensation expense 30
Amounts retained under deferred compensation arrangements 862
Cash provided (used) by changes in operating assets and liabilities:
Cash and market value of securities segregated for the
exclusive benefit of customers (54,535) (10,851)
Deposits with clearing organizations (550) (200)
Receivable from:
Brokers, dealers, and clearing organizations (746) (2,163)
Customers (2,064) (436)
Securities owned 21,901 (10,044)
Securities purchased under agreements to resell 27,849 (11,180)
Securities borrowed (2,895) 3,491
Other assets (221) (378)
Payable to:
Brokers, dealers, and clearing organizations 311 (652)
Customers 34,606 (18,422)
Securities sold but not yet purchased (25,734) 11,519
Securities sold under agreements to repurchase (2,300) (6,475)
Accrued compensation and related benefits (396) (1,945)
Other liabilities and accrued expenses (909) (1,372)
-------- --------
Net cash provided (used) by operating activities 3,435 (40,502)
INVESTING ACTIVITIES:
Purchases of furniture, equipment, and leasehold improvements (1,019) (339)
FINANCING ACTIVITIES:
Proceeds from borrowings, net 5,150 39,150
Proceeds from issuance of common stock 330 2,058
Repurchases of common stock for treasury (7,151) (829)
-------- --------
Net cash provided (used) by financing activities (1,671) 40,379
-------- --------
INCREASE (DECREASE) IN CASH 745 (462)
CASH:
Beginning of period 2,143 4,980
-------- --------
End of period $ 2,888 $ 4,518
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the fiscal period for:
Interest $ 11,013 $ 12,379
Federal income taxes 5,700 5,600
</TABLE>
See Notes to Consolidated Financial Statements
5
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RAGEN MACKENZIE GROUP INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include Ragen
MacKenzie Group Incorporated and its subsidiary (collectively, the Company).
Ragen MacKenzie Group Incorporated is a holding company engaged, through its
subsidiary, in securities brokerage and related investment services that include
retail and institutional brokerage of securities, investment research, market
making, trading, underwriting, distribution of corporate securities and
correspondent clearing. Ragen MacKenzie Group Incorporated's operating
subsidiary, Ragen MacKenzie Incorporated (RMI), is registered with the
Securities and Exchange Commission (the SEC) as a broker/dealer, is a member
firm of the New York Stock Exchange (the NYSE) and has retail offices located in
Washington, Oregon, and Alaska.
These financial statements have been prepared pursuant to the rules and
regulations of the SEC and, therefore, do not include all information and notes
required by generally accepted accounting principles for complete financial
statements. The interim financial statements reflect all adjustments (consisting
only of normal recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of the results for the periods presented. The
nature of the Company's business is such that the results of any interim period
are not necessarily indicative of results for a full year. These financial
statements should be read in conjunction with the consolidated financial
statements and footnotes thereto for the fiscal year ended September 25, 1998
included in the Company's Annual Report on Form 10-K (the 1998 Annual Report) as
filed with the SEC.
Note 2: SHAREHOLDERS' EQUITY
In August 1998, the Board of Directors authorized the repurchase of up to
1,000,000 shares of the Company's common stock over the following 12 months.
Purchases of the common stock may be made from time to time at prevailing prices
in the open market, by block purchases, or in privately negotiated transactions.
The repurchased shares are to be accounted for as treasury stock and used for
the Company's employee stock option plans and other general corporate purposes.
During the six-month period ended March 26, 1999 the Company repurchased 626,000
shares at a total cost of $7,151,000.
During the six-month period ended March 26, 1999, 40,950 shares accounted for as
treasury stock were issued upon the exercise of options under the Company's
employee stock option plans and 10,254 shares accounted for as treasury stock
were issued upon the exercise of options under the Company's employee stock
purchase plan.
Note 3: NET CAPITAL REQUIREMENTS
RMI is subject to the Uniform Net Capital Rule 15c3-1 (the Rule) under the
Securities Exchange Act of 1934. RMI has elected to compute net capital under
the alternative provisions of the Rule, which require RMI to maintain net
capital, as defined, equal to the greater of $1,000,000 or 2% of aggregate debit
items arising from customer transactions, as defined. At March 26, 1999, RMI's
net capital was $96,010,000, which was 82% of aggregate debit items, and which
exceeded the minimum net capital requirement of $2,342,000 by $93,668,000.
The net capital rules of the NYSE also provide that equity capital may not be
withdrawn or cash dividends paid without notification if resulting net capital
would be less than 5% of aggregate debit items.
Note 4: EARNINGS PER COMMON SHARE
Beginning December 31, 1997, basic earnings per share (EPS) and diluted EPS are
required to be computed using the methods specified in Statement of Financial
Accounting Standards No. 128, Earnings per Share. Basic EPS is calculated using
the weighted average number of common shares outstanding for the period, and
diluted EPS is computed using the weighted average number of shares and dilutive
common equivalent shares outstanding calculated under the treasury stock method.
