<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________________
TO _________________
Commission File Number 1-13993
FREEDOM SECURITIES CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 04-3335712
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Beacon Street
Boston, Massachusetts 02108
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (617) 725-2000
Indicate by checkmark 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 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 10, 1999, the Company has 19,759,233 shares of common stock
outstanding.
<PAGE> 2
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition -
March 31, 1999 and December 31, 1998 3
Consolidated Statements of Income - Three months
ended March 31, 1999 and 1998 4
Consolidated Statements of Cash Flows - Three months
ended March 31, 1999 and 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Changes in Securities and Use of Proceeds 14
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
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FREEDOM SECURITIES CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Amounts in thousands, except share data)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
(unaudited)
--------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 8,696 $ 11,292
Receivables from brokers and dealers 66,333 88,674
Securities purchased under agreements to resell 59,613 119,861
Securities owned, at market 274,635 252,478
Fixed assets, net of accumulated depreciation and amortization 20,576 19,479
Goodwill, net of accumulated amortization 38,041 34,875
Exchange memberships owned, at cost 5,939 5,939
Deferred taxes 10,519 10,477
Other receivables 43,224 31,356
Other assets 43,647 31,819
-------- --------
Total assets $571,223 $606,250
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Payables to brokers and dealers $ 67,724 $ 85,306
Securities sold under agreements to repurchase 25,802 28,582
Securities sold, not yet purchased, at market 155,620 124,148
Accrued compensation and benefits 35,771 81,099
Accounts payable and accrued expenses 46,104 47,016
Notes payable to banks 15,723 16,709
-------- --------
Total liabilities 346,744 382,860
-------- --------
Stockholders' equity:
Common stock (60,000,000 shares authorized, 20,521,592 and
20,155,395 shares issued in 1999 and 1998, respectively, $.01 par value) 205 201
Additional paid-in capital 186,610 181,391
Retained earnings 48,975 42,970
Treasury stock, at cost (734,739 and 76,290 shares in 1999 and 1998, respectively) (11,311) (1,172)
-------- --------
Total stockholders' equity 224,479 223,390
-------- --------
Total liabilities and stockholders' equity $571,223 $606,250
======== ========
</TABLE>
See accompanying notes.
3
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FREEDOM SECURITIES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Amounts in thousands, except per share data)
THREE MONTHS ENDED
MARCH 31,
-------------------------
1999 1998
-------- --------
Revenues
Commissions $ 53,834 $ 43,234
Principal transactions 32,555 25,012
Investment banking 13,481 14,089
Asset management 14,605 9,906
Other 1,881 1,818
-------- --------
Total operating revenues 116,356 94,059
Interest income 13,248 13,264
-------- --------
Total revenues 129,604 107,323
Interest expense 6,965 7,014
-------- --------
Net revenues 122,639 100,309
Non-interest expenses
Compensation and benefits 79,765 66,378
Occupancy and equipment 6,591 5,428
Communications 5,301 4,119
Brokerage and clearance 4,485 3,169
Promotional 3,654 2,752
Other 11,386 8,517
-------- --------
Total non-interest expenses 111,182 90,363
Operating pre-tax income 11,457 9,946
Acquisition interest expense -- 1,350
-------- --------
Income before income taxes 11,457 8,596
Income taxes 4,659 3,567
-------- --------
Net income $ 6,798 $ 5,029
Net income per share:
Basic $ 0.34 $ 0.34
Diluted $ 0.33 $ 0.32
Cash dividends declared per share $ 0.04 $ --
Weighted average common shares outstanding:
Basic 19,823 14,825
Diluted 20,726 15,730
See accompanying notes.
4
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FREEDOM SECURITIES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
1999 1998
-------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,798 $ 5,029
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation 1,261 1,112
Amortization 1,513 1,154
Non-cash compensation 41 508
Changes in assets and liabilities, net of purchases of Hopper Soliday and
Charter
(Increase) decrease in operating assets:
Receivables from brokers and dealers 29,311 (29,694)
Securities purchased under agreements to resell 60,248 87,029
Securities owned, at market (20,850) 107,949
Deferred taxes (42) (71)
Other receivables (11,868) (2,161)
Other assets (10,429) (4,130)
Increase (decrease) in operating liabilities:
Payables to brokers and dealers (17,582) 7,363
Securities sold under agreements to repurchase (2,780) --
Securities sold, not yet purchased, at market 31,239 (142,187)
Accrued compensation and benefits (46,470) (29,975)
Accounts payable and accrued expenses (1,494) 337
-------- ---------
Net cash from operating activities 18,896 2,263
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets (2,172) (713)
Acquisitions, net of cash acquired (9,458) --
-------- ---------
Net cash used in investing activities (11,630) (713)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net 2,056 1,313
Purchases of treasury stock (10,140) --
Payment of dividends (792) --
Repayment of notes payable to banks (986) (3,649)
-------- ---------
Net cash used in financing activities (9,862) (2,336)
Increase (decrease) in cash and cash equivalents (2,596) (786)
Cash and cash equivalents, beginning of period 11,292 12,936
-------- ---------
Cash and cash equivalents, end of period $ 8,696 $ 12,150
======== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 4,021 $ 1,445
Interest $ 6,445 $ 8,272
</TABLE>
See accompanying notes.
