<PAGE>
================================================================================
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 September 25, 1998
Commission file number 0-19483
SOUTHWEST SECURITIES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2040825
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 ELM STREET, SUITE 3500, DALLAS, TEXAS 75270
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 651-1800
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---
As of November 6, 1998, there were 10,678,406 shares of the registrant's common
stock, $.10 par value, outstanding.
================================================================================
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition
September 25, l998 and June 26, l998
Consolidated Statements of Income and Comprehensive Income
For the three months ended September 25, l998 and September 26, l997
Consolidated Statements of Cash Flows
For the three months ended September 25, l998 and September 26, l997
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
PART II. OTHER INFORMATION
Item 1. Legal proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 25, l998 and June 26, l998
(In thousands, except par values and share amounts)
<TABLE>
<CAPTION>
September June
(Unaudited)
---------------------- ---------------------
<S> <C> <C>
ASSETS
Cash $ 15,029 $ 13,706
Assets segregated for regulatory purposes 239,696 130,728
Marketable equity securities, at market value 15,597 -
Receivable from brokers, dealers and clearing organizations 1,978,433 2,365,635
Receivable from clients, net 571,731 648,464
Securities owned, at market value 35,438 32,144
Other assets 29,638 29,429
---------------------- ---------------------
$ 2,885,562 $ 3,220,106
====================== =====================
LIABILITIES & STOCKHOLDERS' EQUITY
Short-term borrowings $ - $ -
Payable to brokers, dealers and clearing organizations 1,886,187 2,293,731
Payable to clients 774,115 720,813
Securities sold not yet purchased, at market value 10,203 1,662
Drafts payable 37,672 41,688
Other liabilities 38,055 36,745
---------------------- ---------------------
2,746,232 3,094,639
Minority interest in consolidated subsidiary 100 -
Stockholders' equity:
Preferred stock of $1.00 par value. Authorized 100,000
shares; none issued - -
Common stock of $.10 par value. Authorized 20,000,000 shares;
issued 10,687,583 and outstanding 10,678,406 shares at
September 25, 1998 and June 26, 1998 1,069 1,069
Additional paid-in capital 69,462 69,462
Unrealized holding gain, net of tax 9,857 -
Retained earnings 58,956 55,022
Receivable from employees under the Employee Stock Purchase Plan (40) (12)
Treasury stock (9,177 shares, at cost) (74) (74)
---------------------- ---------------------
Total stockholders' equity 139,230 125,467
---------------------- ---------------------
Commitments and contingencies $ 2,885,562 $ 3,220,106
====================== =====================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the three months ended September 25, 1998 and September 26, 1997
(In thousands, except per share and share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------
1998 1997
-------------------- -------------------
<S> <C> <C>
Net revenues from clearing operations $ 8,094 $ 6,707
Commissions 14,409 13,887
Interest 35,847 34,378
Investment banking, advisory and administrative fees 7,584 4,376
Net gains on principal transactions 3,762 3,138
Other 3,501 2,810
-------------------- -------------------
73,197 65,296
-------------------- -------------------
Commissions and other employee compensation 25,863 20,326
Interest 24,029 24,308
Occupancy, equipment and computer service costs 4,739 3,888
Communications 2,912 3,158
Floor brokerage and clearing organization charges 1,465 1,255
Other 6,833 4,576
-------------------- -------------------
65,841 57,511
-------------------- -------------------
Income before income taxes 7,356 7,785
Income taxes 2,673 2,740
-------------------- -------------------
Net income 4,683 5,045
Other comprehensive income unrealized holding gains
arising during period, net of tax 9,857 -
-------------------- -------------------
Comprehensive income $ 14,540 $ 5,045
==================== ===================
Earnings per share - basic $ .44 $ .47
==================== ===================
Weighted average shares outstanding - basic 10,678,406 10,664,892
==================== ===================
Earnings per share - diluted $ .44 $ .47
==================== ===================
Weighted average shares outstanding - diluted 10,688,590 10,674,890
==================== ===================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended September 25, 1998 and September 26, 1997
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
------------------ -------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 4,683 $ 5,045
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 871 884
Provision for doubtful accounts 146 -
Deferred income taxes 21 183
Decrease (increase) in assets segregated for regulatory purposes (108,968) 187,506
Net change in broker, dealer and clearing organization accounts (20,342) 14,708
Net change in client accounts 129,889 (176,373)
Increase in securities owned (3,294) (3,280)
Increase in other assets (890) (1,394)
Increase (decrease) in securities sold not yet purchased 8,541 (1,062)
Increase (decrease) in drafts payable (4,016) 5,609
Increase (decrease) in other liabilities (4,141) 196
--------------------- --------------------
Net cash provided by operating activities 2,500 32,022
--------------------- --------------------
Cash flows from investing activities:
Purchase of furniture, equipment and leasehold improvements (639) (864)
--------------------- --------------------
Net cash used in investing activities (639) (864)
--------------------- --------------------
Cash flows from financing activities:
Proceeds from short term borrowings - 102
Payment on liabilities subordinated to the claims of
general creditors - (500)
Net change in receivable from employees for Employee
Stock Purchase Plan (28) 11
Net proceeds from exercise of stock options - 225
Payment of cash dividend on common stock (610) (609)
Proceeds from issuance of stock of consolidated subsidiary 100 -
--------------------- --------------------
Net cash used in financing activities (538) (771)
--------------------- --------------------
Net increase in cash 1,323 30,387
Cash at beginning of period 13,706 10,745
--------------------- --------------------
Cash at end of period $ 15,029 $ 41,132
===================== ====================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
GENERAL AND BASIS OF PRESENTATION
The accompanying interim consolidated financial statements include the accounts
of Southwest Securities Group, Inc. ("Parent") and its wholly owned
subsidiaries, (collectively, the "Company"), Southwest Securities, Inc.
