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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED JUNE 26, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM _____TO ______
Commission file number 0-19483
SOUTHWEST SECURITIES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2040825
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 ELM STREET, SUITE 3500, DALLAS, TEXAS 75270
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 651-1800
Securities registered pursuant to Section 12 (b) of the Act: None
----
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $0.10 per share
---------------------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
-----
As of September 15, 1998, there were 10,678,406 shares of the Registrant's
common stock, $.10 par value, outstanding. The aggregate market value of Common
Stock held by non-affiliates was approximately $106,517,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be used in connection with the solicitation
of proxies to be voted at the registrant's annual meeting of shareholders to be
held November 4, 1998, which will be filed with the Commission pursuant to
Regulations 240.14a (6)(c) prior to October 24, 1998, are incorporated by
reference into Part I and Part III of the Report on Form 10-K.
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PART I
Item 1. Business
(a) GENERAL DEVELOPMENT OF BUSINESS
Southwest Securities Group, Inc. and subsidiaries (the "Company") is a
Dallas-based holding company that offers a broad range of investment and related
financial services through its operating subsidiary companies to individual and
institutional clients or their financial intermediaries, primarily in the United
States. Intermediaries include banks, other broker/dealers or independent
registered representatives. The Company was incorporated in Delaware in 1972
and completed its initial public offering on October 11, 1991.
The Company's principal subsidiary, Southwest Securities, Inc.
("Southwest") is a National Association of Securities Dealers ("NASD")
registered securities broker/dealer and a member or the New York Stock
Exchange, Inc. ("NYSE") and other major exchanges. Southwest provides
Correspondent securities services to securities broker/dealers and other
financial institutions in 30 states, Canada, Europe and the Pacific Rim.
Southwest serves individual investors through its Private Client Group offices
in Texas, New Mexico and California and institutional investors nationwide from
its Dallas and Chicago offices. Through these offices, clients gain access to
Southwest's investment research that focuses on corporations primarily in the
Southwestern United States.
The Company operates three other broker/dealer subsidiaries engaged in
certain aspects of the securities brokerage business, all three of which are
Correspondents of Southwest and NASD registered broker/dealers. Brokers
Transaction Services ("BTS") contracts with independent registered
representatives for the administration of their securities business. The Company
offers discount brokerage services through Sovereign Securities, Inc.
("Sovereign") which began operations in 1997. NorAm Investment Services, Inc.,
("NorAm"), formerly Equity Securities Trading Company, Inc., contracts with
Canadian securities brokers on an independent contractor basis for the
administration of their U.S. securities business.
The Company offers investment management, advisory and trust services
through three subsidiaries. Westwood Management Corporation ("Westwood"), a
registered investment advisor, manages the Westwood Family of Mutual Funds as
well as equity and fixed income investments for a diverse clientele including
corporate plan sponsors, charitable institutions, educational endowments and
public funds. Westwood Trust ("Trust") provides trust, custodial and other
management services to high net worth individuals and corporations throughout
Texas and the Southwest. SW Capital Corporation ("Capital"), administers the
Local Government Investment Cooperative ("LOGIC") fund for cities, counties,
schools and other local governments across Texas.
SWST Computer Corporation, incorporated in 1997, provides internet
services, network design and engineering and disaster recovery services to the
Company, its clients and other customers in the Southwest.
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(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company's operations consist of various financial services provided to
its clients. The following table shows revenues by source for the last three
fiscal years (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
Amount Percent Amount Percent Amount Percent
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenues from clearing
operations $ 26,607 9% $ 22,693 10% $ 17,897 10%
---------- ---------- ----------
Commissions:
Listed equities 14,125 5% 9,729 4% 9,550 5%
Over-the-counter equities 12,418 4% 9,635 4% 10,146 6%
Corporate bonds 5,027 2% 1,906 1% 1,015 1%
Government bonds and
mortgage-backed securities 2,785 1% 1,970 1% 2,754 2%
Municipal bonds 4,658 2% 4,026 2% 3,903 2%
Options 1,820 1% 1,228 1% 814 --
Mutual funds 13,737 5% 9,013 4% 7,433 4%
Other 4,831 2% 1,375 1% 1,281 1%
---------- ---------- ----------
59,401 38,882 36,896
---------- ---------- ----------
Interest 143,121 50% 119,176 55% 95,956 53%
---------- ---------- ----------
Investment banking fees:
Corporate 5,786 2% 2,913 1% 2,436 1%
Municipal 9,933 3% 6,218 3% 4,401 2%
---------- ---------- ----------
15,719 9,131 6,837
---------- ---------- ----------
Advisory and administrative fees:
Institutional and individual
accounts 8,135 3% 4,667 2% 3,850 2%
Money market funds 3,559 1% 1,790 1% 1,154 1%
Other 437 -- 443 -- 692 --
---------- ---------- ----------
12,131 6,900 5,696
---------- ---------- ----------
Net gains on principal transactions:
Equity securities 7,295 3% 4,377 2% 3,183 2%
Municipal securities 4,095 1% 6,092 3% 4,135 2%
Other 1,186 -- 1,387 1% 1,417 1%
---------- ---------- ----------
12,576 11,856 8,735
---------- ---------- ----------
Other 16,203 6% 9,766 4% 9,791 5%
---------- ---------- ----------
Total revenue $ 285,758 100% $ 218,404 100% $ 181,808 100%
========== ========== ==========
</TABLE>
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(c) NARRATIVE DESCRIPTION OF BUSINESS
As of June 26, 1998, the Company employed 779 individuals. Southwest
employed 750 of these individuals, 118 of whom were full-time retail
representatives. In addition, 697 full-time retail representatives were
affiliated with the Company as independent contractors. Through its broker
dealer subsidiaries, the Company provides securities services to approximately
242,000 active client accounts. No single client accounts for a material
percentage of the Company's total business.
BROKERAGE SERVICES
SOUTHWEST SECURITIES, INC. Southwest's activities in the securities
business include execution and clearing of securities transactions, individual
and institutional securities brokerage, securities lending, management of and
participation in underwriting of equity and fixed income securities, market
making in corporate securities and research and investment advisory services.
For the year ended June 26, 1998, revenues of Southwest accounted for 85% of the
consolidated revenues of the Company.
Southwest is a member firm of the NYSE, the American Stock Exchange, Inc.
and the Chicago Stock Exchange, Inc. It is also a member of the NASD, the
Securities Investor Protection Corporation ("SIPC"), and other regulatory and
trade organizations. SIPC provides protection for clients up to $500,000 each
with a limitation of $100,000 for claims for cash balances. Southwest purchases
insurance which, when combined with the SIPC insurance, provides total coverage
in certain circumstances of up to $25 million per client for securities held in
clients' accounts with no aggregate limit.
Execution and Clearing. Southwest provides clearing and execution on a
fully-disclosed basis for other broker/dealers including general securities
broker/dealers, bank affiliated firms and those firms specializing in high
volume trading. In a fully disclosed clearing transaction, the identity of the
Correspondent's client is known to Southwest, and Southwest physically maintains
the client's account and performs a variety of services as agent for the
Correspondent. Southwest provides clearing and execution services for 243
Correspondents throughout the United States, Europe and the Pacific Rim.
Correspondent firms are charged fees based on their use of services according to
a standard clearing schedule. Discounts are given from the standard schedule
based on total volume and type of services provided to the Correspondent.
Besides service charges realized from securities clearing activities, the
Company also earns substantial amounts of interest income. Southwest extends
credit directly to its customers, the customers of Correspondent firms and the
Correspondent firms themselves in order to facilitate the conduct of customer
and Correspondent securities transactions. This credit is termed margin lending.
The Correspondents indemnify Southwest against margin losses on their customers'
accounts. The Company also extends margin credit directly to Correspondents to
the extent that such firms pledge proprietary assets as collateral. Since
Southwest must rely on the guaranties and general credit of the Correspondents,
Southwest may be exposed to significant risk of loss if Correspondents are
unable to meet their financial commitments should there be a substantial adverse
change in the value of margined securities.
While Southwest's Correspondent relationships are with a wide range of
general securities broker/dealers and bank-affiliated broker/dealers, Southwest
provides clearing services for a number of high-volume trading firms. These
firms specialize in providing services to those customers who trade actively on
a daily basis. As of June 26, 1998, Southwest provides clearing services for
approximately 20 of these firms. The nature of services provided to the
customers of these firms are substantially different from the standard
Correspondent relationship and, accordingly, fees for services to these
Correspondents are discounted from the fees normally charged in the standard
clearing schedule.
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The following table sets forth, for each of the last three fiscal years,
certain information relating to the number of client transactions processed and
the number of Correspondents at the end of each year:
Fiscal 1998 Fiscal 1997 Fiscal 1996
----------- ----------- -----------
Tickets for third party Correspondents 6,439,240 3,049,700 1,831,455
Tickets for internal Correspondents 159,156 115,963 80,258
Tickets for Southwest account executives 172,203 155,896 128,487
----------- --------- ---------
Total Tickets 6,770,599 3,321,559 2,040,200
=========== ========= =========
Number of Correspondents* 243 239 228
=========== ========= =========
* Number at fiscal year end. BTS, Sovereign and NorAm are included as
Correspondents in fiscal 1998 and 1997. Fiscal 1996 includes BTS only.
In addition to clearing trades, Southwest provides other products and
services to its Correspondents such as recordkeeping, trade reporting,
accounting, general back-office support, securities lending, reorganization and
custody of securities. Southwest also attempts to enrich its Correspondent
relationships by advising the Correspondent on communications and networking
functions as well as making available to them a variety of non-brokerage
products and services on favorable terms.
The terms of Southwest's agreements with its Correspondents define the
allocation of financial, operational and regulatory responsibility arising from
the clearing relationship. To the extent that the Correspondent has available
resources, Southwest is protected against claims by customers of the
Correspondent arising from actions by the Correspondent; however, if the
Correspondent is unable to meet its obligations, dissatisfied customers may
attempt to seek recovery from Southwest.
Commissions. As a securities broker, Southwest acts as agent in the
purchase and sale of securities, options, commodities and futures contracts
traded on various securities and commodities exchanges or in the over-the-
counter ("OTC") market. In most cases, Southwest charges commissions to its
retail clients, on both exchange and OTC transactions, in accordance with its
established commission schedule. In certain instances, varying discounts from
the schedule are given, generally based upon the client's level of business, the
trade size and other relevant factors. Southwest discounts its commissions
substantially on institutional transactions based on trade size and the amount
of business conducted annually with each institution. For certain fee-based
accounts, a fee is charged in lieu of standard commissions. In addition,
Southwest sells a number of professionally managed mutual funds and maintains
dealer-sales agreements with most major distributors of mutual fund shares sold
through broker/dealers. Some account executives employed by Southwest maintain
a license to sell certain insurance products. Southwest is registered with the
Commodity Futures Trading Commission as a non-guaranteed introducing broker and
is a member of the National Futures Association. Southwest is a fully disclosed
client of one of the largest futures commodity merchants in the United States.
As of June 26, 1998, Southwest had 12 retail brokerage offices, four
located in Dallas, Texas and one each in Georgetown, Longview, Lufkin,
Nacogdoches, and San Antonio, Texas; Albuquerque and Santa Fe, New Mexico; and
Beverly Hills, California. In addition, Southwest has bond brokerage offices in
Dallas, Texas and Chicago, Illinois; and an institutional sales office in
Dallas, Texas.
Customer Financing. Client transactions in securities are effected on
either a cash or margin basis. In margin transactions, the client pays a
portion of the purchase price, and Southwest makes a loan to the client for the
balance, collateralized by the securities purchased or by other securities owned
by the client. Southwest provides financing for margin transactions for its own
clients as well as Correspondents' clients. Southwest may extend credit on a
margin basis directly to Correspondents to the extent the Correspondent holds
securities positions for their own account. Interest is charged, at a floating
rate, to clients on the amount borrowed to finance margin transactions. The rate
charged is dependent on the average net debit balance in the client's accounts,
the activity level in the accounts and the applicable cost of funds. The amount
of the loan is subject to the margin regulations
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("Regulation T") of the Board of Governors of the Federal Reserve System, NYSE
margin requirements, and Southwest's internal policies, which in many instances
are more stringent than Regulation T or NYSE requirements. In most transactions,
Regulation T limits the amount loaned to a customer for the purchase of a
particular security to 50% of the purchase price. Furthermore, in the event of a
decline in the value of the collateral, the NYSE regulates the percentage of
client cash or securities that must be on deposit at all times as collateral for
the loans. In permitting clients to purchase on margin, Southwest is subject to
the risk of a market decline, which could reduce the value of its collateral
below the client's indebtedness. Agreements with margin account clients permit
Southwest to liquidate clients' securities with or without prior notice in the
event of an insufficient amount of margin collateral. Despite those agreements,
Southwest may be unable to liquidate clients' securities for various reasons
including the fact that the pledged securities may not be actively traded, there
is an undue concentration of certain securities pledged, or a stop order is
issued with regard to pledged securities.
The primary source of funds to finance clients' margin account balances is
credit balances in clients' accounts. Southwest generally pays interest to
clients on these credit balances at a rate determined periodically. Available
credit balances are used to lend funds to Southwest customers purchasing
securities on margin. SEC regulations restrict the use of clients' funds to the
financing of clients' activities including margin account balances. Excess
customer credit balances are invested in short-term securities segregated for
the exclusive benefit of customers as required by SEC regulations. Southwest
generates net interest income from the positive interest rate spread between the
rate earned from margin lending and alternative short-term investments and the
rate paid on customer credit balances.
The customers of Southwest's high volume trading Correspondents frequently
finance their purchases of margin securities with corresponding short security
positions in related accounts. In these arrangements, the earnings to Southwest
from margin transactions are substantially reduced.
Securities Lending Activities. Southwest performs securities lending
services for its own clients, clients of Correspondents and Correspondents
themselves as well as for other broker/dealers and lending institutions.