5
<PAGE> 6
FREEDOM SECURITIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
1. BASIS OF PRESENTATION
Freedom Securities Corporation is a holding company which together with its
wholly owned subsidiaries (collectively, the "Company") is a full-service,
regionally focused retail brokerage and investment banking firm. The Company is
engaged primarily in the retail and institutional brokerage business including
corporate finance and underwriting services. The consolidated financial
statements include the accounts of the Company and its primary operating
subsidiaries: Tucker Anthony Incorporated ("Tucker Anthony"), Sutro & Co.
Incorporated ("Sutro"), Cleary Gull & Reiland Inc. ("Cleary Gull"), which was
acquired by the Company in the second quarter of 1998, and Freedom Capital
Management Corporation ("Freedom Capital").
The Company was formed in November 1996 to effect the acquisition (the
"Acquisition") of Freedom Securities Holding Corporation and its subsidiaries
from John Hancock Mutual Life Insurance Company ("Hancock"). The consideration
paid to Hancock was financed with equity contributions from two private investor
groups and certain employee investors, bank financing and excess cash of the
Company.
On April 2, 1998, the Company completed its initial public offering, whereby
4.2 million shares of common stock were sold by the Company resulting in net
proceeds to the Company of $75.7 million.
All significant intercompany accounts and transactions have been eliminated
in consolidation. The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from these
estimates. Certain prior period amounts have been reclassified to conform with
the current period's financial statement presentation.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for audited
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included. Operating results for the
three months ended March 31, 1999 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1999. The information
included in this Form 10-Q should be read in conjunction with the audited
financial statements included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1998.
2. ACQUISITION OF HOPPER SOLIDAY & CO., INC.
On January 19, 1999 the Company acquired the investment and municipal
banking firm Hopper Soliday & Co., Inc. ("Hopper Soliday") and merged it with
Tucker Anthony. The consolidated financial statements include Hopper Soliday's
results after December 31, 1998. The purchase price was $9.0 million paid in
cash and the acquisition was accounted for using the purchase method of
accounting. The excess of the purchase price over the estimated fair value of
net assets acquired, which was recorded as goodwill, was $1.5 million and is
being amortized over 15 years using the straight-line method of amortization. In
addition, the Company has agreed to make certain incentive and retention
payments with a total value of $2.0 million (the majority of which is subject to
a three year vesting period).
6
<PAGE> 7
3. ACQUISITION OF CHARTER INVESTMENT GROUP, INC.
On February 1, 1999 the Company, through its Sutro subsidiary, acquired
Charter Investment Group, Inc. ("Charter"), a brokerage firm based in Portland,
Oregon. The consolidated financial statements include the results of Charter
from the date of acquisition and the acquisition was accounted for using the
purchase method of accounting. The purchase price was $3.6 million which
included 203,665 shares of the Company's Common Stock valued at $3.1 million and
$0.5 million paid in cash. The excess of the purchase price over the estimated
fair value of net assets acquired, which was recorded as goodwill, was $2.4
million and is being amortized over 15 years using the straight-line method of
accounting.
4. NET CAPITAL REQUIREMENTS
Certain subsidiaries of the Company are subject to the net capital
requirements of the New York Stock Exchange ("Exchange") and the Uniform Net
Capital requirements of the Securities and Exchange Commission ("Commission")
under Rule 15c3-1. The Exchange and the Commission rules also provide that
equity capital may not be withdrawn or cash dividends paid if certain minimum
net capital requirements are not met. The Company's principal regulated
subsidiaries are discussed below.
Under a clearing arrangement with Wexford Clearing Services Corporation
("Wexford"), Tucker Anthony, Sutro and Cleary Gull are required to maintain
certain minimum levels of net capital and comply with other financial ratio
requirements. At March 31, 1999, Tucker Anthony, Sutro and Cleary Gull were in
compliance with all such requirements.
Tucker Anthony is a registered broker and dealer. At March 31, 1999, Tucker
Anthony had net capital of approximately $22.8 million which was $21.8 million
in excess of the $1.0 million amount required to be maintained at that date.
Sutro is a registered broker and dealer. At March 31, 1999, Sutro had net
capital of approximately $8.7 million which was $7.7 million in excess of the
$1.0 million amount required to be maintained at that date.