For the purpose of calculating the dilutive effect of stock options in diluted
EPS for periods prior to the completion of the Company's initial public offering
(IPO) of common stock on June 26, 1998, the Company utilizes the per-share book
value at the end of each corresponding period as the Company's share repurchase
plan in effect prior to the IPO required selling shareholders to offer their
shares to the Company for redemption at book value as calculated in accordance
with the terms of the share repurchase plan.
6
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The following table sets forth the computations for basic and diluted earnings
per common share (in thousands, except per share amounts):
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Three-Month Period Ended Six-Month Period Ended
------------------------------ ------------------------------
March 26, 1999 March 27, 1998 March 26, 1999 March 27, 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>s
NUMERATOR:
Net income $ 3,723 $ 3,355 $ 8,294 $ 7,255
======= ======= ======= =======
DENOMINATOR:
Weighted-average basic shares outstanding 13,090 10,574 13,221 10,426
Dilutive effect of employee stock plans 180 417 159 493
------- ------- ------- -------
Weighted-average diluted shares outstanding 13,270 10,991 13,380 10,919
======= ======= ======= =======
Earnings per common share:
Basic $ .28 $ .32 $ .63 $ .70
======= ======= ======= =======
Diluted $ .28 $ .31 $ .62 $ .66
======= ======= ======= =======
</TABLE>
Options to purchase 402,887 shares and 424,206 shares for the three-month and
six-month periods ended March 26, 1999, respectively, were not included in the
computation of diluted earnings per share because the options' exercise prices
were greater than the average market price of the common shares for the related
period.
Note 5: SUBSEQUENT EVENT
On March 30, 1999, the Company completed an acquisition of the outstanding
common stock of Columbia Pacific Securities, Inc. The consideration paid for the
acquisition included the issuance of 40,000 shares of the Company's common stock
held in treasury and cash as specified in the purchase agreement. The
transaction has been accounted for as a purchase and, accordingly, the Company's
consolidated financial statements will include the results of Columbia Pacific
Securities Inc.'s operations from the date of acquisition.
7
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with the
Company's Consolidated Financial Statements and the related Notes thereto
appearing in Item 1 of this report. In addition to historical information, this
Form 10-Q contains and may incorporate by reference statements which may
constitute forward-looking statements that involve risks and uncertainties. The
words "believe", "expect", "intend", "anticipate", variations of such words, and
similar expressions identify forward-looking statements, but their absence does
not mean that the statement is not forward-looking. These forward-looking
statements are not guarantees of future performance and are subject to certain
risks, uncertainties and assumptions that are difficult to predict. Accordingly,
actual results may differ materially from those anticipated or expressed in such
statements. Potential risks and uncertainties include, among other things, the
general risks of the securities industry, risks of reduced revenue during
periods of lower stock prices or reduced trading volume; dependence on, and
ability to retain and recruit, key personnel; recent changes in management;
risks relating to the departure of Brooks G. Ragen and related personnel;
dependence on proprietary research; significant fluctuations in quarterly
operating results; regional concentration; competition; management of growth of
new and existing businesses; the risks relating to proprietary trading and
correspondent brokerage services; risks of extension of credit; risks relating
to regulation; risks relating to litigation and potential securities law
liability; risks relating to Year 2000 compliance; and market, credit and
liquidity risks associated with market-making, principal trading and
underwriting activities. More information about factors that could affect the
Company's financial results is included in the section of the Company's 1998
Annual Report entitled "Additional Factors That May Affect Future Results."
The Company's discussion of the issues surrounding the Year 2000 contain
forward-looking statements. These forward-looking statements include, but are
not limited to, discussions concerning (1) the financial impact of the Year 2000
project; (2) the Company's estimated timetables for completion of each phase of
the project; (3) the readiness of third-party service providers, including the
functioning of the Company's core brokerage software provided by an outside
software provider; and (4) contingency plans. Many factors, including those
outside of the control of the Company and those that are difficult or impossible
to predict at this time, could cause actual results to be materially different
than those anticipated and expressed in these forward-looking statements.
OVERVIEW
The Company's primary business is retail securities brokerage, which it conducts
in its Seattle headquarters and 10 additional offices in Washington, Oregon and
Alaska, which include four offices operated by independent contractors. This
business is directly supported by the Company's proprietary research efforts,
which are based on a value-oriented, contrarian approach to investing. The
Company's research department covers approximately 100 publicly traded companies
headquartered in the Pacific Northwest and maintains a recommended list of
selected regional and national stocks. Other aspects of the Company's business
include proprietary trading of certain fixed income securities, institutional
brokerage services, correspondent brokerage services and investment banking
services.
On March 30, 1999, the Company completed an acquisition of the outstanding
common stock of Columbia Pacific Securities, Inc., a privately-held retail
brokerage firm with independent contractors operating branches located in
California, Idaho, Montana, Oregon, Washington, and Wyoming. On April 9, 1999,
the Company announced that it is changing the name of Columbia Pacific
Securities, Inc. to Ragen MacKenzie Investment Services, Inc. The results of
operations from this new subsidiary will be first reported for the third quarter
of fiscal 1999, as the acquisition was completed after the conclusion of the
second fiscal quarter. While we do not expect this acquisition to significantly
affect our consolidated earnings in the near term, we believe the creation of
Ragen MacKenzie Investment Services, Inc. will provide a platform on which we
can grow our independent contractor business over the longer term.
