<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 26, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 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) 859-1800
(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 3, 1999, there were 10,713,820 shares of the registrant's common
stock, $.10 par value, outstanding.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition
March 26, 1999 and June 26, 1998
Consolidated Statements of Income and Comprehensive Income
For the three and nine months ended March 26, 1999 and March 27, 1998
Consolidated Statements of Cash Flows
For the nine months ended March 26, 1999 and March 27, 1998
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
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 26, 1999 and June 26, l998
(In thousands, except par values and share amounts)
<TABLE>
<CAPTION>
March June
(Unaudited)
------------------- ----------------
Assets
<S> <C> <C>
Cash $ 10,451 $ 13,706
Assets segregated for regulatory purposes 278,152 130,728
Marketable equity securities, at market value 95,257 -
Receivable from brokers, dealers and clearing organizations 2,515,199 2,365,635
Receivable from clients, net 689,861 648,464
Securities owned, at market value 69,151 32,144
Other assets 35,148 29,429
------------------- -----------------
$ 3,693,219 $ 3,220,106
=================== =================
Liabilities and Stockholders' Equity
Short-term borrowings $ 55,500 $ -
Payable to brokers, dealers and clearing organizations 2,421,619 2,293,731
Payable to clients 866,533 720,813
Securities sold not yet purchased, at market value 28,185 1,662
Drafts payable 45,600 41,688
Other liabilities 72,023 36,745
------------------- -----------------
3,489,460 3,094,639
Minority interest in consolidated subsidiary 100 -
Stockholders' equity:
Preferred stock of $1.00 par value. Authorized 100,000
shares; none issued - -
Common stock of $.10 par value. Authorized 20,000,000 shares;
10,701,177 issued and outstanding at March 26, 1999;
10,687,583 issued and 10,678,406 shares outstanding at
June 26, 1998 1,070 1,069
Additional paid-in capital 69,874 69,462
Accumulated other comprehensive income -
unrealized holding gain, net of tax 61,636 -
Retained earnings 71,090 55,022
Receivable from employees under the Employee Stock Purchase Plan (11) (12)
Treasury stock (9,177 shares, at cost, at June 26, 1998) (74)
------------------- -----------------
Total stockholders' equity 203,659 125,467
Commitments and contingencies
------------------- -----------------
$ 3,693,219 $ 3,220,106
=================== =================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the three and nine months ended March 26, 1999 and March 27, 1998
(In thousands, except per share and share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
1999 1998 1999 1998
----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from clearing operations $ 10,521 $ 6,243 $ 28,030 $ 19,324
Commissions 16,428 14,791 46,946 44,045
Interest 34,623 33,825 106,286 104,738
Investment banking, advisory and administrative fees 6,372 8,143 21,193 19,071
Net gains on principal transactions 18,580 2,313 29,508 8,625
Other 3,518 3,526 10,572 8,799
-------------------------------------------------------------------
90,042 68,841 242,535 204,602
-------------------------------------------------------------------
Commissions and other employee compensation 36,182 22,849 90,268 64,878
Interest 23,596 23,612 71,736 73,599
Occupancy, equipment and computer service costs 5,605 4,586 15,149 12,581
Communications 3,405 2,943 9,768 9,076
Floor brokerage and clearing organization charges 1,572 1,263 4,391 3,724
Other 7,976 6,219 22,810 17,185
-------------------------------------------------------------------
78,336 61,472 214,122 181,043
-------------------------------------------------------------------
Income before income taxes 11,706 7,369 28,413 23,559
Income taxes 4,173 2,506 10,055 8,261
-------------------------------------------------------------------
Net income 7,533 4,863 18,358 15,298
Other comprehensive income - unrealized holding
gains arising during period, net of tax 35,858 - 61,636 -
-------------------------------------------------------------------
Comprehensive income $ 43,391 $ 4,863 $ 79,994 $ 15,298
===================================================================
Earnings per share - basic $ .70 $ .46 $ 1.72 $ 1.43
===================================================================
Earnings per share - diluted $ .70 $ .45 $ 1.71 $ 1.43
===================================================================
Weighted average shares outstanding - basic 10,696,211 10,678,485 10,683,949 10,673,954
===================================================================
Weighted average shares outstanding - diluted 10,775,321 10,701,566 10,725,042 10,695,356
===================================================================
</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 26, 1999 and March 27, 1998