Cleary Gull is a registered broker and dealer. At March 31, 1999, Cleary
Gull had net capital of approximately $5.7 million which was $5.4 million in
excess of the $0.3 million amount required to be maintained at that date.
Freedom Trust Company ("FTC") is a subsidiary of Freedom Capital and is a
limited purpose trust company. Pursuant to state regulations, FTC is required to
meet and maintain certain capital minimums and ratios. At March 31, 1999, FTC's
regulatory capital, as defined, was $1.2 million and FTC was in compliance with
all such requirements.
5. COMMITMENTS AND CONTINGENCIES
The Company leases office space and various types of equipment under
noncancelable leases generally varying from one to ten years, with certain
renewal options for like terms.
The Company has been named as defendant in a number of civil actions and
arbitrations primarily relating to its broker-dealer activities. The Company is
also involved, from time to time, in proceedings with, and investigations by,
governmental agencies and self regulatory organizations. While the ultimate
outcome of litigation involving the Company cannot be predicted with certainty,
management believes, based on currently available information, it has
meritorious defenses to all such actions and intends to defend each of these
vigorously.
While there can be no assurance that such actions, proceedings,
investigations and litigation will not have a material adverse effect on the
financial results of operations of the Company in any future period, it is the
opinion of management that the resolution of any such actions, proceedings,
investigations and litigation will not have a material adverse effect on the
consolidated financial position and results of operations of the Company.
7
<PAGE> 8
The Company has outstanding underwriting agreements and when-issued
contracts which commit it to purchase securities at specified future dates and
prices. The Company presells such issues to manage risk exposure related to
these off-balance sheet commitments. Transactions which were open at March 31,
1999 have subsequently settled and had no material effect on the consolidated
statements of income and financial condition.
6. EARNINGS PER SHARE
The Company computes its earnings per share in accordance with Statement of
Financial Accounting Standards ("SFAS") 128, "Earnings Per Share." The following
table sets forth the computation for basic and diluted earnings per share (in
thousands, except per share amounts):
THREE MONTHS ENDED
MARCH 31,
---------------------
1999 1998
------- -------
NUMERATOR
- ---------
Net income $ 6,798 $ 5,029
DENOMINATOR
- -----------
Weighted average shares outstanding 19,823 14,825
Dilutive effect of:
Stock options and other exercisable shares 903 905
------- -------
Adjusted weighted average shares outstanding 20,726 15,730
Earnings per share:
Basic $ 0.34 $ 0.34
Diluted $ 0.33 $ 0.32
7. SEGMENT REPORTING DATA
In 1998, the Company adopted SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information." The Company has two reportable segments:
broker-dealer and asset management. The Company's broker-dealer segment includes
the retail operations, equity capital markets and trading businesses of its
three brokerage subsidiaries, Tucker Anthony, Sutro and Cleary Gull, since they
generally offer similar products and services and are subject to uniform
regulatory requirements. The Company offers its broker-dealer clients a wide
range of products and services, including retail brokerage, investment banking,
institutional sales and fixed income products. The asset management segment
includes the Company's asset management subsidiary, Freedom Capital, Cleary
Gull's Investment Management Services group and asset management business from
Tucker Anthony and Sutro. The Company offers its asset management clients
investment advisory, portfolio management and custodial services. Substantially
all of the Company's business is transacted in the United States. The following
table presents information about reported segments (amounts in thousands):
<TABLE>
<CAPTION>
Asset
Broker -Dealer Management Other(a) Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
THREE MONTHS ENDED MARCH 31, 1999
Operating revenues $101,716 $14,605 $ 35 $116,356
Income before income taxes 7,928 3,522 7 11,457
Total assets 457,903 61,085 52,235 571,223
- -------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31, 1998
Operating revenues $ 83,914 $ 9,906 $ 239 $ 94,059
Income (loss) before income taxes 8,185 2,049 (1,638) 8,596
Total assets 442,908 72,140 51,279 566,327
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Other reflects the activities of the Company's holding companies. Income
(loss) before income taxes principally includes amortization of goodwill and
acquisition interest expense related to financing the Acquisition. Total assets
primarily consist of goodwill and deferred taxes.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Company's
consolidated financial statements and notes thereto appearing in Item 1 of this
report. This Form 10-Q may contain or incorporate by reference statements which
may constitute "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Prospective investors are cautioned that any
such forward-looking statements are not guarantees for future performance and
involve risks and uncertainties, and that actual results may differ materially
from those contemplated by such forward-looking statements.
BUSINESS ENVIRONMENT
The Company's retail securities brokerage activities, as well as its
investment banking, asset management, institutional sales and trading and equity
research services, are highly competitive and subject to various risks including
volatile trading markets and fluctuations in the volume of market activity.