("Southwest"), Brokers Transaction Services, Inc. ("BTS"), Southwest Investment
Advisors, Inc. ("Advisors"), Westwood Trust ("Trust"), Westwood Management
Corporation ("Westwood"), SW Capital Corporation ("Capital"), SWST Computer
Corporation ("Computer Corp.") Sovereign Securities, Inc. ("Sovereign") and
NorAm Investment Services, Inc. ("NorAm"). Southwest, BTS, Sovereign and NorAm
are registered broker/dealers under the Securities Exchange Act of 1934 ("1934
Act"). Advisors and Westwood are registered investment advisors under the
Investment Advisors Act of 1940. All significant intercompany balances and
transactions have been eliminated.
The consolidated financial statements as of September 25, 1998, and for the
three month periods ended September 25, 1998 and September 26, 1997, are
unaudited; however, in the opinion of management, these interim statements
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the financial position, results of
operations and cash flows. These financial statements should be read in
conjunction with the audited consolidated financial statements and related notes
as of and for the year ended June 26, 1998 filed on Form 10-K. Amounts included
for June 26, 1998 are from the audited consolidated financial statements as
filed on Form 10-K.
CASH FLOW REPORTING
Cash paid for interest was $36,420,000 and $23,233,000 for the periods ended
September 25, 1998 and September 26, 1997, respectively. Cash paid for income
taxes was $3,075,000 and $2,400,000 in 1998 and 1997, respectively.
In a non-cash transaction, the Parent received approximately 1.7 million common
shares of Knight/Trimark Group, Inc. ("Knight") subsequent to Knight's initial
public offering completed July 10, 1998.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 130
"REPORTING COMPREHENSIVE INCOME"
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130") in the first quarter of fiscal
1999. SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a set of general-purpose financial statements. In
accordance with SFAS 130, the unrealized holding gain on the investment in
Knight, net of tax, is presented as a component of comprehensive income in the
consolidated statements of income and comprehensive income. There were no items
of comprehensive income that required reclassification in the comparative prior
year financial statements presented herein.
SECURITIES PURCHASED UNDER AGREEMENT TO RESELL (REVERSE REPURCHASE AGREEMENTS)
Southwest, from time to time, enters into reverse repurchase agreements
(collateralized by U.S. Government or U.S. Government agency securities), for
the purpose of segregating assets for the exclusive benefit of its customers.
Under a master repurchase agreement ("Agreement") with Trust, securities
purchased under the reverse repurchase agreement are identified and segregated
by Trust on its books and records as subject to the Agreement. Management
regularly monitors the market value of the underlying securities relating to
outstanding reverse repurchase agreements.
ASSETS SEGREGATED FOR REGULATORY PURPOSES
At September 25, 1998, the Company had a certificate of deposit of $876,000,
reverse repurchase agreements of $156,015,000 and U.S. Treasury securities with
a market value of $82,805,000 segregated in a special reserve bank
<PAGE>
account for the exclusive benefit of customers under Rule 15c3-3 of the 1934
Act. The reverse repurchase agreements were collateralized by U.S. Government
securities with a market value of approximately $156,514,000. At June 26, 1998,
the Company had U.S. Treasury securities with a market value of $59,515,000 and
reverse repurchase agreements of $71,213,000 in this account. The reverse
repurchase agreements were collateralized by U.S. Government securities with a
market value of approximately $71,871,000 at June 26, 1998.
MARKETABLE EQUITY SECURITIES
The investment in Knight is classified as marketable equity securities available
for sale, and the unrealized holding gains, net of tax, are recorded as a
separate component of stockholders' equity on the consolidated statements of
financial condition. Realized gains and losses, if any, are recorded using the
specific identification method. There were no realized gains or losses in the
first quarter of fiscal 1999.
