<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 27, 1998
Commission file number 0-19483
SOUTHWEST SECURITIES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2040825
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 ELM STREET, SUITE 3500, DALLAS, TEXAS 75270
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (214) 651-1800
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
As of May 7, 1998, there were 10,169,986 shares of the registrant's common
stock, $.10 par value, outstanding.
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<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition
March 27, 1998 and June 27, l997
Consolidated Statements of Income
For the three and nine months ended March 27, 1998 and March 27, 1997
Consolidated Statements of Cash Flows
For the nine months ended March 27, 1998 and March 27, 1997
Notes to Consolidated Financial Statements
March 27, 1998
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
PART II. OTHER INFORMATION
Item 1. Legal proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
March 27, 1998 and June 27, l997
(In thousands, except par values and share amounts)
<TABLE>
<CAPTION>
March June
(Unaudited)
----------- -----------
ASSETS
<S> <C> <C>
Cash $ 7,017 $ 10,745
Assets segregated for regulatory purposes 191,457 352,197
Receivable from brokers, dealers and clearing organizations 2,599,580 2,282,304
Receivable from clients, net 684,146 570,461
Securities owned, at market value 44,414 31,921
Other assets 29,788 28,764
----------- -----------
$ 3,556,402 $ 3,276,392
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 23,950 $ 4,000
Payable to brokers, dealers and clearing organizations 2,487,625 2,139,611
Payable to clients 842,315 963,552
Drafts payable 49,917 31,036
Other liabilities 31,905 29,865
----------- -----------
3,435,712 3,168,064
Liabilities subordinated to claims of general creditors --- 1,400
----------- -----------
3,435,712 3,169,464
Stockholders' equity:
Preferred stock of $1.00 par value. Authorized 100,000
shares; none issued. --- ---
Common stock of $.10 par value. Authorized 20,000,000 shares.
Issued 10,179,163 and outstanding 10,169,986 at
March 27, 1998. Issued 10,161,599 and
outstanding 10,152,422 shares at June 27, 1997. 1,018 1,016
Additional paid-in capital 56,675 56,139
Retained earnings 63,139 49,984
Receivable from employees under the Employee Stock Purchase Plan (68) (137)
Treasury stock (9,177 shares, at cost) (74) (74)
----------- -----------
Total stockholders' equity 120,690 106,928
Commitments and contingencies
----------- -----------
$ 3,556,402 $ 3,276,392
=========== ===========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the three and nine months ended March 27, 1998 and March 27, 1997
(In thousands, except per share and share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
================================================================
1998 1997 1998 1997
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from clearing operations $ 6,243 $ 5,986 $ 19,324 $ 16,404
Commissions 14,791 10,469 44,045 28,269
Interest 33,825 30,248 104,738 83,968
Investment banking, advisory and administrative fees 8,143 4,654 19,071 11,254
Net gains on principal transactions 2,313 2,339 8,625 8,639
Other 3,526 2,546 8,799 7,131
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68,841 56,242 204,602 155,665
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Commissions and other employee compensation 22,849 17,470 64,878 47,321
Interest 23,612 21,105 73,599 58,283
Occupancy, equipment and computer service costs 4,586 3,038 12,581 8,778
Communications 2,943 2,635 9,076 7,751
Floor brokerage and clearing organization charges 1,263 1,043 3,724 3,014
Other 6,219 4,575 17,185 12,181
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61,472 49,866 181,043 137,328
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Income before income taxes 7,369 6,376 23,559 18,337
Income taxes 2,506 2,130 8,261 6,304
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Net income $ 4,863 $ 4,246 $ 15,298 $ 12,033
================================================================
Earnings per share - basic $ .48 $ .44 $ 1.50 $ 1.25
================================================================
Weighted average shares outstanding - basic 10,169,986 9,661,993 10,165,670 9,661,993
================================================================
Earnings per share - diluted $ .48 $ .44 $ 1.50 $ 1.24