RESULTS OF OPERATIONS
Comparison of three months ended March 26, 1999 and March 27, 1998
Net revenues increased by $1,161,000, or 6.3%, to $19,455,000 for the second
quarter of fiscal 1999 as compared to the same period in fiscal 1998. The
increase in net revenues was due primarily to increased revenue from the
Company's proprietary trading of U.S. government and agency zero coupon bonds
and higher net interest income earned on retail customer balances.
Revenues from principal transactions increased by $451,000, or 7.0%, to
$6,930,000 for the second quarter of fiscal 1999 as compared to the same period
in fiscal 1998. Revenues from trading debt securities increased by $253,000, or
6.6%, to
8
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$4,098,000, due primarily to revenue growth from trading in U.S.
government and agency zero coupon bonds which was partially offset by a decline
in revenue from trading corporate bonds. Similar opportunities for growth in
the trading of U.S. government and agency zero coupon bonds may not recur in
future periods. Revenues from principal transactions in equity securities
increased by $198,000, or 7.5%, to $2,832,000 for the second quarter of fiscal
1999 as compared to the same period in fiscal 1998. The increase reflects a rise
in sales credits from retail trading activity partially offset by lower trading
profits due to increased competition and greater regulatory supervision of these
markets.
Commissions revenues increased by $389,000, or 5.2%, to $7,835,000 for the
second quarter of fiscal 1999 as compared to the same period in fiscal 1998
primarily due to an overall increase in retail brokerage activity. The increase
in commissions from retail brokerage was partially offset by the January 1, 1999
change in status of Brooks G. Ragen and his son from employee brokers to
correspondent brokers. As a result of this change, commission revenue generated
by these two that was previously reported on a gross basis before compensation
and other expenses is now reported on a net basis after payment has been made to
their correspondent brokerage firm.
Other revenue decreased by $376,000, or 28.4%, to $950,000 for the second
quarter of fiscal 1999 compared to the same period in fiscal 1998, primarily due
to lower fees from underwriting management and participation.
Net interest income increased by $697,000, or 22.9%, to $3,740,000 for the
second quarter of fiscal 1999 as compared to the same period in fiscal 1998.
Interest income increased modestly to $8,968,000 due to an increase in money-
market and customer credit balances, which was partially offset by lower
interest rates earned on customer credit and margin balances. Interest expense
decreased by $682,000, or 11.5%, to $5,228,000 due to the application of
$18,634,000 net proceeds from the Company's June 1998 IPO to pay down current
short-term borrowings and lower interest rates paid on customer credit balances.
Noninterest expenses increased by $946,000, or 7.3%, to $13,830,000 for the
second quarter of fiscal 1999 as compared to the same period of fiscal 1998,
primarily due to increases in other expenses and occupancy and equipment.
Compensation and benefits expenses decreased by $165,000, or 1.7%, to $9,351,000
for the second quarter of fiscal 1999 as compared to the same period in fiscal
1998. Commission and other sales compensation expenses decreased by $267,000, or
6.3%, to $3,993,000 for the fiscal 1999 period due to a decrease in guaranteed
broker salary payments that the Company previously provided to recently hired
brokers. Stock option expense in the second quarter of fiscal 1998 was $450,000
under the Company's variable-award, book-value-based stock option plans. No
expense was recorded in the second quarter of fiscal 1999 as the Company's stock
option plans became fixed-award, fair-value-based plans upon consummation of the
Company's June 1998 IPO. These decreases were partially offset by higher
incentive bonus compensation paid to trading-related personnel generally
resulting from increased trading revenue and an increase in employee
compensation and benefits due to increased staffing to support the Company's
expanding retail brokerage business.
Occupancy and equipment expenses increased $248,000, or 19.7%, to $1,504,000,
due to the Company's investment in technology and expansion of the retail sales
force and supporting functions. Communications expenses increased by $114,000,
or 13.2%, to $980,000 due to higher telecommunications costs and fees for
information data services. Clearing and exchange fees increased by $66,000, or
10.0%, to $725,000, due to higher trading volume in retail and correspondent
brokerage services. Other expenses increased by $683,000, or 116.4%, to
$1,270,000, primarily due to higher state and local taxes in the 1999 period
combined with a refund received in the 1998 period for overpayments in prior
years, in addition to higher professional fees.
The Company's effective income tax rate was 33.8% in the second quarter of
fiscal 1999 and 38.0% in the second quarter of fiscal 1998. The Company's 1998
effective income tax rate was higher than the federal statutory rate primarily
due to nondeductible stock option plan expenses which had the effect of
increasing the effective tax rate by 2.9% in the second quarter of fiscal 1998.