The following summarizes the cost and fair value of the investment in Knight at
September 25, 1998 (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Marketable equity securities $ 432 15,165 - $ 15,597
===============================================================================
</TABLE>
RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
At September 25, l998 and June 26, l998, the Company had receivable from and
payable to brokers, dealers and clearing organizations related to the following
(in thousands):
<TABLE>
<CAPTION>
September June
---------------------- ---------------------
<S> <C> <C>
Receivable:
Securities failed to deliver $ 21,140 $ 18,880
Securities borrowed 1,888,091 2,229,587
Correspondent broker/dealers 39,016 62,673
Clearing organizations 1,177 1,245
Other 29,009 53,250
---------------------- ---------------------
$ 1,978,433 $ 2,365,635
====================== =====================
</TABLE>
<TABLE>
<CAPTION>
September June
---------------------- ---------------------
<S> <C> <C>
Payable:
Securities failed to receive $ 20,708 $ 45,956
Securities loaned 1,846,497 2,227,874
Correspondent broker/dealers 10,716 11,300
Other 8,266 8,601
---------------------- ---------------------
$ 1,886,187 $ 2,293,731
====================== =====================
</TABLE>
SHORT-TERM BORROWINGS
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $192,500,000. These lines of credit are used primarily to
finance securities owned, securities held for correspondent broker/dealer
accounts and receivables in customers' margin accounts. These lines may also be
used to release pledged collateral against day loans. These credit arrangements
are provided on an "as offered" basis and are not committed lines of credit.
These arrangements can be terminated at any time by the lender. Any outstanding
balance under these credit
<PAGE>
arrangements is due on demand and bears interest at rates indexed to the federal
funds rate. There were no amounts outstanding at September 25, 1998 or June 26,
1998 on these credit arrangements.
In addition to the broker loans lines, the Company has a $20,000,000 unsecured
line of credit which is due on demand and bears interest at rates indexed to the
federal funds rate. There were no amounts outstanding under this secured line
of credit at September 25, 1998 and June 26, 1998.
At September 25, 1998 and June 26, 1998, the Company had no repurchase
agreements outstanding.
MINORITY INTEREST
Southwest has issued 100 shares of Series A Preferred Stock at $1,000 per share
to certain qualified broker/dealers. Qualified broker/dealers are broker/dealers
registered under the 1934 Act who clear their proprietary transactions through
Southwest and who represent that they are subject to net capital rules of the
SEC and other self-regulatory organizations to which such broker/dealers report.
A total of 5,000 shares of Series A Preferred Stock are reserved for issuance to
such broker/dealers. This investment by third-parties in Southwest is
classified as Minority Interest in Consolidated Subsidiary on the Consolidated
Statements of Financial Position.
NET CAPITAL REQUIREMENTS
The broker/dealer subsidiaries are subject to the Securities and Exchange
Commission's Uniform Net Capital Rule (the "Rule"), which requires the
maintenance of minimum net capital. Southwest has elected to use the
alternative method, permitted by the Rule, which requires that it maintain
minimum net capital, as defined in Rule 15c3-1 under the 1934 Act, equal to the
greater of $1,500,000 or 2% of aggregate debit balances, as defined in Rule
15c3-3 under the 1934 Act. At September 25, 1998, Southwest had net capital of
$83,482,000, or approximately 12% of aggregate debit balances, which is
$69,607,000 in excess of its minimum net capital requirement of $13,875,000 at
that date. Additionally, the net capital rule of the New York Stock Exchange,
Inc. (the "Exchange") provides that equity capital may not be withdrawn or cash
dividends paid if resulting net capital would be less than 5% of aggregate debit
items. At September 25, 1998, Southwest had net capital of $48,795,000 in
excess of 5% of aggregate debit items.
BTS, Sovereign and NorAm follow the primary (aggregate indebtedness) method
under Rule 15c3-1, which requires the maintainance of minimum net capital of
$250,000. At September 25, 1998, BTS had net capital of approximately $317,000
which is $67,000 in excess of the minimum net capital requirement. Sovereign had
net capital of approximately $530,000 which is $280,000 in excess of the minimum
net capital requirement at September 25, 1998. In addition, NorAm had net
capital of approximately $607,000 which is $357,000 in excess of the minimum net
capital requirement at September 25, 1998.
Trust is subject to the capital requirements of the Texas Department of Banking,
and has a minimum capital requirement of $1,000,000. Trust had total
stockholder's equity of approximately $2,593,000, which is $1,593,000 in excess
of its minimum capital requirement at September 25, 1998.
EMPLOYEE BENEFITS
At September 25, 1998, the Company had two stock option plans, the Southwest
Securities Group, Inc. Stock Option Plan (the "1996 Plan") and the Southwest
Securities Group, Inc. 1997 Stock Option Plan (the "1997 Plan"). The 1996 Plan
was adopted by the Board of Directors on September 17, 1996 and approved by the
shareholders on November 6, 1996. The 1996 Plan reserves 1,000,000 shares of
the Company's common stock for issuance to eligible employees of the Company or
its subsidiaries, as well as to non-employee members of the Board of Directors.