Southwest's securities borrowing and lending activities involve borrowing
securities to cover short sales and to complete transactions in which clients
have failed to deliver securities by the required settlement date, and lending
securities to other broker/dealers for similar purposes. When borrowing
securities, Southwest is required to deposit cash or other collateral, or to
post a letter of credit with the lender and Southwest generally receives a
rebate (based on the amount of cash deposited) or a fee calculated to yield a
negotiated rate of return. When lending securities, Southwest receives cash or
similar collateral and generally pays a rebate (based on the amount of cash
deposited) to the other party to the transaction. Southwest earns interest on
the cash or similar collateral received. Stock borrow and stock loan
transactions are generally executed pursuant to written agreements with
counterparties which require that (1) securities borrowed and loaned be marked-
to-market on a daily basis, (2) excess collateral be refunded, and (3) deficit
collateral be furnished. Margin adjustments are usually made on a daily basis
through the facilities of various clearing houses. Southwest is a principal in
these securities borrowing and lending transactions and becomes liable for
losses in the event of a failure of any other party to honor its contractual
obligation. Southwest's management sets limits on transaction volumes with each
counter-party and reviews these limits on a weekly basis to monitor the risk
level with each counter-party.
The stock loan business is conducted primarily out of the Company's New
York office using a highly specialized sales force. Competition for these
professionals is intense and there can be no assurance that Southwest will be
able to retain these stock loan professionals.
Investment Banking and Underwriting Activities. Southwest earns investment
banking revenues by assisting corporate clients in planning to meet their
financial needs and advising them on the most advantageous means of raising
capital. Such plans are sometimes implemented by managing or co-managing public
offerings of securities or by arranging private placements of securities with
institutional or individual investors. These types of activities are conducted
in the corporate finance department that is staffed with 13 professionals and 3
analysts. In addition to public offerings and private placements, Southwest
provides other consulting services, including providing valuations of securities
and companies, arranging and evaluating mergers and acquisitions and advising
clients with respect to financing plans and related matters.
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The syndicate department coordinates the distribution of managed and co-
managed corporate equity underwritings, accepts invitations to participate in
competitive or negotiated underwritings managed by other investment banking
firms, and allocates and merchandises Southwest's selling allotments to its
branch office system, to institutional clients and to other broker-dealers.
The Company is also among the leaders in its geographic region in the
origination, syndication and distribution of securities of municipalities and
political subdivisions. The public finance department, which is staffed by 27
professionals, provides professional financial advisory services to public
entities across Texas and the Southwest and maintains branch offices in San
Antonio, Austin and Houston, Texas, and Albuquerque, New Mexico.
The following table sets forth, for the last three fiscal years, the number
and dollar amounts, using the full credit to the co-manager method, of municipal
bond offerings managed or co-managed by Southwest.
Aggregate
Number of Amount of
Fiscal Years Issues Offerings
------------ --------- --------------
1998 203 $5,143,646,000
1997 165 $2,444,317,000
1996 168 $3,892,244,000
Participation in underwritings, both corporate and municipal, can expose
the Company to material risk, since the possibility exists that securities it
has committed to purchase cannot be sold at the initial offering price. Federal
and state securities laws and regulations also affect the activities of
underwriters and impose substantial potential liabilities for violations in
connection with sales of securities by underwriters to the public.
Trading Activities. Southwest is a market maker in OTC equity securities
as well as a dealer in tax-exempt and governmental fixed income securities.
Trading securities in the over-the-counter market involves the purchase of
securities from and the sale of securities to clients of Southwest or to other
dealers who may be purchasing or selling securities for their own account or
acting as agent for their clients. Profits and losses are derived from the
spreads between bid and asked prices, as well as market trends for the
individual securities during the holding period. At June 26, 1998, Southwest
made markets in 431 common stocks in the OTC market. Southwest frequently acts
as agent in the execution of OTC orders for its clients and, as such, transacts
these trades with other dealers. When Southwest receives a client order in a
security in which it makes a market, it may act as principal as long as it
matches or improves upon the best price in the dealer market, plus or minus a
mark-up or mark-down not exceeding the equivalent agency commission charge.
Recently adopted regulations require that client limit orders be satisfied prior
to the brokerage firm buying securities into or selling the securities from
their own inventory at the same price.
While most of Southwest's principal transactions are executed to facilitate
individual and institutional customer trades, Southwest also maintains certain
inventory positions for its own accounts. These inventories require the
commitment of capital and expose the company to the risk of a loss if market
prices of the securities held in inventory decrease. General market conditions,
interest rates and the financial prospects for issuers of such securities may
affect the market prices of securities held in inventory. Internal guidelines
intended to limit the size and risk of inventories maintained have been
established are reviewed periodically.
Research Activities. Southwest has a research department that provides
analysis, investment recommendations and market information with an emphasis on
companies located in the Southwest region. At June 26, 1998, Southwest had 12
securities analysts publishing research on more than 100 companies. The
department focuses on particular industry groups, including retail, health care,
semi-conductors, energy, financial services, real estate and technology.
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Information Technology. Information technology is an integral part of
Southwest's clearing and brokerage activities. Southwest operates sophisticated
hardware and software to execute and process securities transactions and is
engaged in continuing software development and regular up-grades on its computer
hardware. The Company's data center features an eight processor Himalaya system
and a sophisticated telecommunications network supporting over 3,300 terminals.
While Southwest's software is licensed from Securities Industry Software
Corporation, it employs in-house programmers to develop proprietary enhancements
and to maintain its system. Southwest provides brokerage accounting, order entry
and market data in a local area network/wide area network environment as well as
through other traditional communication environments.
Southwest intends to continue to make significant technology investments
including participation in a joint venture with several other broker/dealers.
The joint venture, Comprehensive Software Systems, Ltd., ("CSS") is developing
the next generation of software for the securities industry capable of
accommodating a variety of hardware platforms and operating systems with a large
degree of customization at each location. The CSS system will automate both
front- and back-office brokerage processes from contract and order management to
clearance and settlement. Southwest is currently operating several CSS modules
and intends to have substantially all modules in place by December 31, 1998.
Southwest is also investing in Internet and other communications
technology. The Company is currently providing Internet access to account
information for certain Correspondents and expects to expand this service. The
Company also provides Internet service for Correspondents and other end users,
as well as employees. Internet and other communication mechanisms may expose
the Company to increased risk of unauthorized access to Company systems.
BROKERS TRANSACTION SERVICES, INC. BTS is an NASD member broker/dealer
that contracts with individual registered representatives who are NASD licensed
salespersons for the conduct of their securities business. BTS is a
Correspondent of Southwest. While these registered representatives must conduct
all of their securities business through BTS, their contracts permit them to
conduct insurance, real estate brokerage or other business for others or for
their own accounts. The registered representatives are responsible for all of
their direct expenses and are paid higher commission rates than Southwest's
account executives to compensate them for their added expenses.
SOVEREIGN SECURITIES, INC. Sovereign, which began operations in 1997, is
an NASD member broker/dealer specializing in deep discount brokerage services
with an emphasis in trading over the internet. Sovereign has positioned itself
as a brokerage firm that discounts commissions without sacrificing customer
service. Although Sovereign's brokers do not provide investment advice or
recommendations, they do offer clients the information needed, including quotes,
market news, and trends, to make informed investment decisions. Sovereign's
brokers work on a salary, rather than commission.
NORAM INVESTMENT SERVICES, INC. Acquired on May 1, 1997 and formerly
known as Equity Securities Trading Company, Inc., NorAm is an NASD member
broker/dealer that contracts with individual registered representatives for the
conduct of their securities business. NorAm representatives are dually
registered in the United States and Canada. These representatives conduct
their business with U.S. customers through NorAm and their business with
Canadian customers through unaffiliated Canadian broker/dealers.
ASSET MANAGEMENT AND TRUST SERVICES
WESTWOOD MANAGEMENT CORPORATION Westwood is a registered investment
advisor founded in 1983 by Susan M. Byrne, who continues to serve as its
President and Chief Executive Officer. The firm, which has offices in Dallas
and New York, manages equity, fixed income, cash and balanced accounts for a
diverse clientele, including corporate plan sponsors, charitable institutions,
educational endowments and public funds. In addition, Westwood manages the
Westwood Family of Mutual Funds which is available to both taxable and non-
taxable investors.
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WESTWOOD TRUST Trust was established in 1974 and provides trust,
custodial and other management services to estates, charitable and other trusts
and retirement plans established by high net worth individuals and corporations
throughout Texas and the Southwest. Trust is chartered and regulated by the
Texas Department of Banking.
SW CAPITAL CORPORATION Capital was established in 1994 and administers
the LOGIC program. The LOGIC program is targeted to the needs of cities,
counties, schools and other local governments across Texas and conforms with the
Interlocal Cooperation Act and the Public Funds Investment Act of the Texas
Government Code. This program allows participants to pool their available
funds, resulting in increased economies of scale, which allow higher returns
while maintaining a high degree of safety and liquidity.
COMPETITION
The Company encounters intense competition in its business and competes
directly with numerous firms, many of which have substantially greater capital
and other resources. The Company also encounters competition from banks,
insurance companies and financial institutions in many elements of its business.
For example, with the prior approval of the Federal Reserve Board, securities
subsidiaries of bank holding companies may now underwrite and deal in corporate
debt and equity securities, provided that they comply with certain "firewalls"
and that the revenues from such activities do not exceed 25 percent of the
security subsidiary's total revenues. Legislative proposals also under
consideration would eliminate this limit on such activities and would permit
commercial banks, bank holding companies and their subsidiaries and affiliates
to offer additional services which have traditionally been provided only by
securities and money management firms.
During 1997 and 1998, a number of banks acquired securities firms and, in
so doing, gained unprecedented entry into the securities industry. While the
effect of such acquisitions cannot yet be determined, they have brought entirely
new sources of capital into the securities industry, resulting in more
formidable competitors for the Company.
Additionally, competition among securities firms and other competitors for
successful sales representatives, securities traders, securities analysts, stock
loan professionals and investment bankers is intense and continuous.
The Company competes with other securities firms and with banks, insurance
companies and other financial institutions principally on the basis of service,
product selection, price, location and reputation in local markets. The Company
operates at a price disadvantage to discount brokerage firms that do not offer
equivalent services. Southwest competes for the Correspondent clearing
business on the basis of service, price, technology, product selection and
reputation. The Company competes in its asset management services business with
other portfolio managers principally based on portfolio performance, price and
service.
REGULATION
The securities industry in the United States is subject to extensive
regulation under federal and state laws. The SEC is the federal agency charged
with administration of the federal securities laws. Much of the regulation of
broker/dealers, however, has been delegated to self-regulatory organizations,
principally the NASD and the NYSE. These self-regulatory organizations adopt
rules (which are subject to approval by the SEC) for governing the industry and
conduct periodic examinations of member broker/dealers. Securities firms are
also subject to regulation by state securities commissions in the states in
which they are registered. Southwest, BTS and Sovereign are registered in all
50 states. Southwest is also registered in Puerto Rico. NorAm is registered in
all states except Maine and Idaho.
The regulations to which broker/dealers are subject cover all aspects of
the securities business, including sales methods, trade practices among
broker/dealers, capital structure of securities firms, record keeping and the
conduct of directors, officers and employees. Additional legislation, changes
in rules promulgated by the SEC and by self-regulatory organizations or changes
in the interpretation or enforcement of existing laws and rules often directly
affect the method of operation and profitability of broker/dealers. The SEC and
the self-regulatory
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organizations may conduct administrative proceedings that can result in censure,
fine, suspension or expulsion of a broker/dealer, its officers or employees. The
principal purpose of regulation and discipline of broker/dealers is the
protection of clients and the securities markets rather than protection of
creditors and shareholders of broker/dealers. See Note 8 of the Notes to
Consolidated Financial Statements for further description of certain SEC
regulations.
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G(3) of Form 10-K, the following list is
included as an unnumbered Item in Part I of this report in lieu of being
included in the Proxy Statement for the Annual meeting of Stockholders to be
held November 4, 1998:
Name Age Position
- --------------------- --- -----------------------------------------------
David Glatstein /(1)/ 49 Director, Chief Executive Officer and President
of the Company
Richard H. Litton 51 Executive Vice President of the Company
William D. Felder 40 Executive Vice President of the Company
W. Norman Thompson 42 Executive Vice President and Chief
Information Officer of the Company
Kenneth R. Hanks 44 Executive Vice President and Chief
Financial Officer of the Company during fiscal
1998 (currently Chief Operating Officer)
- -------------------
/(1)/ Executive Committee
DAVID GLATSTEIN was elected Chief Executive Officer in May 1996 and has
served as President and a director of the Company and President of Southwest
since May 1995. Mr. Glatstein was President of Barre & Company, Inc. from its
founding in 1980 until its acquisition by Southwest in 1995; First Vice
President of the Securities Division of Lehman Brothers Kuhn Loeb, Inc. from
1978 to 1980 and securities broker with White, Weld & Company, Inc. from 1973 to
1978. Mr. Glatstein is a past Chairman of the District 6 Business Conduct
Committee of the NASD.
RICHARD H. LITTON has served as Executive Vice President of the Company and
Executive Vice President in charge of the Public Finance Division of Southwest
since July 1995. Mr. Litton headed the Municipal Securities Group in Dallas for
BA Securities, Inc. from 1993 to 1995. Mr. Litton was President with First
Southwest Company, a regional investment bank from 1987 to 1993; Vice President
and Regional Manager of Merrill Lynch Capital Markets Municipal Group from 1977
to 1987 and a securities broker with White, Weld & Company, Inc. from 1976 to
1977. Mr. Litton served on the Advisory Committee on the Recovery of Real
Estate Finance for the Texas House of Representatives' Financial Institutions
Committee. Mr. Litton is past member and director of the Municipal Advisory
Council of Texas and past member of the Marketing Committee of the Public
Securities Association.
9
<PAGE>
WILLIAM D. FELDER has served as Executive Vice President of the Company
since December 1995 and as Senior Vice President of the Company since 1993. Mr.
Felder has been associated with Southwest in various capacities since 1980,
including Senior Vice President in charge of Clearing Services from 1988 to
1998. Mr. Felder is a past chairman of the District Business Conduct Committee,
District 6, of the NASD.
W. NORMAN THOMPSON has served as Executive Vice President and Chief
Information Officer of the Company since January 1995. Mr. Thompson was
associated with Kenneth Leventhal & Co. in various capacities ranging from Audit
Manager to Senior Consulting Manager from 1987 to 1994. Previously, Mr.
Thompson was an Audit Manager with KPMG Peat Marwick from 1981 to 1987. In the
capacities he held with both Kenneth Leventhal & Co. and KPMG Peat Marwick, he
was heavily involved in EDP auditing and consulting.