================================================================
Weighted average shares outstanding - diluted 10,191,968 9,672,013 10,186,053 9,669,873
================================================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the nine months ended March 27, 1998 and March 27, 1997
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
========= =========
<S> <C> <C>
Cash flows from operating activities:
Net income $ 15,298 $ 12,033
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 2,505 2,114
Provision for doubtful accounts 975 4
Deferred income taxes (426) (1,005)
Decrease (increase) in assets segregated for regulatory purposes 160,740 (106,499)
Net change in broker, dealer and clearing organization accounts 30,738 24,717
Net change in client accounts (235,897) 120,044
Decrease (increase) in securities owned (12,493) 11,592
Decrease (increase) in other assets (1,660) 2,146
Increase in drafts payable 18,881 3,150
Increase in other liabilities 2,034 10,916
--------- ---------
Net cash provided by operating activities (19,305) 79,212
--------- ---------
Cash flows from investing activities:
Purchase of furniture, equipment and leasehold improvements (1,437) (6,786)
Proceeds from sale of fixed assets --- 96
--------- ---------
Net cash used in investing activities (1,437) (6,690)
--------- ---------
Cash flows from financing activities:
Net change in short term borrowings 19,950 (62,854)
Payments on liabilities subordinated to claims of general creditors (1,400) ---
Proceeds from employees for Employee Stock Purchase Plan 69 123
Net proceeds from exercise of stock options 225 ---
Payment of cash dividend on common stock (1,830) (1,668)
--------- ---------
Net cash used in financing activities 17,014 (64,399)
--------- ---------
Net increase in cash (3,728) 8,123
Cash at beginning of period 10,745 5,284
--------- ---------
Cash at end of period $ 7,017 $ 13,407
========= =========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
GENERAL AND BASIS OF PRESENTATION
The accompanying interim consolidated financial statements include the accounts
of Southwest Securities Group, Inc. ("Parent") and its wholly owned
subsidiaries, (collectively, the "Company"), Southwest Securities, Inc.
("Southwest"), Brokers Transaction Services, Inc. ("BTS"), Southwest Investment
Advisors, Inc. ("Advisors"), Westwood Trust ("Trust"), formerly Trust Company of
Texas, Westwood Management Corporation ("Westwood"), SW Capital Corporation
("Capital"), SWST Computer Corporation ("Computer Corp.") Sovereign Securities,
Inc. ("Sovereign") and NorAm Investment Services, Inc. ("NorAm"), formerly
Equity Securities Trading Company. Southwest, BTS, Sovereign and NorAm are
registered broker/dealers under the Securities Exchange Act of 1934 ("1934
Act"). Advisors and Westwood are registered investment advisors under the
Investment Advisors Act of 1940. All significant intercompany balances and
transactions have been eliminated.
The consolidated financial statements as of March 27, 1998 and March 27, 1997,
and for the three and nine month periods ended March 27, 1998 and March 27,
1997, are unaudited; however, in the opinion of management, these interim
statements include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the financial position,
results of operations and cash flows. These financial statements should be read
in conjunction with the consolidated financial statements and related notes in
the Company's annual audited report as of June 27, 1997. Amounts included for
June 27, 1997 are from the audited financial statements as filed on Form 10-K.
CASH FLOW REPORTING
Cash paid for interest was $72,820,000 and $56,595,000 for the nine months ended
March 27, 1998 and March 27, 1997, respectively. Cash paid for income taxes was
$7,175,000 and $5,155,000 in fiscal 1998 and 1997, respectively.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL (REVERSE REPURCHASE AGREEMENTS)
Southwest, from time to time, enters into reverse repurchase agreements
(collateralized by U.S. Government or U.S. Government agency securities), for
the purpose of segregating assets for the exclusive benefit of its customers.
Under a master repurchase agreement ("Agreement") with Trust, securities
purchased under the reverse repurchase agreement are identified and segregated
by Trust on its books and records as subject to the Agreement. Management
regularly monitors the market value of the underlying securities relating to
outstanding reverse repurchase agreements.