As a result of the conversion of the variable-award, book-value-based stock
option plans to fixed-award, fair-value-based stock option plans upon
consummation of the Company's June 1998 IPO, the Company expects that its
effective income tax rate will remain generally consistent with the second
quarter of fiscal 1999 in future periods.
Comparison of six months ended March 26, 1999 and March 27, 1998
Net revenues increased by $1,194,000, or 3.0%, to $41,172,000 for the first six
months of fiscal 1999 as compared to the same period in fiscal 1998. The
increase in net revenues was due primarily to increased revenue from the
Company's proprietary
9
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trading of U.S. government and agency zero coupon bonds and higher net interest
income earned on retail customer balances which was partially offset by lower
retail brokerage commissions.
Revenues from principal transactions increased by $2,279,000, or 17.7%, to
$15,191,000 for the first six months of fiscal 1999 as compared to the same
period in fiscal 1998. Revenues from trading debt securities increased by
$2,005,000, or 27.6%, to $9,260,000, due primarily to significant revenue growth
from trading in U.S. government and agency zero coupon bonds, resulting in part
from opportunistic reconstitution of certain U.S. government and agency zero
coupon bonds. Similar opportunities for growth in the trading of U.S.
government and agency zero coupon bonds may not recur in future periods.
Revenues from principal transactions in equity securities increased by $274,000,
or 4.8%, to $5,931,000 for the first six months of fiscal 1999 as compared to
the same period in fiscal 1998. The increase reflects a modest rise in sales
credits from retail trading activity partially offset by lower trading profits
due to increased competition and greater regulatory supervision of these
markets.
Commissions revenues decreased by $1,624,000, or 9.1%, to $16,197,000 for the
first six months of fiscal 1999 as compared to the same period in fiscal 1998
primarily due to a reduction in retail brokerage activity.
Other revenue decreased by $594,000, or 19.6%, to $2,440,000 for the first six
months of fiscal 1999 compared to the same period in fiscal 1998, primarily due
to lower fees from underwriting management and participation.
Net interest income increased by $1,133,000, or 18.2%, to $7,344,000 for the
first six months of fiscal 1999 as compared to the same period in fiscal 1998.
Interest income decreased modestly to $18,343,000 due to lower interest rates
earned on customer credit and margin balances, which was partially offset by an
increase in money-market and customer credit balances. Interest expense
decreased by $1,155,000, or 9.5%, to $10,999,000 due to the application of
$18,634,000 net proceeds from the Company's June 1998 IPO to pay down current
short-term borrowings and lower interest rates paid on customer credit balances.
Noninterest expenses increased by $406,000, or 1.4%, to $28,611,000 for the
first six months of fiscal 1999 as compared to the same period of fiscal 1998,
primarily due to an increase in other expenses which was partially offset by a
decrease in compensation and benefits expenses.
Compensation and benefits expenses decreased by $556,000, or 2.7%, to
$20,172,000 for the first six months of fiscal 1999 as compared to the same
period in fiscal 1998. Commission and other sales compensation expenses
decreased by $1,232,000, or 12.8%, to $8,384,000 for the fiscal 1999 period, as
a result of the decrease in commission revenues and a decrease in guaranteed
broker salary payments that the Company previously provided to recently hired
brokers. Stock option expense in the first six months of fiscal 1998 was
$1,150,000 under the Company's variable-award, book-value-based stock option
plans. No expense was recorded in the first six months of fiscal 1999 as the
Company's stock option plans became fixed-award, fair-value-based plans upon
consummation of the Company's June 1998 IPO. These decreases were partially
offset by an increase in employee compensation and benefits due to increased
staffing to support the Company's expanding retail brokerage business and higher
incentive bonus compensation paid to trading-related personnel generally
resulting from increased trading revenue.
Occupancy and equipment expenses increased $102,000, or 3.9%, to $2,743,000, due
to the Company's expansion of the retail sales force and supporting functions.
Communications expenses increased by $153,000, or 8.6%, to $1,927,000 due to
higher telecommunications costs and fees for information data services.
Clearing and exchange fees decreased by $118,000, or 8.3%, to $1,310,000, due to
lower trade-related costs. Other expenses increased by $825,000, or 50.5%, to
$2,459,000, primarily due to higher state and local taxes in the 1999 period
combined with refunds received in the 1998 period for overpayments in prior
years.
The Company's effective income tax rate was 34.0% in the first six months of
fiscal 1999 and 38.4% in the first six months of fiscal 1998. The Company's 1998
effective income tax rate was higher than the federal statutory rate primarily
due to nondeductible stock option plan expenses which had the effect of
increasing the effective tax rate by 3.4% in the first six months of fiscal
1998. As a result of the conversion of the variable-award, book-value-based
stock option plans to fixed-award, fair-value-based stock option plans upon
consummation of the Company's June 1998 IPO, the Company expects that its
effective income tax rate in future periods will remain generally consistent
with the rate in the current period.