KENNETH R. HANKS served as Executive Vice President and Chief Financial
Officer from June 1996 to August 1998, at which time he was promoted to Chief
Operating Officer. Mr. Hanks served in various executive capacities of Rauscher
Pierce Refsnes, Inc. from 1981 to 1996, including Executive Vice President and
Chief Financial Officer. He serves as an arbitrator with the NASD and formerly
served as a member of the NASD's District 6 Business Conduct Committee.
Committees. The Company has an Executive Committee, an Audit Committee and
a Compensation Committee, all of which were established in September 1991 and a
Stock Option Committee established in September 1996. The Executive Committee
of the Board of Directors of the Company has the authority, between meetings of
the Board of Directors, to take all actions with respect to the management of
the Company's business that require action by the Board of Directors, except
with respect to certain specified matters that by law must be approved by the
entire Board. The Audit Committee is responsible for (i) reviewing the results
and scope of, and the fees for, the annual audit, (ii) reviewing with the
independent auditors the corporate accounting practices and policies and
recommending to whom reports should be submitted within the Company, (iii)
reviewing with the independent auditors their final report, (iv) reviewing with
internal and independent auditors overall accounting and financial controls, and
(v) being available to the independent auditors during the year for consultation
purposes. The Compensation Committee determines the salaries of the officers of
the Company, assists the officers in determining the salaries of other
personnel, and performs other similar functions. The Stock Option Committee
administers the grant of awards under the Stock Option Plan.
All Directors are elected for a one-year term of office or until their
respective successors are duly elected and qualified. Officers are elected by
and serve at the discretion of the Board of Directors.
Members of the Board of Directors who are not officers or employees of the
Company receive a fee of $1,500 per quarter plus $500 for each directors meeting
they attend. Directors are reimbursed for expenses relating to attendance at
meetings.
Item 2. Properties
The Company presently leases all of its office space. The Company conducts
its Clearing Operations primarily in its principal office in Dallas, Texas and
its office in New York. It has 12 retail brokerage offices, four located in
Dallas, Texas and one each in Georgetown, Longview, Lufkin, Nacogdoches, and San
Antonio, Texas; Albuquerque and Santa Fe, New Mexico; and Beverly Hills,
California. The Company has public finance offices in San Antonio, Austin and
Houston. During 1996, the Company leased space in North Dallas for an off-site
disaster recovery center. The Company's present facilities and equipment are
adequate for current and planned operations.
10
<PAGE>
Item 3. Legal Proceedings
On April 17, 1998, a judgment was entered against the Company in connection
with a breach of contract lawsuit stemming from the 1995 acquisition of Barre &
Company, Inc. The judge awarded the counterparty approximately $40,000 in
damages and approximately $1,700,000 in attorney's fees. The Company believes
it has substantial grounds for appeal and has begun the appellate process. The
Company also believes its reserves are adequate to cover the full amount of the
judgment.
Item 4. Submission of Matters to a Vote of Security Shareholders
None.
11
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The registrant's common stock began trading on the New York Stock Exchange,
Inc. on October 6, 1997 under the symbol "SWS". Previously, the registrant's
stock was traded on the NASDAQ National Market System. At June 26, 1998, there
were in excess of 2,200 holders of record of common stock. The following table
sets forth for the periods indicated the high and low market prices for the
common stock and the cash dividend declared per common share:
<TABLE>
<CAPTION>
1998 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
--------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Cash dividend declared per common share /(4)/ $ .057 $ .057 $ .057 $ .057
Stock Price Range /(4)/
High $23.39 $26.01 $26.19 $28.46
Low $16.77 $20.12 $20.95 $21.85
1997 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
--------------- --------------- ---------------- ---------------
Cash dividend declared per common share /(3)(4)/ $ .043 $ .043 $ .043 $ .043
Stock Price Range /(3)(4)/
High $10.61 $12.45 $15.80 $15.53
Low $ 9.31 $ 9.96 $12.34 $12.88
</TABLE>
Item 6. Selected Financial Data
SELECTED FINANCIAL DATA
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended
June 26, June 27, June 28, June 30, June 24,
1998 1997 1996 1995 1994
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating Results:
Revenues $ 285,758 $ 218,404 $ 181,808 $ 120,181 $ 113,755
Net income $ 20,630 $ 16,983 $ 14,040 $ 5,668 $ 8,192
Earnings per share - basic and diluted
/(3)(4)(5)/ $ 1.93 $ 1.66 $ 1.38 $ .60 $ .85
Weighted average shares outstanding -
basic /(1)(3)(4)(5)/ 10,676 10,245 10,147 9,448 9,590
Weighted average shares outstanding -
diluted /(1)(3)(4)(5)/ 10,694 10,257 10,152 9,448 9,590
Cash dividend declared per common
share /(3)(4)/ $ .23 $ .17 $ .13 $ .12 $ .10
Financial Condition:
Total assets $3,220,106 $3,276,392 $2,196,397 $1,535,979 $1,271,556
Long-term debt $ -- $ -- $ -- $ -- $ 723
Stockholders' equity $ 125,467 $ 106,928 $ 84,449 $ 71,541 $ 63,866
Shares outstanding /(1)(3)(4)/ 10,678 10,660 10,145 10,121 9,527
Tangible book value per common
share /(1)(2)(3)(4)/ $ 11.04 $ 9.28 $ 8.03 $ 6.78 $ 6.36
</TABLE>
12
<PAGE>
(1) Adjusted to reflect the three-for-two stock split which was effective July
1, 1993.
(2) Adjusted to consider goodwill of $7,558 at June 26, 1998, $8,002 at June
27, 1997, $2,976 at June 28, 1996, $2,940 at June 30, 1995 and $3,225 at
June 24, 1994.
(3) Adjusted to reflect a ten percent stock dividend which was effective
October 1, 1997.
(4) Adjusted to reflect a five percent stock dividend declared on May 22, 1998
and paid on August 3, 1998 to shareholders of record on July 15, 1998.
(5) Adjusted to reflect the implementation of Statement of Financial Accounting
Standards No. 128, "Earnings per Share."
Item 7. 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.
13
<PAGE>
Effective May 1, 1997, NorAm Investment Services, Inc. ("NorAm"), formerly
Equity Securities Trading Company, Inc. ("Equity"), became a wholly owned
subsidiary of the Company through the issuance of 445,845 shares of common
stock. The acquisition was accounted for under the purchase method of accounting
and, accordingly, assets and liabilities were recorded at their fair market
values on the date of the acquisition. Goodwill relating to this acquisition of
approximately $5,113,000 is recorded in other assets in the consolidated
statements of financial condition.
RESULTS OF OPERATIONS
During fiscal 1998, net income totaled $20,630,000, an increase of
$3,647,000, or 21%, from fiscal 1997, which is a Company record. In 1997, net
earnings totaled $16,983,000, an increase of $2,943,000, or 21%, from fiscal
1996. For the past three years, the equity markets have experienced an
unprecedented rise, spurring record levels of transaction volume and capital
market activity. These conditions have led to record results in many sectors of
the financial services industry, including most of the Company's primary lines
of business. These industry factors, coupled with the Company's effort to grow
into new areas of the industry, have allowed the Company to reach earnings
records.
The following is a summary of year-to-year increases (decreases) in
categories of net revenues and operating expenses (in thousands):
<TABLE>
<CAPTION>
1998 vs. 1997 1997 vs. 1996
Amount Percent Amount Percent
------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues:
Net revenues from clearing operations $ 3,914 17% $ 4,796 27%
Commissions 20,519 53% 1,986 5%
Net interest 6,479 18% 9,074 34%
Investment banking, advisory and
administrative fees 11,819 74% 3,498 28%
Net gains on principal transactions 720 6% 3,121 36%
Other 6,437 66% (25) 0%
------- -------
49,888 37% 22,450 20%
------- -------
Operating expenses:
Commissions and other employee
compensation 26,755 41% 11,629 22%
Occupancy, equipment and computer
service costs 5,447 45% 2,625 27%
Communications 1,483 13% 1,917 21%
Floor brokerage and clearing
organization charges 943 23% 311 8%
Other 9,105 54% 1,982 13%
------- -------
43,733 40% 18,464 20%
------- -------
Income before income taxes $ 6,155 24% $ 3,986 18%
======= =======
</TABLE>
Net Revenues from Clearing Operations. Net revenues from clearing
increased $3,914,000, or 17%, from 1997 to 1998, primarily as a result of an
increased number of Correspondents and an increase in total transaction volumes.
The number of Correspondents increased to 243 at June 26, 1998 from 239 at June
27, 1997, an increase of 1.7%. Total transactions processed in fiscal 1998
increased 106% to approximately 6.8 million from approximately 3.3 million in
fiscal 1997. 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.
14
<PAGE>
The increase in net revenue from clearing during fiscal 1997 was
attributable to improved market conditions, combined with the addition of
Correspondents. The number of Correspondents increased to 239 at June 27, 1997
from 228 at June 28, 1996.
Commissions. Commissions from the Company's client transactions increased
$20,519,000 to $59,401,000, an increase of 53% when compared with revenues in
fiscal 1997 of $38,882,000. This increase was evenly divided between the
Southwest Securities, Inc. ("Southwest") Private Client Group network and the
Brokers Transaction Services ("BTS") independent contractor network.
Commissions from account executives increased due to increased sales to
individual and institutional investors of (1) offerings managed or co-managed by
the Company, (2) over-the-counter corporate bonds and (3) mutual funds. The
increase in BTS commissions was primarily related to an increased number of
independent contractor sales representatives. The number of independent
contractors was 697 and 536 at June 26, 1998 and June 27, 1997, respectively.
Commissions from the Company's client transactions in 1997 increased
$1,986,000 to $38,882,000, an increase of 5% when compared with revenues in
fiscal 1996 of $36,896,000 due to an increase in the number of account
executives.
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>
June 26, June 27, June 28,
1998 1997 1996
---------------------------------------------------------
<S> <C> <C> <C>
Interest revenue:
Customer margin accounts $ 39,662 $ 28,906 $ 24,621
Assets segregated for regulatory purposes 9,806 15,190 11,755
Stock borrowed 83,332 65,906 51,927
Other 10,321 9,174 7,653
-------- -------- --------
143,121 119,176 95,956
-------- -------- --------
Interest expense:
Customer funds on deposit 27,723 28,365 23,758
Stock loaned 67,956 50,204 40,495
Other 5,025 4,669 4,839
-------- -------- --------
100,704 83,238 69,092
-------- -------- --------
Net interest $ 42,417 $ 35,938 $ 26,864
======== ======== ========
</TABLE>
In fiscal 1998, net interest income accounted for 23% of the Company's net
revenue, while in fiscal 1997, net interest income was 27% of net revenue.
Interest income from customer accounts increased 37% in 1998 as compared to
1997 primarily due to increases in margin account balances as favorable market
conditions coupled with comparatively low interest rates made margin borrowing
popular. Additionally, the Company's acquisition of Equity in May of 1997
resulted in an increase in customer margin accounts of approximately $80
million. Interest expense related to customer funds on deposit in fiscal 1998
decreased 2% from 1997 due to a decrease in the average balances of customer
funds on deposit. During 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 decrease in average customer credit
balances caused a corresponding decrease in assets
15
<PAGE>
segregated for regulatory purposes. Interest income from these assets declined
$5,384,000, or 35%, in fiscal 1998 versus fiscal 1997 as the average balance of
these assets decreased to $167,583,000 in 1998 versus $294,678,000 in 1997.
Interest income from stock borrowed transactions increased $17,426,000, or
26%, in fiscal 1998 compared to fiscal 1997, while interest expense from stock
loaned transactions increased $17,752,000, or 35%. These increases were due to
increases in the average balances borrowed and loaned in the Company's conduit
business. Average stock borrowed balances increased 26% to $2,139,310,000 from
$1,696,668,000 in fiscal 1997 while average stock loaned balances increased 28%
to $2,112,604,000 from $1,656,708,000 in fiscal 1997.
Interest income increased to $119,176,000, an increase of $23,220,000, or
24%, while interest expense increased 20%, or $14,146,000, to $83,238,000 in
fiscal 1997 versus 1996. This resulted in an increase in net interest revenue of
$9,074,000, or 34%, due to higher average balances in securities lending and
customer margin accounts. The Company actively participates in the borrowing
and lending of securities other than those of its clients. The amounts
receivable and payable relating to open positions for securities borrowed and
loaned as of June 27, 1997 were $2,159,204,000 and $2,102,972,000, respectively.
As of June 28, 1996, these amounts were $1,341,788,000 and $1,286,199,000,
respectively.
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 $11,819,000, or 74%, to $27,850,000 when compared to $16,031,000
in fiscal 1997 due to increased volume of transactions in both equity and
municipal investment banking markets. Additionally, advisory fees earned on
investment management increased as average assets under management in 1998 were
approximately $2.9 billion versus $2.2 billion in fiscal 1997.
Investment banking, advisory and administrative fees increased $3,498,000,
or 28%, to $16,031,000 in fiscal 1997 when compared to $12,533,000 in fiscal
1996 due to increased deal flow.
Other Income. Other income increased $6,437,000, or 66%, to $16,203,000
primarily as a result of the Parent's investment in Roundtable Partners, LLC
("Roundtable"). The Parent owned a minority interest in Roundtable, 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. In accordance with the terms of
the limited partnership agreement, prior to the offering, previously
undistributed earnings of Roundtable, approximately $3.7 million, were
distributed to the Parent. Subsequent to the offering, which closed on July 10,
1998, the Parent owned approximately 1.7 million shares of Knight. The
remaining increase in other income was due to increased revenue from transaction
and account fees.
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 fiscal 1998, commissions and other
employee compensation expense increased $26,755,000, or 41%, compared to 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; (3) the addition of 90 full-time employees, including 37 in the
technology area; and (4) increased incentive compensation accruals. The number
of employees increased to 779 at June 26, 1998 compared to 689 at June 27, 1997.
In fiscal 1997, commissions and other employee compensation increased
$11,629,000, or 22%, due to increased incentive compensation, as well as an
increase in the number of full-time employees to 689 at June 27, 1997 compared
to 638 at June 28, 1996. The number of independent contractors was 536 and 462
at June 27, 1997 and June 28, 1996, respectively.
Occupancy, Equipment and Computer Service Expenses. Occupancy, equipment
and computer service expenses increased $5,447,000, or 45%, during fiscal 1998
primarily due to upgrades in computer processing equipment, an increase in
office space and the completion of the remodeling of the Company's headquarters.