ASSETS SEGREGATED FOR REGULATORY PURPOSES
At March 27, 1998, the Company had a certificate of deposit of $860,000, reverse
repurchase agreements of $129,344,000, and U.S. Treasury securities with a
market value of $61,253,000 segregated in a special reserve bank account for the
exclusive benefit of customers under Rule 15c3-3 of the 1934 Act, at Trust
Company. The reverse repurchase agreements were collateralized by U.S.
Government securities with a market value of approximately $130,527,000. At
June 27, 1997, the Company had reverse repurchase agreements of $232,123,000,
U.S. Treasury securities with a market value of $119,984,000 and cash of $90,000
in this account. The reverse repurchase agreements were collateralized by U.S.
Government securities with a market value of approximately $234,372,000 at June
27, 1997.
<PAGE>
RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
At March 28, 1998 and June 27, l997, the Company had receivables from and
payables to brokers, dealers and clearing organizations relating to the
following (in thousands):
MARCH JUNE
---------- ----------
Receivables:
Securities failed to deliver $ 21,054 $ 15,213
Securities borrowed 2,456,644 2,159,204
Correspondent broker/dealers 69,489 62,235
Clearing organizations 1,740 7,355
Other 50,653 38,297
---------- ----------
$2,599,580 $2,282,304
========== ==========
MARCH JUNE
---------- ----------
Payables:
Securities failed to receive $ 35,541 $ 17,889
Securities loaned 2,431,672 2,102,972
Correspondent broker/dealers 11,011 9,013
Other 9,401 9,737
---------- ----------
$2,487,625 $2,139,611
========== ==========
SHORT-TERM BORROWINGS
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $197,000,000. These lines of credit are used primarily to
finance securities owned, securities held for correspondent broker/dealer
accounts, and receivables in clients' margin accounts. These lines may also be
used to release pledged collateral against day loans. These credit arrangements
are provided on an "as offered" basis and are not committed lines of credit.
These arrangements can be terminated at any time by the lender. Any outstanding
balance under these credit arrangements is due on demand and bears interest at
rates indexed to the federal funds rate. The amount outstanding under these
facilities at March 27, 1998 was $23,950,000 and was collateralized by
marketable securities owned valued at approximately $30,374,000, securities held
for correspondent broker/dealer accounts valued at approximately $78,521,000,
and clients' securities valued at approximately $106,797,000. There were no
amounts outstanding at June 27, 1997 on these credit arrangements.
In addition to the broker loans lines, the Parent has a $10,000,000 unsecured
line of credit which is due on demand and bears interest at rates indexed to the
federal funds rate. There was no amount outstanding under this secured line of
credit at March 27, 1998. The amount outstanding was $4,000,000 at June 27,
1997.
At March 27, 1998 and at June 27, 1997, the Company had no repurchase agreements
outstanding.
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 March 27, 1998, Southwest had net capital of
$73,199,000 or approximately 10% of aggregate debit balances, which is
$56,982,000 in excess of its minimum net capital requirement of $16,217,000 at
that date. Additionally, the net capital rule of the New York Stock Exchange,
Inc. (the "Exchange") provides that equity capital may not be withdrawn or cash
dividends paid if resulting net capital would be less than 5% of aggregate debit
items. At March 27, 1998, Southwest had net capital of $32,656,000 in excess of
5% of aggregate debit items.
NorAm has also elected to use the alternative method, permitted by the Rule. At
March 27, 1998, NorAm had net capital of $565,000, which is $315,000 in excess
of its minimum net capital requirement of $250,000 at that date. Additionally,
at March 27, 1998, NorAm had net capital of $445,000 in excess of $120,000.
<PAGE>
BTS follows the primary (aggregate indebtedness) method under Rule 15c3-1, which
requires it to maintain minimum net capital of $100,000. BTS had net capital of
$309,000 which is $209,000 in excess of its minimum net capital requirement at
March 27, 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 March
27, 1998, Sovereign had net capital of $603,000 which is $353,000 in excess of
its minimum net capital requirement.