10
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LIQUIDITY AND CAPITAL RESOURCES
The Company has historically satisfied a large portion of its funding needs with
its own capital resources, consisting largely of internally generated retained
earnings and funds received upon exercise of employee stock options. A majority
of the Company's assets are highly liquid and short term in nature. The
Company's cash, cash equivalents and liquid assets, consisting of receivables
from customers, brokers and dealers, securities purchased under agreements to
resell, securities owned, securities borrowed and deposits with clearing
organizations, represented in excess of 99% of the Company's assets as of
September 25, 1998 and March 26, 1999. Substantially all of the Company's
receivables are secured by customer securities or security transactions in the
process of settlement.
The majority of the Company's assets are financed through daily operations by
securities sold under repurchase agreements, securities sold but not yet
purchased, bank loans, securities loaned, and payables to customers, brokers and
dealers. Short-term funding is generally obtained at rates relating to daily
federal funds rates. Other borrowing costs are negotiated depending on
prevailing market conditions. The Company monitors overall liquidity by tracking
the extent to which unencumbered marketable assets exceed short-term unsecured
borrowings. The Company maintains borrowing arrangements with two financial
institutions, which funds are used primarily to finance U.S. government and
agency zero coupon bond inventories. As of March 26, 1999, the Company had a
secured bank line of credit with $52,375,000 outstanding and available borrowing
capacity of approximately $27,600,000 and a security repurchase arrangement with
$43,600,000 outstanding. The ratio of assets to equity as of March 26, 1999 was
approximately 7.1:1.
On August 25, 1998, the Board of Directors authorized the repurchase of up to
1,000,000 shares of the Company's common stock over the following twelve months.
Purchases of the common stock may be made from time to time at prevailing prices
in the open market, by block purchases, or in privately negotiated transactions
using funds from operations or the Company's other existing financing sources.
The repurchased shares are to be accounted for as treasury stock and used for
the Company's employee stock option plans and other general corporate purposes.
During the three and six-month periods ended March 26, 1999, the Company
repurchased 483,700 shares and 626,000 shares, respectively, at a total cost of
$5,620,000 and $7,151,000, respectively. At March 26, 1999, the remaining
number of shares authorized to be repurchased, in the open market or otherwise,
under the Company's common stock repurchase program was 323,400 shares.
Certain minimum amounts of capital must be maintained by RMI, the Company's
broker-dealer subsidiary, to satisfy the regulatory requirements of the SEC and
the NYSE. RMI's regulatory net capital has historically exceeded these minimum
requirements. See Note 3 to the Company's Notes to Consolidated Financial
Statements.
The Company believes that its current level of liquid assets, combined with
funds anticipated to be generated from operations, will be adequate to fund its
operations for the next 18 to 24 months.
YEAR 2000 COMPLIANCE
The following Year 2000 discussion is a "Year 2000 Readiness Disclosure" within
the meaning of the Year 2000 Information Readiness and Disclosure Act.
The Company uses, and depends on third-parties who use, a wide variety of
computer programs and devices, some of which have used only the last two digits
of each year to represent the calendar year portion of dates. As a result,
calculations performed with these abbreviated date fields could misinterpret the
year 2000 resulting in erroneous calculations or program failures that could
cause significant disruptions in the Company's operations (the "Year 2000
Problem").
In 1996, the Company established a Year 2000 Committee to address the risks
associated with the Year 2000 Problem. The Committee is comprised of key
personnel from information technology, finance and operations departments within
the Company. With the direction of the Year 2000 Committee, the Company is
executing a project plan in an attempt to achieve Year 2000 compliance. In
developing the project plan, the Year 2000 Committee used an enterprise-wide
approach and grouped all of the Company's operations into the following five
broad areas: Business Partners; Computers and Technology (including hardware and
software associated with mainframe, distributed and desktop computer systems
operated by the Company, as well as the Company's core brokerage software
obtained from an unaffiliated software provider); Information Data Feeds
(including all data interfaces with external parties); Facilities and Work
Environments; and Customers and Correspondents. Within each of these areas, the
Year 2000 Committee has organized its activities to include the following steps
or phases: inventory, assessment, remediation, testing and contingency planning.
11
<PAGE>
To date, the Company has completed the inventory phase within all areas of the
project plan and the assessment phase for all systems within the Computers and
Technology and the Facilities and Work Environments groups. The remediation
phase of the Company's plan specifies a remediation strategy for each area of
the Company's project plan. Certain technology used by the Company may be
replaced or retired as part of the Company's remediation strategy. Remediation
of assets included in the Computers and Technology, Facilities and Work
Environments and Customers and Correspondents groups are scheduled for
completion in June 1999, with many elements of remediation of Computers and
Technology now having been completed.
Business Partners and Information Data Feed project areas involve an extensive
network of third-party relationships and external providers of products and
services that include the major securities exchanges, self- regulatory
organizations, industry clearing and depository institutions, other broker-
dealers, and hardware and software technology providers. Where deemed necessary,
the Company has inquired of these parties whether they are making the necessary
efforts to correct their own Year 2000 problems. The Company has received
correspondence from all of its mission critical business partners regarding
their Year 2000 readiness and will continue to monitor the progress of these and
other partners throughout 1999. The Company's assessment of these responses is
in progress. If necessary, and if alternatives exist, the Company will identify
and replace business partners that pose a risk to the success of the Company's
own Year 2000 readiness plans. With regard to Information Data Feeds, the
Company has completed assessment, remediation and testing on approximately 75%
of its mission critical information data feeds and plans to complete these steps
on the remaining Information Data Feeds in the summer of 1999.