During fiscal 1997, occupancy, equipment and computer service expenses increased
$2,625,000, or 27%, primarily
16
<PAGE>
due to an upgrade in computer processing equipment and an increase in square
footage under lease at the Company's headquarters.
Communications Expense. Communications expense increased 13% and 21%,
respectively, in fiscal years 1998 and 1997, due to expanded computer
networking.
Other Expenses. In fiscal 1998, other expenses increased $9,105,000, or
54%, to $26,043,000, primarily due to increases in expenses associated with
underwriting fixed income securities, consulting and legal services and
increases in the Company's litigation and other reserves. Other expenses
increased $1,982,000 in fiscal 1997, or 13%, to $16,938,000, primarily due to
increases in expenses associated with underwriting fixed income securities.
FINANCIAL CONDITION
Regulations governing broker/dealers require securities firms to maintain
assets in a special bank account for the exclusive benefit of its customers
(called "assets segregated for regulatory purposes" in the accompanying
Statements of Financial Condition) approximately equal to the net amount of cash
on deposit from clients. During fiscal 1998, the net cash on deposit from
clients decreased $221 million as customers' cash on deposit was invested in
money market funds and other securities. The decrease in customers' cash on
deposit caused a corresponding decrease in the assets segregated for regulatory
purposes.
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 year was
$13,367,000. Cash was provided by fluctuations in assets segregated for
regulatory purposes, as well as in receivables from brokers, dealers and
clearing organizations.
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 June 26, 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 June 26, 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.
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.
17
<PAGE>
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 will be installed in the first and second quarters of fiscal 1999
to correct some Year 2000 issues found in that system.
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.
18
<PAGE>
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. Since that time, 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.
The Company expects to incur additional costs in 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 $4 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.
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 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.
19
<PAGE>
EFFECTS OF RECENTLY ISSUED ACCOUNTING STANDARDS
On July 1, 1996, the Company adopted Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS
123 did not have a material impact on the Company's consolidated financial
statements, as the Company did not adopt the value-based measurement concept.
Disclosure requirements of SFAS 123 have been complied with in the footnotes to
the Company's consolidated financial statements.
The Company has adopted Statement of Financial Accounting Standards No.
128, "Earnings per Share" and has restated all prior periods presented in
conformity with the new standard.
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130") was issued in June 1997 and establishes
standards for reporting and display of comprehensive income and its components
in a set of general-purpose financial statements. SFAS 130 is effective for
financial statements issued for fiscal years beginning after December 15, 1997,
and reclassification of financial statements for earlier periods provided for
comparative purposes is required. Initial application of SFAS 130 should be as
of the beginning of the fiscal year and must be applied to all interim periods
after initial application. The Company will adopt SFAS 130 in the first quarter
of fiscal 1999.
The FASB issued Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131") in June 1997. This statement establishes standards for the way that a
public business enterprise reports information about operating segments in the
annual financial statements and requires that those enterprises report selected
information about operating segments in interim reports to shareholders. SFAS
131 is effective for financial statements issued for fiscal years beginning
after December 15, 1997, and comparative information requires restatement in the
initial year of application. As SFAS 131 need not be applied to interim
financial statements in the initial year of application, the Company must
implement the disclosure requirements in the consolidated financial statements
for the year ending June 25, 1999.
20
<PAGE>
Item 8. Financial Statements and Supplementary Data
(a) Financial statements, schedules and exhibits filed under this item are
listed in the index appearing on page F-1 of this report.
(b) QUARTERLY FINANCIAL INFORMATION
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
1998 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Revenues $65,296 $70,465 $68,841 $81,156
Income before income taxes $ 7,785 $ 8,405 $ 7,369 $ 8,339
Net income $ 5,045 $ 5,390 $ 4,863 $ 5,332
Earnings per share - basic /(2)(3)/ $ .47 $ .50 $ .46 $ .50
Earnings per share - diluted /(2)(3)/ $ .47 $ .50 $ .45 $ .50
Cash dividend declared per common share /(2)/ $ .057 $ .057 $ .057 $ .057
Stock Price Range /(2)/
High $ 23.39 $ 26.01 $ 26.19 $ 28.46
Low $ 16.77 $ 20.12 $ 20.95 $ 21.85
1997 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
---------------- ---------------- ---------------- ----------------
Revenues $47,704 $51,718 $56,242 $62,740
Income before income taxes $ 6,014 $ 5,947 $ 6,376 $ 7,406
Net income $ 3,928 $ 3,859 $ 4,246 $ 4,950
Earnings per share - basic /(1)(2)(3)/ $ .39 $ .38 $ .42 $ .48
Earnings per share - diluted /(1)(2)(3)/ $ .39 $ .38 $ .42 $ .48
Cash dividend declared per common share /(1)(2)/ $ .043 $ .043 $ .043 $ .043
Stock Price Range /(1)(2)/
High $ 10.61 $ 12.45 $ 15.80 $ 15.53
Low $ 9.31 $ 9.57 $ 12.34 $ 12.88
</TABLE>
(1) Adjusted to reflect a ten percent stock dividend which was effective
October 1, 1997.
(2) Adjusted to reflect a five percent stock dividend declared on May 22, 1998
and paid on August 3, 1998 to shareholders of record on July 15, 1998.
(3) Adjusted to reflect the implementation of Statement of Financial Accounting
Standards No. 128, "Earnings per Share."
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
21
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
For information with respect to executive officers of the registrant, see
"Executive Officers of the Registrant" at the end of Part I, Item 1 of this
report.
The information required by this item regarding Directors is incorporated by
reference to pages 3 through 4 of the Company's Proxy Statement dated September
24, 1998 which will be filed with the Commission pursuant to Regulation 240.14a
(6)(c) prior to October 24, 1998.
Item 11. 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 will be filed with the Commission pursuant to
Regulation 240.14a (6)(c) prior to October 24, 1998.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item regarding security ownership of certain
beneficial owners and management is incorporated by reference to pages 6 and 7
of the Company's Proxy Statement dated September 24, 1998 which will be filed
with the Commission pursuant to Regulation 240.14a (6)(c) prior to October 24,
1998.
Item 13. Certain Relationships and Related Transactions
The information required by this item regarding Directors is incorporated by
reference to pages 2 through 7 of the Company's Proxy Statement dated September
24, 1998 which will be filed with the Commission pursuant to Regulation 240.14a
(6)(c) prior to October 24, 1998.
22
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) List of documents filed as a part of the report:
1. Exhibits required by this Item are either listed in the index appearing
on page F-1 of this report or have been previously filed with the SEC.
2. The following consolidated financial statement schedules of the
Registrant and its subsidiaries, and Independent Auditors' Report
thereon, are attached hereto as required by Item 14 (d):
Exhibit Number
--------------
S-1 Schedule I - Condensed Financial Information of
Registrant
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore
have been omitted.
3. The following exhibits of the Registrant and its subsidiaries are
attached hereto as required by Item 14(d):
Exhibit Number
--------------
3.1 Certificate of Incorporation of the Registrant
incorporated by reference to the Registrant's
Registration Statement No. 33-42338 filed August
21, 1991 (File No. 0-19483).
3.2 By-laws of the Registrant incorporated by
reference to Amendment No. 1 to the Registrant's
Registration Statement No. 33-42338 filed October
7, 1991 (File No. 0-19483).
3.3 Certificate of Amendment of Certificate of
Incorporation, filed September 25, 1997.
10.1 Executive compensation information incorporated by
reference to the Registrant's Proxy Statement
dated September 24, 1998, filed prior to October
24, 1998.
10.2 Employees Stock Purchase Plan. Incorporated by
reference to the Registrant's Registration
Statement on Form S-8, filed November 10, 1994.
(Registration No. 33-86234)
10.3 Stock Option Plan. Incorporated by reference to
the Registrant's Proxy Statement filed September
26, 1996.
10.4 Phantom Stock Plan. Incorporated by reference to
the Registrant's Proxy Statement filed September
26, 1996.
10.5 1997 Stock Option Plan.
10.6 Employee Stock Purchase Plan.
22 Registrant's Proxy Statement dated September 24,
1998, filed prior to October 24, 1998.
23 Consent of KPMG Peat Marwick LLP
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
27.3 Restated Financial Data Schedule
(b) Reports on Form 8-K:
None.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
September 24, 1998 /S/ David Glatstein
- ------------------ --------------------------------------------
(Date) (Signature)
David Glatstein
Director and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
September 24, 1998 /S/ Don A. Buchholz
- ------------------ --------------------------------------------
(Date) (Signature)
Don A. Buchholz
Chairman of the Board
September 24, 1998 /S/ Raymond E. Wooldridge
- ------------------ --------------------------------------------
(Date) (Signature)
Raymond E. Wooldridge
Director and Vice
Chairman of the Board
September 24, 1998 /S/ David Glatstein
- ------------------ --------------------------------------------
(Date) (Signature)
David Glatstein
Director and Chief
Executive Officer
September 24, 1998 /S/ Frederick R. Meyer
- ------------------- --------------------------------------------
(Date) (Signature)
Frederick R. Meyer
Director
September 24, 1998 /S/ Jon L. Mosle, Jr.
- ------------------ --------------------------------------------
(Date) (Signature)
Jon L. Mosle, Jr.
Director
September 24, 1998 /S/ Kenneth R. Hanks
- ------------------ --------------------------------------------
(Date) (Signature)
Kenneth R. Hanks
Chief Financial Officer during
fiscal 1998 (currently Chief
Operating Officer)
24
<PAGE>
September 24, 1998 /S/ Stacy M. Hodges
- ------------------ --------------------------------------------
(Date) (Signature)
Stacy M. Hodges
Controller and Treasurer (Chief
Accounting Officer) during
fiscal 1998 (currently Chief
Financial Officer and Treasurer)
September 24, 1998 /S/ Laura Leventhal
- ------------------ --------------------------------------------
(Date) (Signature)
Laura Leventhal
Controller (Chief Accounting
Officer)
25
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS PAGE(S)
Consolidated Statements of Financial Condition F-2
as of June 26, 1998 and June 27, 1997
Consolidated Statements of Income F-3
for the years ended June 26, 1998, June 27, 1997 and June 28, 1996
Consolidated Statements of Stockholders' Equity F-4
for the years ended June 26, 1998, June 27, 1997 and June 28, 1996
Consolidated Statements of Cash Flows F-5
for the years ended June 26, 1998, June 27, 1997 and June 28, 1996
Notes to Consolidated Financial Statements F-6-15
Independent Auditors' Report F-16
F-1
<PAGE>
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 26, 1998 and June 27, 1997
(In thousands, except par values and share amounts)
<TABLE>
<CAPTION>
1998 1997
--------------------- --------------------
<S> <C> <C>
ASSETS
Cash $ 13,706 $ 10,745
Assets segregated for regulatory purposes (Notes 2 and 14) 130,728 352,197
Receivable from brokers, dealers and clearing organizations (Notes 3 and 6) 2,365,635 2,282,304
Receivable from clients, net (Notes 4 and 6) 648,464 570,461
Securities owned, at market value (Notes 5 and 6) 32,144 31,921
Other assets (Note 7) 29,429 28,764
--------------------- --------------------
$3,220,106 $3,276,392
===================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings (Note 6) $ -- $ 4,000
Payable to brokers, dealers and clearing organizations (Note 3) 2,293,731 2,139,611
Payable to clients (Note 4) 720,813 963,552
Drafts payable 41,688 31,036
Other liabilities 38,407 29,865
--------------------- --------------------
3,094,639 3,168,064
Liabilities subordinated to claims of general creditors (Note 12) -- 1,400
--------------------- --------------------
3,094,639 3,169,464
--------------------- --------------------
Stockholders' equity (Notes 8 and 11):
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 in 1998;
issued 10,161,599 and outstanding 10,152,422 shares in 1997. 1,069 1,016
Additional paid-in capital 69,462 56,139
Retained earnings 55,022 49,984
Receivable from employees under the Employee Stock Purchase Plan
(Note 9) (12) (137)
Treasury stock (9,177 shares, at cost) (74) (74)
--------------------- --------------------
Total stockholders' equity 125,467 106,928
--------------------- --------------------
Commitments and contingencies (Notes 6, 9, 13 and 15)
$3,220,106 $3,276,392
===================== ====================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-2
<PAGE>
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Years ended June 26, 1998, June 27, 1997 and June 28, 1996
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
1998 1997 1996
---------------- --------------- ---------------
<S> <C> <C> <C>
Net revenues from clearing operations $ 26,607 $ 22,693 $ 17,897
Commissions 59,401 38,882 36,896
Interest 143,121 119,176 95,956
Investment banking, advisory and administrative fees 27,850 16,031 12,533
Net gains on principal transactions 12,576 11,856 8,735
Other 16,203 9,766 9,791
---------------- --------------- ---------------
285,758 218,404 181,808
---------------- --------------- ---------------
Commissions and other employee compensation (Note 9) 91,817 65,062 53,433
Interest 100,704 83,238 69,092
Occupancy, equipment and computer service costs (Note 13) 17,663 12,216 9,591
Communications 12,509 11,026 9,109
Floor brokerage and clearing organization charges 5,124 4,181 3,870
Other 26,043 16,938 14,956
---------------- --------------- ---------------
253,860 192,661 160,051
---------------- --------------- ---------------
Income before income taxes 31,898 25,743 21,757
Income taxes (Note 7) 11,268 8,760 7,717
---------------- --------------- ---------------
Net income $ 20,630 $ 16,983 $ 14,040
================ =============== ===============
Earnings per share basic and diluted (Notes 10 and 11) $1.93 $1.66 $1.38
================ =============== ===============
Weighted average shares outstanding - basic (Notes 10 and 11) 10,675,662 10,245,151 10,146,908
================ =============== ===============
Weighted average shares outstanding - diluted (Notes 10 and 11) 10,694,186 10,257,168 10,152,303
================ =============== ===============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-3
<PAGE>
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended June 26, 1998, June 27, 1997 and June 28, 1996
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Receivable
from
employees
under
Employee
Additional Stock
Common stock paid-in Retained Purchase Treasury
Shares Amount capital earnings Plan stock Total
===================================================================================
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1995 8,763,396 $ 876 $26,860 $ 44,181 $(376) $ -- $ 71,541
Purchase of treasury stock (9,177) -- -- -- -- (74) (74)
Issuance of common stock 29,411 3 247 -- -- -- 250
Net income -- -- -- 14,040 -- -- 14,040
Dividends ($.13/share)