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
1999 1998
-------------------- --------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 18,358 $ 15,298
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 2,316 2,505
Provision for doubtful accounts 355 975
Deferred income taxes (1,242) (426)
Deferred compensation expense 31 -
Decrease (increase) in assets segregated for regulatory purposes (147,424) 160,740
Net change in broker, dealer and clearing organization accounts (21,676) 30,738
Net change in client accounts 103,968 (235,897)
Increase in securities owned (37,007) (12,493)
Increase in other assets (10,665) (1,660)
Increase (decrease) in securities sold not yet purchased 26,523 (2,472)
Increase in drafts payable 3,912 18,881
Increase in other liabilities 7,746 4,506
-------------------- --------------------
Net cash used in operating activities (54,805) (19,305)
-------------------- --------------------
Cash flows from investing activities:
Purchase of furniture, equipment and leasehold improvements (2,044) (1,437)
-------------------- --------------------
Net cash used in investing activities (2,044) (1,437)
-------------------- --------------------
Cash flows from financing activities:
Proceeds from short term borrowings 55,500 19,950
Payment on liabilities subordinated to the claims of general creditors - (1,400)
Net change in receivable from employees for Employee
Stock Purchase Plan 1 69
Net proceeds from exercise of stock options 100 225
Payment of cash dividend on common stock (2,107) (1,830)
Proceeds from issuance of stock of consolidated subsidiary 100 -
-------------------- --------------------
Net cash provided by financing activities 53,594 17,014
-------------------- --------------------
Net decrease in cash (3,255) (3,728)
Cash at beginning of period 13,706 10,745
-------------------- --------------------
Cash at end of period $ 10,451 $ 7,017
==================== ====================
</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 interim consolidated financial statements include the accounts of Southwest
Securities Group, Inc. ("Parent") and its consolidated subsidiaries listed below
(collectively, the "Company"):
<TABLE>
<S> <C>
Southwest Securities, Inc. "Southwest"
SWS Financial Services, Inc. "SWSFS"
(formerly Brokers Transaction Services, Inc.)
Southwest Investment Advisors, Inc. "Advisors"
Westwood Trust "Trust"
Westwood Management Corporation "Westwood"
SW Capital Corporation "Capital"
SWS Technologies Corporation "Technologies"
Mydiscountbroker.com, Inc. "MDB"
(formerly Sovereign Securities, Inc.)
NorAm Investment Services, Inc. "NorAm"
Southwest Clearing Corporation "Clearing"
</TABLE>
Southwest, SWSFS, MDB 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.
Although not yet active, Clearing was incorporated in the State of Delaware on
September 30, 1998 and is a fully consolidated subsidiary. All significant
intercompany balances and transactions have been eliminated.
The consolidated financial statements as of March 26, 1999, and for the three
and nine month periods ended March 26, 1999 and March 27, 1998, are unaudited;
however, in the opinion of management, these interim statements include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial position, results of operations and cash
flows. These financial statements should be read in conjunction with the audited
consolidated financial statements and related notes as of and for the year ended
June 26, 1998 filed on Form 10-K. Amounts included for June 26, 1998 are from
the audited consolidated financial statements as filed on Form 10-K.
CASH FLOW REPORTING
Cash paid for interest was $72,285,000 and $72,820,000 for the nine month
periods ended March 26, 1999 and March 27, 1998, respectively. Cash paid for
income taxes was $7,425,000 and $7,175,000 in 1999 and 1998, respectively.
In a non-cash transaction, the Parent received approximately 1.7 million common
shares of Knight/Trimark Group, Inc. ("Knight") subsequent to Knight's initial
public offering completed July 10, 1998.
In conjunction with the Company's Stock Purchase Plan, 9,177 treasury shares
were reissued and 6,380 new shares were issued in January 1999. Deferred
compensation expense totaling $248,000 was recorded and will be amortized over a
period of two years.
<PAGE>
ASSETS SEGREGATED FOR REGULATORY PURPOSES
At March 26, 1999, the Company had reverse repurchase agreements of $262,863,000
and U.S. Treasury securities with a market value of $15,289,000 segregated in a
special reserve bank account for the exclusive benefit of customers under Rule
15c3-3 of the 1934 Act. The reverse repurchase agreements were collateralized
by U.S. Government securities with a market value of approximately $291,502,000.
At June 26, 1998, the Company had U.S. Treasury securities with a market value
of $59,515,000 and reverse repurchase agreements of $71,213,000 in this account.