A significant aspect of the Company's Year 2000 project within the Computers and
Technology area relates to the functioning of the Company's core brokerage
software. This software, which is provided by an outside software provider under
a servicing contract, is used by the Company for the electronic processing and
recording of all data pertinent to securities transactions and general
accounting. While the Company is not directly responsible for the work or costs
associated with making this system Year 2000 ready, the Year 2000 Committee
closely monitors the Year 2000 work performed by the software provider through
regular progress updates and reviews. While remediation and testing of this
system was completed by the outside software provider in December 1998, the
Company continues to work with the outside software provider to coordinate
responsibilities and work effort related to its testing and contingency planning
phases. To date, many of the twenty-six software subsystems that comprise the
Company's core brokerage software system are currently in use by the Company.
The Company anticipates that internal testing will be complete and the remaining
subsystems will be in use by mid 1999.
The testing phase of the project plan began in December 1998. The Company has
identified systems within each area of the overall project plan that it believes
require testing. For each of these systems, the Company has determined the
nature and timing of this testing. An important element of the Company's
internal testing plan for its core brokerage software system was participation
in the recently completed industry-wide test. In this test, which was
coordinated by the Securities Industry Association and occurred in March and
April 1999, RMI and other participants were able to input transactions and send
them to the appropriate markets for execution, confirmation and clearance under
simulated Year 2000 conditions. The Company identified no material problems in
this test. To date, the Company has completed testing on approximately 75% of
its mission critical systems. We anticipate that testing of our remaining
internal systems will be completed by mid 1999.
Nearly every aspect of the Company's business depends on the accurate processing
of date-related information. As a result, failure by the Company or one or more
of the third parties with which the Company has a relationship to successfully
remediate systems for Year 2000 issues poses the risk of material disruption to
operations and material financial loss. A failure on the part of the Company to
identify and implement solutions to all aspects of the Year 2000 Problem could
result in systems failures or outages, inaccuracies in processing trades or
other transactions affecting customer or proprietary accounts, an inability to
reconcile to and settle with counterparties and other business disruptions. In
addition, third parties with which the Company has a relationship could fail in
some element of their Year 2000 efforts. The Company's operations are highly
dependent on the services of the securities exchanges, depositories, its core
brokerage software provider, certain banking relationships, electric utilities
and telecommunications networks. A failure by one of these institutions to
become Year 2000 compliant could disrupt the operations of the Company as well
as the securities industry as a whole. The scope of the Company's relationship
with individual customers, broker-dealer counterparties and vendors varies
widely, as does the resulting risk should any one of them fail to achieve Year
2000 compliance. The Company has ongoing communications with important third
parties with which it has relationships, including its core brokerage software
provider, regarding third party Year 2000 risks. The likelihood of such third
parties achieving Year 2000 compliance cannot be adequately gauged at this time.
The Company has developed written contingency plans to be executed should a Year
2000 failure affect the Company's operations or those of a significant third
party. In developing its contingency plans, the Company has incorporated various
Year 2000 issues into its existing disaster recovery plans. These plans include
identification of various alternative procedures,
12
<PAGE>
where alternatives exist, that could be performed should a Year 2000 failure
affect the Company's mission critical operations or those of a significant third
party. Such alternatives generally rely upon manual procedures or work-around
techniques that could be performed for existing systems on a temporary basis. It
is the Company's belief that alternatives currently do not exist for many of the
functions provided by the exchanges and utilities used throughout the securities
industry. The Company intends to test these contingency plans during 1999. As
these plans are tested and reconsidered, the Company anticipates that it will
make updates and improvements to the plans throughout the year in preparation
for the millennium date change. There can be no assurance that the identified
alternative arrangements include every material risk or contingency, or that
these contingency plans will be effective.
Based on information currently available, including information provided by
third party vendors, the Company expects that the total cost of addressing the
Year 2000 Problem for its internal systems will not be material. Costs related
to the Year 2000 Problem are expensed as incurred. A significant portion of
these costs will not be incremental costs to the Company, but rather will
represent the redeployment of existing information technology and operations
personnel, primarily to test the remediation efforts of the Company's third
party vendors. The Company expects to fund all Year 2000 related costs through
operating cash flows and a reallocation of the Company's overall information
technology developmental spending. The costs of the Company's Year 2000 project
and the date on which the Company plans to complete the Year 2000 modifications
are based on management's best current estimates, which were derived utilizing
numerous assumptions of future events, including the continued availability of
certain resources, third party compliance plans and other factors. However,
there can be no assurance that these estimates will prove correct and actual
results could differ materially from those plans.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
DERIVATIVE FINANCIAL INSTRUMENTS
A derivative financial instrument represents a contractual agreement between
counterparties and has value that is derived from changes in the value of some
other underlying asset such as the price of another security, interest rates,
currency exchange rates, specified rates (e.g. LIBOR) or indices (e.g. S&P 500),
or the value referenced in the contract.