These markets are affected by general economic and market conditions, including
fluctuations in interest rates, volume and price levels of securities and flows
of investor funds into and out of mutual funds and pension plans and by factors
that apply to particular industries such as technological advances and changes
in the regulatory environment. The first quarter of 1999 saw a continuation of
positive monetary conditions and low inflation which both continued to propel
the equity markets in the United States. The Company's financial results have
been and may continue to be subject to fluctuations due to these and other
factors. Consequently, the results of operations for a particular period may not
be indicative of results to be expected for other periods.
COMPONENTS OF REVENUES AND EXPENSES
Revenues. Commission revenues include retail and institutional commissions
received by the Company as an agent in securities transactions, including all
exchange listed, over-the-counter agency, mutual fund, insurance and annuity
transactions. Principal transactions revenues include principal sales credits
and dividends as well as gains and losses from the trading of securities by the
Company as principal. Investment banking revenues include selling concessions,
underwriting fees and management fees received from the underwriting of
corporate or municipal securities as well as fees earned from providing merger
and acquisition and other financial advisory services. Asset management revenues
include fees generated from providing investment advisory, portfolio management
and custodial services to clients, as well as managed account fees and 12b-1
distribution fees. Other revenues primarily consist of retirement plan revenue
and third party correspondent clearing fees. Interest income primarily consists
of interest earned on margin loans made to customers, securities purchased under
agreements to resell and fixed income securities held in the Company's trading
accounts. Net revenues equal total revenues less interest expense. Interest
expense includes interest paid under its Wexford financing arrangement and on
bank borrowings, securities sold under agreements to repurchase, fixed asset
financing and cash balances in customer accounts.
Expenses. Compensation and benefits expense includes sales, trading and
incentive compensation, which are primarily variable based on revenue production
and/or business unit profit contribution, and salaries, payroll taxes and
employee benefits which are relatively fixed in nature. Incentive compensation,
including bonuses for eligible employees, is accrued proratably throughout the
year based on actual or estimated annual amounts. Brokerage and clearance
expense includes the cost of securities clearance, floor brokerage and exchange
fees. Communications expense includes service charges for telecommunications,
news and market data services. Occupancy and equipment expense includes rent and
operating expenses for facilities, expenditures for repairs and maintenance, and
depreciation and amortization of furniture, fixtures and leasehold improvements.
Promotional expense includes travel, entertainment and advertising. Other
expenses include general and administrative expenses, including professional
services, litigation expenses, goodwill amortization, data processing and other
miscellaneous expenses. Acquisition interest expense represents the interest
expense incurred under the previous revolving credit agreement, the balance of
which was repaid with proceeds from the Company's initial public offering in
April 1998.
9
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RESULTS OF OPERATIONS
The following table compares first quarter results (amounts in millions) in
1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS PERIOD TO PERIOD PERCENTAGE OF
------------------- -------------------- ---------------
ENDED MARCH 31, INCREASE/(DECREASE) NET REVENUES
------------------- -------------------- ---------------
1999 1998 AMOUNT PERCENT 1Q99 1Q98
------ ------ ------ ------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Commissions .............................. $ 53.8 $ 43.2 $10.6 25% 44% 43%
Principal transactions ................... 32.6 25.0 7.6 30 27 25
Investment banking ....................... 13.5 14.1 (0.6) (4) 11 14
Asset management ......................... 14.6 9.9 4.7 47 12 10
Other .................................... 1.9 1.8 0.1 3 1 2
------ ------ ----- --- ---
Total operating revenues .............. 116.4 94.0 22.4 24 95 94
Interest income .......................... 13.2 13.3 (0.1) 0 11 13
------ ------ ----- --- ---
Total revenues ........................ 129.6 107.3 22.3 21 106 107
Interest expense ......................... 7.0 7.0 -- 0 6 7
------ ------ ----- --- ---
Net revenues .......................... 122.6 100.3 22.3 22 100 100
Non-interest expenses:
Compensation and benefits ................ 79.8 66.4 13.4 20 65 66
Occupancy and equipment .................. 6.6 5.4 1.2 21 5 5
Communications ........................... 5.3 4.1 1.2 29 4 4
Brokerage and clearance .................. 4.5 3.2 1.3 42 4 3
Promotional .............................. 3.6 2.8 0.8 33 3 3
Other .................................... 11.4 8.5 2.9 34 9 9
------ ------ ----- --- ---
Total non-interest expenses ........... 111.2 90.4 20.8 23 90 90
Operating pre-tax income ................... 11.4 9.9 1.5 15 10 10
Acquisition interest expense ............... -- 1.3 (1.3) (100) 0 1
------ ------ ----- --- ---
Income before income taxes ................. 11.4 8.6 2.8 33 10 9
Income taxes ............................... 4.6 3.6 1.0 31 4 4
------ ------ ----- --- ---
Net income ................................. $ 6.8 $ 5.0 $ 1.8 35% 6% 5%
====== ====== ===== === ===
</TABLE>
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31,
1998
The Company generated first quarter 1999 net income of $6.8 million, a 35%
increase over the first quarter of 1998. With the exception of investment
banking revenues, the Company experienced significant year over year revenue
growth due to strong commission revenues, solid trading activities and a
substantial increase in assets under management. Additionally, the early
retirement of debt in April 1998 resulted in a decline in acquisition interest
expense of $1.3 million in the 1999 first quarter compared to prior year's
quarter. Earnings per share (diluted) were $0.33 for the 1999 first quarter on
20.7 million shares as compared to $0.32 in the first quarter of 1998 on 15.7
million shares. In April 1999 the Company's Board of Directors declared a
quarterly dividend of $0.05 per share, up 25% when compared with prior quarterly
dividends paid.