The reverse repurchase agreements were collateralized by U.S. Government
securities with a market value of approximately $71,871,000 at June 26, 1998.
MARKETABLE EQUITY SECURITIES
The investment in Knight is classified as marketable equity securities available
for sale, and the unrealized holding gains, net of tax, are recorded as a
separate component of stockholders' equity on the consolidated statements of
financial condition. The Knight shares are subject to the provisions of
Securities and Exchange Commission Rule 144 and are currently subject to a 90-
day sales restriction that ends May 27, 1999. The following table summarizes
the cost and market value of the investment in Knight at March 26, 1999 (in
thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Market
Cost Gains Losses Value
----------------------------------------------------
<S> <C> <C> <C> <C>
Marketable equity securities $ 432 94,825 - $ 95,257
====================================================
</TABLE>
Knight declared a two-for-one stock split payable to shareholders of record as
of the close of business on April 30, 1999, to be paid on or about May 14, 1999.
RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
At March 26, 1999 and June 26, l998, the Company had receivable from and payable
to brokers, dealers and clearing organizations related to the following (in
thousands):
<TABLE>
<CAPTION>
March June
-------------------- -------------------
<S> <C> <C>
Receivable
Securities failed to deliver $ 36,176 $ 18,880
Securities borrowed 2,403,609 2,229,587
Correspondent broker/dealers 34,430 62,673
Clearing organizations 1,620 1,245
Other 39,364 53,250
-------------------- -------------------
$ 2,515,199 $ 2,365,635
==================== ===================
Payable
Securities failed to receive $ 36,586 $ 45,956
Securities loaned 2,359,043 2,227,874
Correspondent broker/dealers 11,390 11,300
Other 14,600 8,601
-------------------- -------------------
$ 2,421,619 $ 2,293,731
==================== ===================
</TABLE>
<PAGE>
SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
At March 26, 1999 and June 26, 1998, the Company held securities owned and
securities sold, not yet purchased as follows (in thousands):
<TABLE>
<CAPTION>
March 26, June 26,
1999 1998
----------------- ---------------
<S> <C> <C>
Securities owned
Corporate equity securities $ 12,888 $ 5,220
Municipal obligations 26,207 13,633
U.S. Government and Government agency obligations 16,829 8,696
Corporate obligations 8,745 1,479
Commercial paper - 446
Other 4,482 2,670
----------------- ---------------
$ 69,151 $ 32,144
================= ===============
Securities sold, not yet purchased
Corporate equity securities $ 18,886 $ 1,208
Municipal obligations 1,238 124
U.S. Government and Government agency obligations 5,328 175
Corporate obligations 983 98
Commercial paper - 50
Other 1,750 7
----------------- ---------------
$ 28,185 $ 1,662
================= ===============
</TABLE>
SHORT-TERM BORROWINGS
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $192,500,000. These lines of credit are used primarily to
finance securities owned, securities held for Correspondent broker/dealer
accounts and receivables in customers' margin accounts. These lines may also be
used to release pledged collateral against day loans. These credit arrangements
are provided on an "as offered" basis and are not committed lines of credit.
These arrangements can be terminated at any time by the lender. Any outstanding
balance under these credit arrangements is due on demand and bears interest at
rates indexed to the federal funds rate. At March 26, 1999, the amount
outstanding under these secured arrangements was $55,500,000 which was
collateralized by securities held for Correspondent broker/dealer accounts
valued at $52,764,000 and by marketable equity securities owned valued at
$21,693,000. There were no amounts outstanding at June 26, 1998 on these credit
arrangements.
In addition to the broker loans lines, the Company has a $20,000,000 unsecured
line of credit that is due on demand and bears interest at rates indexed to the
federal funds rate. There were no amounts outstanding under this line of credit
at March 26, 1999 and June 26, 1998.
At March 26, 1999 and June 26, 1998, 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 26, 1999, Southwest had net capital of
$77,308,000, or approximately 9% of aggregate debit
<PAGE>
balances, which is $60,893,000 in excess of its minimum net capital requirement
of $16,415,000 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 26, 1999, Southwest had net capital of
$36,271,000 in excess of 5% of aggregate debit items.
SWSFS, MDB and NorAm follow the primary (aggregate indebtedness) method under
Rule 15c3-1, which requires the maintenance of minimum net capital of $250,000.