Options granted under the 1996 Plan have a maximum ten-year term, and the
vesting period is determined on an individual basis by the Stock Option
Committee. At September 25, 1998, there were approximately 439,000 options
outstanding under the 1996 Plan.
On August 20, 1997, the Board of Directors approved the 1997 Plan, which
reserves 150,000 shares of the Company's common stock for eligible employees or
potential employees of the Company or its subsidiaries.
<PAGE>
Officers and directors are not eligible to receive options under the 1997 Plan.
At September 25, 1998, there were approximately 17,000 options outstanding under
the 1997 Plan. The Company also has approximately 17,000 options outstanding
that were granted on May 25, 1995 in conjunction with the acquisition of Barre &
Company, Inc. ("Barre Options"). These options were vested immediately upon
grant and have a five-year term.
On November 6, 1996, the shareholders of the Company approved the Phantom Stock
Plan ("Phantom Plan") adopted by the Board of Directors on September 17, 1996.
The Phantom Plan allows non-employee directors to receive directors fees in the
form of common stock equivalent units. As of September 25, 1998, 791 units have
been issued under the Phantom Plan. These units have been excluded from the
calculation of weighted average shares outstanding due to their immaterial
nature.
The Company has a defined contribution profit sharing plan covering
substantially all employees. Profit sharing plan benefits become fully vested
after six years of service by the participant. Costs of the profit sharing plan
are accrued and funded at the Company's discretion.
The Company adopted an Employee Stock Purchase Plan ("Plan") as of August 30,
1994 to enable employees of the Company to purchase up to 468,227 shares of
common stock of the Company. Substantially all full-time employees were
eligible to purchase a minimum of $2,500 up to a maximum of $50,000 of the
common stock, subject to certain limitations, at a price of $6.89 per share.
The terms of the Plan provide that the Company will loan the full purchase price
of the stock to the employee under a promissory note due in monthly installments
over a five-year period, bearing interest at the Applicable Federal Rate (4.95%
at September 25, 1998). A total of 61,122 shares were sold under the terms of
the Plan, resulting in loans to employees of $421,000. The amount outstanding
under these notes at September 25, 1998 was $40,000.
On August 20, 1997, the Board of Directors adopted a Stock Purchase Plan ("Stock
Purchase Plan") to enable employees of the Company and its subsidiaries to
purchase up to 1,000,000 shares of common stock of the Company. The initial
purchase period began July 1, 1998.
EARNINGS PER SHARE
A reconciliation between the weighted average shares outstanding used in the
basic and diluted EPS computations is as follows (in thousands, except share and
per share amounts):
<TABLE>
<CAPTION>
1998 1997
--------------------- ---------------------
<S> <C> <C>
Net income $ 4,683 $ 5,045
===================== =====================
Weighted average shares outstanding basic 10,678,406 10,664,892
Effect of dilutive securities:
Assumed exercise of stock options 10,184 9,998
--------------------- ---------------------
Weighted average shares outstanding diluted 10,688,590 10,674,890
===================== =====================
Earnings per share basic and diluted $ .44 $ .47
===================== =====================
</TABLE>
As of September 25, 1998, 21,000 options issued under the 1996 Plan, 2,500
options issued under the 1997 Plan and all outstanding Barre Options were
dilutive and were included in the calculation of weighted average shares
outstanding diluted. All other outstanding options were anti-dilutive at
September 25, 1998.
STOCK DIVIDEND
On May 22, 1998, the Board of Directors declared a five percent stock dividend
which was paid on August 3, 1998 to shareholders of record at the close of
business on July 15, 1998.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
From time to time, Southwest Securities Group, Inc. (the "Parent") and
subsidiaries (collectively, the "Company") may publish "forward-looking
statements" within the meaning of section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended,
(the "Acts") or make oral statements that constitute forward-looking statements.
These forward-looking statements may relate to such matters as anticipated
financial performance, future revenues or earnings, business prospects,
projected ventures, new products, anticipated market performance and similar
matters. The Private Securities Litigation Reform Act of 1995 provides a safe
harbor for forward-looking statements. In order to comply with the terms of the
safe harbor, the Company cautions readers that a variety of factors could cause
the Company's actual results to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
These risks and uncertainties, many of which are beyond the Company's control,
include, but are not limited to (1) transaction volume in the securities
markets; (2) volatility of the securities markets; (3) fluctuations in interest
rates; (4) changes in regulatory requirements which could affect the cost of
doing business; (5) general economic conditions, both domestic and foreign; (6)
changes in the rate of inflation and related impact on securities markets; (7)
competition from existing financial institutions and other new participants in
the securities markets; (8) legal developments affecting the litigation
experience of the securities industry; (9) successful implementation of
technology solutions; and (10) changes in federal and state tax laws which could
affect the popularity of products sold by the Company. The Company does not
undertake any obligation to publicly update or revise any forward-looking
statements.