Total operating revenues increased $22.4 million or 24% to $116.4 million
for the quarter ended March 31, 1999 from $94.0 million for the quarter ended
March 31, 1998 reflecting revenue growth in all of the Company's operating
subsidiaries. The Company's first quarter 1999 revenues reflect the inclusion of
Cleary Gull which was acquired in the second quarter of 1998. The Company's
results also benefited from the first quarter 1999 acquisitions of Hopper
Soliday and Charter. Net revenues rose 22% to a record $122.6 million for the
first quarter of 1999 compared with $100.3 million for the same period last
year.
Commission revenues rose 25% to $53.8 million for the 1999 first quarter
from $43.2 million a year ago, primarily due to an increased number of
investment executives, higher average productivity and continued penetration
into new markets.
Revenues from Principal transactions were $32.6 million, up $7.6 million or
30% from $25.0 million in the 1998 first quarter, mainly due to revenue growth
in the Company's over-the-counter and fixed income businesses as well as higher
revenues from proprietary trading activities.
10
<PAGE> 11
Investment banking revenues for three months ended March 31, 1999 were $13.5
million, down slightly from $14.1 million for the same period a year ago in part
due to transactions slipping to later in the year.
The Company's asset management business remained strong during the first
quarter of 1999 with year over year revenue growth of 47%. This revenue increase
is primarily due to growth in assets under management which reached $9.4 billion
at March 31, 1999, up $2.3 billion due to new money added to the funds as well
as asset appreciation from equity market performance. Asset management revenues
reached $14.6 million for the three months ended March 31, 1999 representing 12%
of the Company's net revenues compared to 10% or $9.9 million for the three
months ended March 31, 1998.
Interest income of $13.2 million for the three months ended March 31, 1999
was essentially flat when compared to the same period a year ago. Interest
expense, excluding those expenses associated with financing the Acquisition, was
$7.0 million for the three months ended March 31, 1999 and was also flat
relative to last year.
Compensation and benefits expense increased $13.4 million or 20% to $79.8
million for the three months ended March 31, 1999 from $66.4 million for the
three months ended March 31, 1998, primarily due to increased incentive and
production related compensation as well as the inclusion of Cleary Gull, Hopper
Soliday and Charter in 1999.
Non-compensation related operating expenses increased an aggregate of $7.4
million or 31% to $31.4 million for the three months ended March 31, 1999 from
$24.0 million in the first quarter 1998. The increase in the first quarter of
1999 includes approximately $3.3 million of operating expenses for Cleary Gull,
Hopper Soliday and Charter which were not included in 1998. The Company's
non-compensation operating expenses, excluding expenses from acquired companies,
rose $4.1 million primarily due to increased occupancy and equipment expense
related to new branches and additional office space, greater communication and
technology investments for business expansions, additional clearing costs
resulting from higher business volumes and increased professional fees and
organizational costs associated with new hiring and acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
The Company receives dividends, interest on loans and other payments from
its subsidiaries, which are the Company's primary source of funds to pay
expenses, service debt and pay dividends. Distributions and interest payments to
the Company from its registered broker-dealer subsidiaries, the Company's
primary sources of liquidity, are restricted as to amounts which may be paid by
applicable law and regulations. The Net Capital Rules are the primary regulatory
restrictions regarding capital resources. The Company's rights to participate in
the assets of any subsidiary are also subject to prior claims of the
subsidiary's creditors, including customers of the broker-dealer subsidiaries.
Borrowings under the previous revolving credit agreement were repaid in full
with the net proceeds from the Company's initial public offering and available
cash, leaving the Company with $15.7 million of indebtedness at March 31, 1999
under a fixed asset credit facility (the "Fixed Asset Facility") secured by the
Company's fixed assets. In August 1998, the Company entered into a new unsecured
revolving credit agreement (the "Credit Agreement") whereby participating banks
have made commitments totaling $50 million. Under the Credit Agreement, the
Company has the option to borrow at the federal funds rate or the eurodollar
rate (each plus applicable margin as defined, ranging from 0.50% to 0.75% based
on a calculated leverage ratio) or the agent's base rate. Borrowings under the
Credit Agreement, which matures on August 21, 2001, may be prepaid without
penalty. Additionally, the Company must pay a quarterly commitment fee for the
new credit facility calculated at 0.15% per year on the unused facility. At
March 31, 1999, the Company did not have any borrowings under the Credit
Agreement.