At March 26, 1999, the net capital and excess net capital of these companies was
as follows:
<TABLE>
<CAPTION>
Net Capital Excess Net Capital
------------------------------------------------
<S> <C> <C>
SWSFS $317,000 $ 67,000
MDB 536,000 286,000
NorAm 621,000 371,000
</TABLE>
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 $2,659,000, which is $1,659,000 in excess
of its minimum capital requirement at March 26, 1999.
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>
Three Months Ended Nine Months Ended
March 26, 1999 March 27, 1998 March 26, 1999 March 27, 1998
------------------------------------- ------------------------------------
<S> <C> <C> <C> <C>
Net income $ 7,533 $ 4,863 $ 18,358 $ 15,298
===================================== ====================================
Weighted average shares outstanding - basic 10,696,211 10,678,485 10,683,949 10,673,954
Effect of dilutive securities:
Assumed exercise of stock options 79,110 23,081 41,093 21,402
------------------------------------- ------------------------------------
Weighted average shares outstanding - diluted 10,775,321 10,701,566 10,725,042 10,695,356
===================================== ====================================
Earnings per share - basic $ .70 $ .46 $ 1.72 $ 1.43
===================================== ====================================
Earnings per share - diluted $ .70 $ .45 $ 1.71 $ 1.43
===================================== ====================================
</TABLE>
At March 26, 1999, 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"). At March 26,
1999, there were approximately 430,000 options outstanding under the 1996 Plan
and approximately 20,000 options outstanding under the 1997 Plan. The Company
also has approximately 17,000 options outstanding that were granted in
conjunction with the acquisition of Barre & Company, Inc. ("Barre Options"). As
of March 26, 1999, all outstanding options were dilutive and were included in
the calculation of weighted average shares outstanding - diluted.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
From time to time, Southwest Securities Group, Inc. (the "Parent") and
subsidiaries (collectively, the "Company") may publish "forward-looking
statements" within the meaning of section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended,
(the "Acts") or make oral statements that constitute forward-looking statements.
These forward-looking statements may relate to such matters as anticipated
financial performance, future revenues or earnings, business prospects,
projected ventures, new products, anticipated market performance and similar
matters. The Private Securities Litigation Reform Act of 1995 provides a safe
harbor for forward-looking statements. In order to comply with the terms of the
safe harbor, the Company cautions readers that a variety of factors could cause
the Company's actual results to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
These risks and uncertainties, many of which are beyond the Company's control,
include, but are not limited to (1) transaction volume in the securities
markets; (2) volatility of the securities markets; (3) fluctuations in interest
rates; (4) changes in regulatory requirements which could affect the cost of
doing business; (5) general economic conditions, both domestic and foreign; (6)
changes in the rate of inflation and related impact on securities markets; (7)
competition from existing financial institutions and other new participants in
the securities markets; (8) legal developments affecting the litigation
experience of the securities industry; (9) successful implementation of
technology solutions; and (10) changes in federal and state tax laws which could
affect the popularity of products sold by the Company. The Company does not
undertake any obligation to publicly update or revise any forward-looking
statements.
The Company's discussion of the issues surrounding the Year 2000 contain
forward-looking statements as defined in the Acts. These forward-looking
statements could relate to, but are not limited to (1) the financial impact of
the Year 2000 project; (2) the Company's estimated timetables for completion of
each phase of the project; (3) the Company's estimates of the availability of
vendor software upgrades and consulting services; (4) the readiness of third-
party service providers; and (5) contingency plans. The Company cautions that
many factors, including those outside of the control of the Company, could cause
actual results to be materially different than those anticipated and expressed
in the forward-looking statements.
GENERAL
The Company is primarily engaged in securities execution and clearance,
securities brokerage, investment banking, securities lending and borrowing and
trading as a principal in equity and fixed income securities. All of these
activities are highly competitive and are sensitive to many factors outside the
control of the Company, including volatility of securities prices and interest
rates; trading volume of securities; economic conditions in the regions where
the Company does business; income tax legislation; and demand for investment
banking and securities brokerage services. While revenues are dependent upon
the level of trading and underwriting volume, which may fluctuate significantly,
a large portion of the Company's expenses remain fixed. Consequently, net
earnings can vary significantly from period to period.