The Company's discussion of the issues surrounding the Year 2000 contain
forward-looking statements as defined in the Acts. These forward-looking
statements could relate to, but are not limited to (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 Company's estimates of the availability of
vendor software upgrades and consulting services; (4) the readiness of third-
party service providers; and (5) contingency plans. The Company cautions that
many factors, including those outside of the control of the Company, could cause
actual results to be materially different than those anticipated and expressed
in the forward-looking statements.
GENERAL
The Company is primarily engaged in securities execution and clearance,
securities brokerage, investment banking, securities lending and borrowing and
trading as a principal in equity and fixed income securities. All of these
activities are highly competitive and are sensitive to many factors outside the
control of the Company, including volatility of securities prices and interest
rates; trading volume of securities; economic conditions in the regions where
the Company does business; income tax legislation; and demand for investment
banking and securities brokerage services. While revenues are dependent upon
the level of trading and underwriting volume, which may fluctuate significantly,
a large portion of the Company's expenses remain fixed. Consequently, net
earnings can vary significantly from period to period.
<PAGE>
RESULTS OF OPERATIONS
During the first quarter of fiscal 1999, net income totaled $4,683,000, a
decrease of $362,000, or 7%, from the same period in fiscal 1998. The following
is a summary of increases (decreases) in categories of net revenues and
operating expenses between the first quarter of fiscal 1999 and the first
quarter of fiscal 1998 (in thousands):
<TABLE>
<CAPTION>
Amount Percent
----------------------------
Net revenues:
<S> <C> <C>
Net revenues from clearing operations $ 1,387 21%
Commissions 522 4%
Net interest 1,748 17%
Investment banking, advisory and
administrative fees 3,208 73%
Net gains on principal transactions 624 20%
Other 691 25%
-------------
8,180 20%
-------------
Operating expenses:
Commissions and other employee compensation 5,537 27%
Occupancy, equipment and computer service
costs 851 22%
Communications (246) (8%)
Floor brokerage and clearing organizations
charges 210 17%
Other 2,257 49%
-------------
8,609 26%
-------------
Income before income taxes $ (429) (6%)
=============
</TABLE>
Net Revenues from Clearing Operations. Net revenues from clearing increased
$1,387,000, or 21%, from the first quarter of fiscal 1998 to 1999, primarily as
a result of an increase in total transaction volumes. Total transactions
processed in the first quarter of fiscal 1999 increased to approximately 3.1
million from approximately 1.3 million in the same quarter of fiscal 1998.
Turbulent market conditions in the first quarter of fiscal 1999 lead to heavy
trading volume in securities markets. The rate of increase in transactions
processed has outpaced the increase in revenues from clearing as the Company has
increased the number of high-volume trading Correspondents in its customer base.
These customers use a relatively low level of clearing services and,
accordingly, are charged substantially discounted clearing fees from the
Company's standard clearing schedule.
Commissions. Commissions from the Company's client transactions increased
$522,000 to $14,409,000, an increase of 4% when compared with revenues in the
first quarter of fiscal 1998 of $13,887,000. This increase is attributable to
continued growth in the Brokers Transaction Services ("BTS") independent
contractor network. The increase in BTS commissions was primarily related to an
increase in the number of independent contractor sales representatives to 693
from 662 at September 25, 1998 and September 26, 1997, respectively.
<PAGE>
Net Interest Income. Net interest income continues to be a stable, growing
source of earnings. The Company's net interest income is dependent upon the
level of customer and stock loan balances as well as the spread between the rate
it earns on those assets compared with the cost of funds. The components of
interest earnings are as follows (in thousands):
<TABLE>
<CAPTION>
September 25, September 26,
1998 1997
----------------------------------------
<S> <C> <C>
Interest revenue:
Customer margin accounts $ 11,812 $ 9,373
Assets segregated for regulatory purposes 1,929 2,824
Stock borrowed 20,085 20,095
Other 2,021 2,086
--------------- ---------------
35,847 34,378
--------------- ---------------
Interest expense:
Customer funds on deposit 7,502 7,689
Stock loaned 16,127 15,759
Other 400 860
--------------- ---------------
24,029 24,308
--------------- ---------------
Net interest $ 11,818 $ 10,070
=============== ===============
</TABLE>
In the first quarter of fiscal 1999, net interest income accounted for 24% of
the Company's net revenue, while in the first quarter of fiscal 1998, net
interest income was 25% of net revenue.