(Note 11) -- -- -- (1,406) -- -- (1,406)
Proceeds from employees for
Employee Stock Purchase
Plan -- -- -- -- 98 -- 98
-----------------------------------------------------------------------------------
Balance at June 28, 1996 8,783,630 879 27,107 56,815 (278) (74) 84,449
Issuance of common stock for
acquisition 445,845 45 7,089 -- -- -- 7,134
Net income -- -- -- 16,983 -- -- 16,983
Dividends ($.17/share)
(Note 11) -- -- -- (1,779) -- -- (1,779)
Stock dividend declared on
August 28, 1997 (Note 11) 922,947 92 21,943 (22,035) -- -- --
Proceeds from employees for
Employee Stock Purchase
Plan -- -- -- -- 141 -- 141
-----------------------------------------------------------------------------------
Balance at June 27, 1997 10,152,422 1,016 56,139 49,984 (137) (74) 106,928
Exercise of stock options
(Note 9) 16,000 2 498 (275) -- -- 225
Stock dividend on exercised
options (Note 11) 1,600 -- 38 (38) -- -- --
Adjustment for fractional
shares on stock dividend
declared on August 28,
1997 (Note 11) (36) -- -- -- -- -- --
Net income -- -- -- 20,630 -- -- 20,630
Dividends ($.23/share)
(Note 11) -- -- -- (2,441) -- -- (2,441)
Stock dividend declared on
May 22, 1998 (Note 11) 508,420 51 12,787 (12,838) -- -- --
Proceeds from employees for
Employee Stock Purchase
Plan -- -- -- -- 125 -- 125
-----------------------------------------------------------------------------------
Balance at June 26, 1998 10,678,406 $1,069 $69,462 $ 55,022 $ (12) $(74) $125,467
===================================================================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-4
<PAGE>
Southwest Securities Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 26, 1998, June 27, 1997 and June 28, 1996
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
---------------- --------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 20,630 $ 16,983 $ 14,040
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization 3,426 2,750 2,815
Provision for doubtful accounts 1,241 -- 984
Deferred income taxes (371) (1,198) (1,208)
Decrease (increase) in assets segregated for regulatory
purposes 221,469 (128,167) (2,087)
Net change in broker, dealer and clearing organization
accounts 70,789 1,452 (67,751)
Net change in client accounts (321,983) 203,161 24,472
Decrease (increase) in securities owned (223) 2,672 1,972
Decrease (increase) in other assets (179) 4,089 5,153
Increase (decrease) in drafts payable 10,652 5,878 (201)
Increase (decrease) in other liabilities 7,916 8,315 (8,607)
---------------- --------------- -------------
Net cash provided by (used in) operating activities 13,367 115,935 (30,418)
---------------- --------------- -------------
Cash flows from investing activities:
Purchase of fixed assets (3,525) (7,597) (2,725)
Proceeds from sale of fixed assets -- 96 481
---------------- --------------- -------------
Net cash used in investing activities (3,525) (7,501) (2,244)
---------------- --------------- -------------
Cash flows from financing activities:
Net change in short-term borrowings (4,000) (100,984) 35,445
Payments on liabilities subordinated to claims of general
creditors (1,400) -- --
Proceeds from employees for Employee Stock Purchase Plan 125 141 98
Purchase of treasury stock -- -- (74)
Net proceeds from exercise of stock options 225 -- --
Net proceeds from issuance of common stock -- -- 250
Payment of cash dividends on common stock (1,831) (2,130) (1,362)
---------------- --------------- -------------
Net cash provided by (used in) financing activities (6,881) (102,973) 34,357
---------------- --------------- -------------
Net increase in cash 2,961 5,461 1,695
Cash at beginning of year 10,745 5,284 3,589
---------------- --------------- -------------
Cash at end of year $ 13,706 $ 10,745 $ 5,284
================ =============== =============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
(a) General and Basis of Presentation
The consolidated financial statements include the accounts of Southwest
Securities Group, Inc. ("Parent") and its wholly owned subsidiaries
(collectively "Company"), Southwest Securities, Inc. ("Southwest"), Brokers
Transaction Services, Inc. ("BTS"), Southwest Investment Advisors ("Advisors"),
SW Capital Corporation ("Capital"), Westwood Trust ("Trust"), formerly Trust
Company of Texas, Westwood Management Corporation ("Westwood"), SWST Computer
Corporation ("Computer Corp."), Sovereign Securities, Inc. ("Sovereign") and
NorAm Investment Services, Inc. ("NorAm"), formerly Equity Securities Trading
Company, Inc.
Southwest, BTS, Sovereign and NorAm are registered broker/dealers under the
Securities Exchange Act of 1934 ("1934 Act"). Sovereign, a discount brokerage
firm, began operations in 1997. NorAm was acquired May 1, 1997 through the
issuance of 445,845 shares of common stock. The acquisition was accounted for
under the purchase method of accounting and, accordingly, assets and liabilities
were recorded at their fair market values on the date of acquisition. Goodwill
relating to this acquisition of approximately $5,113,000 is recorded in other
assets in the accompanying consolidated statements of financial condition.
Westwood and Advisors are registered investment advisors under the
Investment Advisors Act of 1940. Computer Corp., which was formed in 1996,
provides computer processing and programming services to affiliates as well as
third parties. All significant intercompany balances and transactions have been
eliminated.
The annual consolidated financial statements are prepared as of the close
of business on the last Friday of June. Accordingly, the fiscal years for 1998,
1997 and 1996 ended June 26, 1998, June 27, 1997 and June 28, 1996,
respectively.
(b) Securities Transactions
Securities transactions are recorded on a settlement date basis with such
transactions generally settling three business days after trade date. Revenues
and expenses related to such transactions are also recorded on settlement date,
which is not materially different than trade date.
(c) Securities Owned
Marketable securities are carried at quoted market value. The increase or
decrease in net unrealized appreciation or depreciation of securities owned is
credited or charged to operations and is included in net gains on principal
transactions in the consolidated statements of income.
(d) Depreciation and Amortization
Depreciation of furniture, equipment and leasehold improvements is provided
over the estimated useful lives of the assets (5 or 7 years). Equipment under
capital leases is amortized on a straight-line basis over the terms of the
leases. Goodwill is amortized on a straight-line basis over periods ranging from
twenty-five to forty years.
(e) Drafts Payable
In the normal course of business, Southwest uses drafts to make payments
relating to its brokerage transactions. These drafts are presented for payment
through Southwest's bank and are sent to Southwest daily for review and
acceptance. Upon acceptance, the drafts are paid and charged against cash.
(f) Reverse Repurchase and Repurchase Agreements
Securities purchased under agreements to resell ("Reverse Repurchase
Agreements") and securities sold under agreements to repurchase ("Repurchase
Agreements") are carried at the amounts at which these securities will be
subsequently resold or reacquired as specified in the respective agreements
(Notes 2 and 6). Management regularly monitors the market value of the
underlying securities relating to outstanding repurchase and reverse repurchase
agreements.
(g) Federal Income Taxes
The Company and its subsidiaries file a consolidated Federal income tax
return.
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities
F-6
<PAGE>
are measured using enacted tax rates in effect for the year in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
(h) Cash Flow Reporting
For the purposes of the consolidated statements of cash flows, the Company
considers cash to include cash on hand and in depository accounts.
Assets segregated for regulatory purposes are not included as cash
equivalents for purposes of the consolidated statements of cash flows because
such assets are segregated for the benefit of customers only.
Cash paid during the year for interest was $100,422,000, $82,936,000 and
$67,616,000, in 1998, 1997 and 1996, respectively. Cash paid during the year for
income taxes was $10,332,000, $9,235,000 and $8,742,000 in 1998, 1997 and 1996,
respectively.
During 1997, the Company issued common stock valued at approximately
$7,134,000 related to the acquisition of NorAm.
(i) Earnings Per Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128"). SFAS 128 was effective for periods ending after December 15, 1997.
Earnings per share ("EPS") for prior periods presented in these financial
statements have been restated to comply with SFAS 128 (Note 10).
(j) Authorization of Common Stock
On November 6, 1996, the shareholders voted to increase the number of
shares of common stock authorized to 20,000,000.
(k) Stock-Based Compensation
In October 1995, the FASB issued Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS
123 defines a fair value-based method of accounting for employee stock options
and similar equity instruments. Under SFAS 123, the Company has elected to
measure the compensation costs using the intrinsic value-based method of
accounting prescribed by Accounting Principles Bulletin No. 25 ("APB 25") and
has implemented all disclosure requirements of SFAS 123 (Note 9). Prior to
fiscal year 1998, the impact of recording the compensation expense related to
the stock options granted by the Company was not material to the consolidated
financial statements, and therefore no disclosure was presented.
(l) Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
(m) Fair Value of Financial Instruments
Substantially all of the Company's financial assets and liabilities are
carried at market value or at amounts which, because of their short-term nature,
approximate current fair value. The Company's borrowings, if recalculated based
on current interest rates, would not significantly differ from the amounts
recorded at June 27, 1997.
(n) Accounting Pronouncements
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130") was issued in June 1997 and establishes
standards for reporting and display of comprehensive income and its components
in a set of general-purpose financial statements. SFAS 130 is effective for
financial statements issued for fiscal years beginning after December 15, 1997,
and reclassification of financial statements for earlier periods provided for
comparative purposes is required. Initial application of SFAS 130 should be as
of the beginning of the fiscal year and must be applied to all interim periods
after initial application. The Company will adopt SFAS 130 in the first quarter
of fiscal 1999.
F-7
<PAGE>
The FASB issued Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131") in June 1997. This statement establishes standards for the way that a
public business enterprise reports information about operating segments in the
annual financial statements and requires that those enterprises report selected
information about operating segments in interim reports to shareholders. SFAS
131 is effective for financial statements issued for fiscal years beginning
after December 15, 1997, and comparative information requires restatement in the
initial year of application. As SFAS 131 need not be applied to interim
financial statements in the initial year of application, the Company must
implement the disclosure requirements in the consolidated financial statements
for the year ending June 25, 1999.
2. ASSETS SEGREGATED FOR REGULATORY PURPOSES
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 segregated
in special reserve bank accounts for the exclusive benefit of customers under
Rule 15c3-3 of the 1934 Act. Reverse repurchase agreements at June 26, 1998
were collateralized by U.S. Government securities with market values of
approximately $71,871,000.
At June 27, 1997, the Company had cash of $90,000, U.S. Treasury securities
with a market value of $119,984,000 and reverse repurchase agreements of
$232,123,000 in these accounts. The reverse repurchase agreements were
collateralized by U.S. Government securities with market values of approximately
$234,372,000 at June 27, 1997.
3. RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
At June 26, 1998 and June 27, 1997, the Company had receivable from
and payable to brokers, dealers and clearing organizations related to the
following (in thousands):
1998 1997
---------- ----------
Receivable:
Securities failed to deliver $ 18,880 $ 15,213
Securities borrowed 2,229,587 2,159,204
Correspondent broker/dealers 62,673 62,235
Clearing organizations 1,245 7,355
Other 53,250 38,297
---------- ----------
$2,365,635 $2,282,304
========== ==========
Payable:
Securities failed to receive $ 45,956 $ 17,889
Securities loaned 2,227,874 2,102,972
Correspondent broker/dealers 11,300 9,013
Other 8,601 9,737
---------- ----------
$2,293,731 $2,139,611
========== ==========
Securities failed to deliver and receive represent the contract value of
securities that have not been delivered or received subsequent to settlement
date. Securities borrowed and loaned represent deposits made to or received from
other broker/dealers relating to these transactions. These deposits approximate
the market value of the underlying securities.
The Company clears securities transactions for Correspondent
broker/dealers. Settled securities and related transactions for these
Correspondents are included in the receivable from and payable to brokers,
dealers and clearing organizations.
The Company participates in the securities borrowing and lending business
by borrowing and lending securities other than those of its clients. All open
positions are adjusted to market values daily. The amounts receivable and
payable, relating to open positions for the securities borrowed and securities
loaned other than those of the Company's clients, were $2,192,459,000 and
$2,198,278,000, respectively, at June 26, 1998 and $2,097,048,000 and
$2,087,147,000, respectively, at June 27, 1997.
F-8
<PAGE>
4. RECEIVABLE FROM AND PAYABLE TO CLIENTS
Receivable from and payable to clients include amounts due on cash and
margin transactions. Included in these amounts are receivable from and payable
to noncustomers (as defined by Rule 15c3-3 of the 1934 Act, principally
officers, directors and related accounts), which aggregated approximately
$1,916,000 and $2,649,000, respectively, at June 26, 1998 and $1,969,000 and
$6,825,000, respectively, at June 27, 1997. Securities accounts of noncustomers
are subject to the same terms and regulations as those of customers. Securities
owned by customers and noncustomers that collateralize the receivable are not
reflected in the accompanying consolidated financial statements.
The Company pays interest on certain customer "free credit" balances
available for reinvestment. The aggregate balance of such funds was
approximately $542,822,000 and $688,418,000 at June 26, 1998 and June 27, 1997,
respectively. During fiscal years 1998 and 1997, the interest rates paid on
these balances ranged from 4.5% to 4.75%.
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 customers. Provisions
made to this allowance are charged to operations. At June 26, 1998 and June 27,
1997, all unsecured customer receivables had been provided for in this
allowance.
5. SECURITIES OWNED
Securities owned at June 26, 1998 and June 27, 1997, which are carried
at market value, include the following (in thousands):
1998 1997
------- -------
Corporate equity securities $ 5,220 $ 2,280
Municipal obligations 13,633 13,604
U.S. Government and Government agency obligations 8,696 9,205
Corporate obligations 1,479 3,064
Commercial paper 446 2,446
Other 2,670 1,322
------- -------
$32,144 $31,921
======= =======
Certain of the above securities have been pledged to secure short-term
borrowings and as security deposits at clearing organizations for the Company's
clearing business. These pledged securities amounted to $3,572,000 and
$1,583,000 at June 26, 1998 and June 27, 1997, respectively.
6. 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
balances under these credit arrangements are due on demand and bear interest at
rates indexed to the federal funds rate (5.38% at June 26, 1998 and 5.56% at
June 27, 1997). There were no amounts outstanding at June 26, 1998 and June 27,
1997 on these credit arrangements.