Trust is subject to the capital requirements of the Texas Department of Banking,
and has a minimum capital requirement of $1,000,000. Trust Company had total
stockholder's equity of $2,568,000, which is $1,568,000 in excess of its minimum
capital requirement at March 27, 1998.
LIABILITIES SUBORDINATED TO CLAIMS OF GENERAL CREDITORS
There were no subordinated notes outstanding at March 27, 1998. At June 27,
1997, liabilities subordinated to the claims of general creditors represent
loans to Equity Securities Trading Company. 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 is collateralized by securities with a
market value of approximately $9,457,000 at June 27, 1997.
EMPLOYEE BENEFITS
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 (5.45%
at March 27, 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 March 27, 1998 was $68,000.
On November 6, 1996, the shareholders of the Company approved the Stock Option
Plan ("Option Plan") adopted by the Board of Directors on September 17, 1996,
pursuant to which options may be granted to eligible employees of the Company or
its subsidiaries for the purchase of an aggregate of 1,000,000 shares of common
stock of the Company. Options to purchase 195,300 shares of common stock were
outstanding under the Option Plan at March 27, 1998. The options, which vest in
25% increments, expire ten years after date of grant.
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 March 27, 1998, 356 units have
been issued under the Phantom Plan.
On August 20, 1997, the Board of Directors approved the 1997 Stock Option Plan
("1997 Option Plan"), pursuant to which non-qualified options may be granted to
eligible employees or potential employees of the Company or its subsidiaries for
the purchase of an aggregate of 150,000 shares of Common Stock of the Company.
Officers and directors are not eligible to receive options under the 1997 Option
Plan. 11,007 options have been granted under the 1997 Option Plan as of March
27, 1998.
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.
<PAGE>
AUTHORIZED COMMON STOCK
On November 6, 1996, the shareholders of the Company approved the authorization
of an additional 10,000,000 shares of common stock. This brings the total
common shares authorized to 20,000,000.
STOCK DIVIDEND
On August 28, 1997, the Board of Directors declared a ten percent stock dividend
payable on October 1, 1997 to shareholders of record at the close of business on
September 15, 1997. Per share amounts, shares outstanding, and weighted average
shares outstanding as of March 27, 1997 have been restated in the accompanying
financial statements, as have issued and outstanding shares as of June 27, 1997.
EARNINGS PER SHARE
Earnings Per Share ("EPS") has been calculated in conformity with Statement of
Financial Accounting Standards No. 128 "Earnings Per Share" and all prior
periods have been restated. 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>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 27, MARCH 27, MARCH 27, MARCH 27,
1998 1997 1998 1997
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 4,863 $ 4,246 $ 15,298 $ 12,033
=======================================================================
Weighted average shares outstanding - basic 10,169,986 9,661,993 10,165,670 9,661,993
Effect of dilutive securities:
Assumed exercise of stock options 21,982 10,020 20,383 7,880
-----------------------------------------------------------------------
Weighted average shares outstanding - diluted 10,191,968 9,672,013 10,186,053 9,669,873
=======================================================================
Earnings per share - basic $ .48 $ .44 $ 1.50 $ 1.25
=======================================================================
Earnings per share - diluted $ .48 $ .44 $ 1.50 $ 1.24
=======================================================================
</TABLE>
Options to purchase 190,300 shares of common stock at $23.625, granted on August
28, 1997, were outstanding in the first quarter of fiscal 1998, but were not
included in the computation of nine months diluted EPS because the options'
exercise price was greater than the average market price of the common share in
the first quarter of fiscal 1998. 187,300 of these options were still
outstanding at March 27, 1998.
Options to purchase 8,000 shares of common stock at $23.50, granted on November
5, 1997, were not included in the computation of diluted EPS for the nine months
ended March 27, 1998. These options were not included because the options'
exercise price was greater than the average market price of the common share in
the second quarter of fiscal 1998. All of these options were still outstanding
at March 27, 1998.