Interest income from customer accounts increased $2,439,000, or 26%, in the
first quarter of fiscal 1999 as compared to the first quarter of fiscal 1998
primarily due to increases in margin account balances as favorable market
conditions coupled with comparatively low interest rates made margin borrowing
popular. Average margin balances were approximately $530,000,000 and
$444,000,000 in the first quarters of fiscal 1999 and 1998, respectively, an
increase of 19%. Interest expense related to customer funds on deposit in the
first quarter of fiscal 1999 decreased $187,000, or 2%, over the comparable
fiscal 1998 quarter due to an decrease in the average balances of customer funds
on deposit. Average customer funds on deposit decreased $21,000,000 to
approximately $599,000,000 in the first quarter of fiscal 1999 versus
approximately $620,000,000 in the first quarter of fiscal 1998.
In July 1998, the Company transferred approximately $190 million of its customer
funds on deposit to a money market mutual fund program for which the Company
acts as underwriter through its BTS subsidiary. The transfers occurred as a
result of the Company's offering new cash management products to qualified plan
customers. The resultant decrease in average customer credit balances caused a
corresponding decrease in assets segregated for regulatory purposes in the first
quarter of fiscal 1998. Interest income from these assets declined $895,000, or
32%, in the first quarter of fiscal 1999 versus the first quarter of fiscal 1998
as the average balance of these assets decreased to approximately $147,000,000
in 1998 versus approximately $209,000,000 in 1998.
Investment Banking, Advisory and Administrative Fees. Investment banking,
advisory and administrative fees include revenues derived from the underwriting
and distribution of corporate and municipal securities, unit trusts and money
market and other mutual funds. Investment banking, advisory and administrative
fees increased $3,208,000, or 73%, to $7,584,000 when compared to $4,376,000 in
the first quarter of fiscal 1998 due to increases in fees from both municipal
finance and investment advisory businesses. Advisory fees earned on investment
management increased as assets under management at September 25, 1998 were
approximately $3.1 billion versus $2.4 billion at September 26, 1997.
<PAGE>
Commissions and Other Employee Compensation. Commissions and other employee
compensation are generally affected by the level of operating revenues, earnings
and the number of employees. During the first quarter of fiscal 1999,
commissions and other employee compensation expense increased $5,537,000, or
27%, compared to the comparable quarter in the prior year. This was principally
due to (1) increased commissions and benefits paid to revenue-producing
employees generating higher levels of operating revenues; (2) increased
headcount among the Company's independent contractor network; and (3) the
addition of 62 full-time employees. The number of employees increased to 787 at
September 25, 1998 compared to 725 at September 26, 1997.
Occupancy, Equipment and Computer Service Expenses. Occupancy, equipment and
computer service expenses increased $851,000, or 22%, during the first quarter
of fiscal 1999 primarily due to upgrades in computer processing equipment.
Other Expenses. In the first quarter of fiscal 1999, other expenses increased
$2,257,000, or 49%, to $6,833,000, primarily due to increases in contract labor,
professional service and promotional expenses. Contract labor and professional
service expenses relate to, among other things, the Company's involvement in
developing Year 2000 compliant software (see YEAR 2000 discussion below).
FINANCIAL CONDITION
The Parent owned a minority interest in Roundtable Partners, LLC, the
predecessor of Knight/Trimark Group, Inc. ("Knight"), which filed an S-1
registration statement with the U.S. Securities and Exchange Commission on May
1, 1998 for an initial public offering of stock. Subsequent to the offering,
which closed on July 10, 1998, the Parent owned approximately 1.7 million shares
of Knight. The asset is classified as marketable equity securities available for
sale, and the unrealized holding gain, net of tax, is recorded as a separate
component of stockholders' equity on the consolidated statements of financial
condition in accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
LIQUIDITY AND CAPITAL RESOURCES
The Company's assets are substantially liquid in nature and consist mainly of
cash or assets readily convertible into cash. These assets are financed by the
Company's equity capital, short-term bank borrowings, interest bearing and non-
interest bearing client credit balances, Correspondent deposits and other
payables. The Company maintains an allowance for doubtful accounts which
represents amounts, in the judgment of management, that are necessary to
adequately absorb losses from known and inherent risks in receivables from
clients, clients of Correspondents and Correspondents.
Net cash provided by operating activities during the current period was
$2,500,000. Cash was provided by fluctuations in client accounts.
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $192,500,000. These lines of credit are used primarily to
finance securities owned, securities held for Correspondent broker/dealer
accounts and receivables in customers' margin accounts. These credit
arrangements are provided on an "as offered" basis and are not committed lines
of credit. Outstanding balances under these credit arrangements are due on
demand, bear interest at rates indexed to the federal funds rate and are
collateralized by securities of the Company and its clients. There were no
amounts outstanding at September 25, 1998 on these credit arrangements. In the
opinion of management, these credit arrangements are adequate to meet the short-
term operating capital needs of the Company. In addition to the broker loan
lines, the Company also has a $20,000,000 unsecured line of credit which is due
on demand and bears interest at rates indexed to the federal funds rate. There
were no amounts outstanding at September 25, 1998 under this unsecured line of
credit.