The Company also has an irrevocable letter of credit agreement aggregating
$32,000,000 at June 26, 1998 and $26,600,000 at June 27, 1997 pledged to support
its open options positions with an options clearing organization. The letter of
credit bears interest at the brokers' call rate, if drawn, and is renewable
annually. This letter of credit is fully collateralized by marketable securities
held in clients' and nonclients' margin accounts with a value of $55,328,000 and
$29,618,000 at June 26, 1998 and June 27, 1997, respectively.
In addition, the Company has a $20,000,000 unsecured line of credit that is
due on demand and bears interest at rates indexed to the federal funds rate.
The amount outstanding under this unsecured line of credit was $4,000,000 at
June 27, 1997. There were no amounts outstanding on this unsecured line of
credit at June 26, 1998.
At June 26, 1998 and June 27, 1997, the Company had no repurchase
agreements outstanding.
F-9
<PAGE>
7. INCOME TAXES
Income tax expense for the fiscal years ended June 26, 1998, June 27, 1997
and June 28, 1996 (effective rate of 35.3% in 1998, 34.0% in 1997 and 35.5% in
1996) differs from the amount that would otherwise have been calculated by
applying the Federal corporate tax rate (35% in 1998, 1997 and 1996) to income
before income taxes and is comprised of the following (in thousands):
1998 1997 1996
------- ------ ------
Income tax expense at the statutory rate $11,164 $9,010 $7,615
Tax exempt interest (285) (321) (274)
Other, net 389 71 376
------- ------ ------
$11,268 $8,760 $7,717
======= ====== ======
Income taxes as set forth in the consolidated statements of income
consisted of the following components (in thousands):
1998 1997 1996
------- ------- -------
Current $11,639 $ 9,958 $ 8,925
Deferred (371) (1,198) (1,208)
------- ------- ------
Total income taxes $11,268 $ 8,760 $ 7,717
======= ======= =======
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities as of June 26, 1998 and June 27, 1997 are
presented below (in thousands):
1998 1997
---------- ----------
Deferred tax assets:
Expenses for book, not deductible
until paid $3,235 $2,417
Partnership basis in excess of financial
reporting basis (7) 756
Management incentive compensation 910 826
Other 446 79
---------- ----------
Total gross deferred tax assets 4,584 4,078
Deferred tax liabilities:
Unrealized gains (11) (15)
Depreciation at rates different for tax
than for financial reporting 52 --
Other (401) (210)
---------- ----------
Total gross deferred tax liabilities (360) (225)
---------- ----------
Net deferred tax assets $4,224 $3,853
========== ==========
As a result of the Company's history of taxable income and the nature of
the items from which deferred tax assets are derived, management believes that
it is more likely than not that the Company will realize the benefit of the
deferred tax assets.
8. 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 June 26, 1998, Southwest had net capital of
approximately $78,073,000, or approximately 10% of aggregate debit balances,
which is $62,721,000 in excess of its minimum net capital requirement of
approximately $15,352,000 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
F-10
<PAGE>
resulting net capital would be less than 5% of aggregate debit items. At June
26, 1998, Southwest had net capital of approximately $39,693,000 in excess of 5%
of aggregate debit items.
BTS follows the primary (aggregate indebtedness) method under Rule 15c3-1,
which requires it to maintain minimum net capital of $250,000. BTS had net
capital of approximately $317,000 which is $67,000 in excess of its minimum net
capital requirement at June 26, 1998.
Sovereign also follows the primary (aggregate indebtedness) method under
Rule 15c3-1, which requires it to maintain minimum net capital of $250,000. At
June 26, 1998, Sovereign had net capital of approximately $573,000 which is
$323,000 in excess of its minimum net capital requirement.
In addition, NorAm follows the primary (aggregate indebtedness) method
under Rule 15c3-1, which requires it to maintain minimum net capital of
$250,000. NorAm had net capital of approximately $591,000 which is $341,000 in
excess of its minimum net capital requirement at June 26, 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 $2,571,000, which is $1,571,000 in excess
of its minimum capital requirement at June 26, 1998.
9. EMPLOYEE BENEFITS
At June 26, 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. 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. Officers
and directors are not eligible to receive options under the 1997 Plan. The
Company also has options outstanding that were granted on May 25, 1995 in
conjunction with the acquisition of Barre & Company, Inc. ("Barre"). These
options were vested immediately upon grant and have a five-year term.
A summary of the status of the Company's outstanding stock options as of
June 26, 1998, June 27, 1997 and June 28, 1996 is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- -------------------------- --------------------------
Weighted- Weighted- Weighted-
Underlying Average Underlying Average Underlying Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of period 52,000 $11.17 32,000 $ 8.07 32,000 $8.07
Granted 210,973 23.72 20,000 16.13 -- --
Exercised (16,000) 8.07 -- -- -- --
Forfeited (6,000) 23.63 -- -- -- --
Adjustment for five percent
stock dividend (Note 11) 12,039 -- -- -- -- --
---------- ---------- ----------
Outstanding, end of period 253,012 $21.00 52,000 $11.17 32,000 $8.07
========== ========== ==========
Exercisable, end of period 46,200 52,000 32,000
Weighted-average fair value of
options granted during fiscal
year $22.83 $ 16.13 $ --
</TABLE>
F-11
<PAGE>
The following table summarizes information for the stock options
outstanding at June 26, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------------------- -------------------------------------
Weighted-Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$7.69 to $15.36 37,800 2.33 years $11.95 37,800 $11.95
$15.36 to $25.60 215,212 9.22 years 22.59 8,400 22.38
----------------- ---------------
$7.69 to $25.60 253,012 8.19 years $21.00 46,200 $13.85
================= ===============
</TABLE>
The Company applies APB 25 and related interpretations in accounting for
its plans. Accordingly, no compensation cost has been recognized for its stock
options. Had compensation cost been determined consistent with SFAS 123 for the
options granted, the Company's net income and earnings per share would have been
reduced to the pro-forma amounts indicated below for the year ended June 26,
1998:
Net income As reported $20,630
=======
Pro forma $20,357
=======
Earnings per share As reported -- basic and diluted $ 1.93
=======
Pro forma -- basic $ 1.91
=======
Pro forma -- diluted $ 1.90
=======
The fair value of each option was estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions for 1998:
expected volatility 30%, risk-free interest rate 5.09%, expected dividend yield
of 1.25% and an expected life of 5 to 10 years depending on the option.
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 June 26, 1998, 373 units
have been issued under the Phantom Plan. These units have been excluded from
the above stock-based compensation disclosure 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. Profit sharing expense for
fiscal years 1998, 1997 and 1996 was approximately $4,599,000, $3,338,000 and
$3,692,000, respectively.
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 (5.62% at June 26,
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
June 26, 1998 was $12,000.
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
effective date of the Stock Purchase Plan is January 1, 1998 and the initial
purchase period begins July 1, 1998.
F-12
<PAGE>
10. 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 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net income $ 20,630 $ 16,983 $ 14,040
=========== =========== ===========
Weighted average shares outstanding -- basic 10,675,662 10,245,151 10,146,908
Effect of dilutive securities:
Assumed exercise of stock options 18,524 12,017 5,395
----------- ----------- -----------
Weighted average shares outstanding -- diluted 10,694,186 10,257,168 10,152,303
=========== =========== ===========
Earnings per share basic and diluted $ 1.93 $ 1.66 $ 1.38
=========== =========== ===========
</TABLE>
Options to purchase 6,666 shares of common stock granted under the 1997
Plan in the third and fourth quarters of the fiscal year were not included in
the computation of diluted EPS, because the options' exercise price was greater
than the average market price of the common stock. All of these options were
still outstanding at June 26, 1998.
11. STOCK DIVIDENDS
On August 28, 1997, the Board of Directors declared a ten percent stock
dividend which was paid on October 1, 1997 to shareholders of record at the
close of business on September 15, 1997. Additionally, 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. Per share amounts, dividends per share and weighted average shares
outstanding have been restated in the accompanying financial statements to
reflect the effect of these stock dividends. At the discretion of the Stock
Option Committee, the stock options outstanding, as well as the options'
exercise prices, were adjusted for the five percent stock dividend. The number
of stock options outstanding, the number of stock options exercisable and the
weighted-average exercise prices at June 26, 1998, as well as the weighted-
average fair value of options granted during the fiscal year, have been
restated.
12. LIABILITIES SUBORDINATED TO CLAIMS OF GENERAL CREDITORS
There were no subordinated notes outstanding at June 26, 1998. At June 27,
1997, liabilities subordinated to the claims of general creditors represent
loans to NorAm. The loans are covered by agreements approved by the National
Association of Securities Dealers ("NASD") and are thus available to the Company
in computing net capital under the Rule. To the extent that such borrowings are
required for the Company's continued compliance with the minimum net capital
requirements, they may not be repaid. At June 27, 1997, subordinated notes
include the following (in thousands):
Due to officer, due 1/31/98, interest at 2%/(1)/ $ 400
Due to officer, due 2/28/98, interest at prime + 1/2% 500
Due to officer, due 8/31/97, interest at prime + 1/2% 500
------
$1,400
======
(1) This subordinated note is related to secured demand notes receivable which
bear interest at 2% and are collateralized by securities with a market
value of approximately $9,457,000 at June 27, 1997.
F-13
<PAGE>
13. COMMITMENTS AND CONTINGENCIES
The Company leases its offices under noncancelable operating lease
agreements. During fiscal 1998 and 1997, the Company entered into various
noncancelable operating lease agreements relating to data processing equipment
used in the brokerage operations. Rental expense for fiscal years 1998, 1997 and
1996 aggregated approximately $4,833,000, $3,172,000 and $2,543,000,
respectively.
At June 26, 1998, the future rental payments for the noncancelable leases
for each of the following five fiscal years and thereafter follow (in
thousands):
Year ending:
1999 $ 6,235
2000 5,008
2001 3,974
2002 2,621
2003 2,523
Thereafter 4,550
-------
Total payments due $24,911
=======
On April 17, 1998, a judgment was entered against the Company in connection
with a breach of contract lawsuit stemming from the 1995 acquisition of Barre.
The judge awarded the counterparty approximately $40,000 in damages and
approximately $1,700,000 in attorney's fees. The Company believes it has
substantial grounds for appeal and has begun the appellate process. The Company
also believes its reserves are adequate to cover the full amount of the
judgment.
In the general course of its brokerage business and the business of
clearing for other brokerage firms, the Company and/or its subsidiaries have
been named as defendants in various lawsuits and arbitration proceedings. These
claims allege violation of Federal and state securities laws. Management
believes that resolution of these claims will not result in any material adverse
effect on the Company's consolidated financial position or results of
operations.
14. AFFILIATE TRANSACTIONS
The Company, through its principal subsidiary, Southwest, provides
accounting and administrative services for its subsidiaries and clears all
customer transactions for BTS, Sovereign and NorAm. Westwood serves as the
investment manager for the assets discussed in Note 2. Trust acts as an agent
on behalf of Southwest in the direction of transactions related to these assets.
In addition, Westwood serves as the investment manager of the common trust funds
of Trust.
15. FINANCIAL INSTRUMENTS WITH OFF-STATEMENT OF FINANCIAL CONDITION RISK
In the normal course of business, the broker/dealer subsidiaries engage
in activities involving the execution, settlement and financing of various
securities transactions. These activities may expose the Company to off-
statement of financial condition credit and market risks in the event the
customer or counterparty is unable to fulfill its contractual obligation. Such
risks may be increased by volatile trading markets.
As part of its normal brokerage activities, the Company sells securities
not yet purchased (short sales) for its own account. The establishment of short
positions exposes the Company to off-statement of financial condition market
risk in the event prices increase, as the Company may be obligated to acquire
the securities at prevailing market prices.
The Company seeks to control the risks associated with its customer
activities, including customer accounts of its Correspondents for which it
provides clearing services, by requiring customers to maintain margin collateral
in compliance with various regulatory and internal guidelines. The required
margin levels are monitored daily and, pursuant to such guidelines, customers
are required to deposit additional collateral or to reduce positions when
necessary.
A portion of the Company's customer activity involves short sales and the
writing of option contracts. Such transactions may require the Company to
purchase or sell financial instruments at prevailing market prices in order to
fulfill the customer's obligations.
F-14
<PAGE>
At times, the Company lends money using reverse repurchase agreements. All
positions are collateralized by U.S. Government or U.S. Government agency
securities. Such transactions may expose the Company to off-statement of
financial condition risk in the event such borrowers do not repay the loans and
the value of collateral held is less than that of the underlying receivable.
These agreements provide the Company with the right to maintain the relationship
between market value of the collateral and the receivable.
The Company arranges secured financing by pledging securities owned and
unpaid customer securities for short-term borrowings to satisfy margin deposits
of clearing organizations. The Company also actively participates in the
borrowing and lending of securities. In the event the counterparty in these and
other securities loaned transactions is unable to return such securities pledged
or borrowed or to repay the deposit placed with them, the Company may be exposed
to the risks of acquiring the securities at prevailing market prices or holding
collateral possessing a market value less than that of the related pledged
securities. The Company seeks to control the risks by monitoring the market
value of securities pledged and requiring adjustments of collateral levels where
necessary.
16. SUBSEQUENT EVENT
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 will be classified as marketable equity securities
available for sale, and the unrealized holding gains or losses, net of tax, will
be recorded as a separate component of stockholders' equity on the consolidated
statement of financial condition in accordance with Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." At August 28, 1998, the stock in Knight was valued at
approximately $13.3 million and the unrealized holding gain, net of tax, totaled
approximately $8.4 million.