The Company does not act as dealer, trader or end-user of complex derivatives
such as swaps, collars and caps. From time to time, the Company enters into
exchange-listed financial futures contracts for the purpose of hedging certain
dealing activities. Any futures contract commitments are considered held for
trading purposes and are carried at market value. Financial futures contracts
are transactions in which one party agrees to deliver a financial instrument to
a counterparty at a specified price on a specified date. The Company's exposure
to market risk arises from the possibility of unfavorable changes in the market
price of the underlying financial instrument. The Company's exposure to credit
risk at any point is represented by the fair value or replacement cost on
contracts in which the Company has recorded an unrealized gain. The risks
inherent in derivative financial instruments are managed consistent with the
Company's overall risk management policies. See "-- Risk Management".
At March 26, 1999 the contract value of the Company's financial futures
commitments was $4,300,000. The contract amounts of these instruments reflect
the extent of the Company's involvement in the particular class of financial
instrument. They do not include positions which may substantially reduce any
potential market risk and do not represent the Company's risk of loss due to
counterparty nonperformance.
RISK MANAGEMENT
Exposure to risk and the management of risk on a day-to-day basis are critical
to the Company's survival and financial success. The Company monitors its
market, credit and correspondent risks on a daily basis through a number of
control procedures designed to identify and evaluate the various risks to which
the Company is exposed. There can be no assurance, however, that the Company's
risk management procedures and internal controls will prevent losses from
occurring as a result of such risks.
The Company's primary market risk arises from the fact that it owns a variety of
investments that are subject to changes in value and could result in the
Company's incurring material gains or losses. The Company also engages in
proprietary trading and makes dealer markets in equity securities, municipal
obligations, investment- grade corporate debt, U.S. government and agency
securities and collateralized mortgage obligation (CMO) securities. In doing
this, the Company may be required to maintain certain amounts of inventories in
order to facilitate customer order flow. The Company seeks to cover its exposure
to market
13
<PAGE>
risk by limiting its net long or short positions, by selling or buying similar
instruments and by utilizing various financial instruments such as futures.
Trading activities generally result in the creation of inventory positions.
Trading and inventory accounts are monitored on an ongoing basis, and the
Company has established written position limits. Position and exposure reports
are prepared at the end of each trading day by operations staff in each of the
business groups engaged in trading activities and are reviewed by traders,
trading managers, department managers and management personnel. These reports
are reviewed independently by the Company's corporate accounting group on a
daily basis. In addition, on a daily basis, the corporate accounting group
prepares a consolidated summarized position report indicating both long and
short exposure, which is distributed to management and enables senior management
to review inventory levels and monitor results of the trading groups. The
Company also reviews and monitors, at various levels of management, inventory
pricing, concentration and securities ratings.
In addition to position and exposure reports, the Company produces a daily
revenue report that summarizes the trading, interest, commissions, fees,
underwriting and other revenue items for each of its business groups. The daily
revenue report is distributed to various levels of senior management and,
together with the position and exposure report, assists senior management in
monitoring and reviewing overall activity of the trading groups.
Credit risk represents the amount of accounting loss the Company would incur
should counterparties to its proprietary transactions fail to perform and the
value of any collateral proves inadequate. Credit risk relating to various
financing activities is reduced by the industry practice of obtaining and
maintaining collateral until commitments are settled. The Company monitors its
exposure to counterparty risk on a daily basis by using credit exposure
information and monitoring collateral values. Senior management approves various
actions, including setting higher margin requirements for large or concentrated
accounts, requiring a reduction of either the level of margin debt or investment
in high-risk securities or, in some cases, requiring the transfer of the account
to another broker-dealer. The Company actively manages the credit exposure
relating to its trading activities by entering into master agreements that
permit netting, when feasible, monitoring the creditworthiness of counterparties
and their related trading limits on an ongoing basis, requesting additional
collateral when deemed necessary and limiting the amount and duration of
exposure to individual counterparties. The Company also often acts as a
principal in customer-related transactions in financial instruments, which
exposes it to risks of default by customers and counterparties.
Management of risk relating to clearing activities for the Company's
correspondent firms begins with a review by certain members of senior management
of each prospective correspondent firm prior to commencing the relationship.
This review includes an examination of the firm's employees, trading history and
finances. Each new correspondent is required to maintain a security deposit. The
amount required is based upon the volume and type of business to be done. The
correspondent agreement requires each correspondent to submit to RMI copies of
all financial information they are required to file with the SEC and the NASD
Regulation monthly or quarterly, including Financial and Operational Combined
Uniform Single Reports ("FOCUS Reports"). Correspondent FOCUS Reports and other
financial statements are reviewed by management. Additionally, each
correspondent's settlements are reviewed daily.