RESULTS OF OPERATIONS
During the third quarter of fiscal 1999, net income totaled $7,533,000, an
increase of $2,670,000, or 55%, from the third quarter of fiscal 1998. For the
nine months ended March 26, 1999, net income increased 20% to $18,358,000 over
the comparable prior year period.
<PAGE>
The following is a summary of increases (decreases) in categories of net
revenues and operating expenses for the three and nine month periods ended March
26, 1999 and March 27, 1998 (in thousands):
<TABLE>
<CAPTION>
Three Month Change Nine Month Change
Amount Percent Amount Percent
-------------------- -------------------
<S> <C> <C> <C> <C>
Net revenues
Net revenues from clearing operations $ 4,278 69% $ 8,706 45%
Commissions 1,637 11% 2,901 7%
Net interest 814 8% 3,411 11%
Investment banking, advisory and
administrative fees (1,771) (22%) 2,122 11%
Net gains on principal transactions 16,267 703% 20,883 242%
Other (8) - 1,773 20%
-------------------- -------------------
21,217 47% 39,796 30%
-------------------- -------------------
Operating expenses
Commissions and other employee compensation 13,333 58% 25,390 39%
Occupancy, equipment and computer
service costs 1,019 22% 2,568 20%
Communications 462 16% 692 8%
Floor brokerage and clearing
organization charges 309 24% 667 18%
Other 1,757 28% 5,625 33%
-------------------- -------------------
16,880 45% 34,942 33%
-------------------- -------------------
Income before income taxes $ 4,337 59% $ 4,854 21%
==================== ===================
</TABLE>
Net Revenues from Clearing Operations. Net revenues from clearing increased
primarily as a result of an increase in total transaction volumes in the three
and nine month periods ended March 26, 1999 over the same periods in the prior
year. Total transactions processed in the third quarter of fiscal 1999 increased
to approximately 6.2 million from approximately 1.7 million in the third quarter
of fiscal 1998. Transactions processed in the first nine months of fiscal 1999
totaled 13.9 million versus 4.5 million in the first nine-months of fiscal 1998.
Turbulent market conditions thus far during fiscal 1999 and high trading volumes
in the internet and technology sectors lead to heavy trading volume in
securities markets. The rate of increase in transactions processed has outpaced
the increase in revenues from clearing, because, in recent years, the Company
has increased the number of high-volume trading Correspondents in its customer
base, and a substantial portion of the increase in transactions processed were
related to these Correspondents. 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. As transaction
volumes increase, revenue per clearing transaction tends to decrease as
Correspondents take advantage of volume discounts.
Commissions. Commissions from the Company's client transactions in the three
and nine months ended March 26, 1999 increased when compared with revenues in
the comparable prior year periods. This increase is primarily attributable to
an increase in fixed income sales, as well as an increase in the number of
brokers in the Company's independent contractor network. Fixed income sales
increased 45% and 73% over the three and nine month periods, respectively. The
number of independent contractor sales representatives increased to 703 at March
26, 1999 from 683 at March 27, 1998. Also contributing to the increase were
increased commissions from MDB, the Company's on-line investing subsidiary which
began offering on-line trading in the March quarter of fiscal 1998. Commissions
at MDB increased approximately 287% and 210% for the three and nine months ended
March 26, 1999 over the comparable periods in the prior year.
<PAGE>
Net Interest Income. 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. In the three and nine
month periods ended March 26, 1999, net interest income accounted for 17% and
20% of the Company's net revenue, respectively. Net interest income was 23% and
24%, respectively, of net revenue in the three and nine month periods ended
March 27, 1998.
Interest revenue from customer margin balances and interest expense from
customer funds on deposit have fluctuated in relation to average balances over
the three and nine month periods ended March 26, 1999 and March 27, 1998. Net
interest revenue generated from securities lending activities has remained
relatively stable in the current fiscal year versus the prior fiscal year.
Average customer balances and average balances from securities lending
activities are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 26, 1999 March 27, 1998 March 26, 1999 March 27, 1998
---------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Average customer margin balances $ 645,000 $ 494,000 $ 565,000 $ 458,000
Average customer funds on deposit 719,000 563,000 582,000 529,000
Average stock borrowed 2,182,000 2,154,000 2,090,000 2,085,000
Average stock loaned 2,152,000 2,130,000 2,061,000 2,057,000
</TABLE>
Rates on customer margin balances and funds on deposit are influenced by changes
in leading market interest rates and competitive factors. Spreads on securities
lending transactions are influenced by the types of securities borrowed or
loaned, market conditions and counter-party risk. Securities lending
activities are conducted out of the Company's New York office using a highly
specialized sales force. Competition for these individuals is intense and there
can be no assurance that the Company will be able to retain these individuals.