Options to purchase 5,000 shares of common stock at $26.875, granted on March 2,
1998, were not included in the computation of diluted EPS for either the three
months ended or the nine months ended March 27, 1998. These options were not
included because the options' exercise price was greater than the average market
price of the common share in the third quarter of fiscal 1998. All of these
options were still outstanding at March 27, 1998.
SUBSEQUENT EVENT
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. No damages were awarded; however, the judge awarded the
counter-party $1.7 million 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.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The statements under Management's Discussion and Analysis of Financial Condition
and Results of Operations and other statements in this Form 10-Q which are not
historical facts are forward-looking statements. These forward-looking
statements involve risks and uncertainties that could render them materially
different from estimates provided herein. These risks and uncertainties include
but are not limited to the effect of economic conditions, the availability of
technical resources, the ability to develop and implement new software, the
effect of regulatory and legal developments and other risks detailed in the
Company's Securities and Exchange Commission filings.
GENERAL
Southwest Securities Group, Inc. and subsidiaries (the "Company"), through its
principal subsidiary, Southwest Securities, Inc. ("Southwest"), provides
securities transaction processing and other related services and operates a
full-service brokerage, investment banking and asset management firm. Its
primary business is delivering a broad range of securities transaction
processing services to broker/dealers. Transaction processing services include
cost-effective integrated trade execution, clearing, client account processing
and other customized services ("Transaction Processing"). Southwest provides
services that are directly related to Transaction Processing, including margin
lending and stock loan services. The Company also provides securities brokerage
and investment services to individuals and institutions, provides investment
banking services to municipal and corporate clients and trades fixed income and
equity securities.
Brokers Transaction Services, Inc. ("BTS"), a wholly owned subsidiary of the
Company, and a National Association of Securities Dealers ("NASD") registered
broker/dealer, contracts with independent registered representatives for the
administration of their securities business. Sovereign Securities, Inc.
("Sovereign") is a discount brokerage firm and NASD broker/dealer. Based in
Minneapolis, NorAm Investment Services, Inc. ("NorAm"), formerly Equity
Securities Trading Company, Inc., is an NASD broker/dealer which operates a
regional securities clearing business.
SW Capital Corporation, a wholly owned subsidiary of the Company, houses the
Local Government Investment Cooperative ("LOGIC") program. The LOGIC program is
targeted to the needs of cities, counties, schools and other local governments
across Texas. This program allows participants to pool their available funds,
resulting in increased economies of scale, and allows higher returns while
maintaining a high degree of safety and liquidity.
In addition, the Company offers asset management and trust services through its
wholly owned subsidiaries, Westwood Management Corporation ("Westwood") and
Westwood Trust ("Trust"), formerly The Trust Company of Texas. Southwest
Investment Advisors, Inc. ("Advisors"), a wholly owned subsidiary of the Company
is a registered investment advisor. Advisors has been inactive since April 11,
1994. SWST Computer Corporation ("Computer Corp.") provides computer processing
and programming to affiliates as well as third parties.
The Company owns a minority interest in Roundtable Partners, LLC ("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. The Company will not sell any
shares in the initial public offering. Should the proposed transaction occur,
previously undistributed earnings of Roundtable are proposed to be distributed.
There can be no assurance that the proposed transaction will occur, and if the
transaction does occur, no assurance that it will be successful at the price and
number of shares specified in the Knight registration statement.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 27, 1998 COMPARED WITH THE
THREE MONTHS ENDED MARCH 27, 1997
Total revenues increased by $12,599,000, or 22%, in the third quarter of fiscal
1998 to $68,841,000 compared to $56,242,000 in the third quarter of fiscal 1997.
Net income increased 15% to $4,863,000 from $4,246,000 in the third quarter of
the prior year.