MARKET RISK
Market risk represents the potential loss the Company may incur as a result of
absolute and relative price movements in financial instruments due to changes in
interest rates, foreign exchange rates, equity prices, and other political
factors. The Company is not subject to direct market risk due to changes in
foreign exchange rates. However, the Company is subject to market risk as a
result of changes in interest rates and equity prices, which are affected by
global economic conditions. The principal source of this risk arises from
maintaining securities inventory positions and trading and market-making in
these securities. The Company carries inventories of marketable securities
including equities and municipal, U.S. government and agency zero coupon,
corporate, and CMO fixed income securities for resale to its retail and
institutional brokerage customers and other broker-dealers. All of the Company's
inventories are held for trading purposes.
In connection with the Company's dealing activities, the Company is exposed to
interest rate risk due to changes in the level or volatility of interest rates,
changes in the yield curve, mortgage prepayments and credit spreads. The Company
is exposed to equity price risk due to changes in the level and volatility of
equity prices primarily in the Nasdaq and over-the-counter markets. The Company
controls its market risk primarily through notional limits on trading
inventories. In addition, the Company attempts to mitigate its exposure to
interest rate risk on its long CMO and U.S. government and agency inventories by
entering into hedging transactions through the use of short cash positions in
U.S. government obligations and, to a lesser extent, financial futures
contracts.
14
<PAGE>
The following table shows the quoted market values of the Company's securities
owned ("long"), securities sold but not yet purchased ("short"), net positions
and overall position limits as of March 26, 1999:
<TABLE>
<CAPTION>
Long Short Net Limit
------------ -------------- ----------- ----------------------
<S> <C> <C> <C> <C>
Corporate bonds, debentures, and notes $ 1,869,000 $ (1,388,000) $ 481,000 Long $ 7,000,000
U.S. Government and government
agency obligations 136,398,000 (136,680,000) (282,000) Long $180,000,000 (1)
Collateralized mortgage obligations 6,224,000 (97,000) 6,127,000 Long $ 30,000,000 (2)
State and municipal obligations 2,638,000 2,638,000 Long $ 5,000,000
Corporate stocks 380,000 (196,000) 184,000 Long $ 2,500,000
</TABLE>
(1) $175,000,000 of total long position limit must be adequately hedged.
(2) Unless approval is given, long inventory must be adequately hedged.
The information regarding the Company's market risk included above does not
consider other factors that may influence the Company's market risk, such as
credit spread risk, prepayment risk on CMOs, or changes in the shape of the
yield curve. Information with regard to the Company's securities borrowed,
securities loaned, borrowings, and securities sold under agreements to
repurchase is not included, as the interest rates for such instruments are
generally reset on a daily basis.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11 Computation of Earnings Per Share*
27 Financial Data Schedule (This financial data schedule is only required to
be submitted with the registrant's Quarterly Report on Form 10-Q as filed
electronically to the SEC's EDGAR database.)
* See Note 4 to the Company's Notes to Consolidated Financial Statements.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended March 26,
1999.
15
<PAGE>
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.
RAGEN MACKENZIE GROUP INCORPORATED
(REGISTRANT)
DATE: MAY 7, 1999 BY: /s/ Lesa A. Sroufe
--------------------------
Lesa A. Sroufe
Chairman of the Board and Chief Executive
Officer (Principal Executive Officer)
DATE: MAY 7, 1999 BY: /s/ V. Lawrence Bensussen
--------------------------
V. Lawrence Bensussen
Senior Vice President, Chief Financial
Officer and Secretary (Principal
Financial and Accounting Officer)
16
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION
- -------------------------- ----------------------------------------
<C> <S>
11 Computation of Earnings per Share.*
27 Financial Data Schedule.
</TABLE>
* See Note 4 to the Company's Notes to Consolidated Financial Statements
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM RAGEN
MACKENZIE'S MARCH 26, 1999 FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-25-1998
<PERIOD-START> SEP-26-1998
<PERIOD-END> MAR-26-1999
<CASH> 2,888
<RECEIVABLES> 115,899
<SECURITIES-RESALE> 515,067
<SECURITIES-BORROWED> 5,039
<INSTRUMENTS-OWNED> 147,509
<PP&E> 1,938
<TOTAL-ASSETS> 794,942
<SHORT-TERM> 52,375
<PAYABLES> 437,600
<REPOS-SOLD> 43,600
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 138,361
<LONG-TERM> 0
0
0
<COMMON> 135
<OTHER-SE> 111,169
<TOTAL-LIABILITY-AND-EQUITY> 794,942
<TRADING-REVENUE> 15,191
<INTEREST-DIVIDENDS> 18,343
<COMMISSIONS> 16,197
<INVESTMENT-BANKING-REVENUES> 0
<FEE-REVENUE> 2,440
<INTEREST-EXPENSE> 10,999
<COMPENSATION> 20,172
<INCOME-PRETAX> 12,561
<INCOME-PRE-EXTRAORDINARY> 8,294
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,294
<EPS-PRIMARY> .63
<EPS-DILUTED> .63
</TABLE>