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 decreased in the third quarter of fiscal 1999 when compared to the same
period in fiscal 1998 due to decreases in fees from both municipal finance and
corporate finance businesses. This decrease was, however, offset slightly by
increased fees from investment advisory services in the third quarter of fiscal
1999 over the third quarter of fiscal 1998. Advisory fees earned on investment
management increased as assets under management at March 26, 1999 were
approximately $3.8 billion versus $3.4 billion at March 27, 1998. The number
and offering amount of senior and co-managed municipal finance offerings in
which the Company participated decreased 15% for the three month period ended
March 26, 1999 over the comparable period of the prior year.
Investment banking, advisory and administrative fees for the nine months ended
March 26, 1999 were higher than the comparable period of the prior year due to
increases in fees from municipal finance and investment advisory services,
offset by decreases in corporate finance fees. Although the number of senior
and co-managed public finance deals decreased 8% over the comparable prior year
period, the total dollar amount of the offerings increased 35%, resulting in
increased revenues.
<PAGE>
Net Gains on Principal Transactions. Net gains on principal transactions have
experienced significant growth over prior year in both the three and nine month
periods ended March 26, 1999 and March 27, 1998. This growth is due to the
expansion of the Company's equity trading area. The number of market makers
employed in this area has increased to 23 at March 26, 1999 from nine at March
27, 1998, while coverage from market making activities has increased to 567
over-the-counter securities in which the Company makes a market. Revenue in
this area can fluctuate significantly from quarter to quarter based on market
conditions.
Commissions and Other Employee Compensation. Commissions and other employee
compensation are generally affected by the level of operating revenues, earnings
and the number of employees. During the three and nine months ended March 26,
1999, commissions and other employee compensation expense increased over the
same periods in the prior year. This was principally due to (1) increased
commissions and benefits paid to revenue-producing employees generating higher
levels of operating revenues; (2) as previously discussed, increased headcount
among the independent contractor network; and (3) the addition of 118 full-time
employees. The number of employees increased to 877 at March 26, 1999 compared
to 759 at March 27, 1998. Approximately 36% of the increased employee count
relates to those employed in the information technology area.
Occupancy, Equipment and Computer Service Expenses. Occupancy, equipment and
computer service expenses increased for both three and nine month periods
presented primarily due to upgrades in computer processing equipment as the
Company continues to focus its resources on the implementation of its new
brokerage software, Comprehensive Software Systems, Ltd. ("CSS") (see YEAR 2000
discussion below). In addition, the Company accrued approximately $325,000 for
one-time programming expenses related to customer statement processing in the
third quarter of fiscal 1999.
Other Expenses. Other expenses have increased primarily due to increases in
contract labor, professional services and promotional expenses. Contract labor
and professional service expenses relate to, among other things, the Company's
involvement in developing Year 2000 compliant software (see YEAR 2000 discussion
below).
FINANCIAL CONDITION
The Parent owned a minority interest in Roundtable Partners, LLC, the
predecessor of Knight/Trimark Group, Inc. ("Knight"), which filed an S-1
registration statement with the U.S. Securities and Exchange Commission on May
1, 1998 for an initial public offering of stock. Subsequent to the offering,
which closed on July 10, 1998, the Parent owned approximately 1.7 million shares
of Knight. The shares are classified as marketable equity securities available
for sale, and the unrealized holding gain, net of tax, is recorded as a separate
component of stockholders' equity on the consolidated statements of financial
condition in accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Knight filed an S-1 registration statement for a secondary offering on February
1, 1999. The Parent did not sell any of its shares in conjunction with the
offering. The shares owned by the Parent are subject to a 90-day sales
restriction agreement that ends May 27, 1999. Knight declared a two-for-one
stock split payable to shareholders of record as of the close of business on
April 30, 1999, to be paid on or about May 14, 1999.
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
<PAGE>
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.
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. At March 26, 1999,
the amount outstanding under these secured arrangements was $55,500,000 which
was collateralized by securities held for Correspondent broker/dealer accounts
valued at $52,764,000 and by marketable equity securities owned valued at
$21,693,000. 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 that is due on demand and bears interest at rates
indexed to the federal funds rate. There were no amounts outstanding at March
26, 1999 under this unsecured line of credit.