F-15
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Southwest Securities Group, Inc.:
We have audited the consolidated financial statements of Southwest
Securities Group, Inc. and subsidiaries as listed in the accompanying index on
page F-1. In connection with our audits of the consolidated financial
statements, we also have audited the financial statement schedule as listed in
the accompanying index at Part IV. These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Southwest
Securities Group, Inc. and subsidiaries as of June 26, 1998 and June 27, 1997,
and the results of their operations and their cash flows for each of the years
in the three-year period ended June 26, 1998, in conformity with generally
accepted accounting principles. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
KPMG Peat Marwick LLP
Dallas, Texas
July 31, 1998
F-16
<PAGE>
S-1
SCHEDULE I - Condensed Financial Information of Registrant
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Condensed Financial Information of Registrant
Condensed Statements of Financial Condition
-------------------------------------------
June 26, 1998 and June 27, 1997
(In thousands)
ASSETS 1998 1997
- ------ -------- --------
Investment in subsidiaries, at equity $ 98,258 $ 92,807
Notes receivable from subsidiary 19,700 16,700
Other assets 12,958 3,483
-------- --------
$130,916 $112,990
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Loans payable $ -- $ 4,000
Other liabilities 5,449 2,062
Stockholders' equity 125,467 106,928
-------- --------
$130,916 $112,990
======== ========
<PAGE>
S-1 (CONTINUED)
SCHEDULE I - Condensed Financial Information of Registrant - Continued
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Condensed Financial Information of Registrant
Condensed Statements of Income and
-----------------------------------
Stockholders' Equity
--------------------
Years Ended June 26, 1998, June 27, 1997 and June 28, 1996
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Revenues - Interest and other income $ 6,361 $ 2,941 $ 3,211
-------------- -------------- --------------
Expenses:
Interest expense 90 23 2
Other expenses 3,293 1,972 780
-------------- -------------- --------------
3,383 1,995 782
-------------- -------------- --------------
Income before income tax expense
and equity in earnings of subsidiaries 2,978 946 2,429
Income tax expense (1,183) (400) (1,189)
-------------- -------------- --------------
Income before equity in earnings of subsidiaries 1,795 546 1,240
Equity in earnings of subsidiaries 18,835 16,437 12,800
-------------- -------------- --------------
Net income 20,630 16,983 14,040
Stockholders' equity at beginning of year 106,928 84,449 71,541
Net proceeds from issuance of common stock -- -- 250
Issuance of common stock for acquisition -- 7,134 --
Proceeds from employees for Employee Stock Purchase Plan 125 141 98
Dividends (2,441) (1,779) (1,406)
Exercise of stock options 225 -- --
Purchase of treasury stock -- -- (74)
-------------- -------------- --------------
Stockholders' equity at end of year $125,467 $106,928 $84,449
============== ============== ==============
</TABLE>
<PAGE>
S-1 (CONTINUED)
SCHEDULE I - Condensed Financial Information of Registrant - Continued
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Condensed Financial Information of Registrant
Condensed Statements of Cash Flows
----------------------------------
Years Ended June 26, 1998, June 27, 1997 and June 28, 1996
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 20,630 $ 16,983 $ 14,040
Adjustments:
Depreciation and amortization 303 -- 175
Undistributed equity in earnings of subsidiaries (10,180) (20,695) (12,800)
Other 3,528 186 887
--------------- --------------- ---------------
Net cash provided by (used in) operating
activities 14,281 (3,526) 2,302
--------------- --------------- ---------------
Cash flows from investing activities:
Proceeds from (payments on) notes and other
accounts with subsidiaries (8,800) 1,515 (847)
Purchase of investments -- -- (367)
--------------- --------------- ---------------
Net cash provided by (used in) investing
activities (8,800) 1,515 (1,214)
--------------- --------------- ---------------
Cash flows from financing activities:
Net change in short-term borrowings (4,000) 4,000 --
Proceeds from employees for Employee Stock Purchase Plan 125 141 98
Purchase of treasury stock -- -- (74)
Net proceeds from exercise of stock options 225 -- --
Net proceeds from issuance of common stock -- -- 250
Payment of cash dividends on common stock (1,831) (2,130) (1,362)
--------------- --------------- ---------------
Net cash provided by (used in) financing
activities (5,481) 2,011 (1,088)
--------------- --------------- ---------------
Net change in cash -- -- --
Cash at beginning of year 1 1 1
--------------- --------------- ---------------
Cash at end of year $ 1 $ 1 $ 1
=============== =============== ===============
</TABLE>
- ---------------
Note: During 1997, the Company issued common stock valued at $7,134,000 related
to an acquisition. At June 26, 1998, goodwill amounting to $4,729,000 was
transferred to the Company from NorAm Investment Services, Inc., a wholly owned
subsidiary.
<PAGE>
EXHIBIT 10.5
SOUTHWEST SECURITIES GROUP, INC.
1997 STOCK OPTION PLAN
INTRODUCTION
On August 20, 1997, the Board of Directors of the Company adopted the
following Stock Option Plan:
1. PURPOSE. The purpose of the Plan is to provide selected employees with
a proprietary interest in the Company through the granting of Nonqualified
Options which will:
(a) increase the interest of the optionees in the Company's welfare;
(b) furnish an incentive to the optionees to continue their services
for the Company; and
(c) provide a means through which the Company may attract able persons
to enter its employ.
2. ADMINISTRATION. The Plan shall be administered by the Committee.
3. PARTICIPANTS. The Committee shall, from time to time, select the
particular employees of the Company and its Subsidiaries to whom options are to
be granted, and who will, upon such grant, become participants in the Plan. For
purposes of the Plan, "employees" are those employees whose performance and
responsibilities are determined by the Committee to be influential to the
success of the Company; provided, however, that persons who are officers or
directors of the Company are not eligible to receive options under the Plan.
4. SHARES SUBJECT TO PLAN. The Committee may not grant options under the
Plan for more than 150,000 shares of Common Stock of the Company, but this
number shall be adjusted to reflect, if deemed appropriate by the Committee, any
stock dividend, stock split, share
<PAGE>
combination, recapitalization or the like, of or by the Company. Shares to be
optioned and sold may be made available from either authorized but unissued
Common Stock or Common Stock held by the Company in its treasury. Shares that by
reason of the expiration of an option or otherwise are no longer subject to
purchase pursuant to an option granted under the Plan may be re-offered under
the Plan.
5. ALLOTMENT OF SHARES. The Committee shall determine the number of
shares of Common Stock to be offered from time to time by grant of options to
employees of the Company or its Subsidiaries, provided that the grant of an
option to an employee shall not be deemed either to entitle the employee to, or
to disqualify the employee from, participation in any other grant of options
under the Plan.
6. GRANT OF OPTIONS. The grant of options shall be evidenced by stock
option agreements containing such terms and provisions as are approved by the
Committee but not inconsistent with the Plan. Stock option agreements may
provide that an option holder may request approval from the Committee to
exercise an option or a portion thereof by tendering shares of Common Stock of
the Company at the fair market value per share on the date of exercise in lieu
of cash payment of the exercise price. Moreover, stock option agreements may
provide that the option holder may request approval from the Committee to pay
any withholding associated with the option by tendering shares of Common Stock
of the Company at the fair market value per share on the date of exercise. The
Company shall execute stock option agreements upon instructions from the
Committee.
-2-
<PAGE>
7. OPTION PRICE. The option price shall not be less than 100% of the fair
market value per share of the Common Stock on the date the option is granted.
The Committee shall determine the fair market value of the Common Stock on the
date of grant and shall set forth the determination in its minutes, using any
reasonable valuation method.
8. OPTION PERIOD. The Option Period will begin on the date the option is
granted, which will be the date the Committee authorizes the option unless the
Committee specifies a later date. No option may terminate later than ten years
from the date the option is granted. The Committee may provide for the exercise
of options in installments and upon such terms, conditions and restrictions as
it may determine. The Committee may provide for termination of an option in the
case of termination of employment or any other reason.
9. RIGHTS IN EVENT OF DEATH OR DISABILITY. If a participant dies or
becomes disabled [within the meaning of Section 22(e)(3) of the Internal Revenue
Code] prior to termination of his right to exercise an option in accordance with
the provisions of his stock option agreement without having totally exercised
the option, the option agreement may provide that it may be exercised, to the
extent of the shares with respect to which the option could have been exercised
by the participant on the date of the participant's death or disability, (i) in
the case of death, by the participant's estate or by the person who acquired the
right to exercise the option by bequest or inheritance or by reason of the death
of the participant, or (ii) in the case of disability, by the participant or his
personal representative, provided the option is exercised prior to the date of
its expiration or 180 days from the date of the participant's death or
disability, whichever first occurs. The date of disability of a participant
shall be determined by the Committee.
-3-
<PAGE>
10. PAYMENT. Full payment for shares purchased upon exercising an option
shall be made in cash or by check or, if allowed by the stock option agreement
and approved by the Committee, by tendering shares of Common Stock at the fair
market value per share at the time of exercise. Likewise, any withholding
associated with a Nonqualified Option may, if allowed by the stock option
agreement and approved by the Committee, be paid by tendering shares of Common
Stock at the fair market value per share at the time of exercise. No shares may
be issued until full payment of the purchase price therefor has been made, and a
participant will have none of the rights of a shareholder until shares are
issued to him.
11. EXERCISE OF OPTION. Options granted under the Plan may be exercised
during the Option Period, at such times, in such amounts, in accordance with
such terms and subject to such restrictions as are set forth below. In no event
may an option be exercised or shares be issued pursuant to an option if any
requisite action, approval or consent of any governmental authority of any kind
having jurisdiction over the exercise of options shall not have been taken or
secured.
12. CAPITAL ADJUSTMENTS AND REORGANIZATIONS. The number of shares of
Common Stock covered by each outstanding option granted under the Plan and the
option price shall be adjusted to reflect, as deemed appropriate by the
Committee, any stock dividend, stock split, share combination, exchange of
shares, recapitalization, merger, consolidation, separation, reorganization,
liquidation or the like, of or by the Company.
13. NON-ASSIGNABILITY. Options may not be transferred other than by will
or by the laws of descent and distribution. During a participant's lifetime,
options granted to a participant may be exercised only by the participant or as
provided in section 9 hereof.
-4-
<PAGE>
14. INTERPRETATION. The Committee shall interpret the Plan and shall
prescribe such rules and regulations in connection with the operation of the
Plan as it determines to be advisable for the administration of the Plan. The
Committee may rescind and amend its rules and regulations.
15. AMENDMENT OR DISCONTINUANCE. The Plan may be amended or discontinued
by the Board without the approval of the shareholders of the Company.
16. EFFECT OF PLAN. Neither the adoption of the Plan nor any action of the
Board or the Committee shall be deemed to give any employee any right to be
granted an option to purchase Common Stock of the Company or any other rights
except as may be evidenced by the stock option agreement, or any amendment
thereto, duly authorized by the Committee and executed on behalf of the Company
and then only to the extent and on the terms and conditions expressly set forth
therein.
17. TERM. Unless sooner terminated by action of the Board, this Plan will
terminate on August 19, 2007. The Committee may not grant options under the
Plan after that date, but options granted before that date will continue to be
effective in accordance with their terms.
18. DEFINITIONS. For the purpose of this Plan, unless the context requires
otherwise, the following terms shall have the meanings indicated:
(a) "Board" means the Board of Directors of the Company.
(b) "Committee" means the committee of the Board appointed by the
Board to administer the Plan, or in the absence of such a
committee, shall mean the entire Board.
-5-
<PAGE>
(c) "Common Stock" means the Common Stock which the Company is
currently authorized to issue or may in the future be authorized
to issue (as long as the common stock varies from that currently
authorized, if at all, only in amount of par value).
(d) "Company" means Southwest Securities Group, Inc., a Delaware
corporation.
(e) "Incentive Option" means an option granted under the Plan which
meets the requirements of Section 422 of the Internal Revenue Code
of 1986, as amended.
(f) "Nonqualified Option" means an option granted under the Plan which
is not intended to be an Incentive Option.
(g) "Option Period" means the period during which an option may be
exercised.
(h) "Parent" means any corporation in an unbroken chain of
corporations ending with the Company if, at the time of granting
of the option, each of the corporations other than the Company
owns stock possessing 50% or more of the total combined voting
power of all classes of stock in one of the other corporations in
the chain.
(i) "Plan" means this Stock Option Plan, as amended from time to time.
-6-
<PAGE>
(j) "Subsidiary" means any corporation in an unbroken chain of
corporations beginning with the Company if, at the time of the
granting of the option, each of the corporations other than the
last corporation in the unbroken chain owns stock possessing 50%
or more of the total combined voting power of all classes of stock
in one of the other corporations in the chain, and "Subsidiaries"
means more than one of any such corporations.
-7-
<PAGE>
EXHIBIT 10.6
SOUTHWEST SECURITIES GROUP, INC.
STOCK PURCHASE PLAN
ARTICLE I
PURPOSE AND ESTABLISHMENT
-------------------------
1.01 Purpose. The Southwest Securities Group, Inc. Stock Purchase Plan
(the "Plan") is intended to provide a method whereby Eligible Participants will
have an opportunity to acquire a proprietary interest in the Company through the
purchase of shares of Common Stock of the Company.
1.02 Shares Reserved. There shall be reserved for issuance and purchase
by Participants under the Plan an aggregate of 1,000,000 shares of Common Stock
of the Company.
ARTICLE II
DEFINITIONS
-----------
The following words when used in this Plan have the respective meanings set
forth below unless the context clearly indicates otherwise:
2.01 Account means the account or record established and maintained by the
Committee reflecting the value of the cash and Company Stock, if any, of each
Participant attributable to his payroll deductions. Within each such Account,
the Committee shall establish and maintain a cash subaccount, representing a
Participant's payroll deductions awaiting investment in Company Stock and a
Company Stock subaccount, representing shares of Company Stock purchased on
behalf of the Participant by the Committee.
2.02 Affiliated Company means the Company and any subsidiary of the
Company, as defined in section 424(f) of the Code.
2.03 Committee shall mean the individuals described in Article V.
2.04 Company means Southwest Securities Group, Inc., a Delaware
corporation.
2.05 Company Stock means the common stock of the Company, $.10 par value.
2.06 Compensation means the total amount paid to a Participant by an
Employer as reported on Form W-2 or 1099 for each calendar year during the term
hereof.
2.07 Effective Date means January 1, 1998.
Stock Purchase Plan - Page 1
<PAGE>
2.08 Eligible Participant means any person classified by the Committee as
eligible to participate in the Plan; provided, however, that officers and
directors of the Company shall not participate in the Plan.
2.09 Employer means the Company and any other Affiliated Company, provided
such Affiliated Company is designated by the Board of Directors of the Company.
2.10 Participant means an Eligible Participant who has executed a
participation election form pursuant to Section 3.02 hereof and has commenced
participation in the Plan.
2.11 Plan means the stock purchase plan embodied herein, as the same may
be amended from time to time, and shall be known as the "Southwest Securities
Group, Inc. Stock Purchase Plan."
Gender and Number. Except as otherwise indicated by the context, any
masculine terminology used herein also includes the feminine and neuter, and
vice versa, and the definition of any term herein in the singular shall also
include the plural, and vice versa.
ARTICLE III
ELIGIBILITY AND PARTICIPATION
-----------------------------
3.01 Eligibility. Each Eligible Participant shall be eligible to
participate in the plan as of the Effective Date. Each other individual who
becomes an Eligible Participant after the Effective Date shall be eligible to
participate in the Plan as of the first January 1 or July 1 (if he is an
Eligible Participant on that date) that coincides with or next follows the date
such individual becomes an Eligible Participant.