Substantially all of the revenues from Transaction Processing are shown on the
Company's Consolidated Statements of Income as net revenues from clearing
operations. An increase in the number of correspondents resulted in increased
revenues from Transaction Processing of $257,000, an increase of 4%. The number
of correspondents increased to 244 at March 27, 1998 from 228 at March 27, 1997.
Total transactions processed in the third quarter of fiscal 1998 increased 84%
to approximately 1,654,000 from approximately 898,000 in the third quarter of
fiscal 1997 compared to the revenue increase of 4%. This was due to an increase
in tickets from several high volume correspondents who earn substantial
discounts.
<PAGE>
Commissions from Southwest's client transactions increased $4,322,000 to
$14,791,000, an increase of 41% when compared with revenues in the third quarter
of fiscal 1997 of $10,469,000. This was due to increased commissions from
investment banking transactions managed by the Company, as well as an increase
in the number of brokers in the Company's independent contractor network.
Interest income increased to $33,825,000, an increase of $3,577,000, or 12%,
while interest expense increased 12%, or $2,507,000 to $23,612,000. This
resulted in an increase in net interest revenue of $1,070,000, or 12%, due to
increased balances in securities lending and customer margin accounts. The
amounts receivable and payable relating to open positions for securities
borrowed and loaned as of March 27, 1998, were $2,456,644,000 and
$2,431,672,000, respectively. As of March 27, 1997, these amounts were
$2,077,052,000 and $2,052,793,000.
Investment banking, advisory and administrative fees include revenues derived
from the underwriting and distribution of corporate and municipal securities,
unit trusts and money market and other mutual funds. Investment banking,
advisory and administrative fees increased $3,489,000, or 75%, to $8,143,000
when compared to $4,654,000 in the third quarter of fiscal 1997 due to increased
volume of transactions in both equity and municipal investment banking markets.
Total expenses increased $11,606,000, or 23%, to $61,472,000 when compared to
the quarter ended March 27, 1997 primarily as the result of increased interest
expense, as discussed above, and increased commission and employee compensation
expense.
Commissions and other employee compensation increased $5,379,000, or 31%,
compared to the same period last year, as a result of increased commissions
generated by the Company's independent contractor network, as well as an
increase in the number of employees to 759 at March 27, 1998 compared to 683 at
March 27, 1997. The number of independent contractors was 683 and 583 at March
27, 1998 and March 27, 1997, respectively.
Occupancy, equipment and computer service expenses increased $1,548,000, or 51%,
primarily due to upgrades in computer processing equipment and an increase in
office space. Other expenses increased $1,644,000, or 36%, to $6,219,000,
primarily due to increases in expenses associated with underwriting fixed income
securities, professional services and other expenses.
RESULTS OF OPERATIONS - NINE MONTHS ENDED MARCH 27, 1998 COMPARED WITH THE NINE
MONTHS ENDED MARCH 27, 1997
(The factors impacting substantially all of the variances in the above
three-month comparison also apply to the nine-month comparison. Therefore, this
section is limited to the discussion of additional factors influencing the
nine-month discussion.)
As discussed above, improved market conditions as well as an increase in the
number of correspondents resulted in increased revenues from Transaction
Processing. Net revenues from clearing operations increased to $19,324,000 an
increase of $2,920,000, or 18%, from a year ago. Total ticket transactions
increased 102% to approximately 4,514,000 over the same nine-month period in the
prior year. This was due to an increase in tickets from several high volume
correspondents who earn substantial discounts.
Communications expense increased $1,325,000, or 17%, to $9,076,000 from
$7,751,000 when compared to the period ended March 27, 1997 due to expanded
computer networking.
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 the first nine months of fiscal 1998, the net cash on
deposit from clients decreased $161 million as customers' cash on deposit was
invested in money market funds and other securities. The decrease in the net
payable to clients caused a corresponding decrease in the assets segregated for
regulatory purposes.