The assets of the Company's primary operating subsidiaries are highly liquid
with the majority of such assets consisting of securities inventories and
collateralized receivables, both of which fluctuate depending on the levels of
customer business. Collateralized receivables consist mainly of securities
purchased under agreements to resell, which are secured by U.S. government and
agency securities. A relatively small percentage of total assets is fixed or
held for a period of longer than one year.
11
<PAGE> 12
The majority of the subsidiaries' assets are financed through Wexford, by
securities sold under repurchase agreements and by securities sold, not yet
purchased. The Company's principal source of short-term financing is based on
its clearing arrangement with Wexford under which the Company can borrow on an
uncommitted collateralized basis against its proprietary inventory positions.
This financing generally is obtained from Wexford at rates based upon prevailing
market conditions. The Company monitors overall liquidity by tracking the extent
to which unencumbered marketable assets exceed short-term unsecured borrowings.
Repurchase agreements are used primarily for customer accommodation purposes
and to finance the Company's inventory positions in U.S. government and agency
securities. These positions provide products and liquidity for customers and are
not maintained for the Company's investment or market speculation. The level of
activity fluctuates depending on customer and inventory needs; however, these
fluctuations have not materially affected liquidity or capital resources. The
Company monitors the collateral position and counterparty risk on these
transactions daily.
The subsidiaries' total assets and short-term liabilities and the individual
components thereof may vary significantly from period to period because of
changes relating to customer needs and economic and market conditions.
The Company's operating activities generate cash resulting from net income
earned during the period and fluctuations in the Company's current assets and
liabilities. The most significant fluctuations have resulted from changes in the
level of customer activity and securities inventory changes resulting from
proprietary arbitrage trading strategies dictated by prevailing market
conditions.
As noted above, the Company maintains, through two subsidiaries, the Fixed
Asset Facility with BancBoston Leasing Inc. which matures in 2001 and had an
outstanding balance at March 31, 1999 of $15.7 million. The Company has
historically financed capital expenditures through internal cash generation and
through the Fixed Asset Facility. In January 1999, the Company refinanced a
portion of the Fixed Asset Facility and secured additional financing for a $4.7
million upgrade of its computer system. This financing bears interest at 5.00%
annually and is payable in equal monthly installments through May 2003.
In addition to normal operating requirements, capital is required to satisfy
financing and regulatory requirements. The Company's overall capital needs are
continually reviewed to ensure that its capital base can appropriately support
the anticipated capital needs of the subsidiaries. The excess regulatory net
capital of the Company's broker-dealer subsidiaries may fluctuate throughout the
year reflecting changes in the inventory levels/composition, investment banking
commitments and balance sheet components. For example, Tucker Anthony's excess
net capital declined at March 31, 1999 primarily due to higher securities
inventory positions and increased receivables from affiliates. Management
believes that existing capital funds provided from operations, the current
credit arrangements with Wexford and the unutilized Credit Agreement from
participating banks will be sufficient to finance the operating subsidiaries'
ongoing businesses.
In September 1998, the Board of Directors approved a stock repurchase
program that permits the Company's management to purchase at its discretion up
to five percent of its Common Stock outstanding or approximately one million
shares. The Company will fund the stock repurchases from internal sources or
through borrowings and will use the shares for issuance of stock under employee
stock option and stock purchase plans, or retain the shares as treasury stock.
During the first three months of 1999, the Company repurchased 845,748 shares at
an average price of $15.44 per share and issued 187,299 shares to employees as a
matching contribution under the Company's profit sharing plan. Included in the
shares repurchased are 494,748 shares purchased from SCP Private Equity
Partners, L.P., one of the original equity investors in the Company, which were
approved by the Company's Board of Directors apart from the stock repurchase
program. In April 1999, the Board of Directors authorized the purchase of an
additional one million shares pursuant to the Company's stock repurchase
program.
CASH FLOWS
Cash and cash equivalents at March 31, 1999 and 1998 totaled $8.7 million
and $12.2 million, respectively. For the three months ended March 31, 1999,
funds generated from operating activities of $18.9 million, including net income
of $6.8 million, along with available cash were used primarily for purchases of
fixed assets, the acquisitions of Hopper Soliday and Charter and purchases of
treasury stock.