3.02 Commencement of Participation. Subject to the provisions hereof, an
Eligible Participant may elect to become a Participant by executing and filing
with the Committee a participation election form, in such form and manner as the
Committee may prescribe, on which he elects to participate in the Plan,
authorizes his Employer to make payroll deductions and to transfer such payroll
deductions to the Committee on his behalf, and designates a payroll deduction
rate. Participation in the Plan shall commence on the effective date of the
form in accordance with Section 4.02 hereof, and shall continue in effect until
amended or terminated.
3.03 Waiver of Participation. Any Eligible Participant who chooses not to
participate in the Plan when he is first eligible to participate shall waive his
right to participate until either the first January 1 or July 1 of any
subsequent calendar year.
Stock Purchase Plan - Page 2
<PAGE>
ARTICLE IV
PAYROLL DEDUCTIONS
------------------
4.01 Amount of Deduction. At the time an Eligible Participant files his
authorization for payroll deduction, he shall elect to have deductions made from
his pay on each payday during the period he is a Participant at the rate of 5%,
10% or 15% of his Compensation.
4.02 Effective Date of Eligible Participant's Participation and Payroll
Deduction Election. The effective date of an Eligible Participant's
participation and payroll deduction election shall be no earlier than the first
day of the payroll period coinciding with or next following the Effective Date
or the first January 1 or July 1 following the date the Eligible Participant's
participation election form is received in executed form by his Employer and by
the Committee (provided such effective date is no earlier than the date the
Eligible Participant first becomes eligible to participate in the Plan).
4.03 Participant's Account. As soon as administratively practicable
following the date payroll deductions are made from a Participant's
Compensation, the Committee shall cause such amounts to be credited to the
Participant's Account under the Plan. A Participant may not make any separate
cash payment into his Account except when on leave of absence and then only as
provided in Section 4.05.
4.04 Changes in Payroll Deductions. Prior to any January 1 or July 1, a
Participant may at any time increase or decrease his payroll deduction by filing
a new payroll deduction election which shall become effective on the first day
of the payroll period coinciding with or next following the such January 1 or
July 1.
4.05 Leave of Absence. If a Participant is absent from work due to a
leave of absence, such Participant shall have the right to elect (i) to withdraw
the balance in his Account pursuant to Section 7.01 hereof, or (ii) to
discontinue contributions to the Plan but remain a Participant, or (iii) to
remain a Participant in the Plan during such leave of absence, authorizing
deductions to be made from payments, if any, by the Employer to the Participant
during such leave of absence and undertaking to make cash payments directly to
the Committee at the end of each payroll period to the extent that amounts
payable by the Employer to such Participant are insufficient to meet such
Participant's authorized payroll deductions.
4.06 Transfer to Ineligible Participant. A Participant's payroll
deduction election shall terminate automatically if the Participant is no longer
classified by the Committee as an Eligible Participant. During the period a
Participant is ineligible to participate in the Plan pursuant to this Section,
the Participant may withdraw those shares of Company Stock which have vested and
cash held in his Account, if any, and may elect to sell shares of Company Stock
held in his Account pursuant to Section 6.04 hereof. Upon return of the
Participant to eligible employment, the Participant shall be permitted to
execute a new participation election form and resume having payroll deductions
paid to the Committee on his behalf under Section 4.03 hereof, provided that
Stock Purchase Plan - Page 3
<PAGE>
the effective date of the new participation election form shall be no earlier
than the later of (i) January 1 or July 1 of a calendar year following the date
the participation form is received in executed form by the Employer and the
Committee or (ii) the date the individual is deemed an Eligible Participant. In
the event that a Participant ceases to be an employee of the Employer for any
reason before the Vesting Date (as hereafter defined), he will forfeit all
unvested shares. Prior to vesting, any dividends are also subject to forfeiture,
but the shares may be voted by the Participant.
4.07 Registration of Company Stock Distributed to Participant. Stock to be
delivered to a Participant under the Plan will be registered in the name of the
Participant, or, if the Participant so directs by written notice to the
Committee prior to distribution, in the names of the Participant and one such
other person as may be designated by the Participant, as joint tenants with
rights of survivorship or as tenants by the entireties, to the extent permitted
by applicable law.
ARTICLE V
ADMINISTRATION
--------------
5.01 Appointment of Committee. The Board of Directors of the Company may
appoint a Committee to administer the Plan, which shall consist of no fewer than
three members of the Board of Directors. No member of the Committee shall be
eligible to purchase stock under the Plan. If no Committee is appointed, the
Board of Directors shall perform the functions of the Committee.
5.02 Authority of the Committee. Subject to the provisions of the Plan,
the Committee shall have plenary authority in its discretion to interpret and
construe any and all of the provisions of the Plan, and to make all other
determinations deemed necessary or advisable for administering the Plan. The
Committee's determination on the foregoing matters shall be conclusive.
5.03 Administration of the Plan by the Committee. The Committee shall
prepare participation election forms and distribute such forms to Eligible
Participants. Upon receipt by the Committee of an Eligible Participant's
executed participation election form, the Committee shall establish an Account
for such Participant to hold the Participant's payroll deductions pending
investment in Company Stock as hereinafter provided. Pending the investment of
amounts held in Participants' Accounts in shares of Company Stock as hereinafter
provided, the Committee is not responsible for any short-term investment of such
amounts and Participants will not earn interest or other income on any funds
held in their Accounts pending investment.
5.04 Rules Governing Administration of the Committee. The Board of
Directors may from time to time appoint members of the Committee in substitution
for or in addition to members previously appointed and may fill vacancies,
however caused, in the Committee. The Committee may select one of its members
as its Chairman and shall hold its meetings at such
Stock Purchase Plan - Page 4
<PAGE>
times and places as it shall deem advisable and may hold telephonic meetings. A
majority of its members shall constitute a quorum. All determinations of the
Committee shall be made by a majority of its members. The Committee may correct
any defect or omission or reconcile any inconsistency in the Plan, in the manner
and to the extent it shall deem desirable. Any decision or determination reduced
to writing and signed by a majority of the members of the Committee shall be
fully effective as if it had been made by a majority vote at a meeting duly
called and held. The Committee may appoint a secretary and shall make such rules
and regulations for the conduct of its business as it shall deem advisable.
ARTICLE VI
PURCHASE OF SHARES
------------------
6.01 Purchase Price. As of the first business day following the end of
each six month calendar period, or as soon as administratively practicable
thereafter, the Committee shall use the funds accumulated in Participants'
Accounts to purchase from the Company the greatest number of shares of Company
Stock that can then be purchased with such funds at seventy-five percent (75%)
of the fair market value of such shares on that date. "Fair market value" shall
mean the six-month average trading price of the Company Stock, determined by
calculating the average month-end closing prices of the Company Stock for the
preceding six-month period.
6.02 Allocation of Shares. Shares of Company Stock acquired by the
Committee shall be allocated to the Account of each Participant in whole shares,
and any remaining cash shall be retained by the Committee to be used for future
purchases of Company Stock.
6.03 Reporting by the Committee to Participants. As soon as
administratively practicable following the end of each calendar year, the
Committee shall prepare and distribute to each Participant a statement
reflecting the cash and shares of Company Stock then held in the Participant's
Account.
6.04 Sales of Company Stock. The Company Stock issued to the Participants
under the Plan shall be non-transferrable and shall be held by the Committee in
the Participant's Account until it vests two years after the date of purchase
("Vesting Date"). Each Participant may direct the Committee to sell all or any
portion of the shares of Company Stock held in his Account at any time after the
Vesting Date. The Committee shall establish policies and procedures with
Participants to ensure timely sales of Company Stock pursuant to this Section
6.04. The Committee shall prepare and furnish to Participants tax information
returns required by any taxing authority relating to sales of Company Stock on
behalf of a Participant and shall be authorized to withhold amounts required to
be withheld for federal or state tax purposes in connection with such sales.
6.05 Payment of Expenses. The Company shall pay the expenses of
establishing and maintaining the Plan.
Stock Purchase Plan - Page 5
<PAGE>
ARTICLE VII
DISTRIBUTIONS
-------------
7.01 Termination of Employment. As soon as administratively practicable
following the Participant's termination of employment for any reason, including
retirement and death, the payroll deductions and the vested shares of Company
Stock credited to his Account will be distributed to him, or in the case of his
death, to the person or persons entitled thereto under Section 8.01.
ARTICLE VIII
MISCELLANEOUS
-------------
8.01 Death of Participant. Upon the death of a Participant, the Committee
shall deliver the vested Company Stock and/or cash then credited to the
Participant's Account to the executor or administrator of the estate of the
Participant, or if no such executor or administrator has been appointed (to the
knowledge of the Committee), the Committee shall hold the Participant's Account
pending instructions from a person authorized to direct the disposition of
Participants' Account under applicable law.
8.02 Amendment and Termination. The Board of Directors of the Company
shall have complete power and authority to terminate or amend the Plan. No
termination, modification, or amendment of the Plan may, without the consent of
a Participant, adversely affect the rights of such Participant to Company Stock
and cash then credited to his Account.
8.03 No Employment Rights. The Plan does not, directly or indirectly,
create any right for the benefit of any employee or class of employees to
purchase any shares under the Plan, or create in any employee or class of
employees any right with respect to continuation of employment by the Company or
any Affiliated Company, and it shall not be deemed to interfere in any way with
the Company's or an Affiliated Company's right to terminate, or otherwise
modify, an employee's employment at any time.
8.04 Effect of Plan. The provisions of the Plan shall, in accordance with
its terms, be binding upon, and inure to the benefit of, all successors of each
Participant, including, without 'imitation, such Participant's estate and the
executors, administrators or trustees thereof, heirs and legatees, and any
receiver, trustee in bankruptcy or representative of creditors of such
Participant.
8.05 Governing Law. The law of the State of Texas will govern all matters
relating to this Plan except to the extent it is superseded by the laws of the
United States.
Stock Purchase Plan - Page 6
<PAGE>
IN WITNESS WHEREOF, the Company has executed this Plan as of the 20/th/ day
of August, 1997, effective as set forth herein.
SOUTHWEST SECURITIES GROUP, INC.
By: /s/ KENNETH R. HANKS
---------------------------------------------
Stock Purchase Plan - Page 7
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Southwest Securities Group, Inc.:
We consent to incorporation by reference in the registration statement (No. 33-
86234) on Form S-8 of Southwest Securities Group, Inc. of our report dated July
31, 1998, relating to the consolidated statements of financial condition of
Southwest Securities Group, Inc. and subsidiaries as of June 26, 1998 and June
27, 1997, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the years in the three-year period ended June
26, 1998, and related schedule, which report appears in the June 26, 1998,
annual report on Form 10-K of Southwest Securities Group, Inc.
KPMG Peat Marwick LLP
Dallas, Texas
September 24, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-26-1998
<PERIOD-START> JUN-28-1997
<PERIOD-END> JUN-26-1998
<CASH> 13,706
<RECEIVABLES> 3,014,099
<SECURITIES-RESALE> 71,213
<SECURITIES-BORROWED> 2,229,587
<INSTRUMENTS-OWNED> 32,144
<PP&E> 10,445
<TOTAL-ASSETS> 3,220,106
<SHORT-TERM> 0
<PAYABLES> 3,014,544
<REPOS-SOLD> 0
<SECURITIES-LOANED> 2,227,874
<INSTRUMENTS-SOLD> 1,662
<LONG-TERM> 0
0
0
<COMMON> 1,069
<OTHER-SE> 124,398
<TOTAL-LIABILITY-AND-EQUITY> 3,220,106
<TRADING-REVENUE> 12,576
<INTEREST-DIVIDENDS> 143,121
<COMMISSIONS> 59,401
<INVESTMENT-BANKING-REVENUES> 27,850
<FEE-REVENUE> 26,607
<INTEREST-EXPENSE> 100,704
<COMPENSATION> 91,817
<INCOME-PRETAX> 31,898
<INCOME-PRE-EXTRAORDINARY> 31,898
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 20,630
<EPS-PRIMARY> 1.93
<EPS-DILUTED> 1.93
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<RESTATED>
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS YEAR
<FISCAL-YEAR-END> JUN-26-1998 JUN-26-1998 JUN-26-1998 JUN-27-1997
<PERIOD-START> JUN-28-1997 JUN-28-1997 JUN-28-1997 JUN-29-1996
<PERIOD-END> SEP-26-1997 DEC-31-1997 MAR-27-1998 JUN-27-1997
<CASH> 41,132 75,282 7,017 10,745
<RECEIVABLES> 2,861,965 2,987,001 2,599,580 2,852,765
<SECURITIES-RESALE> 78,458 73,106 129,036 232,123
<SECURITIES-BORROWED> 2,100,498 2,209,416 2,456,644 2,159,204
<INSTRUMENTS-OWNED> 35,201 34,136 44,414 31,921
<PP&E> 9,960 9,514 9,123 10,064
<TOTAL-ASSETS> 3,132,949 3,240,619 3,556,402 3,276,392
<SHORT-TERM> 4,000 0 0 4,000
<PAYABLES> 2,950,698 3,043,843 3,435,712 3,103,163
<REPOS-SOLD> 0 0 0 0
<SECURITIES-LOANED> 2,075,249 2,204,388 2,431,672 2,102,972
<INSTRUMENTS-SOLD> 4,243 2,632 2,830 5,343
<LONG-TERM> 0 0 0 0
0 0 0 0
0 0 0 0
<COMMON> 1,018 1,018 1,018 1,016
<OTHER-SE> 110,582 115,379 119,672 105,912
<TOTAL-LIABILITY-AND-EQUITY> 3,132,949 3,240,619 3,556,402 3,276,392
<TRADING-REVENUE> 3,138 6,312 8,625 11,856
<INTEREST-DIVIDENDS> 34,378 70,913 104,738 119,176
<COMMISSIONS> 13,887 29,254 44,045 38,882
<INVESTMENT-BANKING-REVENUES> 4,376 10,928 19,071 16,031
<FEE-REVENUE> 6,707 13,081 19,324 22,693
<INTEREST-EXPENSE> 24,308 49,987 73,599 83,238
<COMPENSATION> 20,326 42,029 64,878 65,062
<INCOME-PRETAX> 7,785 16,190 23,559 25,743
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