Net cash used in operating activities during the nine month period ended March
26, 1999 was $54,805,000. The use of cash was due to the increase in securities
owned and was adequately financed by the short-term borrowings mentioned above.
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.
MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in value of a financial instrument as a result of fluctuations
in interest rates, equity prices, and changes in credit ratings of the issuer.
The Company's exposure to market risk is directly related to its role as a
financial intermediary in customer-related transactions and to its proprietary
trading activities.
Interest Rate Risk. Interest rate risk is a consequence of maintaining
inventory positions and trading in interest-rate-sensitive financial
instruments. The Company does not maintain material positions in interest rate
sensitive financial instruments. The Company's fixed income activities also
expose it to the risk of loss related to changes in credit spreads. Credit
spread risk arises from the potential that changes in an issuers credit rating
or credit perception could affect the value of financial instruments.
Equity Price Risk. The Company is exposed to equity price risk as a result of
making markets in equity securities. Equity price risk results from changes in
the level or volatility of equity prices, which affect the value of equity
securities or instruments that derive their value from a particular stock, a
basket of stocks or a stock index.
Credit Risk. Credit risk arises from the potential nonperformance by
counterparties, customers or debt security issuers. The Company is exposed to
credit risk as a trading counterparty to dealers and customers, as a holder of
securities and as a member of exchanges and clearing organizations.
Managing Risk Exposure. The Company manages risk exposure through the
involvement of various levels of management. Position limits in trading and
inventory accounts are well established and monitored on an ongoing basis.
Current and proposed underwriting, banking and other
<PAGE>
commitments are subject to due diligence reviews by senior management, as well
as professionals in the appropriate business and support units involved. Credit
risk related to various financing activities is reduced by the industry practice
of obtaining and maintaining collateral. The Company monitors its exposure to
counterparty risk through the use of credit exposure information, the monitoring
of collateral values and the establishment of credit limits.
Market Risk Analysis. The Company has performed an analysis of the Company's
financial instruments and has assessed the related risk and materiality in
accordance with the rules. Based on this analysis, in the opinion of
management, the market risk associated with the Company's financial instruments
at March 26, 1999 will not have a material adverse effect on the consolidated
statements of financial position or operating results of the Company.
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 100% complete. 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 have been developed for those
third parties who cannot satisfactorily demonstrate Year 2000 compliance. The
plans are continually refined, updated and tested as changes in third-party
readiness occurs.
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.
<PAGE>
Desktop system updates are complete and upgrade of the communications
infrastructure is ongoing. The main telephone switch and critical branch office
switches have been upgraded where necessary, and upgraded network operating
systems have been loaded into place. The rollout of the Year 2000 compliant
version of the BRASS Equity Trading System has also been completed.
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. Updates to this
system were installed in the second quarter of fiscal 1999 and testing was
completed in the third quarter of fiscal 1999. The financial system itself is
certified by the vendor as Year 2000 compliant.
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 has been pursuing a
replacement strategy for SIS and is implementing a new client-service based
information system ("CSS"). CSS is being developed by Comprehensive Software
Systems, Ltd., an entity in which several securities firms own interests,
including the Company, which owns an 8.18% interest.
While replacement of the SIS system with CSS is our primary solution for Year
2000 issues associated with the SIS system, in September 1998 the Company
engaged an independent consulting firm to begin remediation of the SIS system.
As of March 31, 1999, 100% of the SIS code was remediated and unit tested by the
consulting firm. The Company is currently testing the remediated code in-house
and is installing the code into production after testing. The Company currently
anticipates that 100% of the remediated code will be installed on or about June
30, 1999.
The Company has been working on the CSS project since 1992, as implementation of
this system was in process before the Company began assessment of critical Year
2000 issues. In fiscal 1997, the Company accelerated the pace of the CSS
project so that it would be available as the Year 2000 solution for the SIS
system. Through fiscal 1997 and 1998, costs associated with the joint
venture, including personnel, hardware, software and related costs, were
approximately $4 million. During fiscal 1997 and 1998, the Company incurred an
additional $1 million in costs related to the Year 2000 project primarily
related to compensation and benefits, software upgrades and hardware replacement
for financial and other systems. In the third quarter of fiscal 1999, the
Company has incurred an additional $2.4 million in expenses related to the CSS
project and other Year 2000 initiatives, bringing the total spent in fiscal 1999
to $5.3 million.