LIQUIDITY AND CAPITAL RESOURCES
Approximately 99% of the Company's assets consist of cash, marketable securities
and receivables from clients, clients of Correspondents and Correspondents
themselves (representing borrowings from Southwest to finance the purchase of
securities on margin, which are secured by marketable securities);
broker/dealers; and clearing
<PAGE>
organizations. All 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. Southwest 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.
Southwest has credit arrangements with commercial banks, which include broker
loan lines up to $197,000,000. 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 Southwest and its clients. The amount
outstanding under these facilities at March 27, 1998 was $23,950,000. In
addition to the broker loan lines, the Company has a $10,000,000 unsecured line
of credit, which is due on demand and bears interest at rates indexed to the
federal funds rate. There was no amount outstanding under this secured line of
credit at March 27, 1998. In the opinion of management, these credit
arrangements are adequate to meet the short-term operating capital needs of
Southwest.
Southwest is subject to the requirements of the Securities and Exchange
Commission and the New York Stock Exchange 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 RECENTLY ISSUED ACCOUNTING STANDARDS
On July 1, 1996, the Company adopted Statement of Financial Accounting Standards
No. 123 "Accounting for Stock-Based Compensation" ("FAS 123"). FAS 123 will not
have a material impact on the Company's financial position or results of
operations, as the Company does not intend to adopt the value based measurement
concept, but will require extensive disclosures regarding the Company's stock
option plan at fiscal year end.
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.
EFFECTS OF INFLATION
Management does not believe that changes in replacement costs of fixed assets
will materially affect the Company's operations. The rate of inflation,
however, affects the Company's expenses, such as employee compensation, rent and
communications. Increases in these expenses may not be readily recoverable in
the price the Company charges for its services. Inflation can have significant
effects on interest rates that in turn can affect prices and activities in the
securities markets. These fluctuations may have an adverse impact on the
Company's operations.
YEAR 2000
The widespread use of computer programs that rely on two-digit date programs to
perform computations and decision-making functions may cause computer systems to
malfunction in the Year 2000, and may lead to significant business delays in the
U.S. and internationally.
The impact of the Year 2000 problem on the securities industry as a whole will
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 in the Year 2000 depending
on whether it and the entities with which it does business address this issue
successfully.
The Company has identified areas in which such computer programs affect our
operations, the most significant of which is the Company's securities processing
software. The Company participates with other broker/dealers in a joint venture,
Comprehensive Software Systems, Ltd. ("CSS"), which is developing the next
generation of software for the securities industry. The CSS system will
automate front- and back-office processes and will be Year 2000 compliant. The
system is expected to begin testing January 1, 1999 and to be fully operational
by January 1, 2000. The ultimate cost of developing and implementing CSS is
inestimable at this time; however management does not believe these costs will
have a material impact on the Company's operations in fiscal 1998.
<PAGE>
PART II. OTHER INFORMATION
Item 1. 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. No damages were awarded; however, the judge awarded the counter-
party $1.7 million 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.
(229.103)
Item 2. Changes in Securities
None Reportable (Per Instructions to Form 10-Q)
Item 3. Defaults upon Senior Securities
None Reportable (Per Instructions to Form 10-Q)
Item 4. Submission of Matters to a Vote of Security Holders
None Reportable (Per Instructions to Form 10-Q)
Item 5. Other Information
None Reportable (Per Instructions to Form 10-Q)
Item 6. Exhibits and Reports on Form 8-K
EXHIBITS
10.1 Executive Compensation
The information required by this item regarding Executive compensation is
incorporated by reference to pages 7 through 9 of the Company's Proxy Statement
dated September 25, 1997 which was filed with the Commission pursuant to
Regulation 240.14a (6) (c) prior to October 25, 1997.
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
REPORTS ON FORM 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Southwest Securities Group, Inc.
--------------------------------
(Registrant)
May 7, 1998 /s/ David Glatstein
- ----------- --------------------------------
Date (Signature)
David Glatstein
President
May 7, 1998 /s/ Kenneth R. Hanks
- ----------- --------------------------------
Date (Signature)
Kenneth R. Hanks
Chief Financial Officer
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