The Company's broker/dealer subsidiaries are subject to the requirements of the
Securities and Exchange Commission relating to liquidity, capital standards and
the use of client funds and securities. The Company has historically operated
in excess of the minimum net capital requirements.
<PAGE>
EFFECTS OF INFLATION
Management does not believe that changes in replacement costs of fixed assets
will materially affect the Company's operations. The rate of inflation, however,
affects the Company's expenses, such as employee compensation, rent and
communications. Increases in these expenses may not be readily recoverable in
the price the Company charges for its services. Inflation can have significant
effects on interest rates that, in turn, can affect prices and activities in the
securities markets. These fluctuations may have an adverse impact on the
Company's operations.
YEAR 2000
The widespread use of computer programs that rely on two-digit date programs to
perform computations and decision-making functions may cause information
technology ("IT") systems to malfunction in the Year 2000 and may lead to
significant business delays in the U.S. and internationally. The Year 2000
problem has the potential to impact the securities industry since information is
moved to and from the exchanges and trading partners on a real-time basis from
computer system to computer system with little human interaction. In addition
to potential problems from computer systems, potential problems could arise from
equipment with embedded chips, such as vaults, elevators and other non-IT
systems.
The Company has defined a Year 2000-compliant system as one capable of correct
identification, manipulation and calculation when processing data in connection
with the year change from December 31, 1999 to January 1, 2000. A Year 2000-
compliant system is also capable of correct identification, manipulation and
calculation using leap years both alone and in conjunction with other dates.
Not all of the Company's systems are compliant under the above definition;
however, the Company is addressing the issues with this problem in the following
manner.
In the first stage, the Company prepared an inventory of all IT and non-IT
systems, as well as equipment that could have embedded chips, whether or not
critical to the operation of the business. The Company also compiled a listing
of material relationships with third parties. These relationships include
various exchanges, clearing houses, banks, telecommunications companies and
public utilities. This stage of the Year 2000 process is 100% complete. The
Company continues to review various areas of the business to identify any items
overlooked in the initial inventories.
In stage two, results from the inventory discussed above are being assessed to
determine the Year 2000 impact and what actions need to be taken to obtain Year
2000 compliance. For the Company's internal systems, actions needed range from
obtaining vendor certification of Year 2000 compliance, remediation of internal
systems or replacement of systems and equipment that cannot be remediated. This
stage is 95% complete with respect to internal systems with the major
outstanding items being receipt of vendor certifications and installation of
Year 2000 upgrades for certain non-critical systems. The Company has determined
a course of action for remediation or replacement of all critical internal
systems. The Company is surveying and obtaining information about Year 2000
readiness of its material third-party relationships. Contingency plans will be
developed for those third parties who cannot satisfactorily demonstrate Year
2000 compliance.
The third stage includes the repair, replacement or retirement of systems. This
stage of the Year 2000 process is ongoing and is dependent upon the availability
of upgrades from our IT vendors, technician time to implement the upgrades and
notification from other third parties of Year 2000 compliance. The Company has
been upgrading packaged software throughout the organization. Desktop system
updates are complete and upgrade of the communications infrastructure is
ongoing.
The primary financial system used for financial reporting purposes for the
Company was replaced during fiscal 1998 to prepare for Year 2000 as well as to
derive other benefits from the financial reporting system. Additional updates
to this system are being installed in the second quarter of fiscal 1999 to
correct some Year 2000 issues found in that system.
<PAGE>
The Company's primary operational system is the Securities Industry Software
("SIS") application, which provides both front and back office services to
Correspondents, customers and our internal users. For several years, the
Company has self-supported the SIS application. The Company is pursuing a
replacement strategy for SIS and is implementing a family of new applications
provided by Comprehensive Software Systems, Ltd. ("CSS"). CSS is a venture made
up of several securities firms (including the Company). The Company currently
anticipates receiving all of the modules necessary to replace SIS functionality
during the remainder of calendar 1998.
The Company is also heavily dependent upon the power and telecommunications
infrastructure within the United States and would be subject to business
interruptions as a result of the failure of those systems. Additionally, the
Company would experience disruption in certain of its businesses if the various
exchanges, clearing houses or banks used by the Company reported a system
failure. The Company is communicating with these third parties in order to
obtain assurances regarding Year 2000 readiness.
The last stage of the implementation process includes testing all of the changes
implemented individually and integrating those changes with all of the Company's
systems and those of its customers and trading partners. Testing takes on
various forms depending on the type of change implemented. Each upgrade, to the
extent economically feasible, is run through a test environment before it is
implemented. It is then tested to see how well it integrates into the Company's
overall IT environment. The Company is also engaging in point-to-point testing
with various exchanges, clearing houses and utilities and has established a
future date environment for testing the CSS application. All of the Company's
correction and testing activities are targeted towards participating in the Tier
One securities industry test being coordinated by the Securities Industry
Association, which begins in March 1999. At the current time, the Company is
not employing any independent verification processes of its systems' tests.