12
<PAGE> 13
YEAR 2000 COMPLIANCE
The securities industry is, to a significant extent, technologically driven
and dependent. In addition to internally utilized technological applications,
the Company's businesses are materially dependent upon the performance of
exchanges, market centers, counterparties, customers and vendors (collectively
"the Company's material third parties") who, in turn, may be heavily reliant on
technological applications. In sum, the securities industry is pervasively
interdependent with each "link of the chain" strengthened or weakened by the
quality and performance of its attendant information and embedded technology.
The Company is aware that the Year 2000 provides potential problems with the
programming code in existing computer systems. The "Year 2000 problem" is
extensive and complex as virtually every computer operation will be affected to
some degree by the change of the two digit year value to 00. The issue is
whether computer systems will properly recognize date-sensitive information when
the year changes to 2000. Systems that do not properly recognize such
information could generate erroneous data or fail.
The failure or faulty performance of computer systems could potentially have
a far ranging impact on the Company's businesses such as a diminution in its
ability to (a) ascertain information vital to strategic decision making by both
the Company and its customers; (b) perform interest rate and pricing
calculations; (c) execute and settle proprietary and customer transactions; (d)
undertake regulatory surveillance and risk management; (e) maintain accurate
books and records and provide timely reports; (f) maintain appropriate internal
financial operations and accounting; and (g) access credit facilities for both
the Company and its customers. Accordingly it is necessary for the Company, to
the extent reasonably practicable, to identify the internal computer systems and
software which are likely to have a critical impact on its operations, make an
assessment of its Year 2000 readiness and modify or replace information and
embedded technology as needed. In addition, the Company must make a Year 2000
readiness assessment of the Company's material third parties.
In the fourth quarter of 1995, the Company began to strategically assess the
need for renovation, replacement or retirement of all business applications.
This assessment was coincident with the conversion of the Company's principal
broker-dealer subsidiaries to clear securities transactions through Wexford, an
unaffiliated broker-dealer. During the first half of 1996, in connection with
the conversion to Wexford, a substantial portion of all application and vendor
code were modified to be Year 2000 compliant and these changes were tested and
verified in 1998 to be materially effective. The Company continues to test the
remainder of application and vendor code in order to ensure that it is Year 2000
compliant.
Although Wexford is the contracting party for the provision of clearing
services, it in fact delivers those services through the operations of its
guaranteeing parent company, Prudential Securities Incorporated ("Prudential"),
a leading registered broker and dealer. Consequently, it is the readiness of
Prudential that is critical when assessing the Year 2000 compliance of the
clearing and operations capacity of the Company's active broker-dealer
subsidiaries. Prudential has been assessed, by internal industry standards
established by the Securities Industry Association, to be within the top tier of
Year 2000 readiness. In recent industry-wide testing conducted by the Securities
Industry Association, in which Prudential took part, Prudential 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.
Additionally, the Company has assessed the state of readiness of all known
technologically oriented service vendors and believes, based on letters of
certification, that the vast majority of these vendors are Year 2000 compliant
with the remainder expected to be compliant by August 1999. This determination
does not mean that the vast majority of the Company's material third parties
pose no Year 2000 risk to the Company. First, the Company is relying in large
measure on these parties' assessments of their readiness. Second, there are
several vendors, which account for a substantial portion of the Company's
mission critical operations, which may be partially or largely, but not fully,
Year 2000 compliant. Finally, certain critical third parties, such as exchanges,
clearing houses, depositories and other service vendors have no direct
functional contact with the Company (as they operate directly with Wexford) but
may impact the Company's operations.
At this juncture the Company's plan for the remainder of its Year 2000
remediation efforts includes (1) identification, modification and testing of any
remaining non-compliant Year 2000 code; (2) identification, inventory,
assessment and, if necessary, modification of internal ad hoc systems or
applications that may be material
13
<PAGE> 14
to the Company's operations; (3) with the exception of counterparties and
customers, documentation of the assessment of the readiness of the Company's
material third parties; and (4) a timetable for completion of the plan. The
Company completed its written plan to assess and take measures to enhance its
Year 2000 readiness. In January 1999, the Company successfully tested the Year
2000 readiness of its data network components. The Company's major vendor for
market data certified its system as Year 2000 compliant in February 1999. To
date, the Company's Year 2000 costs have been minimal. The Company believes
that, going forward, it will incur Year 2000 costs of approximately $500,000
which will be funded out of its working capital. Provided there is an absence of
unanticipated critical events, the Company does not expect Year 2000 costs to
have a material effect on its operating results, financial condition or cash
flows.
As a contingency plan, the Company intends to have information systems
personnel on site, from December 31, 1999 through January 2, 2000, on a 24-hour
basis, to insure that any Year 2000 problems that arise, will be addressed and
corrected immediately. The Company has been informed by Prudential that it
intends to implement a similar contingency plan. The Company believes these
measures will be sufficient because of the following reasons: (1) the Company
has substantially modified, to the extent it can ascertain the problem, most
mission critical code and embedded technology; and (2) the Company's vendors
have represented that they are either currently Year 2000 compliant or will
become so by the third quarter of 1999.