The Company expects to incur additional costs in the remainder of fiscal 1999
for the implementation of the CSS software, as well as costs to remediate and
replace other systems, totaling approximately $2.3 million. In the first half
of fiscal 2000, the Company expects to incur an additional $4 million related to
the implementation of the CSS software and other Year 2000 project costs. These
costs will be funded out of working capital and substantially all will be
expensed. 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.
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
<PAGE>
Year 2000 readiness. The Company's contingency plans also address potential
failure of these systems.
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. The Company recently
participated in the Securities Industry Association's industry-wide point-to-
point testing which occurred over a series of weekends and simulated the first
trading cycle to settle in the Year 2000. While final reconciliation of data
from these tests is ongoing, the Company believes it has successfully completed
each phase of the testing. Additional tests are planned with vendors not
included in the industry-wide test as well as with Correspondent customers.
The Company has prepared contingency plans that deal with a variety of failures
that could potentially be caused by Year 2000 or other problems. These plans
range from global issues like the loss of a major stock exchange or utility, to
infrastructure issues like the loss of the primary data communications carrier
or regional electrical power supplier, to failures within the Company's
facilities like the loss of an owned telephone switch or the failure of an
internally maintained application. The Company will continue to refine these
plans over the next several months. Testing related to contingency plans will
begin with those failures we assume are more likely to occur because of
incomplete work or inadequate information on the part of mission critical
vendors.
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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is incorporated in Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations under
the caption Market Risk.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None Reportable (229.103)
Item 2. Changes in Securities and Use of Proceeds
None Reportable (Per Instructions to Form 10-Q)
Item 3. Defaults upon Senior Securities
None Reportable (Per Instructions to Form 10-Q)
<PAGE>
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 8 through 11 of the Company's Proxy Statement
dated September 24, 1998 which was filed with the Commission pursuant to
Regulation 240.14a-6 (c) prior to October 24, 1998.
27 Financial Data Schedule
REPORTS ON FORM 8-K
None.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Southwest Securities Group, Inc.
----------------------------------------
(Registrant)
May 5, 1999 /S/ David Glatstein
- --------------- ----------------------------------------
Date (Signature)
David Glatstein
President and Chief Executive Officer
(Principal Executive Officer)
May 5, 1999 /S/ Stacy M. Hodges
- --------------- ----------------------------------------
Date (Signature)
Stacy M. Hodges
Treasurer and Chief Financial Officer
(Principal Financial Officer)
May 5, 1999 /S/ Laura Leventhal
- --------------- ----------------------------------------
Date (Signature)
Laura Leventhal
Controller
(Principal Accounting Officer)
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> JUN-25-1999 JUN-25-1999
<PERIOD-START> JAN-01-1999 JUN-27-1999
<PERIOD-END> MAR-26-1999 MAR-26-1999
<CASH> 10,451 10,451
<RECEIVABLES> 3,205,060 3,205,060
<SECURITIES-RESALE> 262,343 262,343
<SECURITIES-BORROWED> 2,403,609 2,403,609
<INSTRUMENTS-OWNED> 69,151 69,151
<PP&E> 10,416 10,416
<TOTAL-ASSETS> 3,693,219 3,693,219
<SHORT-TERM> 55,500 55,500
<PAYABLES> 3,288,152 3,288,152
<REPOS-SOLD> 0 0
<SECURITIES-LOANED> 2,359,043 2,359,043
<INSTRUMENTS-SOLD> 28,185 28,185
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 1,070 1,070
<OTHER-SE> 202,589 202,589
<TOTAL-LIABILITY-AND-EQUITY> 3,693,219 3,693,219
<TRADING-REVENUE> 18,580 29,508
<INTEREST-DIVIDENDS> 34,623 106,286
<COMMISSIONS> 16,428 46,946
<INVESTMENT-BANKING-REVENUES> 6,372 21,193
<FEE-REVENUE> 10,521 28,030
<INTEREST-EXPENSE> 23,596 71,736
<COMPENSATION> 36,182 90,268
<INCOME-PRETAX> 11,706 28,413
<INCOME-PRE-EXTRAORDINARY> 11,706 28,413
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 7,533 18,358
<EPS-PRIMARY> .70 1.72
<EPS-DILUTED> .70 1.71
</TABLE>