The Company has been working on the CSS project since 1992, as implementation of
this system was in process before the Company began assessment of critical Year
2000 issues. In fiscal 1997, the Company accelerated the pace of the CSS
project so that it would be available as the Year 2000 solution for the SIS
system. Through fiscal 1997 and 1998, costs associated with the joint
venture, including personnel, hardware, software and related costs, were
approximately $4 million. During fiscal 1997 and 1998, the Company incurred an
additional $1 million in costs related to the Year 2000 project primarily
related to compensation and benefits, software upgrades and hardware replacement
for financial and other systems. In the first quarter of fiscal 1999, the
Company has incurred an additional $1.3 million in expenses related to the CSS
project and other Year 2000 initiatives.
The Company expects to incur additional costs in the remainder of fiscal 1999
for the implementation of the CSS software, as well as costs to remediate and
replace other systems. These costs will be funded out of working capital and
substantially all will be expensed. The costs for remediation of systems are
not expected to exceed $3 million. The budgeted expenditures include
compensation and benefits for IT and other operational staff, consulting
services, software purchases and other remediation costs. Implementation of the
CSS system should result in the reduction of certain existing hardware and
software lease, maintenance and licensing costs.
Despite the Company's best efforts to ready its systems and infrastructure for
the Year 2000, there are many factors outside of the Company's control that
could affect readiness for the Year 2000. The CSS system is the Company's
primary solution to the Year 2000 for its main operating system. While the
Company is reasonably certain that Year 2000-compliance will be accomplished by
this system, there could be other operational issues regarding this system that
prevent the Company from implementing the CSS system quickly enough to solve the
Year 2000-compliance issue. If these types of issues occur and remain
unresolved, the Company could be required to implement a contingency plan for
Year 2000 compliance. While the Company has not completely finalized its
contingency plans, the Company will select from several alternative plans
including remediation of SIS, installation of other third party vendor software
or some combination of alternatives. In the first quarter of fiscal 1999, the
Company began the process of remediating certain aspects of the SIS system.
Contingency plans related to the Company's financial systems, embedded chip
technology and third-party relationships are not yet complete. Substantial
completion of these plans is expected by December 1998 with
<PAGE>
continual refinement to the plans ongoing until all of the Company's critical
systems and all critical third-party relationships have demonstrated Year 2000
compliance.
The potential impact of the Year 2000 problem on the securities industry as a
whole could be material, as virtually every aspect of the sales of securities
and processing of transactions will be affected. Due to the size of the task
facing the securities industry and the interdependent nature of securities
transactions, the Company may be adversely affected by this problem, depending
on whether it and the entities with which it does business address this issue
successfully.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None Reportable (229.103)
Item 2. Changes in Securities
None Reportable (Per Instructions to Form 10-Q)
Item 3. Defaults upon Senior Securities
None Reportable (Per Instructions to Form 10-Q)
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
On September 30, 1998, the Company filed a Form S-8 with the Securities and
Exchange Commission to register the shares of common stock reserved under the
Southwest Securities Group, Inc. Stock Option Plan, the Southwest Securities
Group, Inc. 1997 Stock Option Plan, Southwest Securities Group, Inc. Stock
Purchase Plan and miscellaneous employee options outstanding.
Item 6. Exhibits and Reports on Form 8-K
EXHIBITS
10.1 Executive Compensation
The information required by this item regarding Executive compensation is
incorporated by reference to pages 8 through 11 of the Company's Proxy Statement
dated September 24, 1998 which was filed with the Commission pursuant to
Regulation 240.14a (6) (c) prior to October 24, 1998.
27 Financial Data Schedule
REPORTS ON FORM 8-K
None.
<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.
Southwest Securities Group, Inc.
------------------------------------------
(Registrant)
November 9, 1998 /S/ David Glatstein
- ---------------- ------------------------------------------
Date (Signature)
David Glatstein
President and Chief Executive Officer
(Principal Executive Officer)
November 9, 1998 /S/ Stacy M. Hodges
- ---------------- ------------------------------------------
Date (Signature)
Stacy M. Hodges
Treasurer and Chief Financial Officer
(Principal Financial Officer)
November 9, 1998 /S/ Laura Leventhal
- ---------------- ------------------------------------------
Date (Signature)
Laura Leventhal
Controller
(Principal Accounting Officer)
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<PAGE>
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-25-1999
<PERIOD-START> JUN-27-1998
<PERIOD-END> SEP-25-1998
<CASH> 15,029
<RECEIVABLES> 2,550,164
<SECURITIES-RESALE> 155,739
<SECURITIES-BORROWED> 1,888,091
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