However, it is the Company's position that there are no alternatives in the
event the exchanges or other market centers fail to perform, and the Company
believes it is highly likely that the factors which may prevent a particular
clearing firm from performing, would similarly affect all other clearing firms,
which would either preclude the availability of alternative clearing service
providers or overwhelm the resources of surviving alternative clearing service
providers. In other words, the Year 2000 presents a problem which is not likely
to be susceptible to remediation at a future date, if it is not fixed in
advance.
The Company is cautiously optimistic about its current state of readiness
and its ability to make any further necessary modifications to internal systems
in time for the Year 2000. The Company also believes that its major third party
service provider, Prudential, has undertaken a systematic approach to the Year
2000 problem and will complete its plan which is designed to achieve a state of
readiness. However, there are factors outside the control of the Company which
make certainty impossible such as: (1) the inability to assess the readiness of
market counterparties and customers; (2) the inability to achieve assurance as
to any material third parties' representations of readiness; (3) the global
exposure of material third parties to Year 2000 problems outside the United
States which have a "knock-on" effect within the domestic securities markets and
operations; and (4) the limitations in anticipating all aspects of a problem
with which there is no prior historical experience. The presence of any or all
of these and other factors may well have a material adverse effect on the
Company's businesses, operating results, financial condition and cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information about market risks for the three months ended March 31, 1999 does
not differ materially from that discussed under Item 7a of the Company's Annual
Report on Form 10-K for the year ended December 31,1998.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business, the Company and its subsidiaries are named
as defendants in various legal proceedings and litigation primarily relating to
its broker-dealer activities. The Company believes that it has adequately
reserved for such legal proceedings and litigation matters and that they will
not have a material adverse effect on the Company's financial condition or
results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) UNREGISTERED SECURITIES:
During the period covered by this report, the Company issued an aggregate of
203,665 shares of Common Stock to the former owners of Charter to acquire their
firm in a private placement transaction exempt under section 4(2) of
14
<PAGE> 15
the Securities Act. Additional shares (estimated at no more than 25,000 shares)
may be issued in the future under an earnout provision included in the Company's
acquisition agreement with Charter. This sale of earnout shares was also exempt
under section of 4(2) of the Securities Act.
Also during the period covered by this report in connection with the
Company's acquisition of Hopper Soliday, the Company granted a total of 78,306
shares of restricted stock in a transaction exempt under section 4(2) of the
Securities Act.
Additionally, the Company issued 7,676 shares of Common Stock during the
1999 first quarter in a private placement transaction exempt under section 4(2)
of the Securities Act to John Hancock Subsidiaries, Inc. pursuant to the
Additional Share Agreement entered into in connection with the Acquisition.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
On April 5, 1999 the Company announced that it was joining its Cleary Gull
subsidiary with Tucker Anthony's Equity Capital Markets group to form Tucker
Anthony Cleary Gull Capital Markets. The new institutional capital markets and
investment management firm is known as Tucker Cleary and began operating on May
3, 1999. Tucker Anthony continues to operate as an independent broker-dealer
focusing on its retail brokerage business and other activities including fixed
income, risk arbitrage and asset management.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The following exhibits are included herein or are
incorporated by reference.
27 Financial Data Schedule
(b) Reports on Form 8-K - The company filed no reports on Form 8-K during
the quarter ended March 31, 1999.
15
<PAGE> 16
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.
FREEDOM SECURITIES CORPORATION
(REGISTRANT)
DATE: May 14, 1999 BY: /s/JOHN H. GOLDSMITH
---------------------------------------
JOHN H. GOLDSMITH
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
DATE: May 14, 1999 BY: /s/WILLIAM C. DENNIS, JR.
---------------------------------------
WILLIAM C. DENNIS, JR.
CHIEF FINANCIAL OFFICER
16
<PAGE> 17
EXHIBIT INDEX
ITEM NO. DESCRIPTION SEQUENTIAL PAGE NO.
- -------- ----------- -------------------
27 Financial Data Schedule 18
17
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<ARTICLE> BD
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 8,696
<RECEIVABLES> 109,557
<SECURITIES-RESALE> 59,613
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<INSTRUMENTS-OWNED> 274,635
<PP&E> 20,576
<TOTAL-ASSETS> 571,223
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<PAYABLES> 149,599
<REPOS-SOLD> 25,802
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 155,620
<LONG-TERM> 15,723
0
0
<COMMON> 205
<OTHER-SE> 224,274
<TOTAL-LIABILITY-AND-EQUITY> 571,223
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<COMPENSATION> 79,765
<INCOME-PRETAX> 11,457
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